nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2017‒12‒11
sixteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Price Search, Consumption Inequality, and Expenditure Inequality over the Life Cycle By Bulent Guler
  2. Tests of Policy Interventions in DSGE Models By M Hashem Pesaran; Ron P Smith
  3. Fiscal Consolidation Programs and Income Inequality By Brinca, Pedro; Ferreira, Miguel; Franco, Francesco; Holter, Hans; Malafry, Laurence
  4. Uncertainty Shocks and Firm Dynamics: Search and Monitoring in the Credit Market By Brand, Thomas; Isoré, Marlène; Tripier, Fabien
  5. Interest Rate Uncertainty and Sovereign Default Risk By Shahed Khan; Alok Johri; Cesar Sosa-Padilla
  6. A Real-Business-Cycle model with reciprocity in labor relations and a government sector By Aleksandar Vasilev
  7. How persistent low expected returns alter optimal life cycle saving, investment, and retirement behavior By Horneff, Vanya; Maurer, Raimond; Mitchell, Olivia S.
  8. Monetary Policy, Target Inflation and the Great Moderation: An Empirical Investigation By Qazi Haque
  9. Market Structure and Monetary Non-neutrality By Mongey, Simon
  10. National Fiscal Stimulus Packages And Consolidation Strategies In A Monetary Union By Christoph Bierbrauer
  11. Global temperature, R&D expenditure, and growth By Donadelli, Michael; Grüning, Patrick; Jüppner, Marcus; Kizys, Renatas
  12. Competitive or Random Search? By Espen R Moen; Rasmus Lentz
  13. Sovereign Risk Contagion By Arellano, Cristina; Bai, Yan; Lizarazo, Sandra
  14. Essays on Pay-as-you-go Pension Schemes, Demographics, Fiscal Policy, Credit Rationing and House Prices By Heeringa, Willem
  15. The Welfare Costs of Self-Fulfilling Bank Runs By Elena Mattana; Ettore Panetti
  16. Sweat Equity in U.S. Private Business By McGrattan, Ellen R.; Bhandari, Anmol

  1. By: Bulent Guler (Indiana University)
    Abstract: In this paper, we incorporate price search decision into an otherwise standard life-cycle model with incomplete markets and an endogenous labor supply, differentiating consumption from expenditure. In our model, consumers can allocate part of their time to searching for low prices, and this leads to an endogenous price dispersion. We have three contributions. First, we analytically study the determinants of price search and its relation to consumption and expenditure inequalities in a static model. Second, we study quantitatively the role of price search in a dynamic version of the model. A plausible calibration implies that the life-cycle increase in the cross-sectional variance of log consumption is about 40 percent lower than the increase in the cross-sectional variance of log expenditure. Third, we show that price search provides an additional quantitatively significant partial insurance mechanism against adverse income shocks.
    Keywords: Consumption inequality, price search, incomplete markets, life cycle models, partial insurance
    Date: 2016–09
  2. By: M Hashem Pesaran (University of Southern California; Trinity College, Cambridge); Ron P Smith (Birkbeck, University of London)
    Abstract: This paper considers tests of the effectiveness of a policy intervention, defined as a change in the parameters of a policy rule, in the context of a macroeconometric dynamic stochastic general equilibrium (DSGE) model. We consider two types of intervention, First the standard case of a parameter change that does not alter the steady state, and second one that does alter the steady state, e.g. the target rate of inflation. We consider two types of test, one a multi-horizon test, where the post-intervention policy horizon, H, is small and fixed, and a mean policy effect test where H is allowed to increase without bounds. The multi-horizon test requires Gaussian errors, but the mean policy effect test does not. It is shown that neither of these two tests are consistent, in the sense that the the power of the tests does not tend to unity as H tends to infinity, unless the intervention alters the steady state. This follows directly from the fact that DSGE variables are measured as deviations from the steady state, and the effects of policy change on target variables decay exponentially fast. We investigate the size and power of the proposed mean effect test by simulating a standard three equation New Keynesian DSGE model. The simulation results are in line with our theoretical findings and show that in all applications the tests have the correct size; but unless the intervention alters the steady state, their power does not go to unity with H.
    Keywords: counterfactuals, policy analysis, policy ineffectiveness test, macroeconomics.
    JEL: C18 C54 E65
    Date: 2017–10
  3. By: Brinca, Pedro (Center for Economics and Finance); Ferreira, Miguel (Nova School of Business and Economics); Franco, Francesco (Nova School of Business and Economics); Holter, Hans (Department of Economics); Malafry, Laurence (Dept. of Economics, Stockholm University)
    Abstract: Following the Great Recession, many European countries implemented fiscal consolidation policies aimed at reducing government debt. Using three independent data sources and three different empirical approaches, we document a strong positive relationship between higher income inequality and stronger recessive impacts of fiscal consolidation programs across time and place. To explain this finding, we develop a life-cycle, overlapping generations economy with uninsurable labor market risk. We calibrate our model to match key characteristics of a number of European economies, including the distribution of wages and wealth, social security, taxes and debt, and study the effects of fiscal consolidation programs. We find that higher income risk induces precautionary savings behavior, which decreases the proportion of credit-constrained agents in the economy. Credit-constrained agents have less elastic labor supply responses to fiscal consolidation achieved through either tax hikes or public spending cuts, and this explains the relationship between income inequality and the impact of fiscal consolidation programs. Our model produces a cross-country correlation between inequality and the fiscal consolidation multipliers, which is quite similar to that in the data.
    Keywords: Fiscal Consolidation; Income Inequality; Fiscal Multipliers; Public Debt; Income Risk
    JEL: E21 E62 H31 H50
    Date: 2017–11–27
  4. By: Brand, Thomas; Isoré, Marlène; Tripier, Fabien
    Abstract: We develop a business cycle model with gross flows of firm creation and destruction. The credit market is characterized by two frictions. First, entrepreneurs undergo a costly search for intermediate funding to create a firm. Second, upon a match, a costly-state-verification contract is set up. When defaults occurs, banks monitor firms, seize their assets, and a fraction of financial relationships are severed. The model is estimated using Bayesian methods for the U.S. economy. Among other shocks, uncertainty in productivity turns out to be a major contributor to both macro-financial aggregates and firm dynamics.
    Keywords: Uncertainty shocks, Financial frictions, Search and Matching, Business Cycles, Firm Dynamics
    Date: 2017–12
  5. By: Shahed Khan (McMaster University); Alok Johri (McMaster University); Cesar Sosa-Padilla (University of Notre Dame)
    Abstract: As the United States emerged from the Great Recession, there was considerable uncer- tainty around the future direction of US monetary policy exemplified by the chatter and speculation around tapering of quantitative easing by the US Fed in the financial press. The increased uncertainty around the timing and speed of the tapering coincided with a sharp spike in the sovereign bond yields of several emerging economies. We explore the impact of an increase in interest rate uncertainty on the borrowing costs of a small open economy in an otherwise standard model of sovereign default, where spread is endogenous. We find that introducing time-varying volatility in the world interest rate (i.e. uncertainty shocks) the model predicts a mean sovereign spread that is 115% larger and 126% more volatile. The model also predicts that countries default more than twice as frequently. Moreover, the equilibrium debt-to-income ratio is 19% lower. The welfare gains from eliminating uncertainty about the world interest rate amount up to a 1.8% permanent increase in consumption. Overall, we find quantitative support for the widespread con- cerns regarding the uncertainty about when and how the Fed will unwind its quantitative easing.
    Date: 2017
  6. By: Aleksandar Vasilev
    Abstract: In this paper we introduce reciprocity in labor relations and government sector to in- vestigate how well the real wage rigidity that results out of that arrangement explains business cycle fluctuations in Bulgaria. The reciprocity mechanism described in this paper follows Danthine and Kurmann (2010) and is generally consistent with micro- studies, e.g. Lozev, Vladova, and Paskaleva (2011) and Paskaleva (2016). Rent-sharing considerations, and worker’s own past wages turn out to be the most important as- pects of how labor contracting happens. In contrast, aggregate economic conditions, as captured by the employment rate, are not found to be quantitatively important for wage dynamics. Overall, the model with reciprocity and fiscal policy performs well vis-a-vis data, especially along the labor market dimension.
    Keywords: General equilibrium, reciprocity, gift exchange, efficiency wages, unemployment, fiscal policy, Bulgaria.
    JEL: E24 E32 J41
    Date: 2017–11–09
  7. By: Horneff, Vanya; Maurer, Raimond; Mitchell, Olivia S.
    Abstract: This Chapter explores how an environment of persistent low returns influences saving, investing, and retirement behaviors, as compared to what in the past had been thought of as more "normal" financial conditions. Our calibrated lifecycle dynamic model with realistic tax, minimum distribution, and Social Security benefit rules produces results that agree with observed saving, work, and claiming age behavior of U.S. households. In particular, our model generates a large peak at the earliest claiming age at 62, as in the data. Also in line with the evidence, our baseline results show a smaller second peak at the (system-defined) Full Retirement Age of 66. In the context of a zero-return environment, we show that workers will optimally devote more of their savings to non-retirement accounts and less to 401(k) accounts, since the relative appeal of investing in taxable versus tax-qualified retirement accounts is lower in a low return setting. Finally, we show that people claim Social Security benefits later in a low interest rate environment.
    Keywords: dynamic portfolio choice,401(k) plan,saving,Social Security claiming age,retirement income,minimum distribution requirements,tax
    JEL: G11 G22 D14 D91
    Date: 2017
  8. By: Qazi Haque (School of Economics, University of Adelaide)
    Abstract: This paper compares the empirical fit of a Taylor rule featuring constant versus time-varying inflation target by estimating a Generalized New Keynesian model under positive trend inflation while allowing for indeterminacy. The estimation is conducted over two different periods covering the Great Inflation and the Great Moderation. We find that the rule embedding time variation in target inflation turns out to be empirically superior and determinacy prevails in both sample periods. Counterfactual simulations point toward both `good policy' and `good luck' as drivers of the Great Moderation. We find that better monetary policy, both in terms of a more active response to inflation gap and a more anchored inflation target, has resulted in the decline in inflation gap volatility and predictability. In contrast, the reduction in output growth variability is mainly explained by reduced volatility of technology shocks.
    Keywords: Monetary policy; Great Inflation; Great Moderation; Equilibrium Indeterminacy; Generalized New Keynesian Phillips curve; Taylor rules; Time-varying inflation target; Good policy; Good luck; Sequential Monte Carlo
    JEL: C11 C52 C62 E31 E32 E52 E58
    Date: 2017–11
  9. By: Mongey, Simon (Federal Reserve Bank of Minneapolis)
    Abstract: I propose an equilibrium menu cost model with a continuum of sectors, each consisting of strategically engaged firms. Compared to a model with monopolistically competitive sectors that is calibrated to the same data on good-level price flexibility, the dynamic duopoly model features a smaller inflation response to monetary shocks and output responses that are more than twice as large. The model also implies (i) four times larger welfare losses from nominal rigidities, (ii) smaller menu costs and idiosyncratic shocks are needed to match the data, (iii) a U-shaped relationship between market concentration and price flexibility, for which I find empirical support.
    Keywords: Oligopoly; Menu costs; Monetary policy; Firm dynamics
    JEL: E30 E39 E51 L11 L13
    Date: 2017–10–31
  10. By: Christoph Bierbrauer (Hochschule Darmstadt)
    Abstract: We present a two-country New Open Economy Macroeconomics model of a currency union featuring an overlapping generations structure of the Blanchard (1985)-Yaari (1965) type as well as monopolistic frictions and staggered adjustment in the goods and labor market. We allow for public investment and distortionary taxation. We study the effects of fiscal policy measures such as public spending, tax cuts targeted to households and public investment as suggested by the European Commission (2008). In particular, we explore the effects of fiscal policy as a function of the financing decision of the implementing government. We find that the impact of fiscal measures on national variables as well as the spillovers depend on the assumed degree of household myopia and again, the financing decision of the government. However, the introduction of a complex fiscal sector which enables the government to choose between alternative financing schemes is an important determinant of the effects of fiscal expansions on key macroeconomic variables such as, output and consumptions. Thus, modeling a complex fiscal sector on both sides of the budgets is crucial for the results and therefore the effectiveness of fiscal stimulus packages.
    Keywords: Overlapping generations; New open economy macroeconomics; Public Debt; Decentralized fiscal policy; Monetary union
    JEL: E62 F33 F41 H31 H50 H63
    Date: 2017–11–22
  11. By: Donadelli, Michael; Grüning, Patrick; Jüppner, Marcus; Kizys, Renatas
    Abstract: We shed new light on the macroeconomic effects of rising temperatures. In the data, a shock to global temperature dampens expenditures in research and development (R&D). We rationalize this empirical evidence within a stochastic endogenous growth model, featuring temperature risk and growth sustained through innovations. In line with the novel evidence in the data, temperature shocks undermine economic growth via a drop in R&D. Moreover, in our endogenous growth setting temperature risk generates non-negligible welfare costs (i.e., 11% of lifetime utility). An active government, which is committed to a zero fiscal deficit policy, can offset the welfare costs of global temperature risk by subsidizing the aggregate capital investment with one-fifth of total public spending.
    Keywords: Global Temperature,R&D,Welfare Costs
    JEL: E30 G12 Q00
    Date: 2017
  12. By: Espen R Moen (Norwegian Business School); Rasmus Lentz (University of Wisconsin Madison)
    Abstract: We set up a search model with on-the-job search that spans random and competitive search as well as intermediate cases with partially directed search. Firms are heterogeneous in terms of productivity, and firms with different productivities are in different submarkets, with all firms in the same submarket being identical. Workers are identical, still a worker's optimal search behavior, that is, the optimal submarket for her to visit, depends on the productivity of the current employer. The higher is the productivity of the current employer, the higher is the productivity of the firm it is optimal for the worker to target her search at. We use a discrete choice framework to model the workers' choice of submarkets, with a single noise parameter \mu governing the degree to which search is directed. As \mu goes to zero, search becomes fully directed, while it becomes random as \mu goes to infinity. We derive the equilibrium of the model, and simulate the equilibrium allocation. We also show how the parameter \mu can be identified using a maximum likelihood approach where submarkets are identified via the Bagger and Lentz (2016) poaching rank, or in a classification step as in Lentz, Piyapromdee and Robin (2017). Alternatively, we use a simulated method of moments approach. We will identify \mu on Danish and/or Norwegian matched employer-employee data.
    Date: 2017
  13. By: Arellano, Cristina (Federal Reserve Bank of Minneapolis); Bai, Yan (University of Rochester); Lizarazo, Sandra (International Monetary Fund)
    Abstract: We develop a theory of sovereign risk contagion based on financial links. In our multi-country model, sovereign bond spreads comove because default in one country can trigger default in other countries. Countries are linked because they borrow, default, and renegotiate with common lenders, and the bond price and recovery schedules for each country depend on the choices of other countries. A foreign default increases the lenders' pricing kernel, which makes home borrowing more expensive and can induce a home default. Countries also default together because by doing so they can renegotiate the debt simultaneously and pay lower recoveries. We apply our model to the 2012 debt crises of Italy and Spain and show that it can replicate the time path of spreads during the crises. In a counterfactual exercise, we find that the debt crisis in Spain (Italy) can account for one-half (one-third) of the increase in the bond spreads of Italy (Spain).
    Keywords: Sovereign default; Bond spreads; Renegotiation; European debt crisis
    JEL: F30 G01
    Date: 2017–11–13
  14. By: Heeringa, Willem (Tilburg University, School of Economics and Management)
    Abstract: The four essays collected in this PhD thesis concern pay-as-you-go pension schemes, demographics, fiscal policy, credit constraints and house prices. The first essay shows how a pay-as-you-go pension scheme affects an individual’s optimal investment portfolio over the lifecycle. The second essay investigates policy options to keep the pay-as-you-go pension scheme in the Netherlands (AOW scheme) sustainable in the face of increasing longevity, declining fertility rates and changes in labour participation. The third essay demonstrates how tax-benefit policies impact aggregate consumption in a world of heterogeneous consumers, profit maximizing banks and imperfect information about future income shocks. The fourth essay studies the joint effect of changes in credit constraints, user cost and demographic factors on regional house prices in the Netherlands in conjunction with changes in the housing stock.
    Date: 2017
  15. By: Elena Mattana; Ettore Panetti
    Abstract: We study the welfare implications of self-fulfilling bank runs and liquidity require-ments, in a neoclassical growth model where banks, facing long-lasting possible runs, can choose in any period a run-proof asset portfolio. In this framework, runs distort banks’insurance provision against idiosyncratic liquidity shocks, and liquidity requirements re-solve this distortion by forcing a credit tightening. Quantitatively, the welfare costs of self-fulfilling bank runs are equivalent to a constant consumption loss of up to 2.5 percent of U.S. GDP. Depending on fundamentals, liquidity requirements might generate small welfare gains, but also increase the welfare costs by up to 1.8 percent.
    Keywords: financial intermediation, bank runs, regulation, welfare
    JEL: E21 E44 G01 G20
    Date: 2017–11
  16. By: McGrattan, Ellen R. (Federal Reserve Bank of Minneapolis); Bhandari, Anmol (Federal Reserve Bank of Minneapolis)
    Abstract: This paper uses theory disciplined by U.S. national accounts and business census data to measure private business sweat equity, which is the value of time to build customer bases, client lists, and other intangible assets. We estimate an aggregate sweat equity value of 0.65 times GDP, with little cross-sectional dispersion in valuations when compared to business net incomes and large cross-sectional dispersion in rates of return. Our estimate of sweat equity is close to the estimate of marketable fixed assets used in production by private businesses, implying a high ratio of intangible to total assets. We use the model to evaluate the impact of greater tax compliance of private businesses and lower tax rates on the net income of both privately held and publicly traded businesses.
    Keywords: Intangibles; Business valuation
    JEL: E13 E22 H25
    Date: 2017–11–20

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