|
on Dynamic General Equilibrium |
|
Issue of 2018‒01‒22
forty-four papers chosen by Christian Zimmermann Federal Reserve Bank of St. Louis |
| By: | Yashiv, Eran |
| Abstract: | U.S. CPS data indicate that in recessions firms actually increase their hiring rates from the pools of the unemployed and out of the labor force. Why so? The paper provides an explanation by studying the optimal recruiting behavior of the representative firm. The model combines labor frictions, of the search and matching type, with capital frictions, of the q-model type. Optimal firm behavior is a function of the value of jobs, i.e., the expected present value of the marginal worker to the firm. These are estimated to be counter-cyclical, the underlying reason being the dynamic behavior of the labor share of GDP. The counter-cyclicality of hiring rates and job values, which may appear counter-intuitive, is shown to be consistent with well-known business cycle facts. The analysis emphasizes the difference between current labor productivity and the wider, forwardlooking concept of job values. The paper explains the high volatility of firm recruiting behavior, as well as the reduction over time in labor market fluidity in the U.S., using the same estimated model. Part of the explanation has to do with job values and another part with the interaction of hiring and investment costs, both determinants having been typically overlooked. |
| Keywords: | counter-cyclical job values; business cycles; aggregate hiring; ; vacancies; labor market frictions; capital market frictions; volatility; labor market fluidity |
| JEL: | E24 E32 |
| Date: | 2016–11–14 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:86175&r=dge |
| By: | Thomas Sargent (New York University); Mikhail Golosov (Princeton University); David Evans (University of Oregon); anmol bhandari (university of minnesota) |
| Abstract: | We study business cycles in a heterogeneous agent model with incomplete markets and sticky nominal prices (a modified HANK model (Kaplan et al. (2016))). Optimal fiscal-monetary policy balances gains from “fiscal hedging” against benefits flowing from a countervailing new motive – “redistributional hedging”. A fictitious planner uses inflation to offset adverse shocks to the cross-section distribution of labor earnings. A calibration that imitates how US recessions reshape that cross-section distribution (as documented by Guve- nen et al. (2014)) indicates that substantial welfare benefits come from moving inflation in response to aggregate shocks. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1245&r=dge |
| By: | Marcus Hagedorn (University of Oslo) |
| Abstract: | In standard open economy macro-models, where monetary policy in each country works through setting nominal interest rates, only the expected change but not the level of the nominal exchange rates is determinate. In contrast to this standard result (Kareken+Wallace (1981), in this paper I show determinacy of the level in a large class of heterogenous agents incomplete markets models with aggregate risk. I then characterize the determinants of the nominal exchange rate: assets held by a country, the net foreign asset position, the nominal interest rate and productivity. I also show whether a change in one of the determinants leads to a depreciation or an appreciation. The incompleteness of markets implies that temporary shocks affect the long-run world distribution of assets and exchange rates with interesting feedback effects on the current exchange rate. The determinacy result also enables the researcher to answer many question in open economy macroeconomics within a coherent equilibrium model. I discuss some of these questions, such as how international asset flows affect exchange rates, how a country can divorce itself from these flows and how a country can manage its exchange rate. The model also implies that a country with an exchange rate peg and free asset mobility faces a tetralemma and not a trilemma as it not only loses monetary but also fiscal policy independence. This suggest a new way to think about fiscal coordination in a monetary union as a response to within union asset flows. I also provide some empirical evidence consistent with the theoretical predictions. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1310&r=dge |
| By: | Leo Kaas (University of Konstanz); Wei Cui (University College London) |
| Abstract: | Corporate default rates are counter-cyclical and are often accompanied by declines of business credit over prolonged episodes. This paper develops a tractable macroeconomic model in which persistent credit and default cycles are the outcome of variations in self-fulfilling beliefs about credit market conditions. Interest spreads and leverage ratios are determined in optimal credit contracts that reflect the expected default risk of borrowing firms. Next to sunspot shocks, the model also features shocks to recovery rates and to financial intermediation costs. We calibrate the model to evaluate the impact of these different financial shocks on the credit market and on output dynamics. Self-fulfilling changes in credit market expectations trigger sizable reactions in default rates and generate endogenously persistent credit and output cycles. All credit market shocks together account for over 50% of the variation of U.S. GDP growth during 1982-2015. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1288&r=dge |
| By: | Pau Roldan (New York University); Sophia Gilbukh (NYU Stern) |
| Abstract: | What is the relationship between the rate at which firms accumulate their stock of demand over time and the prices that they set for their products? This paper analyzes the implications of cus- tomer capital accumulation for firms’ pricing behavior and firm dynamics. We build an analytically tractable directed search model of the product market in which firms are ex-post heterogeneous in their customer base and commit to the prices they post. The model features dynamic contracts with endogenous customer reallocation, endogenous entry and exit of firms, and allows for an exact characterization of the firm distribution. Price rigidity at the firm level emerges as an equilibrium outcome, and there is price dispersion in the cross-section because firms of different sizes use differ- ent pricing strategies to strike a balance between attracting new customers and retaining incumbent ones. We show that our mechanism can generate realistic firm dynamics, a right-skewed firm size distribution, and size- and age-dependent markups which are in line with the data. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1235&r=dge |
| By: | Bracke, Philippe; Tenreyro, Silvana |
| Abstract: | New Keynesian models with unemployment and incomplete markets are rapidly becoming a new workhorse model in macroeconomics. Such models typically require heavy computational methods which may obscure intuition and overlook equilibria. We present a tractable version which can be characterized analytically. Our results highlight that ñdue the interaction between incomplete markets, sticky prices and endogenous unemployment risk ñproductivity shocks may have radically di§erent e§ects than in traditional NK models, that the Taylor principle may fail, and that pessimistic beliefs may be self-fulÖlling and move the economy into temporary episodes of low demand and high unemployment, as well as into a long-lasting ìunemployment trapî. At the Zero Lower Bound, the presence of endogenous unemployment risk can create ináation and overturn paradoxical properties of the model. We further study Önancial asset prices and show that non-negligible risk premia emerge. |
| Keywords: | Sticky prices; incomplete asset markets; matching frictions; multiple equilibria; amplication |
| JEL: | E10 E21 E24 E30 E52 |
| Date: | 2016–10 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:86177&r=dge |
| By: | Jeremy Lise (University of Minnesota); Jean Marc Robin (Sciences Po); Rasmus Lentz (University of Wisconsin Madison) |
| Abstract: | Abstract We develop a tractable model of the evolution of the wage distribution, extending Lise and Robin (2017, LR). Building on results in LR, we provide a fully closed form solution for the evolution of the wage distribution within a class of random search models that feature ex-ante heterogeneity of workers and firms, productivity shocks, and endogenous job creation and destruction. The model has interesting implications for the cyclicality of wages since the flow productivity (and home production) affect the wage positively while the continuation value affect the wage negatively. As a result, wages may be pro-, counter- or a-cyclical depending on the worker's bargaining power and the quantitative estimates of the relative contribution of the flow and continuation value to current wages. Structural estimation of the model using matched employer-employee data is currently in progress. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1220&r=dge |
| By: | Kyunghun Kim (KIEP); Ju Hyun Pyun (Korea University); Jiyoun An (Kyung Hee University) |
| Abstract: | This study explores the role of cross-border (short-term and long-term) debt holdings in the transmission of the crisis shock to international real business cycle. We first provide a simple two-country DSGE model which distinguishes two transmission channels of real business cycle in credit markets: i) balance sheet effect operating in the short-term debt market owing to roll-over risk and ii) efficient allocation of investment working through the long-term debt market. Consistent with the model’s prediction, our empirical analysis using country-pair data for 57 countries during 2001–2013 shows the heterogeneous roles of short-term and long-term debt integration during financial crises. Short-term debt integration among developed countries drives the results of business cycle synchronization during the crises, whereas long term debt holdings by emerging and developing countries cushioned the transmission of the real business cycle. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1236&r=dge |
| By: | Leonardo Martinez (International Monetary Fund); Juan Hatchondo (Indiana University) |
| Abstract: | We study economies with credit risk in which, each period, borrowers cannot commit to borrow from only one lender. We extend the analysis in Bizer and DeMarzo (1992) by allowing for multiple borrowing periods. In particular, we remove the exclusive-borrowing- contract assumption from a quantitative model of household bankruptcy a la Chatterjee et al. (2007). We compare equilibrium allocations with and without commitment to exclusive contracts. In contrast with Bizer and DeMarzo (1992), we find that borrowing levels are much lower without commitment. Imposing commitment increases the average debt-to-income ratio in the simulations from 9% to 16%. This is the case because (i) the cost of defaulting is lower without commitment and (ii) only without commitment, an increase in current borrowing levels deteriorates future borrowing opportunities. These effects are not relevant in Bizer and DeMarzo’s (1992) model with a unique borrowing period. In contrast with the standard household bankruptcy model and consistently with the data, the model without commitment features (i) borrowing opportunities that resemble credit lines, (ii) borrowing opportunities that depend on the borrowing history (credit score), (iii) credit rationing, and (iv) a higher dispersion of interest rates across households. Introducing an interest rate limit to deal with the non-exclusivity problem produces ex-ante welfare gains equivalent to a permanent increase in consumption of 0.7%. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1326&r=dge |
| By: | Veronica Guerrieri (University of Chicago); Alessandra Fogli (Minneapolis Federal Reserve Bank) |
| Abstract: | Over the last 40 years, the US has experienced a large increase in inequality. At the same time there has been a substantial increase in residential segregation by income and education. What is the link between inequality and residential and educational choice? We first document a strong correlation between inequality and residential segregation at the MSA level, especially in MSA with higher percentage of families with children. Then we develop a general equilibrium overlapping generations model where parents choose the neighborhood where they live with their children. The key ingredient of the model is that there is a spillover effect: children's future wage is expected to be higher if they live in richer neighborhoods. We model such a spillover effect as a black box that can be explained by different quality of public schools, peer effect, learning from neighbors' experience and so forth. This generates a general equilibrium effect through which the residential choice amplifies future inequality: the higher is inequality, the higher is residential segregation which, due to the spillover effect, generates higher inequality. Is this the end of the American dream? We then calibrate the model, using the elasticities found in Chetty and Hendren (2016) and quantify how much residential segregation has contributed to increase inequality. (We attach slides of a preliminary version of the paper, as the current version is still on progress). |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1309&r=dge |
| By: | Jochen Guentner (Johannes Kepler University Linz); Elena Afanasyeva (Goethe University Frankfurt) |
| Abstract: | In this paper, we use a neoclassical investment model to study the effects of imperfect information on the lending behaviour of financial intermediaries. We start by developing intuition in partial equilibrium. We model a rational financial intermediary with limited knowledge of the current state of the economy. In response to a noise shock, the intermediary lowers the interest rates on risky loans and extends relatively more credit, both of which are unaffected under perfect information. This credit boom is driven by informational rather than financial frictions and accompanied by higher aggregate default and decrease in credit spreads. We further show that these noise-ridden credit booms also survive in the general equilibrium version of the model. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1211&r=dge |
| By: | Leena Rudanko (Federal Reserve Bank of Philadelphia) |
| Abstract: | Recent research argues that a key factor limiting firm growth is the gradual accumulation of product market demand. Motivated by this evidence, this paper studies firm price setting and growth in a frictional product market where firms accumulate customers over time. In this competitive search model of firm growth, firms face a trade-off in setting prices each period, between making profits on existing customers with high prices, and attracting new customers with low prices. Firms with more existing customers choose higher prices, attract fewer new customers, and grow more slowly, than those with less. I show that if a new firm has full commitment to future prices, it can attain efficient growth through its lifetime. This plan is not time consistent, however: if a firm with existing customers reoptimizes, it will choose a higher price today than planned. I study firm pricing and growth when the firm does not have commitment to future prices, focusing on Markov perfect equilibria. The baseline model considers an industry with a single monopolistically competitive firm, but I also consider the impact of a competitive fringe on the monopolist’s pricing, a version with a continuum of firms within the industry that delivers an equilibrium theory of price dispersion, as well as the implications for firm responses to shocks to demand and costs. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1281&r=dge |
| By: | Mikhail Golosov (Princeton University); David Evans (University of Oregon); anmol bhandari (university of minnesota) |
| Abstract: | Asset pricing data indicates that shocks to the nominal interest rates are primarily reflected in changes in risk premium. In this paper we build a New Keynesian model in which the behavior of interest rates and risk premium is consistent with this observation. We show that monetary shocks affect the real and nominal variables through the novel channel -- when nominal price adjustment is costly, firms need to balance needs to maximize current period profit and minimize future cost of price adjustments. Increase in risk, which follows a decrease in interest rates, increases firm's weight of future costs in inflationary environments, and leads to an increase in inflation, nominal and real marginal costs and output. Effectiveness of monetary policy varies with the state of the economy and generally is low in low inflationary environments. We also show that a number of well-known predictions of New Keynesian models reverses when interest rate shocks affect risk premium. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1359&r=dge |
| By: | Kalin Nikolov (European Central Bank); Javier Suarez (CEMFI); Dominik Supera (European Central Bank); Caterina Mendicino (European Central Bank) |
| Abstract: | We characterize welfare maximizing capital requirement policies in a macroeconomic model with household, firm and bank defaults calibrated to Euro Area data. We optimize on the level of the capital requirements applied to each loan class and their sensitivity to changes in default risk. We find that getting the level right (so that bank failure risk remains small) is of foremost importance, while the optimal sensitivity to default risk is positive but typically smaller than under Basel IRB formulas. When starting from low levels, initially both savers and borrowers benefit from higher capital requirements. At higher levels, only savers are in favour of tighter and more time-varying capital charges. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1216&r=dge |
| By: | Alice Albonico; Alessia Paccagnini; Patrizio Tirelli |
| Keywords: | PIIGS, Euro crisis, two-country DSGE, Bayesian estimation |
| JEL: | E32 E21 C13 C32 C11 E37 |
| Date: | 2017–10 |
| URL: | http://d.repec.org/n?u=RePEc:gri:epaper:economics:201710&r=dge |
| By: | Porzio, Tommaso; Santangelo, Gabriella |
| Abstract: | What explains labor reallocation out of agriculture? We show that decreases in the supply of agricultural workers, due to younger birth-cohorts having skills which are more valued out of agriculture, play a major, and previously overlooked, role. First, we use micro data from 52 countries to decompose aggregate labor reallocation into year and cohort effects. Cohort effects accounts for more than half of overall reallocation. Then, we develop an overlapping generations model to provide an analytical and parsimonious map from the statistical objects, year and cohort effects, into the structural objects of interest, demand and supply of agricultural workers. The map is modulated by mobility frictions and general equilibrium, which we discipline with micro data. Filtering the data through the model, we conclude that decreases in the supply of agricultural workers account for a sizable fraction, approximately one third, of labor reallocation. Finally, we show that, both within and across countries, larger increases in schooling across cohorts are correlated with faster reallocation out of agriculture, suggesting that human capital determines the supply of agricultural workers. We provide further, and causal, evidence on the role of human capital by showing that a school construction program in Indonesia led to labor reallocation out of agriculture. |
| Date: | 2017–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:12495&r=dge |
| By: | Daniele Siena (Banque de France) |
| Abstract: | The role of news shocks in international business cycles is first evaluated using a structural factor-augmented VAR model (FAVAR). An international FAVAR model is shown to be necessary to recover the correct news shocks in open economies, except the US, without incurring in the ‘non-fundamentalness’ problem. Then, a standard two-country, two-good real business cycle model, featuring news shocks, investment adjustment costs and variable wealth elasticity of the labor supply is used to match and explain the empirical evidence. News shocks are only marginal drivers of international business cycles synchronization. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1206&r=dge |
| By: | Martino N. Ricci; Patrizio Tirelli |
| Keywords: | Housing, Mortgage default, subprime risk, DSGE. |
| JEL: | E32 R31 G01 E44 |
| Date: | 2017–09 |
| URL: | http://d.repec.org/n?u=RePEc:gri:epaper:economics:201709&r=dge |
| By: | Romanos Priftis (European Commission); Rigas Oikonomou (Université Catholique de Louvain); Hafedh Bouakez (HEC Montreal) |
| Abstract: | We study optimal debt management in the face of shocks that can drive the economy into a liquidity trap and call for an increase in public spending in order to mitigate the resulting recession. Our approach follows the literature of macroeconomic models of debt management, which we extend to the case where the zero lower bound on the short-term interest rate may bind. We wish to identify the conditions under which removing long-maturity government debt from the secondary market can be an optimal policy outcome. We show that the optimal debt-management strategy is to issue short-term debt if the government faces a sizable exogenous increase in public spending and if its initial liability is not very large. In this case, our results run against the standard prescription of the debt-management literature. In contrast, if the initial debt level is high, then issuing long term government bonds is optimal. Finding the portfolios requires to solve the model using global numerical approximation methods. As a methodological contribution, we propose numerical procedures within the class of parameterized expectations algorithms (PEA) to solve the nonlinear model subject to the zero lower bound. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1316&r=dge |
| By: | Athreya, Kartik B.; Mustre-del-Rio, Jose (Federal Reserve Bank of Kansas City); Sanchez, Juan M. |
| Abstract: | Using recently available proprietary panel data, we show that while many (35%) US consumers experience fi nancial distress at some point in the life cycle, most of the events of nancial distress are primarily concentrated in a much smaller proportion of consumers in persistent trouble. Roughly 10% of consumers are distressed for more than a quarter of the life cycle, and less than 10% of borrowers account for half of all distress events. These facts can be largely accounted for in a straightforward extension of a workhorse model of defaultable debt that accommodates a simple form of heterogeneity in time preference but not otherwise. |
| Keywords: | Default; Fi nancial distress; Consumer credit; credit card debt |
| JEL: | D60 E21 E44 |
| Date: | 2017–11–27 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedkrw:rwp17-15&r=dge |
| By: | Garriga, Carlos; Kydland, Finn E.; Šustek, Roman |
| Abstract: | Standard models used for monetary policy analysis rely on sticky prices. Recently, the literature started to explore also nominal debt contracts. Focusing on mortgages, this paper compares the two channels of transmission within a common framework. The sticky price channel is dominant when shocks to the policy interest rate are temporary, the mortgage channel is important when the shocks are persistent. The first channel has significant aggregate effects but small redistributive effects. The opposite holds for the second channel. Using yield curve data decomposed into temporary and persistent components, the redistributive and aggregate consequences are found to be quantitatively comparable. |
| JEL: | E32 E52 G21 R21 |
| Date: | 2016–08–23 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:86223&r=dge |
| By: | Corsetti, Giancarlo; Mavroeidi, Eleonora; Thwaites, Gregory; Wolf, Martin |
| Abstract: | We study how small open economies can escape from deflation and unemployment in a situation where the world economy is permanently depressed. Building on the framework of Eggertsson et al. (2016), we show that the transition to full employment and at-target inflation requires real and nominal depreciation of the exchange rate. However, because of adverse income and valuation effects from real depreciation, the escape can be beggar thy self, raising employment but actually lowering welfare. We show that as long as the economy remains financially open, domestic asset supply policies or reducing the effective lower bound on policy rates may be ineffective or even counterproductive. However, closing domestic capital markets does not necessarily enhance the monetary authorities’ ability to rescue the economy from stagnation. |
| Keywords: | Monetary policy; zero lower bound; deflation; depreciation; beggar-thy-neighbour; capital controls |
| JEL: | E62 F41 |
| Date: | 2017–05–31 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:86153&r=dge |
| By: | Balke, Neele L.; Ravn, Morten O. |
| Abstract: | We analyze time-consistent fiscal policy in a sovereign debt model. We consider a production economy that incorporates feedback from policy to output through employment, features inequality though unemployment, and in which the government lacks a commitment technology. The government’s optimal policies play off wedges due to the lack of lumpsum taxes and the distortions that taxes and transfers introduce on employment. Lack of commitment matters during a debt crises – episodes where the price of debt reacts elastically to the issuance of new debt. In normal times, the government sets procyclical taxes, transfers and public goods provision but in crisis times it is optimal to implement austerity policies which minimize the distortions deriving from default premia. Could a third party provide a commitment technology, austerity is no longer optimal. |
| Keywords: | Time-consistent fiscal policy; sovereign debt; debt crisis; austerity |
| JEL: | E20 E62 F34 F41 |
| Date: | 2016–11 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:86174&r=dge |
| By: | Marius Clemens (German Institute for Economic Research (DIW Berlin)); Guillaume Claveres (Universite Paris 1 Pantheon-Sorbonne) |
| Abstract: | A European unemployment insurance scheme has gained increased attention as a new and ambitious common fiscal instrument which could be used for temporary cross-country transfers. Part of the national stabilizers composing unemployment insurance schemes would be transferred to the central level. Unemployed are then insured by both layers. When a country is hit by an asymmetric shock, it would receive positive net transfers from the central fund in the form of reduced taxes and increased benefits, providing risk-sharing for the whole union. We build a two-country DSGE model with supply, demand and labor market shocks in order to capture the recent national insurance system and the unemployment insurance union (UIU) design. The model is calibrated to the euro area core and periphery data and matches the empirically observed cyclicality of the net replacement rate, the wage and unemployment dynamics. This baseline scenario is then compared to a optimal unemployment insurance union with passive and active benefit policies. For all underlying shocks, we find that the UIU reduces the fluctuation of consumption and unemployment while it increases the fluctuation of the trade balance. In case of a positive domestic government spending shock the UIU reduces the negative crowding out effect on private consumption and investment. The model will be used to analyze the effects of national and supranational benefit policies on labour market patterns and welfare. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1340&r=dge |
| By: | Croce, Mariano (University of North Carolina at Chapel Hill,); Karantounias, Anastasios G. (Federal Reserve Bank of Atlanta); Raymond, Stephen (University of North Carolina at Chapel Hill); Schmid, Lukas (Duke University) |
| Abstract: | In times when elevated government debt raises concerns about dimmer global growth prospects, we ask: How can the government provide incentives for innovation in a fiscally sustainable way? We address this question by examining the Ramsey problem of finding optimal tax and subsidy schemes in a model in which growth is endogenously sustained by risky innovation. We characterize the shadow value of growth and entry in the innovation sector. We find that a profit tax is required to replicate the first-best in order to balance the externalities associated with innovative activity. At the second-best, the profit tax is designed to optimally respond to growth shocks above and beyond what is prescribed by the standard tax-smoothing incentives in economies with exogenous growth. The interplay of risk and innovation opens a new margin for optimal taxation. |
| Keywords: | innovation; R&D investment; endogenous growth; government debt; labor tax; subsidy; profit tax |
| JEL: | E32 E62 H21 H63 O3 |
| Date: | 2017–11–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedawp:2017-13&r=dge |
| By: | Teulings, Coen |
| Abstract: | It is well known that rational bubbles can be sustained in balanced growth path of a deterministic economy when the return to capital r is equal to the growth rate g. When there is a lack of stores of value, bubbles can implement an e¢ cient allocation. This paper considers a world where r áuctuates over time due to shocks to the marginal productivity of capital. Then, bubbles further e¢ ciency, though they cannot implement Örst best. While bubbles can only be sustained when r = g in a deterministic economy, r > g "on average" in a stochastic economy. Fiscal policy improves welfare by adding an extra asset. Where only the elderly contribute to shifting resources between investment and consumption in a bubbly economy, Öscal policy allows part of that burden to be shifted to the young. Contrary to common wisdom, trade in bubbly assets implements intergenerational transfers, while Öscal policy implements intragenerational transfers. Hence, while bubbles and Öscal policy are perfect substitutes in the deterministic economy, Öscal policy dominates bubbles in a stochastic economy. For plausible parameter values, a higher degree of dynamic ine¢ ciency should lead to a higher sovereign debt. |
| Keywords: | rational bubbles; fiscal policy; secular stagnation |
| JEL: | E44 E62 |
| Date: | 2016–07–22 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:86220&r=dge |
| By: | Karantounias, Anastasios G. (Federal Reserve Bank of Atlanta) |
| Abstract: | We study optimal time-consistent distortionary taxation when the repayment of government debt is not enforceable. The government taxes labor income or issues noncontingent debt in order to finance an exogenous stream of stochastic government expenditures. The government can repudiate its debt subject to some default costs, thereby introducing some state-contingency to debt. We are motivated by the fact that domestic sovereign default is an empirically relevant phenomenon, as Reinhart and Rogoff (2011) demonstrated. Optimal policy is characterized by two opposing incentives: an incentive to postpone taxes by issuing more debt for the future and an incentive to tax more currently in order to avoid punishing default premia. A generalized Euler equation (GEE) captures these two effects and determines the optimal back-loading or front-loading of tax distortions. |
| Keywords: | labor tax; sovereign default; Markov-perfect equilibrium; time-consistency; generalized Euler equation; long-term debt |
| JEL: | D52 E43 E62 H21 H63 |
| Date: | 2017–11–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedawp:2017-12&r=dge |
| By: | Thomas Sargent (New York University); Lars Ljungqvist (Stockholm School of Economics); Isaac Baley (Universitat Pompeu Fabra & Barcelona GSE) |
| Abstract: | Ljungqvist and Sargent (2007) show that increases in turbulence, in the sense of worse skill transition probabilities for workers who suffer involuntary layoffs, generate higher unemployment in a welfare state. den Haan, Haefke and Ramey (2005) challenge this finding and argue that if turbulence also exposes voluntary quits to a tiny risk of skill loss, then higher turbulence leads to a reduction in unemployment. In this paper we explore the source of these disparate results within the two adopted matching models. We find that the latter authors' assumption of additional exposure of the high-skilled unemployed to skill losses following unsuccessful job market encounters, together with the parameterization of their model, implies small incentives for labor mobility in tranquil times. Hence, any small cost to mobility would cause voluntary separations to shut down, e.g., tiny government mandated layoff costs would have counterfactually large effects of suppressing unemployment. Once the additional exposure to turbulence is dismissed and the parameterization is adjusted to account for the unemployment dynamics in data, the positive relationship between turbulence and unemployment reemerges. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1391&r=dge |
| By: | Maryam Farboodi; Gregor Jarosch; Guido Menzio |
| Abstract: | We propose a theory of intermediation as rent extraction, and explore its implications for the extent of intermediation, welfare and policy. A frictional asset market is populated by agents who are heterogeneous with respect to their bargaining skills, as some can commit to take-it-or-leave-it offers and others cannot. In equilibrium, agents with commitment power act as intermediaries and those without act as final users. Agents with commitment trade on behalf of agents without commitment to extract more rents from third parties. If agents can invest in a commitment technology, there are multiple equilibria differing in the fraction of intermediaries. Equilibria with more intermediaries have lower welfare and any equilibrium with intermediation is inefficient. Intermediation grows as trading frictions become small and during times when interest rates are low. A simple transaction tax can restore efficiency by eliminating any scope for bargaining. |
| JEL: | D40 |
| Date: | 2017–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:24171&r=dge |
| By: | George-Marios Angeletos |
| Abstract: | The notion that business cycles are driven by demand shocks is subtle. I first review the conceptual and empirical challenges faced when trying to accommodate this notion in modern, micro-founded, general-equilibrium models. I next review my own research, which sheds new light on the observed business cycles by relaxing the common-knowledge restrictions of such models. My work shifts the focus from nominal rigidity to frictional coordination. It makes room for forces akin to animal spirits even when the equilibrium is unique. It allows demand shocks to generate realistic business cycles even when nominal rigidity is absent or undone by appropriate monetary policy. And it modifies the general-equilibrium predictions of workhorse macroeconomic models in manners that seem both conceptually appealing and empirically relevant. |
| JEL: | E1 E3 E5 E62 |
| Date: | 2017–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:24178&r=dge |
| By: | Huw Lloyd-Ellis (Queen's University); Derek Stacey (Ryerson University); Allen Head (Queen's University) |
| Abstract: | Cross-city variation in the rate of home-ownership and the relative costs of renting and owning are studied using a model of frictional assignment. Houses of different types are built by a competitive construction industry and either rented in Walrasian markets or sold through a process of competitive search to households. Households differ with regard to their permanent income and sort over house types and housing tenure at each point in time. Along a balanced growth path, both the composition of the city's housing stock and the rate of home-ownership depend on the distributions of income, construction costs, and housing amenities. In the absence of either financial frictions or minimum house size requirements, higher income households live in better houses and are more likely on average to be homeowners than lower income ones. A calibrated version illustrates the extent to which income/wealth inequality alone can ac- count for variation in home-ownership and the price-rent ratio both within and across cities. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1336&r=dge |
| By: | Marc Fleurbaey; Marie-Louise Leroux; Pierre Pestieau; Grégory Ponthière; Stéphane Zuber |
| Abstract: | While little agreement exists regarding the taxation of bequests in general, there is a widely held view that accidental bequests should be subject to a confiscatory tax. We propose to reexamine the optimal taxation of accidental bequests in an economy where individuals care about what they leave to their offspring in case of premature death. We show that, whereas the conventional 100 % tax view holds under the standard utilitarian social welfare criterion, it does not hold under the ex post egalitarian criterion, which assigns a strong weight to the welfare of unlucky short-lived individuals. From an egalitarian perspective, it is optimal not to tax, but to subsidize accidental bequests. We examine the robustness of those results in a dynamic OLG model of wealth accumulation, and show that, whereas the sign of the optimal tax on accidental bequests depends on the form of the joy of giving motive, it remains true that the 100 % tax view does not hold under the ex post egalitarian criterion. |
| Keywords: | mortality, accidental bequests, optimal taxation, egalitarianism, OLG models |
| JEL: | D63 D64 D91 H31 J10 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:lvl:criacr:1704&r=dge |
| By: | Diba Behzad (Department of Economics; Georgetown University); Olivier Loisel (CREST; ENSAE) |
| Abstract: | We develop a model of monetary policy with a small departure from the basic New Keynesian (NK) model. In this model, the central bank can set the interest rate on bank reserves and the nominal stock of bank reserves independently, because these reserves reduce the costs of banking (i.e., have a convenience yield). The model delivers local-equilibrium determinacy under a permanent interest-rate peg. Consequently, it does not share the puzzling and paradoxical implications of the basic NK model under a temporary peg (e.g., in the context of a liquidity trap). More specifically, it offers a resolution of the \forward guidance puzzle," a related puzzle about scal multipliers, and the \paradox of exibility," even for an arbitrarily small departure from the basic NK model (i.e., arbitrarily small banking costs and convenience yield of reserves). |
| URL: | http://d.repec.org/n?u=RePEc:crs:wpaper:2017-01&r=dge |
| By: | Hamish Low (University of Cambridge); Aruni Mitra (University of British Columbia); Giovanni Gallipoli (UBC) |
| Abstract: | We examine the persistence of economic outcomes within families. First, we link parents and children in U.S. longitudinal data and document the cross-generational association in both incomes and ex- penditures. Next, we develop a richer model of intra-family persistence and derive a set of theoretical moment restrictions. This allows us to identify and estimate key parameters describing how different shocks influence long-term economic outcomes. We use these estimates to quantify the contribution of parental factors to the observed dispersion of income and consumption among adult children. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1215&r=dge |
| By: | Bratsiotis, George |
| Abstract: | This paper examines the role of the precautionary demand for liquidity and the interest on reserves as two potential determinants of the deposits channel that can help explain the role of monetary policy, particularly at the near zero-bound. At high levels of precautionary liquidity hoarding the optimal policy response of a Taylor rule is shown to indicate a zero weight on inflation. This is a determinate outcome, despite the violation of the Taylor Principle, because of the effect that the demand for liquidity has on the deposit rate which determines the intertemporal choices of households. Similarly, through its effect on the deposits channel the interest on reserves can act as the main monetary policy tool that can provide determinacy and replace the Taylor rule. This result holds at the zero-bound and it is independent of precautionary demand for liquidity, or fiscal theory of the price level properties. |
| Keywords: | Deposits channel,zero-bound monetary policy,excess reserves,credit risk,welfare,required reserve ratio,interest on reserves,balance sheet channel,DSGE models |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:esprep:172770&r=dge |
| By: | Luo, Yulei; Nie, Jun (Federal Reserve Bank of Kansas City); Wang, Haijun |
| Abstract: | This paper constructs a recursive utility version of a canonical Merton (1971) model with uninsurable labor income and unknown income growth to study how the interaction between two types of uncertainty due to ignorance affects strategic consumption-portfolio rules and precautionary savings. Specifically, after solving the model explicitly, we theoretically and quantitatively explore (i) how these ignorance-induced uncertainties interact with intertemporal substitution, risk aversion, and the correlation between the equity return and labor income, and (ii) how they jointly affect strategic asset allocation, precautionary savings, and the equilibrium asset returns. Furthermore, we use data to test our model’s predictions on the relationship between ignorance and asset allocation and quantitatively show that the interaction between the two types of uncertainty is the key to explain the data. Finally, we find that the welfare costs of ignorance can be very large. |
| Keywords: | Ignorance; Unknown Income Growth; Induced Uncertainty; Strategic Asset Allocation |
| JEL: | C61 D81 E21 |
| Date: | 2017–11–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedkrw:rwp17-13&r=dge |
| By: | Kurt Mitman (Stockholm University); Iourii Manovskii (University of Pennsylvania); Marcus Hagedorn (University of Oslo) |
| Abstract: | This paper studies the size of the fiscal multiplier in a model with incomplete markets and rigid prices and wages. Allowing for incomplete markets instead of complete markets---the prevalent assumption in the literature---comes with two advantages. First, the incomplete markets model delivers a realistic distribution of the marginal propensity to consume across the population, whereas all households counterfactually behave according to the permanent income hypothesis if markets are complete. Second, in our model the response of prices, output, consumption and employment is uniquely determined by fiscal policy for any monetary policy including the zero-lower bound (ZLB) as opposed to most of the previous literature, where an infinite number of equilibria exists, leaving the researcher to arbitrarily pick one. Our preliminary findings indicate that the impact multiplier is quite large between 2 and 3 depending on whether tax or deficit financing is used and increase to values above 3 in a liquidity trap. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1383&r=dge |
| By: | Masolo, Riccardo M.; Monti, Francesca |
| Abstract: | Allowing for ambiguity, or Knightian uncertainty, about the behavior of the policymaker helps explain the evolution of trend inflation in the US in a simple new-Keynesian model, without resorting to exogenous changes in the inflation target. Using Blue Chip survey data to gauge the degree of private sector confidence, our model helps reconcile the difference between target inflation and the inflation trend measured in the data. We also show how, in the presence of ambiguity, it is optimal for policymakers to lean against the private sectors pessimistic expectations. |
| Keywords: | Ambiguity aversion; monetary policy; trend inflation |
| JEL: | D84 E31 E43 E52 E58 |
| Date: | 2017–02–06 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:86165&r=dge |
| By: | Francois Velde (Federal Reserve Bank of Chicago); Benoït Mojon; Magali Marx (banque de france) |
| Abstract: | Risk-free rates have been falling since the 1980s while the return on capital has not. We analyze these trends in a calibrated OLG model designed to encompass many of the "usual suspects" cited in the debate on secular stagnation. Declining labor force and productivity growth imply a limited decline in real interest rates and deleveraging cannot account for the joint decline in the risk free rate and increase in the risk premium. If we allow for a change in the (perceived) risk to productivity growth to fit the data, we find that the decline in the risk-free rate requires an increase in the borrowing capacity of the indebted agents in the model, consistent with the increase in the sum of public and private debt since the crisis but at odds with a deleveraging-based explanation put forth in Eggertsson and Krugman (2012). |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1292&r=dge |
| By: | Brunnermeier, Markus K.; Langfield, Sam; Pagano, Marco; Reis, Ricardo; Nieuwerburgh, Stijn Van; Vayanos, Dimitri |
| Abstract: | It is well known that rational bubbles can be sustained in balanced growth path of a deterministic economy when the return to capital r is equal to the growth rate g. When there is a lack of stores of value, bubbles can implement an e¢ cient allocation. This paper considers a world where r áuctuates over time due to shocks to the marginal productivity of capital. Then, bubbles further e¢ ciency, though they cannot implement Örst best. While bubbles can only be sustained when r = g in a deterministic economy, r > g "on average" in a stochastic economy. Fiscal policy improves welfare by adding an extra asset. Where only the elderly contribute to shifting resources between investment and consumption in a bubbly economy, Öscal policy allows part of that burden to be shifted to the young. Contrary to common wisdom, trade in bubbly assets implements intergenerational transfers, while Öscal policy implements intragenerational transfers. Hence, while bubbles and Öscal policy are perfect substitutes in the deterministic economy, Öscal policy dominates bubbles in a stochastic economy. For plausible parameter values, a higher degree of dynamic ine¢ ciency should lead to a higher sovereign debt. |
| JEL: | J1 |
| Date: | 2016–09–12 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:86221&r=dge |
| By: | Sharon Traiberman (Princeton) |
| Abstract: | There is a growing concern that many workers do not share in the gains from trade. In this paper, I argue that occupational reallocation plays a crucial role in determining the winners and losers from trade liberalization: what specific workers do \emph{within} an industry or a firm matters. Adjustment to trade liberalization can be protracted and costly, especially when workers need to switch occupations. To quantify these effects, I build and estimate a dynamic model of the Danish labor market. The model features nearly forty occupations, complicating estimation. To reduce dimensionality I project occupations onto a lower-dimensional task space. This parameter reduction coupled with conditional choice probability techniques yields a tractable nonlinear least squares problem. I find that for the median worker, a 1% decrease in income, holding the income in other occupations fixed, raises the probability of switching occupations by .3%. However, adjustment frictions can be large---on the order of five years of income---so that workers tend to move in a narrow band of similar occupations. To quantify the importance of these forces for understanding import competition, I simulate the economy with and without observed changes in import prices. In the short-run, import competition can cost workers up to one half percent of lifetime earnings. Moreover, the variance in earnings outcomes is twice the size of the total gains from trade. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1237&r=dge |
| By: | Manuel Bachmann (Department of Economics, Vienna University of Economics and Business) |
| Abstract: | In this paper I propose a two-step theoretical extension of the baseline model by Diamond and Rajan (2011) and examine the amplification mechanisms when collateralized funding shocks are endogenously affected by liquidity shocks. Based on high returns on illiquid assets that are potentially available conditional on future fire sales, liquid banks increase their cash holdings by limiting term lending – a speculative motive of liquidity hoarding directly aggravated by a cash reduction due to increased haircuts on collateralized borrowing. As a result, funding liquidity shrinks steadily and credit freezes are more likely. On the other hand, illiquid banks refuse to sell more illiquid assets than necessary to meet depositors’ claims – a speculative motive of illiquidity seeking indirectly amplified as fire sale prices are endogenously depressed via increased collateral requirements. Illiquid banks are forced to sell more assets, the problem of insolvency becomes more severe and market freezes are thus even more likely. |
| Keywords: | Fire Sales, Insolvency, Market & Credit Freezes, Collateralized Borrowing |
| JEL: | G01 G12 G21 |
| Date: | 2018–01 |
| URL: | http://d.repec.org/n?u=RePEc:wiw:wiwwuw:wuwp255&r=dge |
| By: | Florian Oswald (Sciences Po); Costas Meghir (Yale University); Wenli Li (Federal Reserve Bank of Philadelphia) |
| Abstract: | We specify and estimate a rich model of consumption, housing demand and labor supply in an environment where individuals may file for bankruptcy or default on their mortgage. Uncertainty in the model is driven both by house price shocks and income shocks, while bankruptcy is governed by the basic institutional framework in the US as implied by chpater 7 and chapter 13. The model is estimated using micro data on credit reports and mortgages combined with individual level data from the American Community Survey. We perform several counterfactual experiments with the model which investigate welfare aspects of an important reform of the US consumer bankruptcy code implemented in 2006. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1260&r=dge |
| By: | luciene pereira (Fundação Getulio Vargas); Pedro Cavalcanti Ferreira (Fundação Getulio Vargas); Alexander Monge-Naranjo (Federal Reserve Bank of St. Louis) |
| Abstract: | The emergence of slums is a common feature in a country's path towards urbanization, structural transformation and development. Based on salient micro and macro evidence of Brazilian labor, housing and education markets, we construct a simple model to examine the conditions for slums to emerge. We then use the model to examine whether slums are barriers or stepping stones for lower skilled households and for the development of the country as a whole. We calibrate our model to explore the dynamic interaction between skill formation, income inequality and structural transformation with the rise (and potential fall) of slums in Brazil. We then conduct policy counterfactuals. For instance, we find that cracking down on slums could slow down the acquisition of human capital, the growth of cities (outside slums) and non-agricultural employment. The impact of reducing housing barriers to entry into cities and of different forms of school integration between the city and the slums is also explored. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1308&r=dge |