nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2018‒03‒05
twenty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Optimal taxes on capital in the OLG model with uninsurable idiosyncratic income risk By Krueger, Dirk; Ludwig, Alexander
  2. The Macroeconomic Consequences of Early Childhood Development Policies By Diego Daruich
  3. Organizational Belief, Managerial Vision, and International Trade By Samil Oh; Thepthida Sopraseuth
  4. Welfare-improving Consumption Tax in the Presence of Wage Tax under Idiosyncratic Returns from Investment and Incomplete Markets By Hisahiro Naito
  5. Wages and Family Time Allocation By THELOUDIS Alexandros
  6. A contribution to the theory of fertility and economic development By Gori, Luca; Sodini, Mauro
  7. A Catch-22 for HANK Models: No Puzzles, No Amplification By Bilbiie, Florin Ovidiu
  8. On the origin of current account deficits in the Euro area periphery: A DSGE perspective By Christoph Zwick
  9. Financial Crisis, Monetary Base Expansion and Risk By Stylianos Tsiaras
  10. Understanding HANK: insights from a PRANK By Acharya, Sushant; Dogra, Keshav
  11. Product Cycles and Prices:Search Foundation By Mei Dong; Yuki Teranishi
  12. Open Mouth Operations By Campbell, Jeffrey R.; Weber, Jacob P.
  13. Chained financial frictions and credit cycles By Federico Lubello; Ivan Petrella; Emiliano Santoro
  14. Bank Capital Regulation in a Zero Interest Environment By Robin Döttling
  15. Optimal Monetary Policy Under Bounded Rationality By Benchimol, Jonathan; Bounader, Lachen
  16. Macroeconomic Implications of Changes in Social Security Rules By Bagis, Bilal
  17. Accounting for the Sources of Macroeconomic Tail Risks By Atalay, Enghin; Drautzburg, Thorsten; Wang, Zhenting
  18. Mortgage Debt and Time-Varying Monetary Policy Transmission By David Finck; Joerg Schmidt; Peter Tillmann
  19. Forward Guidance and the Exchange Rate By Jordi Galí
  20. Monetary theory reversed: Virtual currency issuance and miners’ remuneration By Luca Marchiori
  21. Why Have Interest Rates Fallen Far Below the Return on Capital By Marx, Magali; Mojon, Benoit; Velde, Francois R.

  1. By: Krueger, Dirk; Ludwig, Alexander
    Abstract: We characterize the optimal linear tax on capital in an Overlapping Generations model with two period lived households facing uninsurable idiosyncratic labor income risk. The Ramsey government internalizes the general equilibrium feedback of private precautionary saving. For logarithmic utility our full analytical solution of the Ramsey problem shows that the optimal aggregate saving rate is independent of income risk. The optimal time-invariant tax on capital is increasing in income risk. Its sign depends on the extent of risk and on the Pareto weight of future generations. If the Ramsey tax rate that maximizes steady state utility is positive, then implementing this tax rate permanently generates a Pareto-improving transition even if the initial equilibrium is dynamically efficient. We generalize our results to Epstein-Zin-Weil utility and show that the optimal steady state saving rate is increasing in income risk if and only if the intertemporal elasticity of substitution is smaller than 1.
    Keywords: Idiosyncratic Risk,Taxation of Capital,Overlapping Generations,Precautionary Saving,Pecuniary Externality
    JEL: H21 H31 E21
    Date: 2018
  2. By: Diego Daruich (New York University)
    Abstract: The macroeconomic consequences of large-scale early childhood development policies depend on intergenerational dynamics, general equilibrium (GE) effects on labor and capital markets, and the deadweight loss of raising taxes to finance the policies. To study these policies, this paper extends a standard GE heterogeneous-agent overlapping-generations macro model with earnings risk and credit constraints to incorporate early childhood investments (parental time and money) and estimates it using US data. We validate the model by performing an RCT evaluation of a short-run small-scale government program that funds early childhood investments and showing that the effects on children’s education and adult income in the model are similar to the empirical evidence. We then evaluate a permanent large-scale version of this early childhood program, taking into account GE and taxation effects, and find that it yields a 10% welfare increase (in consumption equivalence terms), reduces inequality by 7%, and increases intergenerational mobility of income by 30%—approximately enough for the US to achieve Canadian or Australian levels of inequality and mobility. Welfare gains are twice the ones obtained by introducing the same early childhood program as a short-run partial-equilibrium policy—similar to an RCT. Although GE and taxation effects reduce the gains by one-tenth each, the long-run change in the distribution of parental characteristics more than compensates for those reductions. Key to this welfare gain is that investing in a child not only improves her skills but also creates a better parent for the next generation. Although earlier generations gain less, welfare gains are positive for every new generation and grow rapidly during the transition.
    Keywords: Inequality, intergenerational mobility, early childhood, education, quantitative model
    JEL: J13 J24 J62
    Date: 2018–02
  3. By: Samil Oh; Thepthida Sopraseuth (Université de Cergy-Pontoise, THEMA)
    Abstract: This paper investigates the impact of uncertainty shocks in a small open economy with search and matching frictions, endogenous job separation and rm entry. We rst develop our empirical analysis in the context of the Korean economy, as all dimensions of the model are relevant in this country. An increase in uncertainty lowers output, consumption, investment and job nding rate, while raising unemployment and job separations. We also supplement the existing empirical evidence by looking at rm dynamics, real exchange rate and current account behavior. Increased uncertainty gen- erates current account surplus, real exchange rate depreciation and reduces the number of rms in the economy. In our theoretical framework, we illustrate new transmissions mechanism that are ignored in the literature. The interaction of search frictions, rm entry and open economy leads to sizable macroeconomic eects of heightened uncer- tainty. Moreover, the model's predictions are consistent with empirical ndings.
    Keywords: small open economy, search and matching, rm entry, uncertainty shocks
    JEL: E32 F41 F32 J64
    Date: 2017
  4. By: Hisahiro Naito
    Abstract: In a standard multi-period model, consumption tax and wage tax are equivalent. I show that when a capital market is incomplete---in the sense that the rates of return from risky investments are idiosyncratic and there is no insurance for such idiosyncratic risk---the introduction of consumption tax in the presence of wage tax improves welfare. This holds true even in the presence of optimal or non-optimal capital income taxes. In the general equilibrium model, the optimal level of consumption tax is determined to balance the benefits of the risk-sharing effect and asset accumulation effect and the costs of postponing government revenue to later periods.
    Date: 2018–02
  5. By: THELOUDIS Alexandros
    Abstract: This paper examines changes in married people's allocation of time since 1980, a period in which female labor supply increased substantially, men's share of household work rose, and the gender wage gap narrowed down. I develop a life-cycle collective household model for market and non-market work, consumption and asset accumulation, which also features lack of commitment to lifetime marriage. Wages in the model shift intra-family bargaining power and induce bargaining effects on outcomes in addition to standard income and substitution effects. I estimate gender-specific preferences and how intra-family bargaining power changes with a narrowing gender gap using data from the PSID. The results suggest that a narrowing gender gap improved women's bargaining power in the family resulting in a shift of household work to their husbands. It also contributed to the increase in female labor market participation. If the gender gap is counterfactually eliminated, the proportion of women in full-time work rises throughout the lifecycle to match approximately that of men. The increase comes from women who cut down household chores and enter the labor market when they previously did not participate.
    Keywords: Life-cycle collective model; home production; lack of commitment; gender wage gap; bargaining effects; equal pay; simulated method of moments; PSID
    JEL: D12 D13 D91 J22
    Date: 2018–02
  6. By: Gori, Luca; Sodini, Mauro
    Abstract: The aim of this research is to build on a theory for explaining economic development in a (neoclassical) growth model with endogenous fertility. The economy is comprised of overlapping generations of rational and identical individuals and identical competitive firms producing with a constant-returns-to-scale technology with no externalities. From a theoretical perspective, the distinguishing feature of this work is that endogenous fertility per se is able to explain the existence of low and high development regimes. It provides alternative reasons (history driven or expectations driven) why some countries enter development trajectories with high GDP and low fertility and others experience under-performances with low GDP and high fertility. The model is also able to reproduce fertility fluctuations and explain the baby busts and baby booms observed in the last century in some developed countries.
    Keywords: Economic development,Endogenous fertility,Local and global indeterminacy,OLG model
    JEL: C61 C62 J1 J22 O41
    Date: 2018
  7. By: Bilbiie, Florin Ovidiu
    Abstract: New Keynesian (NK) models with heterogeneous agents (HA) can deliver aggregate-demand amplification (monetary-fiscal multipliers and deep recessions) through a New Keynesian Cross---but only if hand-to-mouth's income elasticity to aggregate is larger than one. This "hand-to-mouth channel" gives static amplification through the within-the-period elasticity of aggregate demand to policies. A dynamic, complementary "self-insurance channel" magnifies the effects when households are hand-to-mouth only occasionally: the aggregate Euler equation features discounting when the elasticity is lower than one, but compounding when larger. The former channel matters most for short-lived shocks, the latter for persistent or future news. Yet amplification has a dark side: the very same condition that delivers it also aggravates the NK troubles (the forward guidance puzzle, neo-Fisherian effects, and the paradox of flexibility) and creates new ones (insufficiency of the Taylor principle and a paradox of thrift). Phrased positively: adding HA can solve all these NK troubles, but that also rules out amplification and multipliers---a Catch-22.
    Date: 2018–01
  8. By: Christoph Zwick (University of Graz, Austria)
    Abstract: This paper studies the sources of current account deficits in Greece, Ireland, Portugal and Spain after the introduction of the Euro. I lay out a DSGE model with a rich structure of the external sector and estimate it separately on each periphery country. A three-region model structure allows for interactions between the respective periphery country, a “Rest of the Euro Area” aggregate and a “Rest of the World” block. I show that the model exhibits a solid in-sample-fit across periphery countries and use it to quantitatively assess the relevance of several explanations concerning the origin of the deficits.
    Keywords: Current account; Competitiveness; Euro area; DSGE
    JEL: C32 E42 E52 F32 F41
    Date: 2018–02
  9. By: Stylianos Tsiaras (University of Surrey)
    Abstract: This paper examines the post-2008 European Central Bank's liquidity enhancing policies, namely 'Long Term Refinancing Operations', and the increase of banks' excess reserves that followed. To evaluate this in a quantitative environment, I build a dynamic, general equilibrium model that incorporates financial frictions in both the supply and demand for credit and allows banks to receive liquidity and hold reserves. Results suggest the existence of a risk-shifting channel of monetary policy in the recent ECB operations. Specifically, I show that when the central bank supplies liquidity during turbulent times, banks grant loans to riskier _rms. This increases the firms' default on new credit and worsens the performance of the economy although the banks' health is improved. Additionally, I find that an increase in the riskiness of the non-financial corporations can explain the recent reserve accumulation by the banking system. Lastly, I evaluate the effects of negative interest rates on credit and assess the welfare implications of the recent policies.
    JEL: E44 E58
    Date: 2018–01
  10. By: Acharya, Sushant (Federal Reserve Bank of New York); Dogra, Keshav (Federal Reserve Bank of New York)
    Abstract: Does market incompleteness radically transform the properties of monetary economies? Using an analytically tractable heterogeneous agent New Keynesian (HANK) model, we show that whether incomplete markets resolve “policy paradoxes” in the representative agent New Keynesian model (RANK) depends primarily on the cyclicality of income risk, rather than incomplete markets per se. Incomplete markets reduce the effectiveness of forward guidance and multipliers in a liquidity trap only if risk is procyclical. Acyclical or countercyclical risk amplifies these puzzles relative to RANK. Cyclicality of risk also affects determinacy: procyclical risk permits determinacy even under an interest rate peg, while countercyclical income risk generates indeterminacy even if the Taylor principle holds. Finally, we uncover a new dimension of monetary-fiscal interaction. Since fiscal policy affects the cyclicality of income risk, it influences the effects of monetary policy even when “passive.”
    Keywords: New Keynesian; incomplete markets; monetary and fiscal policy; determinacy; forward guidance; fiscal multipliers
    JEL: E21 E30 E52 E62 E63
    Date: 2018–02–01
  11. By: Mei Dong (University of Melbourne); Yuki Teranishi (Keio University)
    Abstract: This paper develops a price model with a search foundation based on product cycles and prices. Observations conclude that firms match with a new product, then set a new price through negotiation and fix the price until the product exits from a market. This evident behavior results in a new model of price stickiness as a Search-based Phillips curve. The model includes a New Keynesian Phillips curve with Calvo's price adjustment as a special case and describes new phenom- ena. First, new parameters and variables of a frictional goods market determine price dynamics. As separation rate in a goods market decreases, price becomes more sticky, i.e., a flatter slope in a Search-based Phillips curve, since the product turnover cycle is sluggish. Moreover, other goods market features, such as proba- bility of match, elasticity of match, and bargaining power for a price setting decide price dynamics. Second, goods market friction can make endogenously persistent inflation dynamics without an assumption of indexation to a lagged inflation rate. Third, when the number of a product persistently increases, deflation continues for a long period. It can explain a secular deflation.
    Keywords: Phillips curve; search and matching; product chain
    Date: 2018–02
  12. By: Campbell, Jeffrey R. (Federal Reserve Bank of Chicago); Weber, Jacob P. (Federal Reserve Bank of Chicago)
    Abstract: We examine the standard New Keynesian economy’s Ramsey problem written in terms of instrument settings instead of allocations. Its standard formulation makes two instruments available: the path of current and future interest rates, and an “open mouth operation” which selects one of the many equilibria consistent with the chosen interest rates. Removing the open mouth operation by imposing a finite commitment horizon yields pathological policy advice that relies on the model's forward guidance puzzle.
    Keywords: Keynesian economics; equilibrium multiplicity; monetary policy; open market operations
    JEL: E12 E52 E58
    Date: 2018–02–05
  13. By: Federico Lubello; Ivan Petrella; Emiliano Santoro
    Abstract: We examine the role of bank collateral in shaping credit cycles. To this end, we develop a tractable model where bankers intermediate funds between savers and borrowers. If bankers default, savers acquire the right to liquidate bankers' assets. However, due to the vertically integrated structure of our credit economy, savers anticipate that liquidating nancial assets (i.e., bank loans) is conditional on borrowers being solvent on their debt obligations. This friction limits the collateralization of bankers' financial assets beyond that of other assets that are not involved in more than one layer of financial contracting. In this context, increasing the pledgeability of financial assets eases more credit and reduces the spread between the loan and the deposit rate, thus attenuating capital misallocation as it typically emerges in credit economies a la Kiyotaki and Moore (1997). We uncover a close connection between the collateralization of bank loans, macroeconomic amplification of shocks and the degree of procyclicality of bank leverage. A regulator may reduce macroeconomic volatility through the introduction of a countercyclical capital buffer, while a fixed capital adequacy requirement displays limited stabilization power.
    Keywords: Banking; Bank Collateral; Liquidity; Capital Misallocation; Macroprudential Policy.
    JEL: E32 E44 G21 G28
    Date: 2018–02
  14. By: Robin Döttling (University of Amsterdam)
    Abstract: How do near-zero interest rates affect bank competition, risk taking and regulation? I study these questions in a tractable dynamic general equilibrium model, in which forward-looking banks compete imperfectly for deposit funding, and deposit insurance may induce excessive risk taking. The zero lower bound on deposit rates (ZLB) distorts bank competition and boosts risk shifting incentives, particularly if rates are expected to remain near-zero for long. At the ZLB, capital regulation becomes a less effective tool to curb risk shifting incentives. When banks cannot pass on the cost of capital to depositors, tight capital requirements erode franchise value, countervailing the usual "skin in the game" effect. Optimal capital requirements vary with the interest rate cycle, highlighting a novel interaction between monetary and macro-prudential policies. Complementing existing regulation with policy tools that subsidize the funding cost of banks may improve welfare at the ZLB.
    Keywords: Zero lower bound; search for yield; capital regulation; bank competition; risk shifting; franchise value
    JEL: G21 G28 E43
    Date: 2018–02–28
  15. By: Benchimol, Jonathan (Bank of Israel); Bounader, Lachen (Mohammed V University)
    Abstract: Optimal monetary policy under discretion, commitment, and optimal simple rules regimes is analyzed through a behavioral New Keynesian model. Flexible price level targeting dominates under discretion; flexible inflation targeting dominates under commitment; and strict price level targeting dominates when using optimal simple rules. Stabilizing properties and bounded rationality-independence generally affect the regime's optimality. The policymaker's knowledge of an agent's myopia is decisive, whereas bounded rationality is not necessarily associated with decreased welfare. Several forms of economic inattention can be welfare increasing.
    JEL: C53 D01 D11 E37 E52
    Date: 2018–01–01
  16. By: Bagis, Bilal
    Abstract: The Turkish social insurance system has been feverishly debated for years, particularly through its burden on the economy. The most recent reform is an attempt to neutralize the deterioration within the social security system and its effects on the economy. After the recent reform, ‘the way that retirement benefits are calculated’ is changed unfavorably for workers and the minimum age for retirement is increased. In particular, for an agent with 25 years of social security tax payments, the replacement rate is down from 65 percent to 50 percent. On the other hand, retirement age is up from 60 to 65. The aim of this paper is to investigate the macroeconomic effects of these changes using an OLG model. The author’s findings indicate that labor supply, output and capital stock increase when changes above are applied to the benchmark economy calibrated to the Turkish economy data in 2005. A critical change with the current reform is that the marginal benefit of working has become uniform over ages. In a simulation exercise, the marginal retirement benefit in the benchmark economy is changed to be uniform over ages while keeping the size of social security system unchanged. As a result, the benefit of retiring at a later period increases. However, uniform distribution of the marginal benefits itself decreases both the capital stock and output of the economy. Increasing the retirement age has positive effects on the economy since agents obtain retirement benefits for fewer years and at an older age.
    Keywords: Social Security Reform, Retirement Age, Replacement Rate, Macroeconomics.
    JEL: D1 E2 H2 H5 J1 J2
    Date: 2017–02
  17. By: Atalay, Enghin (University of Wisconsin-Madison); Drautzburg, Thorsten (Federal Reserve Bank of Philadelphia); Wang, Zhenting (Tianhong Asset Management)
    Abstract: Using a multi-industry real business cycle model, we empirically examine the microeconomic origins of aggregate tail risks. Our model, estimated using industry-level data from 1972 to 2016, indicates that industry-specific shocks account for most of the third and fourth moments of GDP growth.
    Keywords: production networks; business cycles; tail risk
    JEL: D5 E2 E3
    Date: 2018–02–05
  18. By: David Finck (University of Giessen); Joerg Schmidt (University of Giessen); Peter Tillmann (University of Giessen)
    Abstract: We study the role of monetary policy for the dynamics of U.S. mortgage debt, which is the largest component of household indebtedness. A time-varying parameter VAR model allows us to study the variation in the mortgage debt sensitivity to monetary policy. We find that an identically-sized policy shock became less effective over time. We use a DSGE model to show that a fall in the share of adjustable-rate mortgages (ARMs) could replicate this finding. Calibrating the model to the drop in the ARM share since the 1980s yields a drop in the sensitivity of housing debt to monetary policy which is quantitatively similar to the VAR results. A sacrifice ratio for mortgage debt reveals that a policy tightening directed towards reducing household debt became more expensive in terms of a loss in employment. Counterfactuals show that this result cannot be attributed to changes in monetary policy itself. The results are consistent with the "mortgage rate conundrum" found by Justiniano et al. (2017) and have strong implications for policy.
    Keywords: mortgage debt, monetary policy, deleveraging, time-varying VAR, DSGE
    JEL: E3 E5 G2
    Date: 2018
  19. By: Jordi Galí
    Abstract: I analyze the effectiveness of forward guidance policies in open economies, focusing on the role played by the exchange rate in their transmission. An open economy version of the "forward guidance puzzle" is shown to emerge. In partial equilibrium, the effect on the current exchange rate of an anticipated change in the interest rate does not decline with the horizon of implementation. In general equilibrium, the size of the effect is larger the longer is that horizon. Empirical evidence using U.S. and euro area data euro-dollar points to the presence of a forward guidance exchange rate puzzle: expectations of interest rate differentials in the near (distant) future have much larger (smaller) effects on the euro-dollar exchange rate than is implied by the theory.
    Keywords: forward guidance puzzle, uncovered interest rate parity, unconventional monetary policies, open economy New Keynesian model
    JEL: E43 E58 F41
    Date: 2018–02
  20. By: Luca Marchiori
    Abstract: This study analyzes the macroeconomic implications of virtual currency issuance. It builds on a standard cash-in-advance model extended with (i) ‘virtual’ goods, sold against virtual currency, and (ii) miners, the agents providing payment services. The main finding is that virtual currency growthmay have effects opposite to those predicted by monetary theory when miners are rewarded with newly created coins. Declining currency issuance, as in Bitcoin, raises the price of virtual goods, which counteracts the traditional impact of a reduced inflation tax. The paper also shows how fiat money growth affects the welfare effects of virtual currency creation.
    Keywords: Cash-in-advance, virtual currency, fiat money, money supply
    JEL: E41 E42 E51
    Date: 2018–02
  21. By: Marx, Magali (Banque de France); Mojon, Benoit (Banque de France); Velde, Francois R. (Federal Reserve Bank of Chicago)
    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 with recursive preferences, 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).
    Keywords: Interest rates; secular stagnation; risk; return on capital
    JEL: E00 E40
    Date: 2018–01–25

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