nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2018‒03‒12
eighteen 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. Housing Market Dynamics with Search Frictions By Victor Ortego-Marti; Miroslav Gabrovski
  3. Monetary policy and the asset risk-taking channel By Angela Abbate; Dominik Thaler
  4. Bounded-rationality and heterogeneous agents: Long or short forecasters? By Beqiraj Elton; Di Bartolomeo Giovanni; Di Pietro Marco; Serpieri Carolina
  5. US financial shocks and the distribution of income and consumption in the UK By Haroon Mumtaz; Konstantinos Theodoridis
  6. Fiscal transfers in a monetary union with sovereign risk By Guilherme Bandeira
  7. The Optimal Inflation Target and the Natural Rate of Interest By Andrade, Philippe; Galí, Jordi; Lebihan, Hervé; Matheron, Julien
  8. Regional Consumption Responses and the Aggregate Fiscal Multiplier By Dupor, William D.; Karabarbounis, Marios; Kudlyak, Marianna; Mehkari, M. Saif
  9. Bubbly Recessions By Biswas, Siddhartha; Hanson, Andrew; Phan, Toan
  10. Uncertainty-dependent Effects of Monetary Policy Shocks: A New Keynesian Interpretation By Efrem Castelnuovo; Giovanni Pellegrino
  11. Estimates of Fiscal Multipliers using MEDSEA By Noel Rapa
  12. Premature Deaths, Accidental Bequests and Fairness By Marc Fleurbaey; Marie-Louise Leroux; Pierre Pestieau; Grégory Ponthiere; Stéphane Zuber
  13. Technological Progress, the Supply of Hours Worked, and the Consumption-Leisure Complementarity By Andreas Irmen
  14. Pricing Assets in a Perpetual Youth Model By Roger Farmer; Pawel Zabczyk
  15. Can subsidising job-related training reduce inequality? By Konstantinos Angelopoulos; Andrea Benecchi; James Malley
  16. Debt Sustainability and Welfare along an Optimal Laffer Curve By Xiaoshan Chen; Campbell Leith; Matta Ricci
  17. Ambiguity and the historical equity premium By Fabrice Collard; Sujoy Mukerji
  18. The Effect of News Shocks and Monetary Policy By Luca Gambetti; Dimitris Korobilis; John D. Tsoukalas; Francesco Zanetti

  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; Overlapping Generations; precautionary saving; Taxation of Capital
    JEL: E21 H21 H31
    Date: 2018–02
  2. By: Victor Ortego-Marti (Department of Economics, University of California Riverside); Miroslav Gabrovski (UC Riverside)
    Abstract: This paper develops a business cycle model of the housing market with search frictions and entry of both buyers and sellers. The housing market exhibits a well-established cyclical component, which features three stylized facts: prices move in the same direction as sales and the number of houses for sale, but opposite to the time it takes to sell a house. These stylized facts imply that in the data vacancies and the number of buyers are positively correlated, i.e. that the Beveridge Curve is upward sloping. A baseline search and matching model of the housing market is unable to match these stylized facts because it inherently generates a downward sloping Beveridge Curve. With free entry of both buyers and sellers, our model reproduces the positive correlation between prices, sales, and housing vacancies, and matches the stylized facts qualitatively and quantitatively.
    Keywords: Housing market; business cycles; search and matching; Beveridge Curve
    JEL: E2 E32 R21 R31
    Date: 2018–03
  3. By: Angela Abbate (Swiss National Bank); Dominik Thaler (Banco de España)
    Abstract: How important is the risk-taking channel for monetary policy? To answer this question, we develop and estimate a quantitative monetary DSGE model where banks choose excessively risky investments, due to an agency problem which distorts banks’ incentives. As the real interest rate declines, these distortions become more important and excessive risk taking increases, lowering the efficiency of investment. We show that this novel transmission channel generates a new and quantitatively significant monetary policy trade-off between inflation and real interest rate stabilization: it is optimal for the central bank to tolerate greater inflation volatility in exchange for lower risk taking.
    Keywords: bank risk, monetary policy, DSGE models
    JEL: E12 E44 E58
    Date: 2018–02
  4. By: Beqiraj Elton; Di Bartolomeo Giovanni; Di Pietro Marco; Serpieri Carolina
    Abstract: Our paper estimates and compares behavioral New-Keynesian DSGE models derived under two alternative ways to introduce heterogeneous expectations. We assume that agents may be either short-sighted or long-horizon forecasters. The difference does not matter when agents have rational expectations, but it does when a fraction of them form beliefs about the future according to some heuristics. Bayesian estimations show that a behavioral model based on short forecasters fits the data better than one based on long forecasters. Long-horizon predictors exhibit very poor predictive ability, whereas the short forecasters' model also outperforms the rational expectation framework. We show that the superiority is due to its ability to capture heterogeneous consumers' expectations. Finally, by Monte-Carlo-filtering mapping, we investigate the indeterminacy regions to complement existing literature.
    Date: 2017–11
  5. By: Haroon Mumtaz (Queen Mary University of London); Konstantinos Theodoridis (Cardiff Business School)
    Abstract: We show that US financial shocks have an impact on the distribution of UK income and consumption. Households with higher income and higher levels of consumption are affected more by this shock than households located towards the lower end of these distributions. An estimated multiple agent DSGE model suggests that the heterogeneity in the household responses can be explained by the different levels of access to financial markets. We find that this heterogeneity magnifies the effect of this shock on aggregate output.
    Keywords: FAVAR, DSGE model, Financial Shock
    JEL: D31 E32 E44
    Date: 2018–01–29
  6. By: Guilherme Bandeira (Banco de España)
    Abstract: This paper investigates the welfare and economic stabilization properties of a fiscal transfers scheme between members of a monetary union subject to sovereign spread shocks. The scheme, which consists of cross-country transfer rules triggered when sovereign spreads widen, is incorporated in a two-country model with financial frictions. In particular, banks hold government bonds in their portfolios, being exposed to sovereign risk. When this increases, a drop bank’s equity value forces them to contract credit and to raise lending rates at the same time as they retain funds to build up their net worth. I show that, when domestic fiscal policy is not distortionary, fiscal transfers improve welfare and macroeconomic stability. This is because fiscal transfers can reduce banks’ exposure to government debt, freeing credit supply to the private sector. On the contrary, when domestic fiscal policy is distortionary, fiscal transfers cause welfare losses, despite stabilizing the economy. This result arises because the distortions caused by funding the scheme outweigh the positive effects of fiscal transfers in smoothing the adjustment of the economy hit by the shock.
    Keywords: sovereign risk, banks, monetary union, fiscal transfers
    JEL: E62 F41 F42
    Date: 2018–02
  7. By: Andrade, Philippe; Galí, Jordi; Lebihan, Hervé; Matheron, Julien
    Abstract: We study how changes in the value of the steady-state real interest rate affect the optimal inflation target, both in the U.S. and the euro area, using an estimated New Keynesian DSGE model that incorporates the zero (or effective) lower bound on the nominal interest rate. We find that this relation is downward sloping, but its slope is not necessarily one-for-one: increases in the optimal inflation rate are generally lower than declines in the steady-state real interest rate. Our approach allows us not only to assess the uncertainty surrounding the optimal inflation target, but also to determine the latter while taking into account the parameter uncertainty facing the policy maker, including uncertainty with regard to the determinants of the steady-state real interest rate. We find that in the currently empirically relevant region for the US as well as the euro area, the slope of the curve is close to -0.9. That finding is robust to allowing for parameter uncertainty.
    Keywords: effective lower bound; inflation target
    JEL: E31 E52 E58
    Date: 2018–02
  8. By: Dupor, William D. (Federal Reserve Bank of St. Louis); Karabarbounis, Marios (Federal Reserve Bank of Richmond); Kudlyak, Marianna (Federal Reserve Bank of San Francisco); Mehkari, M. Saif (University of Richmond)
    Abstract: We use regional variation in the American Recovery and Reinvestment Act (2009-2012) to analyze the effect of government spending on consumer spending. Our consumption data come from household-level retail purchases in Nielsen and auto purchases from Equifax credit balances. We estimate that a $1 increase in county-level government spending increases consumer spending by $0.18. We translate the regional consumption responses to an aggregate fiscal multiplier using a multi-region, New Keynesian model with heterogeneous agents and incomplete markets. Our model successfully generates the estimated positive local multiplier, a result that distinguishes our incomplete markets model from models with complete markets. The aggregate consumption multiplier is 0.4, which implies an output multiplier higher than one. The aggregate consumption multiplier is almost twice the local estimate because trade linkages propagate government spending across regions.
    Keywords: Consumer Spending; Fiscal Multiplier; Regional Variation; Heterogeneous Agents.
    JEL: E21 E62 H31 H71
    Date: 2018–02–20
  9. By: Biswas, Siddhartha (University of North Carolina at Chapel Hill); Hanson, Andrew (University of North Carolina at Chapel Hill); Phan, Toan (Federal Reserve Bank of Richmond)
    Abstract: We develop a tractable rational bubbles model with financial frictions, downward nominal wage rigidity, and the zero lower bound. The interaction of financial frictions and nominal rigidities leads to a "bubbly pecuniary externality," where competitive speculation in risky bubbly assets can result in excessive investment booms that precede inefficient busts. The collapse of a large bubble can push the economy into a "secular stagnation" equilibrium, where the zero lower bound and the nominal wage rigidity constraint bind, leading to a persistent and inefficient recession. We evaluate a macroprudential leaning-against-the-bubble policy that balances the trade-off between the booms and busts of bubbles.
    Keywords: recessions; bubbles; secular stagnation
    JEL: E10 E21 E40 E44
    Date: 2018–02–22
  10. By: Efrem Castelnuovo; Giovanni Pellegrino
    Abstract: We estimate a nonlinear VAR model to study the real effects of monetary policy shocks in regimes characterized by high vs. low macroeconomic uncertainty. We find unexpected monetary policy moves to exert a substantially milder impact in presence of high uncertainty. We then exploit the set of impulse responses coming from the nonlinear VAR framework to estimate a medium-scale new-Keynesian DSGE model with a minimum-distance approach. The DSGE model is shown to be able to replicate the VAR evidence in both regimes thanks to different estimates of some crucial structural parameters. In particular, we identify a steeper new-Keynesian Phillips curve as the key factor behind the DSGE model’s ability to replicate the milder macroeconomic responses to a monetary policy shock estimated with our VAR in presence of high uncertainty. A version of the model featuring firm-specific capital is shown to be associated to estimates of the price frequency which are in line with some recent evidence based on micro data.
    Keywords: monetary policy shocks, uncertainty, Threshold VAR, medium scale DSGE framework, minimum-distance estimation
    JEL: C22 E32 E52
    Date: 2017
  11. By: Noel Rapa (Central Bank of Malta)
    Abstract: This paper documents the fiscal extension to MEDSEA, the Central Bank of Malta DSGE model. The model contains a relatively rich fiscal sector. Decisions made by the agents in the model are affected by distortionary taxes on labour income, capital income and consumption. On the expenditure side, the model distinguishes between public sector expenditure on final goods and services, public investment, public employment as well as transfers to households. The model is used to assess the size of fiscal multipliers in a very open and small open economy such as Malta. Both transitory and permanent shocks are considered. It also allows for changes in the instrument used to finance the change in fiscal policy.
    JEL: E62 H63
    Date: 2017
  12. By: Marc Fleurbaey; Marie-Louise Leroux; Pierre Pestieau; Grégory Ponthiere; 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
  13. By: Andreas Irmen
    Abstract: At least since 1870 hours worked per worker declined and real wages increased in many of today’s industrialized countries. The dual nature of technological progress in conjunction with a consumption-leisure complementarity explains these stylized facts. Technological progress drives real wages up and expands the amount of available consumption goods. Enjoying consumption goods increases the value of leisure. Therefore, individuals demand more leisure and supply less labor. This mechanism appears in an OLG-model with two-period lived individuals equipped with per-period utility functions of the generalized log-log type proposed by Boppart-Krusell (2016). The optimal plan is piecewise defined and hinges on the wage level. Technological progress moves a poor economy out of a regime with low wages and an inelastic supply of hours worked into a regime where wages increase further and hours worked continuously decline.
    Keywords: technological change, capital accumulation, endogenous labor supply, OLG-model
    JEL: D91 J22 O33 O41
    Date: 2018
  14. By: Roger Farmer; Pawel Zabczyk
    Abstract: We refer to the idea that government must ‘tighten its belt’ as a necessary policy response to higher indebtedness as the household fallacy. We provide a reason to be skeptical of this claim that holds even if the economy always operates at full employment and all markets clear. Our argument rests on the fact that, in an overlapping-generations (OLG) model, changes in government debt cause changes in the real interest rate that redistribute the burden of repayment across generations. We do not rely on the assumption that the equilibrium is dynamically inefficient, and our argument holds in a version of the OLG model where the real interest rate is always positive.
    Keywords: deficit, austerity, government budget
    JEL: E0 H62
    Date: 2018–03
  15. By: Konstantinos Angelopoulos; Andrea Benecchi; James Malley
    Abstract: A well-established stylised fact is that employer provided job-related training raises productivity and wages. Using UK data, we further find that job-related training is positively related to subsidies aimed at reducing training costs for employers. We also find that there is a positive, albeit quantitatively small, relationship between wage inequality and training in- equality in the UK. Motivated by the above, we explore whether policies to subsidise firms monetary cost of training can improve earnings for the lower skilled and reduce inequality. We achieve this by developing a dynamic gen- eral equilibrium model, featuring skilled and unskilled labour, capital-skill complementarity in production and an endogenous training allocation. Our results suggest that training subsidies for the unskilled have a significant impact on the labour income of unskilled workers. These subsides also in- crease earnings for skilled workers and raise aggregate income with implied lifetime multipliers exceeding unity. Finally, the positive spill over effects to skilled workers imply that training subsidies are not very effective in re- ducing inequality, measured as the distance between skilled and unskilled wages and incomes.
    Keywords: Job-related training, wage and earning inequality, training subsidies
    JEL: E24 J24 J31
    Date: 2017–08
  16. By: Xiaoshan Chen; Campbell Leith; Matta Ricci
    Abstract: A recent literature on sovereign debt sustainability (see Trabandt and Uhlig (2011) and Mendoza et al. (2014)) has produced Laffer curve calculations for Eurozone countries. These calculations have been car- ried out mainly in a quasi-static fashion by considering policy experi- ments where individual tax rates are permanently set at a new value while keeping all others constant. However, such fiscal policy design disregards complementarities among tax instruments as well as the po- tential for altering tax rates during the transition to the steady-state in a manner which exploits expectations. Our paper addresses this issue by considering policy experiments where fiscal policy is set op- timally and fiscal instruments are jointly varied along the transition to steady-state. Through the Ramsey problem we map the maximum amount of tax revenues a government can further raise to the welfare costs of the associated tax distortions. We label this relation as the ‘optimal Laffer curve’. We show that tax revenue and welfare gains relative to the policy experiments examined by the previous literature are dramatic.
    Keywords: Laffer Curve, Optimal Policy, Fiscal Sustainability, Fis- cal Limit, Fiscal Consolidations
    JEL: E62 H30 H60
    Date: 2018–01
  17. By: Fabrice Collard (Department of Economics, University of Bern); Sujoy Mukerji (Queen Mary University of London)
    Abstract: This paper assessed the quantitative impact of ambiguity on historically observed financial asset returns and growth rates. The single agent, in a dynamic exchange economy, treats the conditional uncertainty about the consumption and dividends next period as ambiguous. We calibrate the agent's ambiguity aversion to match only the first moment of the risk-free rate in data and measure the uncertainty each period conditional on the actual, observed histroy of (U.S.) macroeconomic growth outcomes. Ambiguity aversion accentuates the conditional uncertainty endogenously in a dynamic way, depending on the history; e.g., it increases during recessions. We show the model implied time series of asset returns substantially match the first and second conditional moments of observed return dynamics. In particular, we find the time-series properties of our mdoel generated equity premium, which may be regarded as an index measure of revealed uncertainty, relates closely to those of the macroeconomic uncertainty indices developed recently in Jurado, Ludvigson, and Ng (2015) and Carriero, Clark, and Marcellino (2017).
    Keywords: Ambiguity aversion, Asset pricing, Equity premium puzzle, Time-varying uncertainty, Uncertainty shocks
    JEL: G12 E21 D81 C63
    Date: 2017–09–15
  18. By: Luca Gambetti; Dimitris Korobilis; John D. Tsoukalas; Francesco Zanetti
    Abstract: A VAR model estimated on U.S. data before and after 1980 documents systematic differences in the response of short- and long-term interest rates, corporate bond spreads and durable spending to news TFP shocks. Interest rates across the maturity spectrum broadly increase in the pre-1980s and broadly decline in the post-1980s. Corporate bond spreads decline significantly, and durable spending rises significantly in the post-1980 period while the opposite short-run response is observed in the pre-1980 period. Measuring expectations of future monetary policy rates conditional on a news shock suggests that the Federal Reserve has adopted a restrictive stance before the 1980s with the goal of retaining control over inflation while adopting a neutral/accommodative stance in the post-1980 period.
    Keywords: News shocks, Business cycles, VAR models, DSGE models
    JEL: E20 E32 E43 E52
    Date: 2017–09

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