nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2018‒03‒19
thirty-six 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 Dirk Krueger; Alexander Ludwig
  2. Labor Market Institutions and the Cost of Recessions By Martin Scheffel; Tom Krebs
  3. Term structure and real-time learning By Pablo Aguilar; Jesús Vázquez
  4. The effects of fiscal policy in an estimated DSGE model: The case of the German stimulus packages during the great recession By Drygalla, Andrej; Holtemöller, Oliver; Kiesel, Konstantin
  5. Positive and Normative Implications of Liability Dollarization for Sudden Stops Models of Macroprudential Policy By Enrique G. Mendoza; Eugenio I. Rojas
  6. Fiscal Policy Interventions at the Zero Lower Bound By Boubaker, Sabri; Nguyen, Duc Khuong; Paltalidis, Nikos
  7. Financial Frictions, Volatility, and Skewness By David Zeke
  8. Learning, On-the-Job Search and Wage-Tenure Contracts By Kevin Fawcett; Shouyong Shi
  9. Nonlinear Household Earnings Dynamics, Self-insurance, and Welfare By Mariacristina De Nardi; Giulio Fella; Gonzalo Paz Pardo
  10. The Optimal Inflation Target and the Natural Rate of Interest By Philippe Andrade; Jordi Galí; Hervé Le Bihan; Julien Matheron
  11. Structural Transformation by Cohort By Todd Schoellman; Bart Hobijn
  12. Optimal capital and labor income taxation in small and developing countries By Avdiu, Besart
  13. Pensions, Retirement, and the Disutility of Labor: Bunching in Brazil By Benjamin Thompson
  14. An introduction of a simple monetary policy with savings taxation in the overlapping generations model By Taro Ikeda
  15. Optimal fiscal policy with environmental tax and abatement spending in a model with pollution and utility-enhancing environmental quality: the case of Bulgaria By Vasilev, Aleksandar
  16. Money Aggregates and Determinacy : A Reinterpretation of Monetary Policy During the Great Inflation By Qureshi, Irfan
  17. Insuring entrepreneurial downside risk By Sumudu Kankanamge; Alexandre Gaillard
  18. Protectionism and the Business Cycle By Alessandro Barattieri; Matteo Cacciatore; Fabio Ghironi
  19. International co-movements in recessions By Moritz A. Roth
  20. A Real-Business-Cycle model with pollution and environmental taxation: the case of Bulgaria By Vasilev, Aleksandar
  21. The Competition Between Cash and Mobile Payments in Markets with Mobile Partnerships A Monetary Search Model Point of View By Françoise Vasselin
  22. Saving and Wealth Inequality By Mariacristina De Nardi; Giulio Fella
  23. Comparing different data descriptors in Indirect Inference tests on DSGE models By Meenagh, David; Minford, Patrick; Wickens, Michael; Xu, Yongdeng
  24. Comparing Central Europe and the Baltic macro-economies: A Bayesian approach By Beqiraj, Elton; Di Bartolomeo, Giovanni; Di Pietro, Marco; Serpieri, Carolina
  25. Demand Shocks and Labor Market Dynamics: Firm Level Responses to a Commodity Boom By Sergio Urzua; Felipe Saffie; Felipe Benguria
  26. Population aging and cross-country redistribution in integrated capital markets By Davoine, Thomas
  27. The side effects of safe asset creation By Acharya, Sushant; Dogra, Keshav
  28. Levered Ideas: Risk Premia along the Credit Cycle By Lukas Schmid; Wenxi Liao
  29. Stock Market Cross-Sectional Skewness and Business Cycle Fluctuations By Thiago Revil T. Ferreira
  30. The Side Effects of Safe Asset Creation By Keshav Dogra; Sushant Acharya
  31. Financial Stability and Fractional Reserve Banking By Shengxing Zhang; Cyril Monet; Stephan Imhof
  32. Gilded Bubbles By David Perez-Reyna; Xavier Freixas
  33. Monetary Policy, Oil Stabilization Fund and the Dutch Disease By Jean-Pierre Allegret; Mohamed Tahar Benkhodjay; Tovonony Razafindrabe
  34. Social capital, human capital and fertility By Raffaella Coppier; Fabio Sabatini; Mauro Sodini
  35. Income Inequality, Financial Crises and Monetary Policy By Isabel Cairo; Jae Sim
  36. Dynamic Information Acquisition and Home Bias in Portfolios By Rosen Valchev

  1. By: Dirk Krueger; Alexander Ludwig
    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.
    JEL: E21 H21 H31
    Date: 2018–02
  2. By: Martin Scheffel (University of Cologne); Tom Krebs (University of Mannheim)
    Abstract: This paper studies the effect of two labor market institutions, unemployment insurance (UI) and job search assistance (JSA), on the output cost and welfare cost of recessions. The paper develops a tractable incomplete-market model with search unemployment, skill depreciation during unemployment, and idiosyncratic as well as aggregate labor market risk. The theoretical analysis shows that an increase in JSA and a reduction in UI reduce the output cost of recessions by making the labor market more fluid along the job finding margin and thus making the economy more resilient to macroeconomic shocks. In contrast, the effect of JSA and UI on the welfare cost of recessions is in general ambiguous. The paper also provides a quantitative application to the German labor market reforms of 2003-2005, the so-called Hartz reforms, which improved JSA (Hartz III reform) and reduced UI (Hartz IV reform). According to the baseline calibration, the two labor market reforms led to a substantial reduction in the output cost of recessions and a moderate reduction in the welfare cost of recessions in Germany.
    Date: 2017
  3. By: Pablo Aguilar (Banco de España); Jesús Vázquez (Universidad del País Vasco (UPV/EHU))
    Abstract: This paper introduces the term structure of interest rates into a medium-scale DSGE model. This extension results in a multi-period forecasting model that is estimated under both adaptive learning and rational expectations. Term structure information enables us to characterize agents’ expectations in real time, which addresses an imperfect information issue mostly neglected in the adaptive learning literature. Relative to the rational expectations version, our estimated DSGE model under adaptive learning largely improves the model fit to the data, which include not just macroeconomic data but also the yield curve and the consumption growth and inflation forecasts reported in the Survey of Professional Forecasters. Moreover, the estimation results show that most endogenous sources of aggregate persistence are dramatically undercut when adaptive learning based on multi-period forecasting is incorporated through the term structure of interest rates.
    Keywords: real-time adaptive learning, term spread, multi-period forecasting, short-versus long-sighted agents, SPF forecasts, medium-scale DSGE model
    JEL: C53 D84 E30 E44
    Date: 2018–01
  4. By: Drygalla, Andrej; Holtemöller, Oliver; Kiesel, Konstantin
    Abstract: In this paper, we analyse the effects of the stimulus packages adopted by the German government during the Great Recession. We employ a standard mediumscale dynamic stochastic general equilibrium (DSGE) model extended by nonoptimising households and a detailed fiscal sector. In particular, the dynamics of spending and revenue variables are modeled as feedback rules with respect to the cyclical component of output. Based on the estimated rules, fiscal shocks are identified. According to the results, fiscal policy, in particular public consumption, investment, transfers and changes in labour tax rates including social security contributions prevented a sharper and prolonged decline of German output at the beginning of the Great Recession, suggesting a timely response of fiscal policy. The overall effects, however, are small when compared to other domestic and international shocks that contributed to the economic downturn. Our overall findings are not sensitive to the allowance of fiscal foresight.
    Keywords: fiscal policy shocks,DSGE model,Bayesian inference,stimulus packages
    JEL: C32 E32 E62
    Date: 2017
  5. By: Enrique G. Mendoza; Eugenio I. Rojas
    Abstract: "Liability dollarization,'' namely intermediation of capital inflows in units of tradables into domestic loans in units of aggregate consumption, adds three important effects driven by real-exchange-rate fluctuations that alter standard models of Sudden Stops significantly: Changes on the debt repayment burden, on the price of new debt, and on a risk-taking incentive (i.e. a negative premium on domestic debt). Under perfect foresight, the first effect makes Sudden Stops milder and multiple equilibria harder to obtain. The three effects add an ``intermediation externality'' to the macroprudential externality of standard models, which is present even without credit constraints. Optimal policy under commitment can be decentralized equally by taxing domestic credit or capital inflows, and hence capital controls as a separate instrument are not justified. This optimal policy is time-inconsistent and follows a complex, non-linear schedule. Quantitatively, an optimized pair of constant taxes on domestic debt and capital inflows makes crises slightly less likely and yields a small welfare gain, but other pairs reduce welfare sharply. For high effective debt taxes, capital controls and domestic debt taxes are again equivalent, and for low ones welfare is higher with higher taxes on domestic debt than on capital inflows.
    JEL: E44 F34 F41
    Date: 2018–02
  6. By: Boubaker, Sabri; Nguyen, Duc Khuong; Paltalidis, Nikos
    Abstract: We build on a New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model to explore the macroeconomic consequences of fiscal expansionary shocks during the economic crisis of 2008 in the eurozone. In this setting, we find that the big four eurozone economies (France, Germany, Italy, and Spain) can effectively escape from their liquidity trap through fiscal policy interventions caused by government purchases. We estimate the government spending multiplier to be above 1.8 when this policy is associated with a long-term commitment to keeping the nominal interest rate at the zero lower bound, as suggested by Krugman (1998). Notably, the short-term deficit effect on the budget balance can be offset five years after the implementation of a large spending program. We also show that alternative policies with tax cuts that expand the supply do not appear to have the same power in the short run. Moreover, we provide novel empirical evidence that a large government debt renders a government spending policy ineffective.
    Keywords: Fiscal policy; Liquidity trap; Fiscal multipliers; Zero lower bound
    JEL: E12 E52 E62 E63
    Date: 2016–12
  7. By: David Zeke (University of Southern California)
    Abstract: A number of recent papers use the interaction of firm idiosyncratic volatility shocks with firm financial frictions to explain business cycle fluctuations. I argue that a key parameter for these models is the cost of default, as it has a quantitatively first-order effect on the magnitude of the decline in employment and other aggregates in response to idiosyncratic volatility shocks. I use firm-level panel data and a structural model of financial frictions and volatility shocks to assess the role of volatility shocks and the cost of default on firm and aggregate employment over the business cycle. I find that when the cost of default is calibrated to the range of estimates coming from the corporate finance literature, the model reproduces key cross-sectional moments of equity volatility, bond spreads, and employment growth. However, this calibration implies aggregate employment losses driven by shocks to firm idiosyncratic volatility are modest. I propose two additional shocks calibrated using firm-level panel data which could amplify the decline in employment in the context of such a model. First, the decline in employment is amplified when the increase in firm idiosyncratic risk is modeled not only as a positive second moment shock but also a negative third moment shock. Second, a plausible increase in the cost of default over the business cycle can interact with volatility shocks to dramatically reduce aggregate employment.
    Date: 2017
  8. By: Kevin Fawcett; Shouyong Shi
    Abstract: When workers have incomplete information about their ability, they can learn about this ability by searching for jobs, both while employed and unemployed. Search outcomes yield information for updating the belief about the ability which affects optimal search decisions in the future. Firms respond to updated beliefs by altering vacancy creation and optimal wage contracts. To study equilibrium interactions between learning and search, this paper integrates learning into a search equilibrium with on-the-job search and wage-tenure contracts. The model generates results that shed light on a number of empirical facts, such as wage cuts in job-to-job transition, wage growth over tenure, true duration dependence of unemployment, and frictional wage inequality. We calibrate the model to quantify the extent to which learning and on-the-job search explain these empirical facts.
    Keywords: Learning; On-the-job search; Contracts; Inequality
    JEL: E21 E24 J60
    Date: 2018–03–09
  9. By: Mariacristina De Nardi; Giulio Fella; Gonzalo Paz Pardo
    Abstract: Earnings dynamics are much richer than typically assumed in macro models with heterogenous agents. This holds for individual-pre-tax and household-post-tax earnings and across administrative (Social Security Administration) and survey (Panel Study of Income Dynamics) data. We study the implications of two household-post-tax earnings processes in a standard life-cycle model: the canonical earnings process (that includes a persistent and a transitory shock) and a rich earnings dynamics process (that allows for age-dependence of moments, non-normality, and nonlinearity in previous earnings and age). Allowing for richer earnings dynamics implies a substantially better fit of the evolution of the cross-sectional consumption inequality over the life cycle and of the individual-level degree of consumption insurance against persistent earnings shocks. Richer earnings dynamics also imply lower welfare costs of earnings risk, but, as the canonical earnings process, do not generate enough concentration at the upper tail of the wealth distribution.
    JEL: E21 H21 J3
    Date: 2018–02
  10. By: Philippe Andrade; Jordi Galí; Hervé Le Bihan; Julien Matheron
    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
    JEL: E31 E51 E58
    Date: 2018–02
  11. By: Todd Schoellman (Arizona State University); Bart Hobijn (ASU)
    Abstract: This paper documents the facts of which workers are reallocated across sectors during the process of structural transformation using repeated cross-sectional microdata covering 47 countries at all levels of development. The key finding is that structural transformation affects primarily the young. More than half of all structural transformation happens between cohorts, meaning that new cohorts choose different sectors than existing ones. Half of the within-cohort reallocation happens by age 30 and most by age 40. We develop and calibrate an overlapping generations model of structural transformation with sector-specific human capital investments that replicates these and other stylized facts. The model generates much slower transitional dynamics than the standard growth model even in the face of a large, one-time shock to TFP.
    Date: 2017
  12. By: Avdiu, Besart
    Abstract: This paper argues that smaller and poorer countries have lower optimal tax rates on capital and labor income than their larger and richer counterparts. It further provides an alternative explanation for such empirically observed differences in tax rates. The model focuses on a closed economy, but is extended by introducing mobile capital. The difference in tax rates here is efficient and not due to tax competition. For the result, less than perfect competition is necessary. The intuition is that monopolistic markups distort markets in a similar way as taxes. Hence, optimal tax rates are inversely related to markups and I show theoretically that smaller and poorer countries have larger markups. Therefore, these countries have lower optimal tax rates. Since smaller and poorer countries face larger competition distortions, there is less space for tax distortions. Hence, a smaller tax rate itself is insufficient to conclude a country is engaging in tax competition. Empirical analysis of the banking industry also shows that smaller and poorer countries have larger markups.
    Keywords: Optimal Taxation, Monopolistic Competition, Developing Countries, International Fiscal Issues, Tax Competition
    JEL: D43 H21 O23
    Date: 2018–03–01
  13. By: Benjamin Thompson (University of Michigan)
    Abstract: Elderly workers in developing countries face certain frictions, such as credit constraints, in their retirement decisions that may not be as common among their counterparts in the developed world, and these concerns may lead workers to work more or less than their preferred number of years. In this study, I firstly use regression discontinuity methods to show that a large fraction of urban male heads of households in Brazil (roughly 45%) react contemporaneously to pension eligibility by retiring. Because retirement is not required to receive the pension and because the return to working does not change discontinuously at the eligibility cutoff, workers should not react contemporaneously unless optimization frictions, such as credit constraints, are at work. Secondly, I develop a model of retirement decisions that explores how pensions in the face of credit constraints can influence such decisions, and I discuss applications of this model to determine how the observed behavior in conjunction with the model can be used to make inferences about welfare and labor supply decisions in the face of different pension values.
    Date: 2017
  14. By: Taro Ikeda (Graduate School of Economics, Kobe University)
    Abstract: In this paper, we introduce a simple monetary policy with savings taxation into Samuelson’s (1958) overlapping generations model. In our model, we confirm that the real market interest rate increases in response to an increase in the rate of the savings taxation as a policy lending rate.
    Keywords: overlapping generations model; monetary policy; savings taxation
    JEL: E10 E20 E52
    Date: 2018–03
  15. By: Vasilev, Aleksandar
    Abstract: This paper characterized optimal fiscal policy - with environmental taxes, and public spending on abatement - in the presence of pollution, and evaluated it relative to the exogenous (observed) one in Bulgaria, an economy with a largely unreformed and polluting industry. The results are evaluated in light of the optimal environmental taxation of dirty production and the optimal spending on abatement, and the effect of those fiscal measures on the utility-enhancing environmental quality. To this end, a dynamic general-equilibrium model is calibrated to Bulgarian data (1999-2016). The main findings from the computational experiments performed are: (i) The optimal steady-state income tax rate is zero; (ii) The benevolent Ramsey planner provides twenty percent higher utility-enhancing environmental quality; (iii) The optimal level of carbon taxes is almost three times higher, and the optimal level of abatement spending is six times higher; (iv) The optimal steady-state consumption tax is twice lower.
    Keywords: Ramsey policy,pollution,environmental tax,environmental quality
    JEL: C68 Q58
    Date: 2018
  16. By: Qureshi, Irfan (Department of Economics,University of Warwick)
    Abstract: Should a policy rule include money? Including money exerts policy inertia and increases inflation aversion. In a New-Keynesian model with trend inflation,these features guarantee price determinacy even when the Taylor principle is not satisfied. Novel Greenbook data confirm money aggregates as U.S.Federal Open Market Committee policy objectives, enabling monetary policy to insulate the U.S.economy from self-fulfilling fluctuations despite positive trend inflation. A high response to inflation and lowtrend inflation guarantees determinacy post-1982. Cross-country applications highlight the superiority of the rule with money. Raising the inflation target from 2 percent to 4 percent violates the Taylor principle ; including money resolves this issue
    Keywords: Determinacy, Great Inflation, Inflation Target, Money Aggregates, Time-Varying Policy
    JEL: E41 E42 E51 E52 E58 E61 E65
    Date: 2018
  17. By: Sumudu Kankanamge (Toulouse School of Economics); Alexandre Gaillard (Toulouse School of Economics)
    Abstract: This paper examines the effects of entrepreneurial downside risk insurance on the level and composition of the entrepreneurial pool and to a larger extent on unemployment, production and welfare. We build a rich theoretical framework combining occupational choice, heterogenous agents and incomplete markets to address our main policy concerns. Using CPS, SCF and SBO data, we match our economy to fundamental empirical elements on unemployment, entrepreneurship and mobility and provide contributions on the transition between occupations with respect to individual ability such as matching the U-shaped curve of the transition from worker to self-employed or the hump-shaped curve of the reverse transition. Depending on the downside risk insurance policy considered, we find that this insurance can have a significative impact not only on the level of entrepreneurship but also on the firm size in the entrepreneurial pool and production, although the impact on unemployment is modest.
    Date: 2017
  18. By: Alessandro Barattieri; Matteo Cacciatore; Fabio Ghironi
    Abstract: We study the consequences of protectionism for macroeconomic fluctuations. First, using high-frequency trade policy data, we present fresh evidence on the dynamic effects of temporary trade barriers. Estimates from country-level and panel VARs show that protectionism acts as a supply shock, causing output to fall and inflation to rise in the short run. Moreover, protectionism has at best a small positive effect on the trade balance. Second, we build a small open economy model with firm heterogeneity, endogenous selection into trade, and nominal rigidity to study the channels through which protectionism affects aggregate fluctuations. The model successfully reproduces the VAR evidence and highlights the importance of aggregate investment dynamics and micro-level reallocations for the contractionary effects of tariffs. We then use the model to study scenarios where temporary trade barriers have been advocated as potentially beneficial, including recessions with binding constraints on monetary policy easing or in the presence of a fixed exchange rate. Our main conclusion is that, in all the scenarios we consider, protectionism is not an effective tool for macroeconomic stimulus and/or to promote rebalancing of external accounts.
    JEL: E31 E52 F13 F41
    Date: 2018–02
  19. By: Moritz A. Roth (Banco de España)
    Abstract: Business cycle correlations are state-dependent and higher in recessions than in expansions. In this paper, I suggest a mechanism to explain why this is the case. For this purpose, I build an international real business cycle model with occasionally binding constraints on capacity utilization which can account for state-dependent cross-country correlations in GDP growth rates. The intuition is that firms can only use their machines up to a capacity ceiling. Therefore, in booms the growth of an individual economy can be dampened when the economy hits its capacity constraint. This creates an asymmetry that can spill-over to other economies, thereby creating state-dependent cross-country correlations in GDP growth rates. Empirically, I successfully test for the presence of capacity constraints using data from the G7 advanced economies in a Bayesian threshold autoregressive (T-VAR) model. This finding supports capacity constraints as a prominent transmission channel of cross-country GDP asymmetries in recessions compared to expansions.
    Keywords: international business cycles, business cycle asymmetries, GDP co-movement, capacity constraints, occasionally binding constraints
    JEL: E32 E60 F41 F44 F47
    Date: 2018–01
  20. By: Vasilev, Aleksandar
    Abstract: We introduce an environmental dimension into a real-business-cycle model augmented with a detailed government sector. We calibrate the model to Bulgarian data for the period following the introduction of the currency board arrangement (1999-2016). We investigate the quantitative importance of utility-enhancing environmental quality, and the mechanics of environmental ("carbon") tax on polluting production, as well as the effect of government spending on pollution abatement over the cycle. In particular, a positive shock to pollution emission in the model works like a positive technological shock, but its effect is quantitatively very small. Allowing for pollution as a by-product of production improves the model performance against data, and in addition this extended setup dominates the standard RBC model framework, e.g., Vasilev (2009).
    Keywords: Business cycles,pollution,environmental quality,environmental tax,abatement spending
    JEL: E32 C68 Q58
    Date: 2018
  21. By: Françoise Vasselin (MATISSE - Modélisation Appliquée, Trajectoires Institutionnelles et Stratégies Socio-Économiques - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)
    Abstract: A payment platform provides mobile money (M-money) to buyers who can also use cash to transact. An exogenous fraction of " traditional sellers " only accepts cash and creates no partnership with buyers while the remainder fraction consists of " mobile sellers " who accept M-money only and create partnerships with buyers to reduce search frictions. So, buyers without a partner must use cash and buyers with a partner must use M-money to trade. Buyers without a partner may hold cash, M-money, both monies or none while buyers with a partner always choose to hold M-money only or both monies. Hence, we obtain different equilibria where M-money always circulates, alone or in addition to cash. So, the partnership is a valuable coordination mechanism that makes M-money circulation permanent. Our model can explain why it may be useful to implement prescribed usages to trigger the adoption of a new payment instrument that aims to replace cash and why retailers implement partnerships through loyalty programs before the launching of their own M-money application. However, cash disappears only if traditional sellers have almost all disappeared.
    Keywords: cash,mobile payments,search theory,partnerships,investment cost,mobile money
    Date: 2018–03–03
  22. By: Mariacristina De Nardi (University College London); Giulio Fella (Queen Mary University of London)
    Abstract: Why are some people wealth rich while others are poor? To what extent can governments affect inequality? Which instruments should they use? Answering these questions requires understanding why people save. Dynamic quantitative models of wealth inequality can help us to understand and quantify the determinants of the outcomes that we observe in the data and to evaluate the consequences of policy reform. This paper surveys the savings mechanisms generated by the transmission of bequests and human capital, by preference heterogeneity, by rate of return heterogeneity, by entrepreneurship, by richer earnings processes, and by medical expenses. It concludes that the transmission of bequests and human capital, entrepreneurship, and medical-expense risk are crucial determinants of savings and wealth inequality and that we need to look at more data to measure their relative importance.
    Keywords: Human Capital; Bequests; Taxation; Entrepreneurship; Rates of Return; Earnings Shocks
    JEL: E21 D14 D3
    Date: 2017–05–09
  23. By: Meenagh, David (Cardiff Business School); Minford, Patrick (Cardiff Business School); Wickens, Michael (Cardiff Business School); Xu, Yongdeng (Cardiff Business School)
    Abstract: Indirect inference testing can be carried out with a variety of auxiliary models. Asymptotically these different models make no difference. However, in small samples power can differ. We explore small sample power and estimation bias both with different variable combinations and models of description --- Vector Auto Regressions, Impulse Response Functions or Moments (corresponding to the Simulated Methods of Moments) --- in the auxiliary model. We find that VAR and IRF descriptors perform slightly better than Moments but that different three variable combinations make little difference. More than three variables raises power and lowers bias but reduces the chances of finding a tractable model that passes the test.
    Keywords: Indirect Inference, DGSE model, Auxiliary Models, Simulated Moments Method, Impulse Response Functions, VAR, Moments, power, bias
    JEL: C12 C32 C52 E1
    Date: 2018–03
  24. By: Beqiraj, Elton; Di Bartolomeo, Giovanni; Di Pietro, Marco; Serpieri, Carolina
    Abstract: Applying the Bayesian approach, a small open economy DSGE model was estimated using a sample of quarterly data for a macro-region formed by six Central Europe and Baltic economies: Czech Republic, Estonia, Hungary, Lithuania, Poland, and Slovakia. Estimates have been employed to investigate the effects of a financial crisis, exploring the role played by country differences in the relative performances. We also use our Bayesian estimations to compute two measures of resilience in the considered region.
    Keywords: resilience,Bayesian estimations,financial crisis,macroeconomic performance,emerging markets
    JEL: E02 E32 E58
    Date: 2018
  25. By: Sergio Urzua (University of Maryland, College Park); Felipe Saffie (University of Maryland); Felipe Benguria (University of Kentucky)
    Abstract: This paper studies the role of labor markets in the transmission of commodity price super cycles, including the causal association between dynamic labor distortions and recessions during cycle busts. Our theoretical contributions emerge from a three-sector model of a small open economy with firm heterogeneity, entry and exit decisions, and skilled and unskilled labor. We show that during the boom, the commodity and non-tradable sectors expand, the skill wage premium narrows, and the non-commodity export sector contracts. During the bust, on the other hand, downward wage rigidity generates dynamic misallocation between sectors, triggering a persistent recession characterized by unemployment and a sluggish recovery of non-commodity exporters. This opens a door for precautionary policy during the boom. We then present empirical evidence to asses these mechanisms. In particular, we study the case of Brazil between 1996-2013, a period in which large commodity price fluctuations provided a clean quasi-natural experiment. We examine linked employer-employee data and exploit variation across commodities and across regions to measure the direct impact of commodity prices on labor market outcomes of both commodity producing firms and firms in other sectors of the economy. Our empirical evidence support our theoretical implications.
    Date: 2017
  26. By: Davoine, Thomas (Institute for Advanced Studies, Vienna)
    Abstract: Population aging challenges the financing of social security systems in developed economies, as the fraction of the population in working age declines. The resulting pressure on capital-labor ratios translates into a pressure on factor prices and production. While European countries all face this challenge, the speed at which their population ages differs, and thus the pressure on capital-labor ratios. If capital markets are integrated, differences in population aging may lead to cross-country spillovers, as investors freely seek the best returns on capital. Using a multi-country overlapping-generations model covering 14 European Union countries, I quantify spillovers and find that capital market integration leads to redistribution across countries over the long run. For instance, GDP per capita would on average be 2.9 %-points lower in Germany in each of the next 50 years if capital markets were perfectly integrated and public debts kept constants with increases in labor income taxes, compared to a closed economy case; by contrast, GDP per capita would on average be 2.1 %-points higher in France, whose population ages slower than in Germany. I also show that pension reforms can change the cross-country redistribution patterns, some countries losing from capital market integration without the reform but winning with it.
    Keywords: population aging, pension reforms, capital markets, cross-country spillovers, overlapping-generations modelling
    JEL: C68 E60 F41 J11
    Date: 2018–02
  27. By: Acharya, Sushant (Federal Reserve Bank of New York); Dogra, Keshav (Federal Reserve Bank of New York)
    Abstract: We present an incomplete markets model to understand the costs and benefits of increasing government debt in a low interest rate environment. Higher risk increases the demand for safe assets, lowering the natural rate of interest below zero, constraining monetary policy at the zero lower bound, and raising unemployment. Higher government debt satiates the demand for safe assets, raising the natural rate and restoring full employment. While this permanently lowers investment, a policymaker committed to low inflation has no alternative. Higher inflation targets, instead, permit both full employment and high investment, but allow for harmful bubbles. Aggressive fiscal policy can prevent bubbles.
    Keywords: safe assets; negative natural rate; crowding out; risk premium; liquidity traps; bubbles
    JEL: E3 E4 E5 G1 H6
    Date: 2018–03–01
  28. By: Lukas Schmid (Duke University); Wenxi Liao (Fuqua School of Business)
    Abstract: We quantitatively evaluate a general equilibrium model in which the endogenous supply of collateral drives the joint dynamics of credit, risk and risk premia. Endogenous adoption facilitates the transformation of intangible ideas into technology that productive firms can borrow against. In the model, the arrival of new technologies drives the ratio between ideas and collateralizable capital (IC ratio) which is a significant predictor of leverage and returns in stock and corporate bond markets. In particular, a high IC ratio predicts a high market price of risk and high unlevered returns to technology adoption, while a low IC ratio comes with a low market price of risk but high levered returns. Interpreted in the context of venture capitalists (adopters) and buyout funds (levered firms), the model rationalizes repeated, but distinct, venture capital and buyout waves, and returns. Quantitatively, our model of a credit cycle driven by the slow transformation of new ideas into collateralizable assets rationalizes well the predictability evidence in stock and corporate bond markets.
    Date: 2017
  29. By: Thiago Revil T. Ferreira
    Abstract: Using U.S. data from 1926 to 2015, I show that financial skewness—a measure comparing cross-sectional upside and downside risks of the distribution of stock market returns of financial firms—is a powerful predictor of business cycle fluctuations. I then show that shocks to financial skewness are important drivers of business cycles, identifying these shocks using both vector autoregressions and a dynamic stochastic general equilibrium model. Financial skewness appears to reflect the exposure of financial firms to the economic performance of their borrowers.
    Keywords: Cross-Sectional Skewness ; Business Cycle Fluctuations ; Financial Channel
    JEL: C32 E32 E37 E44
    Date: 2018–03–06
  30. By: Keshav Dogra (Federal Reserve Bank of New York); Sushant Acharya (Federal Reserve Bank of New York)
    Abstract: We present a model with incomplete markets in order to understand the costs and benefits of increasing government debt in a low interest rate environment. Higher idiosyncratic risk increases the demand for safe assets and can even lower real interest rates below zero. A fiscal authority can issue more debt to meet this increased demand for safe assets and arrest the decline in real interest rates. While such a policy succeeds in keeping real rates above zero, it comes at a cost as higher real interest rates can lead to permanently lower investment. However, in an environment with nominal rigidities and a zero bound on nominal rates, policymakers may not have a choice. On the one hand, without creating additional safe assets, constrained monetary policy is powerless to combat higher unemployment. On the other hand, creating safe assets can make monetary policy potent again, allowing policymakers to lower unemployment, but such a policy only shifts the malaise elsewhere in the economy where it manifests itself as a permanent investment slump.
    Date: 2017
  31. By: Shengxing Zhang (London School of Economics); Cyril Monet; Stephan Imhof (Swiss National Bank)
    Abstract: We analyze the optimal risk-return trade-off when banks can issue inside money. Optimally the quantity of inside money is restricted by some reserve requirements. Increasing the reserve requirements or decreasing the rate of return on central bank money makes loans to the private sector more expensive. This induces borrowers to take more risk. However, leverage also decline, which induces borrowers to take safer decision. The optimal combination of reserve requirement and inflation trades-off both effects. The Friedman rule or zero reserve requirement is not necessarily optimal, as it would induce too much leverage. In spite of being the safest system, fully backed inside money is not optimal as it reduces leverage too much.
    Date: 2017
  32. By: David Perez-Reyna (Universidad de los Andes); Xavier Freixas (Universitat Pompeu Fabra)
    Abstract: Excessive credit growth and high asset prices increase the probability of a crisis. Because these two variables are determined in equilibrium, the analysis of systemic risk and the cost-benefit analysis of macroprudential regulation requires a specific framework consistent with the empirical observation. We argue that an overlapping generation model of rational bubbles can explain some of the main features of banking crises and, therefore, provide a microfounded framework for the rigorous analysis of macroprudential policy. We find that credit financed bubbles may have a role as a buffer in reducing excessive investiment at the firms' level and, thus, increasing efficiency. Still, when banks have a risk of going bankrupt a trade-off appears between financial stability and efficiency. When this is the case, macroprudential policy has a key role in improving efficiency while preserving financial stability.
    Date: 2017
  33. By: Jean-Pierre Allegret (Université Côte d'Azur, France; GREDEG CNRS); Mohamed Tahar Benkhodjay (ESSCA, School of Management); Tovonony Razafindrabe (CREM, Université Rennes 1)
    Abstract: This paper contributes to the literature on the Dutch disease effect in a small open oil exporting economy. Specifically, our contribution to the literature is twofold. On the one hand, we formulate a DSGE model in line with the balanced-growth path theory. On the other hand, besides alternative monetary rules, the model introduces an oil stabilization fund, an oil price rule, and a fiscal rule. Our aim is to analyze to what extent the combinations between our alternative monetary rules and fiscal policy are effective to prevent a Dutch disease effect in the aftermath of a positive oil price shock. Our main findings show that the Dutch disease, through the spending effect, occurs only in the case of inflation targeting regime. An expansionary fiscal policy contributes to improve the state of the economy through its impact on the productivity of the manufacturing sector.
    Keywords: Monetary Policy, Oil Stabilization Fund, Dutch disease, Oil Prices, DSGE model
    JEL: E52 F41 Q40
    Date: 2018–03
  34. By: Raffaella Coppier; Fabio Sabatini; Mauro Sodini
    Abstract: We develop an overlapping generations model to study how the interplay between social and human capital affects fertility. In a frame- work where families face a trade-off between the quantity and quality of children, we incorporate the assumption that social capital plays a key role in the accumulation of human capital. We show how the erosion of social capital can trigger a chain of reactions leading households to base their childbearing decisions on quantity, instead of quality, resulting in higher fertility.
    Keywords: Fertility, quantity-quality trade-off, human capital, education, social capital, trust.
    JEL: J13 Z1 Z13
    Date: 2018–03–04
  35. By: Isabel Cairo (Board of Governors of the Federal Reserve System); Jae Sim (Federal Reserve Board)
    Abstract: We construct a general equilibrium model in which income inequality results in insufficient aggregate demand and deflation pressure by allocating a greater share of national income to a group with the least marginal propensity to consume, and if excessive, can lead to an endogenous financial crisis. The effectiveness of monetary policy during financial crises is severely distorted by the zero lower bound (ZLB) constraint. Such an economy generates left-skewed distributions for equilibrium prices and quantities, creating disproportionately large downside risks. Consequently, symmetric monetary policy rules that are designed to minimize the fluctuations in equilibrium quantities and prices around fixed means become inefficient. We evaluate alternative monetary policy rules in their ability to minimize not only the variance but also the skewness of the target variable. We find that a type of forward guidance rule of promising to lower the long-run natural rate of interest persistently in response to crises may bring large welfare gains by correcting the skewness of the distributions and thus increasing the means of aggregate output and inflation. While we assume no direct preferences of central bankers over income inequality, monetary policy rules correcting the skewed distributions also lessen the degree of income inequality substantially as low income households suffer the most from the asymmetric macroeconomic risks.
    Date: 2017
  36. By: Rosen Valchev (Boston College)
    Abstract: While international portfolios are still heavily biased towards home assets, the home bias has exhibited a clear downward trend in the last few decades. Understanding the decline could help us shed new light on the puzzle as a whole, and to this end this paper develops a dynamic model of endogenous information acquisition. Due to the presence of non-tradable income and the usual feedback between information and portfolio choice, agents find it optimal to specialize their information acquisition on domestic assets, leading to information asymmetry and home bias in equilibrium. The dynamic framework, however, also introduces a measure of endogenous unlearnable uncertainty, absent in a static model, which generates decreasing returns to information when agents are sufficiently well informed about an asset. As a result, the model can explain both the high overall level of the home bias, and its decline over time. The model makes a clear predictions that the home bias decline is linked to the fall in information costs, and I show that this is true in the data as well.
    Date: 2017

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