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on Dynamic General Equilibrium |
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Issue of 2018‒04‒02
forty-five papers chosen by Christian Zimmermann Federal Reserve Bank of St. Louis |
| By: | Aubhik Khan (Ohio State University) |
| Abstract: | We explore business cycles in quantitative overlapping generations economies where households face earnings risk characterised by the high kurtosis seen in the data, and unemployment risk. The model economy exhibits large inter-generational differences in wealth driven by households' savings over the life-cycle. This substantially increases the inequality of wealth arising from households' response to uninsurable income risk, and reproduces much of the wealth inequality in the data. Solving for equilibrium under aggregate uncertainty, we explore the mechanics of a large recession for both aggregate consumption and investment and the distribution of households. Importantly, our incomplete markets model generates declines in aggregate quantities similar to that seen in the Great Recession. As result, it allows us to evaluate the welfare costs of a large recession in an incomplete markets model consistent with the overall aggregate business cycle. While TFP fell relatively little, in the recent recession, there was a large fall in hours worked. Consistency with these observations, in the model, requires a large, persistent increase in unemployment risk. Overall, the welfare costs of the recession vary by the share of income households derive from capital and labour. Younger workers, with relatively low levels of wealth, suffer most of the large fall in expected earnings. These welfare costs are large, given the persistence of the recession and its large impact on the earnings of finite-lived households. Uninsurable risk and wealth inequality help shape the aggregate response of the economy. Investment falls by more when households face little income risk, holds less precautionary savings, and are more responsive to changes in real interest rates. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1559&r=dge |
| By: | Serafín Frache (Banco Central del Uruguay y Departamento de Economía, Facultad de Ciencias Sociales, Universidad de la República); Javier García-Cicco (Banco Central de Chile y Universidad Católica Argentina); Jorge Ponce (Banco Central del Uruguay y Departamento de Economía, Facultad de Ciencias Sociales, Universidad de la República) |
| Abstract: | We develop a DSGE model for a small, open economy with a banking sector and endogenous default. The model is used to perform a realistic assessment of two macroprudential tools: countercyclical capital buffers (CCB) and dynamic provisions (DP). The model is estimated with data for Uruguay, where dynamic provisioning is in place since early 2000s. In general, while both tools force banks to build buffers, we find that DP seems to outperform the CCB in terms of smoothing the cycle. We also find that the source of the shock affecting the financial system matters to discuss the relative performance of both tools. In particular, given a positive external shock the ratio of credit to GDP decreases, which discourages its use as an indicator variable to activate countercyclical regulation. |
| Keywords: | banking regulation, minimum capital requirement, countercyclical capital buffer, reserve requirement, (countercyclical or dynamic) loan loss provision, endogenous default, Basel III, DSGE, Uruguay |
| JEL: | G21 G28 |
| Date: | 2017–08 |
| URL: | http://d.repec.org/n?u=RePEc:ude:wpaper:0917&r=dge |
| By: | Shuhei Aoki (Shinshu University); Makoto Nirei (University of Tokyo); Kazufumi Yamana (Kanagawa University) |
| Abstract: | We develop a tractable dynamic general equilibrium model with incomplete markets for business risk sharing, which allows for analytical characterization under Epstein-Zin preference with unitary elasticity of intertemporal substitution and Cobb-Douglas technology. Household stationary wealth dispersion is shown to follow a Pareto distribution. In this environment, we conduct comparative statics of stationary output and household inequality when the cost of business risk sharing is reduced. Enhanced risk-taking results in greater long-run outputs and real wage and a lower risk-free interest rate, while its impact on inequality is ambiguous. A quantitative analysis under the parameter values calibrated to Japanese economy shows that elimination of purchase costs for mutual funds leads to an increase in output by 1.3 percent, a decrease in risk-free rate by 15 basis points, and an increase in Gini coefficient of wealth in 2 percentage points. |
| Keywords: | Financial development; risk-free rate; safe asset; Pareto distribution; depository institutions; mutual funds |
| JEL: | E2 G2 |
| Date: | 2018–03–12 |
| URL: | http://d.repec.org/n?u=RePEc:boj:bojwps:wp18e04&r=dge |
| By: | Francesca Carapella (Federal Reserve Board) |
| Abstract: | In a dynamic model with credit under limited commitment money can be essential when limited memory weakens the effects of punishment for default. There exist equilibria where both money and credit are used as media of exchange, and default occurs. In this equilibria the Friedman rule is not optimal. Inflation acts to discourage default by raising the cost of holding money, which is primarily held by defaulters. This results in relaxing the limited commitment constraint and raising welfare for all agents, including defaulting ones. The equilibrium is unique if and only if monetary policy and agents' money holdings are chosen sequentially. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1523&r=dge |
| By: | Maximiliano Dvorkin (Federal Reserve Bank of St. Louis) |
| Abstract: | Business cycles have heterogeneous effects in the labor market. Workers with different characteristics and skills are not equally affected by the cyclical swings in the demand for labor of different occupations. This paper studies the employment and occupational decisions of workers with heterogeneous skill portfolios and how business cycle conditions affect the patterns of sorting of workers into occupations, the accumulation of skills, and earnings. For this I develop and estimate a dynamic general equilibrium Roy (1951) model with aggregate shocks and propose a new method to characterize the solution recursively. The estimation shows that workers’ comparative advantage strongly influence their occupational choices, but changes in business cycle conditions affect the sorting of workers into occupations and can have long lasting effect in the accumulation of skills. The model is able to capture the direction and cyclical patterns of occupational switching. I compute measures of the missallocation of talent and labor productivity losses from recessions. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1527&r=dge |
| By: | Carrillo, Julio A.; Mendoza, Enrique G.; Nuguer, Victoria; Roldán-Peña, Jessica |
| Abstract: | Quantitative analysis of a New Keynesian model with the Bernanke-Gertler accelerator and risk shocks shows that violations of Tinbergen’s Rule and strategic interaction between policymaking authorities undermine significantly the effectiveness of monetary and financial policies. Separate monetary and financial policy rules, with the latter subsidizing lenders to encourage lending when credit spreads rise, produce higher welfare and smoother business cycles than a monetary rule augmented with credit spreads. The latter yields a tight money-tight credit regime in which the interest rate responds too much to inflation and not enough to adverse credit conditions. Reaction curves for the choice of policy-rule elasticity that minimizes each authority’s loss function given the other authority’s elasticity are nonlinear, reflecting shifts from strategic substitutes to complements in setting policy-rule parameters. The Nash equilibrium is significantly inferior to the Cooperative equilibrium, both are inferior to a first-best outcome that maximizes welfare, and both produce tight money-tight credit regimes. JEL Classification: E44, E52, E58 |
| Keywords: | financial frictions, financial policy, monetary policy |
| Date: | 2018–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20182129&r=dge |
| By: | E. Jondeau; J-G. Sahuc |
| Abstract: | We quantify the capital shortfall that results from a global financial crisis by using a macrofinance dynamic stochastic general equilibrium model that captures the interactions between the financial and real sectors of the economy. We show that a crisis similar to that observed in 2008 generates a capital shortfall (or stressed expected loss, SEL) equal to 2.8% of euro-area GDP, which corresponds to approximately 250 billion euros. We also find that using a cycle-dependent capital ratio that combines concern for both credit growth and SEL has a positive effect on output growth while mitigating the excessive risk taking of the banking system. Finally, our estimates confirm that most of the variability of the macroeconomic and financial variables at business cycle frequencies is due to investment and risk shocks. |
| Keywords: | capital shortfall, systemic risk, leverage, financial system, euro area, DSGE model. |
| JEL: | E32 E44 G01 G21 |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:bfr:banfra:668&r=dge |
| By: | Reichlin, Pietro |
| Abstract: | Equilibria where altruistic generations are linked via positive bequests are indeterminate and subject to sunspot variables when each individual's utility in non-separable in her own age contingent consumption and sufficiently biased towards old age. This result does not require strong income effects and it applies if individuals select their own savings and bequests by taking the decisions of their offsprings and successors as given. In this case, the equivalence with the Dynastic Equilibria of a Ramsey-type model envisaged in Barro (1974) fails. I show that the structure of equilibria of the olg model with altruism is more similar to the one generated in a canonical olg economy with two goods. |
| Keywords: | Bequets; Indeterminacy; parental altruism |
| JEL: | E10 E21 E32 |
| Date: | 2018–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:12787&r=dge |
| By: | Filippeli, Thomai (Bank of England); Harrison, Richard (Bank of England); Theodoridis, Konstantinos (Cardiff Business School) |
| Abstract: | We present a new method for estimating Bayesian vector auto-regression (VAR) models using priors from a dynamic stochastic general equilibrium (DSGE) model. We use the DSGE model priors to determine the moments of an independent Normal-Wishart prior for the VAR parameters. Two hyper-parameters control the tightness of the DSGE-implied priors on the autoregressive coefficients and the residual covariance matrix respectively. Determining these hyper-parameters by selecting the values that maximize the marginal likelihood of the Bayesian VAR provides a method for isolating subsets of DSGE parameter priors that are at odds with the data. We illustrate the ability of our approach to correctly detect incorrect DSGE priors for the variance of structural shocks using a Monte Carlo experiment. We also demonstrate how posterior estimates of the DSGE parameter vector can be recovered from the BVAR posterior estimates: a new ‘quasi-Bayesian’ DSGE estimation. An empirical application on US data reveals economically meaningful differences in posterior parameter estimates when comparing our quasi-Bayesian estimator with Bayesian maximum likelihood. Our method also indicates that the DSGE prior implications for the residual covariance matrix are at odds with the data. |
| Keywords: | BVAR; DSGE; DSGE-VAR; Gibbs sampling; marginal likelihood evaluation; predictive likelihood evaluation; quasi-Bayesian DSGE estimation |
| JEL: | C11 C13 C32 C52 |
| Date: | 2018–03–02 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:0716&r=dge |
| By: | Matthew Rognlie (Princeton University); Ludwig Straub (MIT); Adrien Auclert (Stanford) |
| Abstract: | We derive a microfounded, dynamic version of the traditional Keynesian cross, which we call the intertemporal Keynesian cross. It characterizes the mapping from all partial equilibrium demand shocks to their general equilibrium outcomes. The aggregate demand feedbacks between periods can be interpreted as a network, and the linkages in the network can be generalized to reflect both the feedback from consumption and other dynamic forces, such as fiscal and monetary policy responses. We explore the general equilibrium amplification and propagation of impulses, and show how they vary with features of the economy. General equilibrium amplification is especially strong when agents are constrained, face uncertainty, or are unequally exposed to aggregate fluctuations, and it plays a crucial role in the transmission of monetary policy. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1587&r=dge |
| By: | Farmer, Roger E A; Zabczyk, Pawel |
| 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. |
| JEL: | E0 H62 |
| Date: | 2018–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:12770&r=dge |
| By: | Marcelo Veracierto (Federal Reserve Bank of Chicago) |
| Abstract: | I consider a real business cycle model in which agents have private information about their stochastic value of leisure. For the case of logarithmic preferences I provide an analytical characterization of the solution to the associated mechanism design problem. Moreover, I show a striking irrelevance result: That the stationary behavior of all aggregate variables are exactly the same in the private information economy as in the full information case. I then introduce a new computational method to show that the irrelevance result holds numerically for more general CRRA preferences. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1574&r=dge |
| By: | JungJae Park (National University of Singapore); Charles Engel (University of Wisconsin) |
| Abstract: | This paper quantitatively investigates the currency composition of sovereign debt in the presence of two types of limited enforcement frictions arising from a government’s monetary and debt policy: strategic currency debasement and default on sovereign debt. Local currency debt has better state contingency than foreign currency debt in the sense that its real value can be changed by a government’s monetary policy, thus acting as a better consumption hedge against income shocks. However, this higher degree of state contingency for local currency debt provides a government with more temptation to deviate from disciplined monetary policy, thus restricting borrowing in local currency more than in foreign currency. The two financial frictions related to the two limited enforcement problems combine to generate an endogenous debt frontier for local and foreign currency debts. Our model predicts that a less disciplined country in terms of monetary policy borrows mainly in foreign currency, as the country faces a much tighter borrowing limit for local currency debt than for the foreign currency debt. Our model accounts for the surge in local currency borrowings by emerging economies in the recent decade and “Mystery of Original Sin” by Eichengreen, Haussman, Panizza (2002) |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1558&r=dge |
| By: | Christian Moser (Columbia University); Niklas Engbom (Princeton University) |
| Abstract: | We assess the extent to which a rise in the minimum wage can account for three facts characterizing a large decline in earnings inequality in Brazil from 1996--2012: (i) the decline is bottom-driven yet wide-spread; (ii) lower-tail inequality is negatively correlated with the bindingness of the minimum wage across Brazilian states over time; and (iii) a large share of the decline is due to a compression in the returns to firm and worker characteristics in pay. To this end, we build a general equilibrium search model with heterogeneous firms engaging in monopsonistic competition for heterogeneous workers. The rise in the minimum wage in our model explains 70 percent of the observed decline in the variance of log earnings, while being consistent with the above three facts. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1521&r=dge |
| By: | Pablo A. Guerron-Quintana (Boston College and Espol); Tomohiro Hirano (University of Tokyo); Ryo Jinnai (Hitotsubashi University) |
| Abstract: | We propose a model that generates permanent effects on economic growth following a recession (super hysteresis). Recurrent bubbles are introduced to an otherwise standard infinite-horizon business-cycle model with liquidity scarcity and endogenous productivity. In our setup, bubbles promote growth because they provide liquidity to constrained investors. Bubbles are sustained only when the financial system is under-developed. If the financial development is in an intermediate stage, recurrent bubbles can be harmful in the sense that they decrease the unconditional mean and increase the unconditional volatility of the growth rate relative to the fundamental equilibrium in the same economy. Through the lens of an estimated version of our model fitted to U.S. data, we argue that 1) there is evidence of recurrent bubbles; 2) the Great Moderation results from the collapse of the monetary bubble in the late 1970s; and 3) the burst of the housing bubble is partially responsible for the post-Great Recession dismal recovery of the U.S. economy. |
| Date: | 2018–03–12 |
| URL: | http://d.repec.org/n?u=RePEc:boj:bojwps:wp18e05&r=dge |
| By: | Rohit Lamba (Penn State University); Ilia Krasikov (Penn State University) |
| Abstract: | We study a dynamic principal-agent model where the agent has access to a persistent private technology but is strapped for cash. Financial constraints are generated by the periodic interaction between incentives (private information) and feasibility (being strapped for cash).This interaction produces dynamic distortions that are a sum of two effects: backloading of incentives and illiquidity. Bad technology shocks increase distortions and monotonically push the agent further away from efficiency. An endogenous number of good shocks is required for the agent to become liquid, and eventually for the contract to become efficient. Efficiency is an absorbing state that is reached almost surely. The optimal allocation can be implemented through a mechanism which is precisely pinned down by a dynamic information operator. The shares of principal and agent in the net present value of economic surplus are endogenous to the evolution of technology shocks. Surplus itself is increasing in the share of the agent, and in his type contingent utility spread. By comparing the agent’s utility with and without financial constraints, the model provides a foundation for the usefulness of limited liability in dynamic contracts |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1544&r=dge |
| By: | Ross Doppelt (Penn State) |
| Abstract: | I investigate, both empirically and theoretically, how minimum-wage laws affect the intensive margin of labor, or the number hours per employee. Using CPS data, I document the fact that minimum-wage employees work longer hours when the minimum wage is higher. To explain this pattern, I introduce a theoretical model of search and bargaining, subject to minimum-wage laws. Within a match, the number of hours is determined by an upward-sloping labor-supply curve, so people are willing to work more when the minimum wage goes up. Because contracts are bargained bilaterally, the firm's marginal profit from hiring an extra hour is positive, so firms are willing to accept the extra labor. However, higher wages diminish total profits, vacancy creation, and employment. I derive conditions under which a minimum wage can be welfare-improving, and I discuss empirical tests to determine whether those conditions are satisfied. In particular, if an increase in the minimum wage leads to an increase in total payrolls, then it suggests that a higher minimum wage is welfare-improving. After deriving these analytical results, I extend the model to facilitate a quantitative analysis. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1578&r=dge |
| By: | Pedro Silos (Temple University); German Cubas (University of Houston) |
| Abstract: | Occupations differ in their degree of earnings uncertainty. Progressive taxation provides insurance to risk-averse workers against adverse earnings outcomes. As a result, progressive tax systems distort the price of risk and influence the mo- bility and sorting of workers across occupations. This paper proposes a theory to understand the effect of the degree of tax progressivity on workers’ career choices when markets are incomplete. We quantify the distortion and we find that tax progressivity incentives young workers to take on risk, thus partially completing the insurance markets. Hence, we provide a new perspective on the welfare cost of uninsurable earnings risk. To that end, we employ micro-data on occupational mobility and earnings from the United States and Germany to estimate a model of occupational choice and uninsurable earnings uncertainty. The model predicts that, as observed in the data, everything else equal, were US workers to face the relatively more progressive earnings tax function of Germany, a larger fraction of young workers will take risk and they will end up working into safer occupations. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1581&r=dge |
| By: | Sebastian Fanelli (MIT) |
| Abstract: | A recent and rapidly increasing literature has documented the presence of sizeable cross-currency mismatches in countries' balance sheets. Yet, existing studies of optimal monetary policy focus on economies with either a single bond or complete markets. We bridge this gap by studying a small open economy with nominal rigidities where home agents are able to borrow abroad in both home- and foreign-currency bonds. In this environment, monetary policy faces a trade-off between providing insurance and doing inflation-targeting. To solve the optimal policy problem, we develop a technique to approximate the solution around the deterministic steady state with locally incomplete markets. When home-currency-bond markets are perfect, the central bank commits to a smooth exchange rate to induce agents to be significantly exposed to currency risk, giving monetary policy firepower to create wealth transfers at low cost. In contrast, if markets are imperfect and agents cannot choose such large positions, a volatile exchange rate is the only way to provide insurance. Finally, we show that despite the presence of aggregate demand externalities, private portfolio choice decisions are efficient in the approximated model. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1586&r=dge |
| By: | Fujiwara, Ippei; Waki, Yuichiro |
| Abstract: | Should the fiscal authority use forward guidance to reduce future policy uncertainty perceived by private agents? Using dynamic general equilibrium models, we examine the welfare effects of announcing future fiscal policy shocks and show that selective transparency is desirable — announcing future policy shocks that are distortionary can be detrimental to ex ante social welfare, whereas announcing non-distortionary shocks generally improves welfare. Sizable welfare gains are found with constructive ambiguity regarding the timing of a tax increase in a realistic fiscal consolidation scenario. However, being secretive about distortionary shocks is time inconsistent, and welfare loss from communication may be unavoidable. |
| Keywords: | news shock, fiscal policy, private information, communication, forward guidance |
| JEL: | D82 E62 H20 E30 |
| Date: | 2018–03 |
| URL: | http://d.repec.org/n?u=RePEc:hit:hitcei:2017-8&r=dge |
| By: | Jacquinot, Pascal; Lozej, Matija; Pisani, Massimiliano |
| Abstract: | We evaluate the effects of permanently reducing labour tax rates in the euro area (EA) by simulating a large-scale open economy dynamic general equilibrium model. The model features the EA as a monetary union, split in two regions (Home and the rest of the EA - REA), the US, and the rest of the world, region-specific labour markets with search and matching frictions, and public employment. Our results are as follows. First, a permanent reduction in labour tax rates in the Home region would have stimulating effects on domestic economic activity and employment. Second, reducing labour tax rates simultaneously in both Home and REA would have additional expansionary effects on the Home region. Third, in the short run the expansionary effects on the EA economy of a EA-wide tax reduction are enhanced if the EA monetary policy is accommodative. JEL Classification: E24, E32, E52, E62, F45 |
| Keywords: | DSGE models, labour taxes, monetary union, open-economy macroeconomics, unemployment |
| Date: | 2018–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20182127&r=dge |
| By: | Tim Landvoigt (University of Texas at Austin); Stijn Van Nieuwerburgh (New York University); Daniel Greenwald (MIT) |
| Abstract: | Shared Appreciation Mortgages (SAMs) feature mortgage payments that adjust with house prices. Such mortgage contracts can stave off home owner default by providing payment relief in the wake of a large house price shock. SAMs have been hailed as an innovative solution that could prevent the next foreclosure crisis, act as a work-out tool during a crisis, and alleviate fiscal pressure during a downturn. They have inspired Fintech companies to offer home equity contracts. However, the home owner’s gains are the mortgage lender’s losses. We consider a model with financial intermediaries who channel savings from saver households to borrower households. The financial sector has limited risk bearing capacity. SAMs pass through more aggregate house price risk and lead to financial fragility when the shock happens in periods of low intermediary capital. We compare house prices,mortgage rates, the size of the mortgage sector, default and refinancing rates, as well as borrower and saver consumption between an economy with standard mortgage contracts and an economy with SAMs. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1525&r=dge |
| By: | Pricila Maziero (University of Pennsylvania) |
| Abstract: | This paper studies the optimal lending contract between an international lender and a sovereign country. A benevolent government finances uncertain expenditures - which are privately observed by the country - using external debt and optimally choosing domestic debt and taxes as in a standard Ramsey environment. Without imposing any restriction on the structure of the loan, we determine the optimal lending contract offered by the lender when the domestic fiscal policy is observed and when the fiscal policy is not observed by the lender. In the first case, we show under which conditions the optimal loan contract is contingent not only on the realization of government expenditures, but also on the sovereign fiscal policy. Finally we show how the optimal loan contract influences equilibrium taxes and prices in a welfare increasing manner. In particular, the external loan can be used as instrument to reduce the distortions induced by the Ramsey government on the domestic economy. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1547&r=dge |
| By: | Joao Ramos (University of Southern California); Bernard Herskovic (UCLA Anderson School of Management) |
| Abstract: | This paper investigates the implications of affirmative action in college admissions for welfare, aggregate output, educational investment decisions and intergenerational persistence of earnings. We construct an overlapping-generations model in which parents choose how much to invest in their child's education, thereby increasing both human capital and likelihood of college admission. Affirmative action improves the pool of admitted students, although it changes incentives towards educational investments. We calibrate the model to quantify affirmative action long-run effects. We find that affirmative action targeting the bottom quintile of the income distribution is a powerful policy to reduce intergenerational persistence of earnings and improve welfare and aggregate output. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1552&r=dge |
| By: | Gilles Joseph (LC2S - Laboratoire caribéen de sciences sociales - CNRS - Centre National de la Recherche Scientifique - UA - Université des Antilles); Paul-Emile Maingé (LAMIA - Laboratoire de Mathématiques Informatique et Applications - UAG - Université des Antilles et de la Guyane) |
| Abstract: | This paper studies the optimal duration of unemployment insurance (UI) benefits in a basic job search model where a risk neutral UI agency can not monitor the search effort of risk-averse workers. Social assistance payments are taken as exogenous by the unemployment agency which chooses optimally the level of UI benefits, the date of their exhaustion and the level of the financing tax. So, due to possible finite values of the duration of unemployment benefits, the resulting agency's problem brings nonstationarity complexities that are usually deemed intractable in models where utility and search costs functions are nonlinear. We then propose a new strategy, based on the study of the geometric properties of the set of constraints, and explicit formal conditions, with very general utility and search costs functions , for obtaining a zero, positive or infinite optimal duration of UI. |
| Keywords: | Moral hazard,Job search,Potential benefits duration,Unemployment insurance |
| Date: | 2018–03–02 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-01722116&r=dge |
| By: | Juan Passadore (Einaudi Institute for Economics and Fina); Facundo Piguillem (EIEF); Adriana Grasso (LUISS Guido Carli) |
| Abstract: | In the last 20 years we have witnessed a decline in the labor shares, low real interest rates and anemic growth in developed economies. Using a neoclassical growth model with Cobb Douglas technology, a capital intensity that fluctuates over time, and a financial frictions, we explore whether changes in the relative productivity of capital can generate these facts through changes in the risk taking behavior of capital holders and what would be the implications for financial regulations. A combination of financial frictions and a persistent change in the capital intensity (decline in the labor share) can account for a decline in the price of risk, and a moderate increase in the dividends of capital firms but cannot account for the decrease in the real rates. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1513&r=dge |
| By: | Yongyang Cai (Ohio State University); Simon Scheidegger (University of Zürich); Sevin Yeltekin (Carnegie Mellon University); Philipp Renner (Lancaster University); Kenneth Judd (Stanford University) |
| Abstract: | Since the financial crisis of 2008 and increased government debt levels worldwide, fiscal austerity has been a focal point in public debates. Central to these debates is the natural debt limit, i.e. the level of public debt that's sustainable in the long run, and the design of fiscal policy that is consistent with that limit. In much of the earlier work on dynamic fiscal policy, governments are not allowed to lend, and the upper limit on debt is determined in an ad-hoc manner Aiyagari et. al (2002)'s (AMSS) seminal paper on fiscal policy in incomplete markets relaxed the lending assumption and revisited earlier work of Barro (1979) and Lucas and Stokey (1983) to study the implications on tax policy. Their results implied that taxes should roughly follow a random walk. They also presented examples where the long-run tax rate is zero, and any spending is financed out of its asset income (i.e., government holds debt of the people). However, their approach had some weaknesses. First, it imposed an artificial limit on government debt and therefore did not address the question of a natural debt limit. Second, it assumed, as much of the literature prior to it did, government spending to be exogenous. We relax the assumptions on debt and spending, and we use computational methods that do not rely only on local optimality. While we focus on the models examined in AMSS, we present a framework that can address fiscal policy issues in a self-consistent manner. In particular, we derive the endogenous limits on debt and allow for endogenous government spending. Our approach involves recasting the policy problem as an infinite horizon dynamic programming problem. The government's value function may not be concave and it can also very high curvature, particularly as debt approaches its endogenous limit. In dynamic taxation problems, the government's problem is a mathematical program with complementary constraints (MPCC). We explicitly use the MPCC formulation, which is essential in order to do the necessary global optimization analysis of the government's problem. Our MPCC approach uses the computational algorithms that were developed only in the past twenty years, and allows us to solve the problem reliably and accurately. Using our combination of computational tools and more general economic assumptions, we re-address questions regarding optimal taxation and debt management in a more realistic setup. These tools allow us to determine debt limits implied by assumptions on the primitives of the economic environment and to assess how the level of debt affects both tax policy and general economic performance, and the time series properties of tax rates and debt levels. Our results show that under the more general framework of endogenous government debt limits and spending has substantially different implications than earlier analyses have suggested. First, the behavior of optimal policy is, over long horizons (e.g., 1000 years), is much more complex than simpler models imply. In particular, the long-run distribution of debt is multimodal, and the long-run level of debt is history-dependent. If initial debt is low enough and government spending is not hit with large shocks, then the government will accumulate a "war chest" which allows long-run tax rates to be zero. However, if, in the same model, initial debt is high and/or the government gets hit with a long series of bad spending shocks, then debt will rise to a high level and will not fall even if the government is not hit with bad spending shocks. In the second case, governments with large debt levels will avoid default by reducing spending and use taxes to finance a persistently high debt. We examine the case of fixed government spending and find that the results are dramatically affected. In particular, we illustrate a case where if spending shocks are of moderate size (less than US historical experience) no positive level of debt is feasible. That is, if a government begins with positive debt then there is a sequence of spending shocks such that there is no feasible tax and borrowing policy to finance those expenditures. In such cases, exogenous spending assumptions imply that governments must have their endowed war chests in the beginning and cannot with probability one build up its war chest. These examples illustrate clearly that any analysis of fiscal policy that wants examine historical fiscal policy must consider making spending flexible. The application of our methodology is not limited to optimal tax problems. Optimal macroeconomic policy problems, as well as social insurance design typically involve solving high-dimensional dynamic programming problems. Solving such problems is a complicated, but very important task, as the policy recommendations depend crucially on the accuracy of the numerical results. In much of the optimal macroeconomic policy and social insurance literature, accuracy of the numerical solutions is unclear. Additionally, most solution approaches ignore feasibility issues and impose ad-hoc limits on state variables such as government debt. An accurate approach to solving dynamic policy models requires the ability to handle the high-dimensional nature of the problems as well as the unknown, feasible state space. The methodology offered in this paper can be used for computing high-dimensional dynamic policy problems with unknown state spaces. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1543&r=dge |
| By: | Dasha Safonova (University of Notre Dame) |
| Abstract: | Shocks to the structure of the interbank lending network can have important macroeconomic repercussions. This paper examines the impact of the dynamic structure of the interbank lending network on interest rates and investment in the nonfinancial sector. By incorporating a network of bank relationships into a general equilibrium model with monetary policy, I show that the aggregate interest rate increases in response to a shock that destroys a large fraction of bank relationships and decreases in response to a shock that destroys a small fraction of relationships. Moreover, the shape of the interbank network matters for these dynamics: the interest rate is least responsive to the network disruptions if the interbank network is scale-free. Additionally, the amplification and propagation of the network shocks depend on the corridor of the policy rates set by the central bank. In particular, as the difference between the discount rate and the excess reserve rate decreases, the effect of a network disruption on interest rates becomes less significant but more persistent, which in turn leads to a smaller but more prolonged effect on the real sector. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1568&r=dge |
| By: | Gauti Eggertsson (Brown University); Neil Mehrotra (Brown University) |
| Abstract: | This paper analyzes the effect of increasing income inequality on real interest rates and the transmission of monetary policy to demand. Using a quantitative overlapping generations model, we investigate how skill-biased technical change and rising monopoly power in the US since 1980 can account for increases in income inequality, a decline in the labor share, and a decline in the investment to output ratio. We find that rising income inequality due to skill-biased technical change has a sizable effect on the real interest rate and attenuates the effectiveness of monetary policy by reducing the demand effect of a fall in the real interest rate. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1567&r=dge |
| By: | Lisack, Noëmie (Bank of England); Sajedi, Rana (Bank of England); Thwaites, Gregory (Bank of England) |
| Abstract: | We quantify the impact of past and future global demographic change on real interest rates, house prices and household debt in an overlapping generations model. Falling birth and death rates can explain a large part of the fall in world real interest rates and the rise in house prices and household debt since the 1980s. These trends will persist as the share of the population in the high-wealth 50+ age bracket continues to rise. As the United States ages relatively slowly, its net foreign liability position will grow. The availability of housing and debt as alternative stores of value attenuates these trends. The increasing monopolisation of the economy has ambiguous effects. |
| Keywords: | Demographics; population ageing; neutral interest rates |
| JEL: | E13 E21 E43 J11 |
| Date: | 2017–12–21 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:0701&r=dge |
| By: | Jarocinski, Marek; Karadi, Peter |
| Abstract: | Central bank announcements simultaneously convey information about monetary policy and the central bank's assessment of the economic outlook. This paper disentangles these two components and studies their effect on the economy using a structural vector autoregression estimated on both US and euro area data. It relies on the information inherent in high-frequency comovement of interest rates and stock prices around policy announcements: a surprise policy tightening raises interest rates and reduces stock prices, while the complementary positive central bank information shock raises both. These two shocks have intuitive and very different effects on the economy. Ignoring the central bank information shocks biases the inference on monetary policy non-neutrality. We make this point formally and offer an interpretation of the central bank information shock using a New Keynesian macroeconomic model with financial frictions. |
| Keywords: | Central Bank Private Information; High-Frequency Identification; Monetary Policy Shock; structural VAR |
| JEL: | E32 E52 E58 |
| Date: | 2018–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:12765&r=dge |
| By: | Alexandr Kopytov; Nikolai Roussanov; Mathieu Taschereau-Dumouchel |
| Abstract: | Recent empirical evidence suggests that job polarization associated with skill-biased technological change accelerated during the Great Recession. We use a standard neoclassical growth framework to analyze how business cycle fluctuations interact with the long-run transition towards a skill-intensive technology. In the model, since adopting the new technology disrupts production, firms prefer to do so in recessions, when profits are low. Similarly, workers also tend to learn new skills during downturns. As a result, recessions are deeper during periods of technological transition, but they also speed up adoption of the new technology. We document evidence for these mechanisms in the data. Our calibrated model is able to match both the long-run downward trend in routine employment and the dramatic impact of the Great Recession. We also show that even in the absence of the Great Recession the routine employment share would have reached the observed level by the year 2012. |
| JEL: | E24 E25 E3 |
| Date: | 2018–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:24373&r=dge |
| By: | Chang Ma; Fabian Valencia |
| Abstract: | Over the past two decades, Mexico has hedged oil price risk through the purchase of put options. We examine the resulting welfare gains using a standard sovereign default model calibrated to Mexican data. We show that hedging increases welfare by reducing income volatility and reducing risk spreads on sovereign debt. We find welfare gains equivalent to a permanent increase in consumption of 0.44 percent with 90 percent of these gains stemming from lower risk spreads. |
| Date: | 2018–03–02 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:18/35&r=dge |
| By: | Anthony Smith (Yale University); Per Krusell (Stockholm University) |
| Abstract: | This paper builds a highly disaggregated, dynamic, general equilibrium model of interactions between the climate and the economy. The model consists of approximately 19,000 1-degree by 1-degree regions containing land. Regional climates (or average annual temperatures) respond differently to increases in the Earth's temperature, and regional productivity varies with regional temperature. Each region makes optimal consumption-savings decisions in response to its changing productivity in one of two extreme market structures: autarky and free capital mobility. The relationship between regional temperature and productivity has an inverse U-shape, calibrated so that the many-region model replicates estimates of aggregate global damages from climate change; the implied optimal temperature is approximately twelve degrees. The central result is that climate change affects regions very differently, with many regions gaining while others lose. Although a tax on carbon increases average welfare, there is a large disparity of views across regions, with both winners and losers. These findings depend very little on the structure of capital markets. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1582&r=dge |
| By: | Krzysztof Makarski (Narodowy Bank Polski; Warsaw School Economics; Group for Research in Applied Economics (GRAPE)); Joanna Tyrowicz (Group for Research in Applied Economics (GRAPE); University of Warsaw; Institut für Arbeitsrecht und Arbeitsbeziehungen in der Europäischen Union (IAAEU); Institute of Labor Economics (IZA)); Magda Malec (Group for Research in Applied Economics (GRAPE); Warsaw School of Economics) |
| Abstract: | In the context of the second demographic transition, many countries consider rising fertility through pro-family polices as a potentially viable solution to the fiscal pressure stemming from longevity. However, an increased number of births implies private and immediate costs, whereas the gains are not likely to surface until later and appear via internalizing the public benefits of younger and larger population. Hence, quantification of the net effects remains a challenge. We propose using an overlapping generations model with a rich family structure to quantify the effects of increased birth rates. We analyze the overall macroeconomic and welfare effects as well as the distribution of these effects across cohorts and study the sensitivity of the final effects to the assumed target value and path of increased fertility. We find that fiscal effects are positive but, even in the case of relatively large fertility increase, they are small. The sign and the size of both welfare and fiscal effects depend substantially on the patterns of increased fertility: if increased fertility occurs via lower childlessness, the fiscal effects are smaller and welfare effects are more likely to be negative than in the case of the intensive margin adjustments. |
| Keywords: | gender wage gap, age, cohort, decomposition, non-parametric estimates, Germany |
| JEL: | J31 J71 |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:fme:wpaper:26&r=dge |
| By: | Hagedorn, Marcus |
| Abstract: | In this paper I show that models in which government bonds are net wealth - that is, their value exceeds that of tax liabilities (Barro, 1974) - offer a new perspective on several issues in monetary economics. First and foremost, prices and inflation are jointly and uniquely determined by fiscal and monetary policy. In contrast to the conventional view, the long-run inflation rate here is, in the absence of output growth, and even when monetary policy operates an interest rate rule with a different inflation target, equal to the growth rate of nominal fiscal variables, which are controlled by fiscal policy. This novel theory also offers a different perspective on the fiscal and monetary transmission mechanism, policies at the zero-lower bound, U.S. inflation history, recent attempts to stimulate inflation in the Euro area and several puzzles which arise in New Keyensian models during a liquidity trap. To derive my findings, I first use a reduced form approach in which households derive utility from holding bonds. I prove how and for which policy rules the price level is globally determinate, then showing that the reduced form results carry over to a Bewley-Imrohoroglu-Huggett-Aiyagari heterogenous agent incomplete market model. |
| Keywords: | Fiscal Multiplier; Fiscal policy; incomplete markets; inflation; monetary policy; Policy Coordination; Price Level Determinacy; Ricardian Equivalence; zero lower bound |
| JEL: | D52 E31 E43 E52 E62 E63 |
| Date: | 2018–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:12769&r=dge |
| By: | Colacito, Riccardo; Croce, Mariano Massimiliano; Ho, Steven; Howard, Philip |
| Abstract: | We study the response of international investment flows to short- and long-run growth news. Among developed G7 countries, positive long-run news for domestic productivity induces a net outflow of investments, in contrast to the effects of short-run growth shocks. We document that a standard Backus, Kehoe, and Kydland (1994) (BKK) model fails to reproduce this novel empirical evidence. We augment this model with Epstein and Zin (1989) preferences (EZ-BKK) and characterize the resulting recursive risk-sharing scheme. The response of international capital flows in the EZ-BKK model is consistent with the data. |
| JEL: | C62 F31 G12 |
| Date: | 2018–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:12783&r=dge |
| By: | Iourii Manovskii (University of Pennsylvania); Dmytro Hryshko (University of Alberta) |
| Abstract: | Most of what the profession knows about joint income and consumption dynamics at the household level in the U.S. is based on the data from the Panel Study of Income Dynamics (PSID). We find that there are two sets of households in the PSID that differ dramatically in the dynamics of their income and consumption. Households headed by the original PSID males and their sons have a highly persistent income process, and permanent shocks to their income almost fully pass through to consumption. Household headed by males who marry daughters of the original PSID members have a much less persistent income process and a dramatically higher degree of insurance. These differences are surprising but highly robust. Conditional on income dynamics, the degree of insurance in each subsample is consistent with the prediction of the standard incomplete-markets model. This is in contrast to the famous puzzle in Blundell, Pistaferri, and Preston (2008) of excess insurance of permanent income shocks for the combined sample. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1584&r=dge |
| By: | Tiago Tavares (CIE ITAM); Alexandros Fakos (ITAM) |
| Abstract: | In this paper we study firm-level investment dynamics by incorporating an idiosyncratic investment cost shock in a dynamic investment model of heterogeneous firms with adjustment costs. We interpret this idiosyncratic shock as an investment wedge summarizing firm deviations from model implied efficient behavior. We estimate our dynamic model using data micro-level data of Greek manufacturing firms, allowing for firms to be heterogenous in both profitability and investment cost. Our estimation results show that the level of dispersion of the idiosyncratic investment shock is of the same order of magnitude as the profitability shock which tends to be substantial in most micro-studies. We also find evidence that the investment wedge is correlated with variables not explicitly taken into account by our model such as measures of firm-level leverage and export intensity. This suggests that a financial channel in models of capital accumulation may be crucial in explaining data patterns. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1597&r=dge |
| By: | Julieta Caunedo (Cornell University) |
| Abstract: | Disparities in revenue productivity for narrowly defined industries is ubiquitous in firm-level data. Whereas often times such a heterogeneity is a symptom of factor misallocation, it is also possible that part of it is induced by firms' optimal decisions under technology and information constraints. To date, there is limited understanding of the implications of the observed revenue product heterogeneity for efficiency in frameworks where both sources for dispersion coexist. This paper fills the gap. Market distortions that generate inefficient factor accumulation may feed back into the equilibrium distribution of revenue productivity, and hence, empirical measures of allocative efficiency. Understanding such interaction is key for policy design. In this paper, I focus on the study of market distortions generated by firms' market power and I generate endogenous revenue product dispersion through either heterogeneous market power, non-convex production technologies, or information frictions. I characterize the market decentralization of efficient outcomes via policies that do not require firm-level information. Most importantly, I show that the welfare gains for a wide class of models when implementing these optimal policies follows a common pattern: welfare gains are proportional to the change in average revenue product and the number of operating units in the market. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1541&r=dge |
| By: | Hirokuni Iiboshi; Mototsugu Shintani; Kozo Ueda |
| Abstract: | We estimate a small-scale macroeconomic model for Japan by taking into account the nonlinearity stemming from the zero lower bound (ZLB) of the nominal interest rate. To this end, we apply the Sequential Monte Carlo Squared method to the case of Japan, where the ZLB has constrained the country's monetary policy for a considerably long period. Employing a nonlinear estimation is crucial to deriving implications for monetary policy. For example, the Bayesian model selection suggests that past experience of recessions reducing the nominal interest rate to zero is carried over to today's monetary policy. However, a nonlinear estimation has little effect on the estimate of the natural rate of interest, which has often been negative since the mid-1990s. |
| Date: | 2018–03 |
| URL: | http://d.repec.org/n?u=RePEc:tcr:wpaper:e120&r=dge |
| By: | Andreas Fuster; Greg Kaplan; Basit Zafar |
| Abstract: | We use survey questions about spending in hypothetical scenarios to investigate features of propensities to consume that are useful for distinguishing between consumption theories. We find that (i) responses to unanticipated gains are vastly heterogeneous (either zero or substantially positive); (ii) responses to losses are much larger and more widespread than responses to gains; and (iii) even those with large responses to gains do not respond to news about future gains. These three findings suggest that limited access to disposable resources is an important determinant of spending behavior. We also find that (iv) households do not respond to the offer of a one-year interest-free loan, suggesting that this is not a consequence of short-term credit constraints; and (v) people do cut spending in response to news about future losses, suggesting that neither is this a consequence of myopia. A calibrated two-asset life-cycle precautionary savings model can account for these features of propensities to consume, but cannot account for (vi) a positive extensive-margin size-effect for spending responses to gains, which suggests that non-convexities due to durability, salience or attention costs may also be important. |
| JEL: | D12 D14 E21 |
| Date: | 2018–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:24386&r=dge |
| By: | Aaron Hedlund (University of Missouri); Grey Gordon (Indiana University) |
| Abstract: | We develop a quantitative model of higher education to test explanations for the steep rise in college tuition between 1987 and 2010. The framework extends the paradigm in Epple, Romano, Sarpca, and Sieg (2013) of imperfectly competitive, quality-maximizing colleges and embeds it in an incomplete markets, life-cycle environment. We measure how much changes in college costs, reforms to the Federal Student Loan Program (FSLP), and the returns to college have contributed to tuition inflation. Taken together, the changes can fully explain the tuition increases seen at U.S. colleges. Our findings suggest that the FSLP and college costs are the main drivers of college tuition. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1550&r=dge |
| By: | Jonathan Willis (Federal Reserve Bank of Kansas City); Didem Tuzemen (Federal Reserve Bank of Kansas City) |
| Abstract: | Non-participation among prime-age men in the U.S. has doubled from 6 percent in 1976 to 12 percent in 2016. Over these four decades, there have also been rapid increases in the employment shares of low- and high-skill jobs, while the employment share of middle-skill jobs has declined in the U.S. labor market. This aggregate shift in the composition of jobs, known as "job polarization," may be contributing to the long-term trend of increasing non-participation among prime-age men. To investigate, we first analyze four decades of data from the Current Population Survey to characterize the relationship between job polarization and the decline in labor force participation among prime-age men. Then, we construct a labor-search model with heterogenous sectors and individuals, and occupational choice. In the model, job polarization leads to an increase in the demand for better-educated workers and a decline in the demand for less-educated workers who are employed in middle-skill jobs. Some middle-skill workers transition to high-skill occupations, while others move to low-skill service sector jobs. However, some of the displaced middle-skill workers permanently drop out of the labor force as they are not willing to accept low-wages at service sector jobs. Our aim is to quantify the contribution of job polarization to the long-term increase in non-participation among less-educated workers, which is a key element of the long-term decline in the labor force participation rate of prime-age men. In order to stabilize and potentially reverse the trend, labor market policies need to provide incentives and opportunities for workers in middle-skill jobs to obtain the necessary skills to become qualified for high-skill jobs. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1516&r=dge |
| By: | Rubina Verma (Instituto Tecnologico Autonomo de Mexico (ITAM)); Rahul Giri (International Monetary Fund); Caroline Betts (University of Southern California) |
| Abstract: | We develop a quantitative two country, three-sector model to measure the effects of trade policies for Korean structural change from 1963 through 2000. The model features non-homothetic preferences, Armington trade, proportional import tariffs and export subsidies, and is carefully calibrated to match sectoral value added production and value added trade between Korea and the OECD. We find that tariff liberalization increased imports and total trade, especially agricultural imports, accelerating de-agriculturization and intensifying Korean industrialization. Subsidy liberalization lowered exports and trade, especially industrial exports, attenuating industrialization. Thus, these effects of trade reform were individually powerful, but negated each other. Korea’s subsidy reform dominated quantitatively; relative to a “no reform” regime which maintains both 1963 tariff and subsidy rates forever, observed trade reform produces comparable but lower trade volumes, a larger agricultural and lower industrial employment share, and slower industrialization. “Complete reform”, lowering tariffs and subsidies to zero from 1963 onwards, would have substantially increased trade volumes and facilitated industrialization. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1530&r=dge |