nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2018‒04‒30
24 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. An Estimated DSGE Model to Analyze Housing Market Policies in Hong Kong SAR By Pau Rabanal
  2. Efficiency Units of Labor: Life-Cycle Profiles Estimates from the CPS 1987-2017 By Marco Cozzi
  3. Time-Consistent Consumption Taxation By Sarolta Laczo; Raffaele Rossi
  4. On real interest rates, tariff policy, exchange rates and the ZLB By van Wijnbergen, Sweder
  5. Endogenous Separations, Wage Rigidities and Unemployment Volatility By Carlsson, Mikael; Westermark, Andreas
  6. Health insurance, endogenous medical progress, and health expenditure growth By Frankovic, Ivan; Kuhn, Michael
  7. Countercyclical capital regulation in a small open economy DSGE model By Lozej, Matija; Onorante, Luca; Rannenberg, Ansgar
  8. On the Optimal Progressivity of Higher Education Subsidies: the Role of Endogenous Fertility By Vera Tolstova
  9. Optimal monetary policy under bounded rationality By Benchimol, Jonathan; Bounader, Lahcen
  10. Forward Guidance By Marcus Hagedorn; Jinfeng Luo; Iourii Manovskii; Kurt Mitman
  11. Financial Frictions and the Rule of Law By Ashantha Ranasinghe; Diego Restuccia
  12. Fiscal Commitment and Sovereign Default Risk By Siming Liu; Hewei Shen
  13. On Welfare Effects of Increasing Retirement Age By Makarski, Krzysztof; Tyrowicz, Joanna
  14. Accounting for Busines Cycles in Canada: II. The Role of Money By Accolley, Delali
  15. Asset Pledgeability and Endogenously Leveraged Bubbles By Bengui, Julien; Phan, Toan
  17. Sweat Equity in U.S. Private Business By Anmol Bhandari; Ellen R. McGrattan
  18. Regressive Welfare Effects of Housing Bubbles By Graczyk, Andrew; Phan, Toan
  19. Credit Constraints, House Prices, and the Impact of Life Cycle Dynamics By Aaron Hedlund
  20. Supply-side policy and economic growth: A case study of the UK By Minford, Lucy; Meenagh, David
  21. Exchange Rate Misalignment, Capital Flows, and Optimal Monetary Policy Trade-offs By Corsetti, Giancarlo; Dedola, Luca; Leduc, Sylvain
  22. Declining Search Frictions, Unemployment and Growth By Paolo Martellini; Guido Menzio
  23. International monetary policy coordination in a new Keynesian model with NICE features By Jean-Christophe Poutineau; Gauthier Vermandel

  1. By: Pau Rabanal
    Abstract: During the last decade, Hong Kong SAR has experienced a large increase in house prices and credit, prompting the authorities to respond with several rounds of tightening macroprudential rules and increasing stamp duty taxes. This paper provides a Dynamic Stochastic General Equilibrium (DSGE) model for Hong Kong SAR and analyzes the effectiveness of these measures, and finds that they have helped reduce house price appreciation and household leverage. A baseline small open economy real business cycle model is extended by including a housing sector, financial frictions, foreign demand for the domestic housing stock, and is estimated using Bayesian methods and data for Hong Kong SAR between 1996 and 2017. The paper finds that, without these policies, house prices would have been 10.5 percent higher, and the household credit-GDP ratio 14 percent higher.
    Date: 2018–04–13
  2. By: Marco Cozzi (Department of Economics, University of Victoria)
    Abstract: This note provides a set of estimates of the efficiency units profiles that workers supply over the life-cycle in the U.S. labor market. These are helpful for the calibration of OLG models. I rely on data from the March CPS in the 1987-2017 period, and use both non-parametric and parametric estimation methods. Irrespective of the methodology used to obtain the profiles, I find that they differ in essential features from the ones that are typically used in applied work. In terms of the quantitative answers obtained from a life-cycle OLG model with idiosyncratic income shocks and incomplete markets, the discrepancies in the efficiency units profiles are found to be sizable. In terms of consumption equivalent variation, households' welfare decreases by up to 5 percentage points when moving from the standard profiles to the ones estimated here. Quantitatively, the specific profile used have also a substantial impact on the variables that are typically analyzed with this class of models, such as the saving behavior over the life-cycle and the concentration of wealth. JEL Classification: D15, D52, D58, E21
    Keywords: Labor efficiency units, Life-cycle models, Calibration.
    Date: 2018–04–23
  3. By: Sarolta Laczo (Queen Mary University of London); Raffaele Rossi (University of Manchester, Department of Economics)
    Abstract: We characterise optimal tax policies when the government has access to consumption taxation and cannot credibly commit to future policies. We consider a neoclassical economy where factor income taxation is distortionary within the period, due to endogenous labour and capital utilisation and non-tax-deductibility of depreciation. Contrary to the case where only labour and capital income are taxed, the optimal time-consistent policies with consumption taxation are remarkably similar to their Ramsey counterparts. The welfare gains from commitment are negligible, while they are substantial without consumption taxation. Further, the welfare gains from taxing consumption are much higher without commitment.
    Keywords: fiscal policy, Markov-perfect policies, consumption taxation, variable capital utilisation
    JEL: E62 H21
    Date: 2018–04–12
  4. By: van Wijnbergen, Sweder
    Abstract: What could be the drivers of low real rates? What are the implications of the Zero Lower Bound for economic policy? To discuss these questions we introduce a full general equilibrium model of the world economy with a simple (2 period) intertemporal structure. The model is simple enough to allow for full analytical solution yet sufficiently complex to allow us to address the impact of anticipated future productivity slow down, aging, structural reform and fiscal policy on real interest rates if markets clear and on aggregate economic activity if they do not because of the ZLB. We extend both the equilibrium model and the ZLB variant to a more-goods-per-period set up with complete specialization to address (real) exchange rate policy and the macroeconomic impact of trade tariffs.
    Keywords: aging; equilibrium real interest rates; import tariffs; productivity change; the ZLB; real exchange rates
    JEL: E62 F13 F40 F41 H30
    Date: 2018–04
  5. By: Carlsson, Mikael (Uppsala University, Nationalekonomiska institutionen); Westermark, Andreas (Research Department, Sveriges Riksbank, Stockholm)
    Abstract: We show that in microdata, as well as in a search and matching model with flexible wages for new hires, wage rigidities of incumbent workers have substantial effects on separations and unemployment volatility. Allowing for an empirically relevant degree of wage rigidities for incumbent workers drives unemployment volatility, as well as the volatility of vacancies and tightness to that in the data. Thus, the degree of wage rigidity for newly hired workers is not a sufficient statistic for determining the effect of wage rigidities on macroeconomic outcomes. This finding affects the interpretation of a large empirical literature on wage rigidities.
    Keywords: Search and matching; Unemployment volatility puzzle; Wage rigidities; Job Destruction
    JEL: E30 J63 J64
    Date: 2018–04–20
  6. By: Frankovic, Ivan; Kuhn, Michael
    Abstract: We study the impact of health insurance expansion in the US on health expenditure, longevity growth and welfare in an overlapping generations economy in which individuals purchase health care to lower mortality. We consider three sectors: final goods production; a health care sector, selling medical services to individuals; and an R&D sector, selling increasingly effective medical technology to the health care sector. We calibrate the model to match the development of the US economy/health care system from 1965 to 2005 and study numerically the impact of the insurance expansion on health expenditures, medical progress and longevity. We find that more extensive health insurance accounts for a large share of the rise in US health spending but also boosts the rate of medical progress. A welfare analysis shows that while the moral hazard associated with subsidized health care creates excessive health care expenditure, the gains in life expectancy brought about by induced medical progress more than compensate for this. By mitigating an intergenerational externality associated with the longevity benefits from current medical innovation the expansion of health insurance constitutes a Pareto improvement.
    Keywords: life-cycle model,health care spending,health insurance,medical progress,moral hazard,overlapping generations
    JEL: I11 I12 I18 J11 J17 O31 O41
    Date: 2018
  7. By: Lozej, Matija; Onorante, Luca; Rannenberg, Ansgar
    Abstract: We examine, conditional on structural shocks, the macroeconomic performance of different countercyclical capital buffer (CCyB) rules in small open economy estimated medium scale DSGE. We find that rules based on the credit gap create a trade-off between the stabilization of fluctuations originating in the housing market and fluctuations caused by foreign demand shocks. The trade-off disappears if the regulator targets house prices instead. As a result, the optimal simple CCyB rule depends only on the house price but not the credit gap. Moreover, the optimal simple rule leads to significant welfare gains compared to the no CCyB case. JEL Classification: F41, G21, G28, E32, E44
    Keywords: bank capital, boom-and-bust, countercyclical capital regulation, housing bubbles
    Date: 2018–04
  8. By: Vera Tolstova
    Abstract: I develop a simple dynastic model in the style of Barro and Becker, with endogenous fertility and human capital accumulation, to quantify the optimal progressivity of higher education subsidies. I find that the optimal policy is characterised by a higher degree of progressivity than current U.S. education subsidies. Additionally, the relation between progressivity of education policy and welfare/ population growth is hump-/ U-shaped respectively. While an assumption of endogenous fertility is quantitatively important, heterogeneity in fertilities is sufficient to generate these results. This is because welfare gains from more progressive subsidies are driven not only by decreases in fertility rates of low income individuals, but also by the fact that their children transit to states associated with higher incomes and, consequently, relatively low fertilities.
    Keywords: higher education subsidies; endogenous fertility; heterogeneous agents;
    JEL: J13 J24 I22
    Date: 2018–03
  9. By: Benchimol, Jonathan; Bounader, Lahcen
    Abstract: Optimal monetary policy under discretion, commitment, and optimal simple rules regimes is analyzed through a behavioral New Keynesian model. Flexible price level targeting dominates under discretion; flexible inflation targeting dominates under commitment; and strict price level targeting dominates when using optimal simple rules. The optimality of a particular regime is found to be independent of bounded rationality and only regime 's stabilizing properties condition its hierarchy. For every targeting regime, the policymaker 's knowledge of agents' myopia is decisive in terms of policy reactions. Welfare evaluation of different targeting regimes reveals that bounded rationality is not necessarily associated with decreased welfare. Several forms of economic inattention can increase welfare.
    JEL: C53 E37 E52 D01 D11
    Date: 2018–04–19
  10. By: Marcus Hagedorn; Jinfeng Luo; Iourii Manovskii; Kurt Mitman
    Abstract: We assess the power of forward guidance—promises about future interest rates—as a monetary tool in a liquidity trap using a quantitative incomplete-markets model. Our results suggest the effects of forward guidance are negligible. A commitment to keep future nominal interest rates low for a few quarters—although macro indicators suggest otherwise—has only trivial effects on current output and employment. We explain theoretically why in complete markets models forward guidance is powerful—generating a “forward guidance puzzle”—and why this puzzle disappears in our model. We also clarify theoretically ambiguous conclusions from previous research about the effectiveness of forward guidance in incomplete and complete markets models.
    JEL: E21 E30 E52 E58 E62
    Date: 2018–04
  11. By: Ashantha Ranasinghe; Diego Restuccia
    Abstract: Using cross-country micro establishment-level data we document that crime and lack of access to finance are two major obstacles to business operation in poor and developing countries. Using an otherwise standard model of production heterogeneity that integrates institutional differences in the degree of financial development and the rule of law, we quantify the effects of these institutions on aggregate outcomes and economic development. The model accounts for the patterns across establishments in access to finance and crime as obstacles to their operation. Weaker financial development and rule of law have substantial negative effects on aggregate output, reducing output per capita by 50 percent. Weak rule-of-law institutions substantially amplify the negative impact of financial frictions. While financial markets are crucial for development, an essential precondition to reap the gains from financial liberalization is that property rights are secure.
    Keywords: misallocation, establishments, financial frictions, rule of law, crime, micro data.
    JEL: O1 O4
    Date: 2018–04–17
  12. By: Siming Liu (Indiana University); Hewei Shen (Indiana University)
    Abstract: This paper studies the effects of fiscal policy commitment in countries that suffer sovereign default risk. Since a government does not incorporate the effect of their taxation decisions on past bond prices, a time-inconsistency problem arises, resulting in too many defaults and too few fiscal adjustments. We show that a fiscal commitment device can mitigate the government’s default incentives and improve their borrowing opportunities. Moreover, instead of committing to a single tax rate, introducing a commitment device that depends on economic conditions can further reduce default risk while preserving the contingency of a pro-cyclical fiscal policy.
    Keywords: overeign default risk; Pro-cyclical fiscal policy; Time-inconsistency; Fiscal commitment; Fiscal austerity
    Date: 2018–04
  13. By: Makarski, Krzysztof (Warsaw School of Economics); Tyrowicz, Joanna (University of Warsaw)
    Abstract: We develop an OLG model with realistic assumptions about longevity to analyze the welfare effects of raising the retirement age. We look at a scenario where an economy has a pay-as-you-go defined benefit scheme and compare it to a scenario with defined contribution schemes (funded or notional). We show that, initially, in both types of pension system schemes the majority of welfare effects comes from adjustments in taxes and/or prices. After the transition period, welfare effects are predominantly generated by the preference for smoothing inherent in many widely used models. We also show that although incentives differ between defined benefit and defined contribution systems, the welfare effects are of comparable magnitude under both schemes. We provide an explanation for this counter-intuitive result.
    Keywords: longevity, PAYG, retirement age, pension system reform, welfare
    JEL: C68 E21 J11 H55
    Date: 2018–03
  14. By: Accolley, Delali
    Abstract: I have explained business cycles in Canada focusing on the role of money. To do that, I have used both empirical and theoretical models. The empirical investigations include performing causality tests and computing impulse responses based on structural and co-integrated vector autoregressive models. The theoretical models consist of RBC and new-Keynesian models. Some of these theoretical models are: the inflation tax, the inflation and tax code, the sticky price, and the financial accelerator models. The empirical models indicate monetary disturbances are instrumental in business cycle fluctuations but do not necessarily cause them. The theoretical models also point out that monetary disturbances contribute to business cycle fluctuations but not as much as technological change. Some channels through which they propagate are: nominal capital gain tax, price stickiness, and deteriorating financial conditions. Price stickiness turns out to play a major r
    Keywords: Business Cycles, Macroeconomics, Monetary Policy, Sticky Prices, Vector Autoregression, Vector Error Correction.
    JEL: E31 E32 E37 E52
    Date: 2018–03–25
  15. By: Bengui, Julien (Université de Montréal); Phan, Toan (Federal Reserve Bank of Richmond)
    Abstract: We develop a simple model of defaultable debt and rational bubbles in the price of an asset, which can be pledged as collateral in a competitive credit pool. When the asset pledgeability is low, the down payment is high, and bubble investment is unleveraged, as in a standard rational bubble model. When the pledgeability is high, the down payment is low, making it easier for leveraged borrowers to invest in the bubbly asset. As loans are packaged together into a competitive pool, the pricing of individual default risk may facilitate risk-taking. In equilibrium, credit-constrained borrowers may optimally choose a risky leveraged investment strategy – borrow to invest in the bubbly asset and default if the bubble bursts. The model predicts joint boom-bust cycles in asset prices and securitized credit.
    Keywords: rational bubbles; collateral; credit pool; household debt; equilibrium default
    JEL: E12 E24 E44 G01
    Date: 2018–04–19
    Date: 2018
  17. By: Anmol Bhandari; Ellen R. McGrattan
    Abstract: In this paper, we first provide evidence that existing measures of business incomes and valuations based on widely-used surveys such as the Survey of Consumer Finances are mismeasured. We then develop a theory disciplined by U.S. national accounts and business census data to measure net incomes and private business sweat equity—which is the value of time to build customer bases, client lists, and other intangible assets. We estimate an aggregate sweat equity value of 0.65 times GDP, with little cross-sectional dispersion in valuations when compared to business net incomes and large cross-sectional dispersion in rates of return. Our estimate of sweat equity is close to the estimate of marketable fixed assets used in production by private businesses, implying a high ratio of intangible to total assets. We use the model to evaluate the impact of greater tax compliance of private businesses and lower tax rates on the net income of both privately held and publicly traded businesses. We find larger sectoral and aggregate effects from the tax policy experiments relative to studies that abstract from private business and, in particular, the accumulation of sweat capital. Finally, we show that our results are robust to including non-pecuniary benefits of business ownership.
    JEL: E13 E22 H25
    Date: 2018–04
  18. By: Graczyk, Andrew (Wake Forest University); Phan, Toan (Federal Reserve Bank of Richmond)
    Abstract: We analyze the welfare effects of asset bubbles in a model with income inequality and financial friction. We show that a bubble that emerges in the value of housing, a durable asset that is fundamentally useful for everyone, has regressive welfare effects. By raising the housing price, the bubble benefits high-income savers but negatively affects low-income borrowers. The key intuition is that, by creating a bubble in the market price, savers' demand for the housing asset for investment purposes imposes a negative externality on borrowers, who only demand the housing asset for utility purposes. The model also implies a feedback loop: high income inequality depresses the interest rates, facilitating the existence of housing bubbles, which in turn have regressive welfare effects.
    Keywords: rational bubble; inequality; housing; financial friction
    JEL: E10 E21 E44
    Date: 2018–04–18
  19. By: Aaron Hedlund (University of Missouri-Columbia)
    Abstract: How does the life cycle|namely, mortality risk and the expectation at birth of a rising age-profile of income and assets--impact house price dynamics? This paper investigates how equilibrium house prices respond to a tightening in credit constraints under two different but similarly calibrated models: one an infinite-horizon setting and the other a life-cycle environment. The main conclusion is that house price dynamics are magnified by the presence of life cycle features. Two primary explanations stand out: the distinction between stocks and flows of mortgage debt in the cross-section and the importance of gross housing tenure flows, i.e. churn.
    Keywords: House Prices, Mortgage Debt, Credit Constraints, Life Cycle Models
    JEL: D31 E21 E44 G11 G12 G21 R21 R31
    Date: 2018–04–23
  20. By: Minford, Lucy (Swansean University); Meenagh, David (Cardiff Business School)
    Abstract: This paper investigates the potential for a causal relationship between certain supply-side policies and UK output and productivity growth between 1970 and 2009. We outline an open economy DSGE model of the UK in which productivity growth is determined by the tax and regulatory environment faced by firms. This model is estimated and tested using simulation-based econometric methods (indirect inference). Using Monte Carlo methods we investigate the power of the test as we apply it, allowing the construction of uncertainty bounds for the structural parameter estimates and hence for the quantitative implications of policy reform in the estimated model. We also test and confirm the modelís identification, thus ensuring that the direction of causality is unambiguously from policy to productivity. The results offer robust empirical evidence that temporary changes in policies underpinning the business environment can have sizeable effects on economic growth over the medium term.
    Keywords: Taxation, Regulation, Labour Market Regulation, Economic Growth, DSGE
    JEL: E02 O4 O43 O5
    Date: 2018–04
  21. By: Corsetti, Giancarlo; Dedola, Luca; Leduc, Sylvain
    Abstract: What determines the optimal monetary trade-off between internal objectives (inflation, and output gap) and external objectives (competitiveness and trade imbalances) when inefficient capital flows cause exchange rate misalignment and distort current account positions? We characterize this trade-off analytically, using the workhorse model of modern monetary theory in open economies under incomplete markets–where inefficient capital flows and exchange rate misalignments can arise independently of nominal distortions. We derive a quadratic approximation of the utility-based global policy loss function under fairly general assumptions on preferences and openness, and solve for the optimal targeting rules under co- operation. We show that, in economies with a low degree of exchange rate pass-through, the optimal response to inefficient capital inflows associated with real appreciation is contractionary, above and beyond the natural rate: the optimal policy curbs excessive demand at the cost of exacerbating currency overvaluation. In contrast, a high degree of pass-through, and/or low trade elasticities, warrants expansionary policies that lean against exchange rate appreciation and competitive losses, at the cost of inefficient inflation.
    Keywords: asset markets and risk sharing; Currency misalignments; exchange rate pass-through; international policy cooperation; optimal targeting rules; trade imbalances
    JEL: E44 E52 E61 F41 F42
    Date: 2018–04
  22. By: Paolo Martellini; Guido Menzio
    Abstract: Over the last century, unemployment, vacancy, job-finding and job-loss rates as well as the Beveridge curve have no trend. Yet, the last century has seen the development and diffusion of many information technologies—such as telephones, fax machines, computers, the Internet—which presumably have increased the efficiency of search in the labor market. We explain this phenomenon using a textbook search-theoretic model of the labor market. We show that there exists an equilibrium in which unemployment, vacancies, job-finding and job-loss rates are constant while the search technology improves over time if and only if firm-worker matches are heterogeneous in quality, the distribution of match qualities is Pareto, and the quality of a match is observed before the start of the employment relationship. Under these conditions, improvements in search lead to an increase in the rate at which workers meet firms and to a proportional decline in the probability that the quality of a firm-worker match is acceptable leading to a constant job-finding rate, unemployment, etc... Interestingly, under the same conditions, unemployment, vacancies, job-finding and job-loss rates are independent of the size of the labor market even in the presence of increasing returns to scale in search. While declining search frictions do not lower unemployment, they contribute to growth. The magnitude of the contribution depends on the thickness of the tail of the Pareto distribution. We present a simple strategy to measure the decline in search frictions and its contribution to growth. A rudimentary implementation of this strategy suggests that the decline in search frictions has been substantial, it has been caused by both improvements in the search technology and increasing returns to scale in the search process, and it has had a non-negligible impact on growth.
    JEL: E24 O40 R11
    Date: 2018–04
  23. By: Jean-Christophe Poutineau (CREM - Centre de recherche en économie et management - UNICAEN - Université de Caen Normandie - NU - Normandie Université - UR1 - Université de Rennes 1 - CNRS - Centre National de la Recherche Scientifique); Gauthier Vermandel (LEDa - Laboratoire d'Economie de Dauphine - Université Paris-Dauphine)
    Abstract: This paper provides a static two country new Keynesian model to teach two related questions in international macroeconomics: the international transmission of unilateral monetary policy decisions and the gains coming from the coordination monetary rules. We concentrate on “normal times” and use a thoroughly graphical approach to analyze the questions at hands. In this setting monetary policy is conducted using interest rates rules and economic integration between nations does not necessarily create the case for the coordination of monetary policy. In particular, we show that the conduct of optimal national monetary policies does not make any difference with the coordination of national policies, as this creates a situation where the international monetary system operates “Near an International Cooperative Equilibrium”.
    Keywords: monetary policy,New Keynesian macroeconomics,international macroeconomics,economic policy,optimal interest rate rules,A20,E10,E50,F41
    Date: 2018
    Date: 2018

This nep-dge issue is ©2018 by Christian Zimmermann. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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