nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2018‒05‒07
twenty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Optimal taxes on capital in the OLG model with uninsurable idiosyncratic income risk By Krueger, Dirk; Ludwig, Alexander
  2. Bounded-rationality and heterogeneous agents: Long or short forecasters? By Elton Beqiraj; Giovanni Di Bartolomeo; Marco Di Pietro; Carolina Serpieri
  3. How Much Consumption Insurance in Bewley Models with Endogenous Family Labor Supply? By Krueger, Dirk; Wu, Chunzan
  4. Does More Female Labor Supply Really Save a Graying Japan? By Ryuta Ray Kato
  5. Theoretical considerations on the retirement consumption puzzle and the optimal age of retirement By Nicolas Drouhin
  6. The Role of News about TFP in U.S. Recessions and Booms By Faccini, Renato; Melosi, Leonardo
  7. Price Stickiness along the Income Distribution and the Effects of Monetary Policy By Javier Cravino; Ting Lan; Andrei A. Levchenko
  8. Does the foreign sector help forecast domestic variables in DSGE models? By Marcin Kolasa; Michał Rubaszek
  9. Forward Guidance By Hagedorn, Marcus; Luo, Jinfeng; Manovskii, Iourii; Mitman, Kurt
  10. Interbank market turmoils and the macroeconomy By Paweł Kopiec
  11. Crisis, contagion and international policy spillovers under foreign ownership of banks By Michał Brzoza-Brzezina; Marcin Kolasa; Krzysztof Makarski
  12. "Employment and Hours over the Business Cycle in a Model with Search Frictions" By Noritaka Kudoh; Hiroaki Miyamoto; Masaru Sasaki
  13. Evaluating welfare and economic effects of raised fertility By Krzysztof Makarski; Joanna Tyrowicz; Magda Malec
  14. The Role of Energy in a Real-business-cycle Model with an Endogenous Capital Utilization Rate and a Government Sector: Lessons from Bulgaria (1999-2016) By Aleksandar Vasilev
  15. Macroeconomic consequences of the demographic and educational transition in Poland By Aleksandra Kolasa
  16. Idiosyncratic risk, aggregate risk, and the welfare effects of social security By Harenberg, Daniel; Ludwig, Alexander
  17. The sources and effects of rental market underdevelopment in Central Europe. The results of a survey and DSGE model simulations By Michal Rubaszek; Margarita Rubio
  18. Socially Optimal Wealth Inequality By Reichlin, Pietro
  19. Consumption Dynamics, Housing Collateral and Stabilisation Policies: AWay Forward for Policy Co-Ordination? By Jagjit S. Chadha; Germana Corrado; Luisa Corrado
  20. Foreign Exchange Intervention Redux By Roberto Chang
  21. The Future Prospect of the Long-term Care Insurance in Japan By Ryuta Ray Kato

  1. By: Krueger, Dirk; Ludwig, Alexander
    Abstract: We characterize the optimal linear tax on capital in an Overlapping Generations model with two period lived households facing uninsurable idiosyncratic labor income risk. The Ramsey government internalizes the general equilibrium feedback of private precautionary saving. For logarithmic utility our full analytical solution of the Ramsey problem shows that the optimal aggregate saving rate is independent of income risk. The optimal time-invariant tax on capital is increasing in income risk. Its sign depends on the extent of risk and on the Pareto weight of future generations. If the Ramsey tax rate that maximizes steady state utility is positive, then implementing this tax rate permanently generates a Pareto-improving transition even if the initial equilibrium is dynamically efficient. We generalize our results to Epstein-Zin-Weil utility and show that the optimal steady state saving rate is increasing in income risk if and only if the intertemporal elasticity of substitution is smaller than 1.
    Keywords: Idiosyncratic Risk,Taxation of Capital,Overlapping Generations,Precautionary Saving,Pecuniary Externality
    JEL: H21 H31 E21
    Date: 2018
  2. By: Elton Beqiraj (University La Sapienza); Giovanni Di Bartolomeo (University La Sapienza); Marco Di Pietro (University La Sapienza); Carolina Serpieri (European Commission - JRC)
    Abstract: Our paper estimates and compares behavioral New-Keynesian DSGE models derived under two alternative ways to introduce heterogeneous expectations. We assume that agents may be either short-sighted or long-horizon forecasters. The difference does not matter when agents have rational expectations, but it does when a fraction of them form beliefs about the future according to some heuristics. Bayesian estimations show that a behavioral model based on short forecasters fits the data better than one based on long forecasters. Long-horizon predictors exhibit very poor predictive ability, whereas the short forecasters’ model also outperforms the rational expectation framework. We show that the superiority is due to its ability to capture heterogeneous consumers’ expectations. Finally, by Monte-Carlo-filtering mapping, we investigate the indeterminacy regions to complement existing literature.
    Keywords: monetary policy, bounded rationality, heterogeneous expecta- tions
    Date: 2018–04
  3. By: Krueger, Dirk; Wu, Chunzan
    Abstract: We show that a calibrated life-cycle two-earner household model with endogenous labor supply can rationalize the extent of consumption insurance against shocks to male and female wages, as estimated empirically by Blundell, Pistaferri and Saporta-Eksten (2016) in U.S. data. With additively separable preferences, 43% of male and 23% of female permanent wage shocks pass through to consumption, compared to the empirical estimates of 34% and 20%. With non-separable preferences the model predicts more consumption insurance, with pass-through rates of $29% and $16%. Most of the consumption insurance against permanent male wage shocks is provided through the labor supply response of the female earner.
    Keywords: Bewley Models; Consumption Insurance; Labor Supply
    Date: 2018–03
  4. By: Ryuta Ray Kato (International University of Japan)
    Abstract: This paper examines the impact of stimulated female labor supply on the Japanese economy as well as the government fiscal imbalance within a numerical dynamic general equilibrium model with multiple overlapping generations, particularly by paying attention to females' time costs of child rearing and elderly care in a graying Japan. Several numerical results indicate that even complete elimination of females' time costs of child rearing and elderly care stimulates the total GDP only by 1 percent. If complete elimination of time costs occurs in accordance with no gender gap in wage profiles, then the total GDP expands by 4 percent. The results also suggest importance of government policies not only to stimulate female labor force participation but also to improve human capital accumulation of females to reduce a gender gap in wage profiles.
    Keywords: Female Labor Supply, Childcare, Child Allowance, Elderly Care, Public Pension, Long-Term Care Insurance, Population Aging, Japan, Simulation
    JEL: C68 H51 E62 H55 J16
    Date: 2017–09
  5. By: Nicolas Drouhin (CREST - Centre de Recherche en Économie et Statistique - ENSAI - Ecole Nationale de la Statistique et de l'Analyse de l'Information [Bruz] - X - École polytechnique - ENSAE ParisTech - École Nationale de la Statistique et de l'Administration Économique, ENS Paris Saclay - Ecole Normale Supérieure Paris-Saclay)
    Abstract: Defining retirement as a discontinuity in the labor supply of the agent, this paper resolves the retirement consumption puzzle in a very general model of in-tertemporal choice of consumption and savings of a fully rational, forward looking, agent. Building on a specific version of Bellman (1957) principle of optimality, it provides a very general and parsimonious formula for determining the optimal age of retirement taking into account the possible discontinuity of the optimal consumption profile at the age of retirement. Code JEL: C61 D91 J26
    Keywords: life cycle theory of consumption and saving,optimal retirement,retirement consumption puzzle,discontinuous optimal control
    Date: 2018–04–15
  6. By: Faccini, Renato (Queen Mary University of London); Melosi, Leonardo (Federal Reserve Bank of Chicago)
    Abstract: We develop a general equilibrium model to study the historical contribution of TFP news to the U.S. business cycle. Hiring frictions provide incentives for firms to start hiring ahead of an anticipated improvement in technology. For plausibly calibrated hiring costs, employment gradually rises in response to positive TFP news shocks even under standard preferences. TFP news shocks are identified mainly by current and expected unemployment rates since periods in which average unemployment is relatively high (low) are also periods in which average TFP growth is slow (fast). We work out the noise component of the identified TFP news shocks. Noise captures changes in agents' beliefs about future TFP shocks that do not materialize. These autonomous changes in beliefs have induced fluctuations in the unemployment rate within a two-percentage-point range across the post-war recessions and expansions. After the Great Recession, noise about TFP growth has been the most important factor behind the rise in the employment rate. The index of consumer sentiment and the dismal TFP growth in recent years support these predictions.
    Keywords: Unemployment rate; hiring frictions; beliefs; the Great Recession; labor market trends; employment gap; Bayesian estimation
    JEL: C11 C51 E32 J64
    Date: 2018–04–15
  7. By: Javier Cravino (University of Michigan and NBER); Ting Lan (University of Michigan); Andrei A. Levchenko (University of Michigan, NBER, and CEPR)
    Abstract: We document that the prices of the goods consumed by high-income households are more sticky and less volatile than those of the goods consumed by middle-income households. This suggests that monetary shocks can have distributional consequences by affecting the relative prices of the goods consumed at different points on the income distribution. We use a Factor-Augmented VAR (FAVAR) model to show that, following a monetary policy shock, the estimated impulse responses of high-income householdsÕ consumer price indices are 22% lower than those of the middle-income households. We then evaluate the macroeconomic implications of our empirical findings in a quantitative New-Keynesian model featuring households that are heterogeneous in their income and consumption patterns, and sectors that are heterogeneous in their frequency of price changes. We find that: (i) the distributional consequences of monetary policy shocks are large and similar to those in the FAVAR model, and (ii) greater income inequality increases the effectiveness of monetary policy, although this effect is modest for realistic changes in inequality.
    Keywords: Inflation, distributional effects, consumption baskets, monetary policy.
    JEL: E31 E52
    Date: 2018–04
  8. By: Marcin Kolasa (SGH Warsaw School of Economics and Narodowy Bank Polski); Michał Rubaszek (SGH Warsaw School of Economics)
    Abstract: This paper evaluates the forecasting performance of several small open economy DSGE models relative to a closed economy benchmark using a long span of data for Australia, Canada and the United Kingdom. We find that opening the model economy usually does not improve, and even deteriorates the quality of point and density forecasts for key domestic variables. We show that this result can be to a large extent attributed to an increase in forecast error due to a more sophisticated structure of the extended setup which is not compensated by better model specification. This claim is based on a Monte Carlo experiment, in which an open economy model fails to consistently beat its closed economy benchmark even if the former is the true data generating process.
    Keywords: Forecasting, DSGE models, New Open Economy Macroeconomics, Bayesian estimation
    JEL: D58 E17 F41 F47
    Date: 2018
  9. By: Hagedorn, Marcus; Luo, Jinfeng; Manovskii, Iourii; Mitman, Kurt
    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.
    Keywords: forward guidance; incomplete markets; monetary policy
    Date: 2018–04
  10. By: Paweł Kopiec (Narodowy Bank Polski)
    Abstract: This paper studies the macroeconomic consequences of interbank market disruptions caused by higher counterparty risk. I propose a novel, dynamic model of banking sector where banks trade liquidity in the frictional OTC market à la Afonso and Lagos (2015) that features counterparty risk. The model is then embedded into an otherwise standard New Keynesian framework to analyze the macroeconomic impact of interbank market turmoils: economy suffers from a prolonged slump and deflationary pressure during such episodes. I use the model to analyze the effectiveness of two policy measures: rise in the supply of central bank reserves and interbank market guarantees in mitigating the adverse effects of those disruptions.
    Keywords: Financial crisis, Interbank market, Policy intervention, OTC market
    JEL: D80 E44 E58 G21
    Date: 2018
  11. By: Michał Brzoza-Brzezina (Narodowy Bank Polski; Warsaw School Economics); Marcin Kolasa (Narodowy Bank Polski; Warsaw School Economics); Krzysztof Makarski (Narodowy Bank Polski; Warsaw School Economics; Group for Research in Applied Economics (GRAPE))
    Abstract: This paper checks how international spillovers of shocks and policies are modified when banks are foreign owned. To this end we build a two-country macroeconomic model with banking sectors that are owned by residents of one (big and foreign) country. Consistently with empirical findings, in our model foreign ownership of banks amplifies spillovers from foreign shocks. It also strengthens the international transmission of monetary and macroprudential policies. We next use the model to replicate the financial crisis in the euro area and show how, by preventing bank capital outflow in 2009, the Polish regulatory authorities managed to reduce its contagion to Poland. We also find that under foreign bank ownership such policy is strongly preferred to a recapitalization of domestic banks. Finally, we check how foreign ownership of banks affects transmission of domestic shocks to find that it has a stabilizing effect.
    Keywords: foreign-owned banks, monetary and macroprudential policy, international spillovers, DSGE models with banking
    JEL: E32 E44 E58
    Date: 2017
  12. By: Noritaka Kudoh (Department of Economics, Nagoya University); Hiroaki Miyamoto (International Monetary Fund); Masaru Sasaki (Graduate School of Economics, Osaka University)
    Abstract: This paper studies a large-firm search-matching model with variable hours of work to investigate how firms utilize the intensive and extensive margins of labor adjustment over the business cycle. Introduction of variable hours of work introduces the Frisch elasticity parameter into the analysis, and this is a key determinant of the magnitude of fluctuations in hours of work. The model replicates the observed cyclical behavior of the Japanese labor market, in which fluctuations in hours of work account for 79 percent of the variations in total labor input, well. Total labor input in the model is as volatile as that in the data, and is 25 times as volatile as that in the model without the intensive margin.
    Date: 2018–04
  13. 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: fertility, welfare, natalistic policies, overlapping generations model
    JEL: H55 E17 C60 C68 E21 D63
    Date: 2018
  14. By: Aleksandar Vasilev (Independent Researcher)
    Abstract: We introduce a pro-cyclical endogenous utilization rate of physical capita1 stock 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 the endogenous depreciation rate, and the capital utilization mechanism working through the use of energy for cyclical uctuations in Bulgaria. In particular, a positive shock to energy prices in the model works like a negative technological shock. Allowing for variations in factor utilization and the presence of energy as a factor of production improves the model performance against data, and in addition this extended setup dominates the standard RBC model framework with constant depreciation and a fixed utilization rate of physical capital, e.g., Vasilev (2009).
    Keywords: Business uctuations, capital utilization rate, endogenous depreciation rate, energy use, energy prices, Bulgaria
    JEL: E32 E22 E37
    Date: 2018–04
  15. By: Aleksandra Kolasa (University of Warsaw)
    Abstract: Soon after the start of the transition to market economy in the early 1990s, Poland has experienced both a dramatic decline in the fertility rate and an increase in the share of students among young high-school graduates. These two processes significantly changed the age structure of the population and average income characteristics of households. Using a general equilibrium model with heterogeneous households and uninsured income shocks I try to assess the impact of these demographic and educational changes on the Polish economic performance and inequalities. I find that in the long term the positive effects of educational transition on output per capita more than offset the negative impact of lower fertility, but the outcome strongly depends on the adjustments in the structure of labor demand. I also show that the educational transition increases income and consumption inequalities, while the demographic transition decreases inequality in assets.
    Keywords: population aging, educational transition, inequalities, models with heterogeneous agents
    JEL: J11 D31 I24 D58 J26
    Date: 2018
  16. By: Harenberg, Daniel; Ludwig, Alexander
    Abstract: We ask whether a pay-as-you-go financed social security system is welfare improving in an economy with idiosyncratic productivity and aggregate business cycle risk. We show analytically that the whole welfare benefit from joint insurance against both risks is greater than the sum of benefits from insurance against the isolated risk components. One reason is the convexity of the welfare gain in total risk. The other reason is a direct risk interaction which amplifies the utility losses from consumption risk. We proceed with a quantitative evaluation of social security's welfare effects. We find that introducing an unconditional minimum pension leads to substantial welfare gains in expectation, even net of the welfare losses from crowding out. About 60% of the welfare gains would be missing when simply summing up the isolated benefits.
    Keywords: social security,idiosyncratic risk,aggregate risk,welfare
    JEL: C68 E27 E62 G12 H55
    Date: 2018
  17. By: Michal Rubaszek; Margarita Rubio
    Abstract: A low share of the private rental market observed in most Central European countries, including Poland, might be considered as a serious structural weakness in housing markets that may affect the macroeconomy. This paper assesses two important questions. The first one relates to the reasons behind this rental market underdevelopment. The second question is what can be done to increase the size of the rental market. We conduct an original survey among a representative group of Poles and find that preferences are strongly tilted towards owning. Results of logit regressions, as well as the distribution of answers to selected questions, indicate that these preferences are strongly influenced by economic and psychological beliefs. Inefficient institutions and the lack of professional renting services also turned out to be important in the housing tenure choice. Then, using a macro DSGE model we propose a set of reforms that aim at improving the efficiency in rental markets: (i) removing the bad tenant effect" on the level of rents, (ii) equalising fiscal incentives for different types of housing tenure, and (iii) improving the standard of rental services leading to a shift in housing tenure preferences. Our computations indicate that introducing these three reforms would shift the rental share from 6.8%to 15.0%, contributing as well to macroeconomic stability.
    Keywords: DSGE model; Rental market; survey data
    JEL: R3
    Date: 2017–07–01
  18. By: Reichlin, Pietro
    Abstract: I discuss two alternative notions of social welfare (utilitarian and self-enforcing) in a dynastic model with heterogeneous and persistent degrees of parental altruism and evaluate the implied levels of consumption inequality. Then, I study a decentralization of planning optima in a competitive equilibrium where the only source of inequality arises from intergenerational wealth transmission and I show that the self-enforcing criterion implies a negative tax rate on the less altruistic individuals' capital income.
    Keywords: Capital taxation; inequality; Wealth
    JEL: D31 E21 H21 J62
    Date: 2018–04
  19. By: Jagjit S. Chadha (NIESR & University of Cambridge); Germana Corrado (DEF,University of Rome "Tor Vergata"); Luisa Corrado (DEF & CEIS,University of Rome "Tor Vergata")
    Abstract: We decompose aggregate consumption of heterogeneous consumers by modelling both savers and their links to collateral constrained borrowers through a bank which prices credit risk. Savers own both ?rms and the commercial bank while borrowers require loans from the commercial bank to e¤ect their consumption plans. The bank lends at a premium over the interest rate on central bank money in proportion to the riskiness of loans, the demand for loans, the asset price and the quantity of housing collateral. We show that even though house prices do not represent wealth, aggregate consumption is closely related to movements in house prices. House price-induced changes may lead to large variations in household spending via the collateral e¤ect with important policy implications. We consider the case for jointly determined macro-prudential, ?scal and monetary policies in order to minimise losses for a representative household. We also analyse the implications when there is uncertainty over some of the policy parameters such as the loan default rate.
    Keywords: Heterogeneous households, Credit constraints, Housing collateral, Asset prices, Bank lending, Macro-prudential tools, Fiscal and monetary policy.
    JEL: E31 E40 E51
    Date: 2018–05–03
  20. By: Roberto Chang
    Abstract: Received wisdom posits that sterilized foreign exchange intervention can be effective by altering the currency composition of assets held by the public. This paper proposes an alternative channel: sterilized intervention may (or may not) have real effects because it changes the net credit position of the central bank vis a vis financial intermediaries, thereby affecting external debt limits. This argument is developed in the context of an open economy model with domestic banks subject to occasionally binding collateral constraints. Intervention has real effects if and only if it occurs when the constraints bind; at such times, a sterilized sale of official reserves relaxes the constraints by reducing the central bank's debt to domestic banks, freeing resources for the latter to increase the supply of credit to domestic agents. The analysis yields several noteworthy implications for intervention policy, official reserves accumulation, and the interaction between intervention and monetary policy.
    JEL: E58 F33 F41
    Date: 2018–03
  21. By: Ryuta Ray Kato (International University of Japan)
    Abstract: This paper explores the impact of population aging on the Japanese public longterm care insurnace (LTCI) within a numerical dynamic general equilibrium model with multiple overlapping generations. The impact of three policy options, such as an increase in co-payments, an earlier starting age of contribution, and more distribution of the cost to the public sector, is also examined. The numerial results show that in the next about forty years the burdens on the first (age 65 and over) and second (age 40 to 64) groups become more than 1.7 times and more than 2.7 times as much, respectively. A relatively more increase in the burdens on the second group cannot be avaiodable, even if adjustment of the cost distribution between both groups is made every three years in the future in accordance with the schedule by the MHLW. Furthermore, in order to reduce future burdens in the LTCI, an increase in co-payments is most preferable, rather than an earlier starting age of contribution in longer duration of contribution with lower burdens every year, or a shift of the cost to the public sector followed by a very higher consumption tax.
    Keywords: Long-term Care Insurance, Population Aging, Japan, Simulation
    JEL: C68 H51 E62 H55 J16
    Date: 2017–10

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