nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2018‒05‒21
fourteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Myopia and Anchoring By George-Marios Angeletos; Zhen Huo
  2. Commercial Banks, Credit Unions, and Monetary Policy By Edgar A. Ghossoub
  3. Financial Frictions and the Rule of Law By Ashantha Ranasinghe; Diego Restuccia
  4. The Accuracy of Linear and Nonlinear Estimation in the Presence of the Zero Lower Bound By Atkinson, Tyler; Richter, Alexander; Throckmorton, Nathaniel
  5. Capital Income Taxation, Economic Growth, and the Politics of Public Education By Tetsuo Ono; Yuki Uchida
  6. Intergenerational policies, public debt, and economic growth: a politico{economic analysis By Real Arai; Katsuyuki Naito; Tetsuo Ono
  7. The Optimal Supply of Public and Private Liquidity By Marina Azzimonti; Pierre Yared
  8. How Important are the International Financial Market Imperfections for the Foreign Exchange Rate Dynamics: A Study of the Sterling Exchange Rate By Xue, Dong; Minford, Patrick; Meenagh, David
  9. Search capital and Unemployment Duration (Preliminary) By Cristina Lafuente
  10. The Finance Uncertainty Multiplier By Iván Alfaro; Nicholas Bloom; Xiaoji Lin
  11. Optimal Taxation and Debt Management without Commitment By Davide Debortoli; Ricardo Nunes; Pierre Yared
  12. Investment subsidies and regional welfare: A dynamic framework By Korzhenevych, Artem; Bröcker, Johannes
  13. Structural Change in Investment and Consumption: A Unified Approach By Berthold Herrendorf; Richard Rogerson; Ákos Valentinyi
  14. Exchange Rate Exposure and Firm Dynamics By Salomao, Juliana; Varela, Liliana

  1. By: George-Marios Angeletos; Zhen Huo
    Abstract: We consider a stationary setting featuring forward-looking behavior, higher-order uncertainty, and learning. We obtain an observational equivalence result that recasts the aggregate dynamics of this setting as that of a representative-agent model featuring two distortions: myopia in the sense of extra discounting of the future; and anchoring of the current outcome to the past outcome, as in models featuring habit persistence, adjustment costs, or momentum. This builds a bridge to both the DSGE literature and an emerging literature on bounded rationality. We further show that the as-if distortions are larger when the general-equilibrium interaction is stronger; this property reflects the role of higher-order uncertainty and helps reduce the gap between macroeconomic and microeconomic estimates of adjustment frictions. We illustrate the quantitative potential of our theory in the context of inflation by showing how it can help rationalize existing estimates of the Hybrid NKPC while also matching survey evidence on expectations. We discuss additional applications to consumption, investment, and asset prices.
    JEL: D83 D84 E10 E32 G12
    Date: 2018–04
  2. By: Edgar A. Ghossoub (UTSA)
    Abstract: The objective of this manuscript is to study the strategic interaction between different types of financial institutions and its implications for economic activity and monetary policy. While commercial banks and credit unions provide similar financial services, they have different ownership structure and therefore have different objectives. For instance, banks are often perceived as profit maximizers, while credit unions act like cooperative entities seeking value and aim to maximize the welfare of their depositors. Following the 2007-2008 financial crisis, credit unions gained more market share and their role in the process of financial intermediation became more pronounced. Such changes raise some important questions that I attempt to address in this manuscript. First, how does the strategic interaction between credit unions and commercial banks affect risk sharing, total welfare, and capital formation? Second, will the effects of monetary policy become stronger if credit unions gain more market share? Finally, what is the optimal size of each financial institution? In order to address these important questions, I study a dynamic general equilibrium model with an important role for money and where different types of financial intermediaries interact strategically in deposit and capital markets. Length: 22 pages
    Keywords: Credit Union, Banking Competition, Monetary Policy
    JEL: E31 E41 E44 O42
    Date: 2016–11–30
  3. 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.
    JEL: O1 O11 O4 O43 O5
    Date: 2018–04
  4. By: Atkinson, Tyler (Federal Reserve Bank of Dallas); Richter, Alexander (Federal Reserve Bank of Dallas); Throckmorton, Nathaniel (College of William & Mary)
    Abstract: This paper evaluates the accuracy of linear and nonlinear estimation methods for dynamic stochastic general equilibrium models. We generate a large sample of artificial datasets using a global solution to a nonlinear New Keynesian model with an occasionally binding zero lower bound (ZLB) constraint on the nominal interest rate. For each dataset, we estimate the nonlinear model—solved globally, accounting for the ZLB—and the linear analogue of the nonlinear model—solved locally, ignoring the ZLB—with a Metropolis-Hastings algorithm where the likelihood function is evaluated with a Kalman filter, unscented Kalman filter, or particle filter. In datasets that resemble the U.S. experience, the nonlinear model estimated with a particle filter is more accurate and has a higher marginal data density than the linear model estimated with a Kalman filter, as long as the measurement error variances in the particle filter are not too big.
    Keywords: Bayesian estimation; nonlinear solution; particle filter; unscented Kalman filter
    JEL: C11 C32 C51 E43
    Date: 2018–05–07
  5. By: Tetsuo Ono (Graduate School of Economics, Osaka University); Yuki Uchida (Faculty of Economics, Seikei University)
    Abstract: This study considers the politics of public education and its impacts on economic growth and welfare across generations. Public education is funded by taxing the labor income of the working generation and capital income of the retired. We employ probabilistic voting to demonstrate the politics of taxes and expenditure and show that aging results in a shift of the tax burden from the old to the young and a slowdown of economic growth. We then consider three alternative constraints that limit the choice of taxes and/or expenditure: a minimum level of public education expenditure, an upper limit of the capital income tax rate, and a combination of the two. These constraints all create a trade-off between current and future generations in terms of welfare.
    Keywords: Public education, Economic growth, Capital income tax, Political equilibrium
    JEL: D70 E24 H63
    Date: 2018–02
  6. By: Real Arai (Department of Management, Kochi University of Technology); Katsuyuki Naito (Faculty of Economics, Asia University); Tetsuo Ono (Graduate School of Economics, Osaka University)
    Abstract: This study presents a two-period overlapping-generations model with endoge- nous growth. In each period, the government representing young and old gener- ations provides a public good financed by labor income taxation and public debt issuance, and the government's policies are determined by probabilistic voting. Increased political power of the old lowers economic growth. A debt-ceiling rule is considered to resolve the negative growth effect, but it creates a trade-off between generations in terms of welfare.
    Keywords: public debt; probabilistic voting; Markov perfect equilibrium; eco- nomic growth
    JEL: D72 H41 H63 O43
    Date: 2018–04
  7. By: Marina Azzimonti; Pierre Yared
    Abstract: We develop a theory of optimal government debt in which publicly-issued and privately-issued safe assets are substitutes. While government bonds are backed by future tax revenues, privately-issued safe assets are backed by the future repayment of pools of defaultable private loans. We find that a higher supply of public debt crowds out privately-issued safe assets less than one for one and reduces the interest spread between borrowing and deposit rates. Our main result is that the optimal level of public debt does not fully crowd out private lending and maintains a positive interest spread. Moreover, the optimal level of public debt is higher the more severe are financial frictions.
    JEL: E21 E25 E62 H21 H63
    Date: 2018–04
  8. By: Xue, Dong (Cardiff Business School); Minford, Patrick (Cardiff Business School); Meenagh, David (Cardiff Business School)
    Abstract: The UK has been a net debtor over the past two decades and the sterling exchange rates are sensitive to any chaos that might occur in the Financial market. This paper examines the importance of the inter-national financial imperfections in the sterling exchange rate dynamics. We build a small open economy DSGE model with the constrained international financial institutions that intermediate capital flows, and derive tractable analytical solutions. The constraint works to introduce a wedge between lending and borrowing rates, which compensates financiers for their currency risk-taking. The model has been estimated by using a simulation-based Indirect Inference approach, which provides a natural framework for testing the hypothesis implied by the model. We find that the model cannot be rejected by the UK data. Shocks to financial forces are the main driving forces behind the large and sudden depreciation of the Sterling exchange rates in the aftermath of the collapse of Lehman Brothers and the Brexit vote. Furthermore, the optimal policy rules have been proposed.
    Keywords: Small open economy DSGE model, International financial imperfections, Sterling exchange rates, Indirect Inference, Crisis, Policy rules
    JEL: E63 F31 F34 F41 F47
    Date: 2018–05
  9. By: Cristina Lafuente
    Abstract: I propose a novel mechanism called search capital to explain long term unemployment patters across different ages: workers who have been successful in finding jobs in the recent past become more efficient at finding jobs in the present. Search ability increases with search experience and depreciates with tenure if workers do not search often enough. This leaves young (who have not gained enough search experience) and older workers in a disadvantaged position, making them more likely to suffer long term unemployment. I focus on the case of Spain, as its dual labour market structure favours the identification of search capital. I provide empirical evidence that search capital affects unemployment duration and wages at the individual level. Then I propose a search model with search capital and calibrate it using Spanish administrative data. The addition of search capital helps the model match the dynamics of unemployment and job finding rates in the data, specially for younger workers.
    Keywords: unemployment, search
    JEL: J24 J63 J64
    Date: 2017–12
  10. By: Iván Alfaro; Nicholas Bloom; Xiaoji Lin
    Abstract: We show how real and financial frictions amplify the impact of uncertainty shocks. We build a model with real frictions, and find adding financial frictions roughly doubles the impact of uncertainty shocks. Higher uncertainty alongside financial frictions induces the standard real-options effects on investment and hiring, but also leads firms to hoard cash, further reducing investment and hiring. We then test the model using a panel of US firms and a novel instrumentation strategy for uncertainty exploiting differential firm exposure to exchange rate and price volatility. These results highlight why in periods with greater financial frictions uncertainty can be particularly damaging.
    JEL: E0 G0
    Date: 2018–05
  11. By: Davide Debortoli; Ricardo Nunes; Pierre Yared
    Abstract: This paper considers optimal fiscal policy in a deterministic Lucas and Stokey (1983) economy in the absence of government commitment. In every period, the government chooses a labor income tax and issues any unconstrained maturity structure of debt as a function of its outstanding debt portfolio. We find that the solution under commitment cannot always be sustained through the appropriate choice of debt maturities, a result which contrasts with previous conclusions in the literature. This is because a government today cannot commit future governments to a particular side of the Laffer curve, even if it can commit them to future revenues. We find that the unique stable debt maturity structure under no commitment is flat, with the government owing the same amount of resources to the private sector at all future dates. We present examples in which the maturity structure converges to such a flat distribution over time. In cases where the commitment and no-commitment solutions do not coincide, debt converges to the natural debt limit.
    JEL: E62 H21 H63
    Date: 2018–04
  12. By: Korzhenevych, Artem; Bröcker, Johannes
    Abstract: Subsidising investment in lagging regions is an important regional policy instrument in many countries. Some argue that this instrument is not specific enough to concentrate the aid towards the regions that are lagging behind most, because investment subsidies benefit capital owners who might reside elsewhere, possibly in very rich places. Checking under which conditions this is true is thus highly policy relevant. The present paper studies regional investment subsidies in a multiregional neoclassical dynamic framework. We set up a model with trade in heterogeneous goods, with a perfectly integrated financial capital market and sluggish adjustment of regional capital stocks. Consumers and investors act under perfect foresight. We derive the equilibrium system, show how to solve it, and simulate actual European regional subsidies in computational applications. We find that the size of the welfare gains depends on the portfolio distribution held by the households. If households own diversified asset portfolios, we find that the supported regions gain roughly the amounts that are allocated to them in the form of investment subsidies. If they only own local capital stocks, a part of the money is lost through the drop in share prices. From the point of view of total welfare, the subsidy is not efficient. It can lead to a welfare loss for the EU as a whole and definitely leads to welfare losses in the rest of the world, from where investment ows to the supported EU regions.
    Keywords: Exporter wage premium,Heterogeneous firms,Ability differences of workers,Positive assortative matching,Trade and wage inequality
    JEL: C31 F12 F15 J31
    Date: 2018
  13. By: Berthold Herrendorf; Richard Rogerson; Ákos Valentinyi
    Abstract: Existing models of structural change typically assume that all of investment is produced in manufacturing. This assumption is strongly counterfactual: in the postwar US, the share of services value added in investment expenditure has been steadily growing and it now exceeds 0.5. We build a new model, which takes a unified approach to structural change in investment and consumption. Our unified approach leads to three new insights: technological change is endogenously investment specific; having constant TFP growth in all sectors is inconsistent with structural change and aggregate balanced growth occurring jointly; the sector with the slowest TFP growth absorbs all resources asymptotically. We also provide empirical support from the postwar US for the first and third insight.
    JEL: O11 O14
    Date: 2018–05
  14. By: Salomao, Juliana (University of Minnesota); Varela, Liliana (University of Warwick)
    Abstract: This paper develops a firm-dynamics model with endogenous currency debt composition to study financing and investment decisions in developing economies. In our model, foreign currency borrowing arises from a trade-off between exposure to currency risk and growth. There is cross-sectional heterogeneity in these decisions in two dimensions. First, there is selection into foreign currency borrowing, as only productive firms employ it. Second, there is heterogeneity in firms’ share of foreign currency loans, driven by their potential growth. We assess econometrically the pattern of foreign currency borrowing using firm-level census data on Hungary, calibrate the model and quantify its aggregate impact.
    Keywords: firm dynamics, foreign currency debt, currency mismatch, uncovered interest rate parity. JEL Classification: F30, F34, F36
    Date: 2018

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