nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2018‒05‒28
fourteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Lending Relationships and Labor Market Dynamics By Finkelstein Shapiroy, Alan; Olivero, Maria
  2. The Macrodynamics of Sorting between Workers and Firms By Jeremy Lise; Jean-Marc Robin
  3. A Dynamic Analysis of Nash Equilibria in Search Models with Fiat Money By Federico Bonetto; Maurizio Iacopetta
  4. The non-linear nature of country risk and its implications for DSGE models By Michal Brzoza-Brzezina; Jacek Kotlowski
  5. The Changing Structure of Government Spending By Moro, Alessio; Rachedi, Omar
  6. Effects of Taxes and Safety Net Pensions on life-cycle Labor Supply, Savings and Human Capital: the Case of Australia By Fedor Iskhakov; Michael Keane
  7. Breaking the trilemma: the effects of financial regulations on foreign assets By David Perez-Reyna; Mauricio Villamizar-Villegas
  8. Bad Investments and Missed Opportunities? Postwar Capital Flows to Asia and Latin America By Ohanian, Lee E.; Restrepo-Echavarria, Paulina; Wright, Mark L. J.
  9. Household labour supply and the marriage market in the UK, 1991-2008 By Marion Gousse; Nicolas Jacquemet; Jean-Marc Robin
  10. International Credit Markets and Global Business Cycles By Patrick A. Pintus; Yi Wen; Xiaochuan Xing
  11. Money growth targeting and indeterminacy in small open economies By Kevin x.d. Huang; Qinglai Meng; Jianpo Xue
  12. The Finance Uncertainty Multiplier By Alfaro, Ivan; Bloom, Nicholas; Lin, Xiaoji
  13. Jobless Recovery, Liquidity Trap, Tight Monetary Policy and the Cost Channel By Lasitha R.C. Pathberiya
  14. Corporate Profit Taxes, Capital Expenditure and Real Wages: The analytics behind a contentious debate By Buiter, Willem H.; Sibert, Anne

  1. By: Finkelstein Shapiroy, Alan (Tufts Unversity); Olivero, Maria (Drexel University)
    Abstract: Standard models with search frictions in labor markets face limitations in replicating the empirical volatility of unemployment and market tightness in the U.S. In this paper we study the importance of endogenous labor force participation amid credit market disruptions in a labor search model with bank lending relationships. In response to both aggregate productivity and financial shocks that replicate the empirical volatility of labor force participation and volatility and cyclicality of credit spreads, the model produces more than 75 percent of the volatility of unemployment and 90 percent of the volatility of market tightness in the data. The interaction between endogenous participation in labor markets, and long-lasting lending relationships that quantitatively generate the cyclical behavior of credit spreads gives rise to sharper vacancy fluctuations amid financial shocks and plays a key role in replicating the data. In addition, we document a negative link between measures of credit-market distress and labor force participation alongside a positive link between measures of credit-market distress and unemployment. Moreover, we illustrate the policy importance of accounting for labor force participation by analyzing the effects of countercyclical credit subsidies. Only when labor force participation is an endogenous choice does this policy represent an effective stabilization tool.
    Keywords: unemployment; endogenous labor force participation; financial shocks; deep habits in credit markets; lending relationships
    JEL: E24 E32 E44
    Date: 2018–05–07
  2. By: Jeremy Lise (University College of London); Jean-Marc Robin (Département d'économie)
    Abstract: We develop an equilibrium model of on-the-job search with ex ante heterogeneous workers and firms, aggregate uncertainty, and vacancy creation. The model produces rich dynamics in which the distributions of unemployed workers, vacancies, and worker-firm matches evolve stochastically over time. We prove that the surplus function, which fully characterizes the match value and the mobility decision of workers, does not depend on these distributions. This result means the model is tractable and can be estimated. We illustrate the quantitative implications of the model by fitting to US aggregate labor market data from 1951-2012. The model has rich implications for the cyclical dynamics of the distribution of skills of the unemployed, the distribution of types of vacancies posted, and sorting between heterogeneous workers and firms.
    JEL: E24 E32 J24 J63 J64
    Date: 2017–04
  3. By: Federico Bonetto; Maurizio Iacopetta
    Abstract: We study the rise in the acceptability fiat money in a Kiyotaki-Wright economy by developing a method that can determine dynamic Nash equilibria for a class of search models with genuine heterogenous agents. We also address open issues regarding the stability properties of pure strategies equilibria and the presence of multiple equilibria. Experiments illustrate the liquidity conditions that favor the transition from partial to full acceptance of fiat money, and the effects of inflationary shocks on production, liquidity, and trade.
    Date: 2018–05
  4. By: Michal Brzoza-Brzezina; Jacek Kotlowski
    Abstract: Country risk premia can substantially affect macroeconomic dynamics. We concentrate on one of their most important determinants - a country’s net foreign asset position and - in contrast to the existing research - investigate its nonlinear link to risk premia. The importance of this particular non-linearity is twofold. First, it allows to identify the NFA level above which the elasticity becomes much (possibly dangerously) higher. Second, such a non-linear relationship is a standard ingredient of DSGE models, but its proper calibration/ estimation is missing. Our estimation shows that indeed the link is highly nonlinear and helps to identify the NFA position where the non-linearity kicks in at approximately -70% to -75% of GDP. We also provide a proper calibration of the risk premium - NFA relationship which can be used in DSGE models and demonstrate that its slope matters significantly for economic dynamics in such a model.
    Keywords: Risk premium, PSTR model, open economy DSGE model
    JEL: C23 E43 E44
    Date: 2018–05
  5. By: Moro, Alessio; Rachedi, Omar
    Abstract: We document that advanced economies experience a secular increase in the share of purchases from the private sector in total government spending, implying that over time governments purchase relatively more private-sector goods, and rely less on own production of value added. We build a calibrated general equilibrium model to show that this secular process can be accounted for by investment-specific technological change. We then use the model to measure the effect of this secular process on the transmission of fiscal policy, and find that (i) it shifts the stimulative effects of government spending towards private economic activity and (ii) it dampens the response of hours - but not of output - to fiscal shocks.
    Keywords: Government Gross Output, Fiscal Multiplier
    JEL: E62 H10 O41
    Date: 2018–05–07
  6. By: Fedor Iskhakov; Michael Keane
    Abstract: In this paper we structurally estimate a life-cycle model of consumption/savings, labor supply and retirement, using data from the Australian HILDA panel. We use the model to evaluate effects of the Australian aged pension system and tax policy on labor supply, consumption and retirement decisions. Our model accounts for human capital accumulation via learning by doing, as well as wealth accumulation and decumulation over the life cycle, uninsurable wage risk, credit constraints, a non-absorbing retirement decision, and labor market frictions. We account for the ’bunching’ of hours by discretizing job offers into several hours levels, allowing us to investigate labor supply on both intensive and extensive margins. Our model allows us to quantify the effects of anticipated and unanticipated tax and pension policy changes at different points of the life cycle. Our results imply that the Australian Aged Pension system as currently designed is very poorly targeted, so that means testing and other program rules could be improved.
    Keywords: Labor supply, human capital accumulation, retirement, pensions, taxes, struc-tural model, anticipated and unanticipated policy changes, counterfactual simulations
    JEL: J22 J24 J26 C63
    Date: 2018–05
  7. By: David Perez-Reyna; Mauricio Villamizar-Villegas
    Abstract: In this paper we analyze the effects of financial constraints on the exchange rate through the portfolio balance channel. Our contribution is twofold: First, we construct a tractable two-period general equilibrium model in which financial constraints inhibit capital flows. Hence, departures from the uncovered interest rate parity condition are used to explain the effects of sterilized foreign exchange intervention. Second, using high frequency data during 2004-2015, we use a sharp policy discontinuity within Colombian regulatory banking limits to empirically test for the portfolio balance channel. Consistent with our model's postulations, our findings suggest that the effects on the exchange rate are short-lived, and significant only when banking constraints are binding.
    Keywords: liquidity dependence, macro-financial linkages, Smooth Transition Bayesian VAR
    JEL: G2 O16 C32
    Date: 2018–05
  8. By: Ohanian, Lee E. (Federal Reserve Bank of Minneapolis); Restrepo-Echavarria, Paulina (Federal Reserve Bank of St Louis); Wright, Mark L. J. (Federal Reserve Bank of Minneapolis)
    Abstract: After World War II, international capital flowed into slow-growing Latin America rather than fast-growing Asia. This is surprising as, everything else equal, fast growth should imply high capital returns. This paper develops a capital flow accounting framework to quantify the role of different factor market distortions in producing these patterns. Surprisingly, we find that distortions in labor markets — rather than domestic or international capital markets — account for the bulk of these flows. Labor market distortions that indirectly depress investment incentives by lowering equilibrium labor supply explain two-thirds of observed flows, while improvement in these distortions over time accounts for much of Asia’s rapid growth.
    Keywords: Capital flows; Labor markets; Domestic capital markets; International capital markets
    JEL: E21 F21 F41 J20
    Date: 2018–05–14
  9. By: Marion Gousse (Université Laval (Québec)); Nicolas Jacquemet (Centre d'économie de la Sorbonne); Jean-Marc Robin (Département d'économie)
    Abstract: We document changes in labour supply, wage and education by gender and marital status using the British Household Panel Survey, 1991-2008, and seek to disentangle the main channels behind these changes. To this end, we use a version of Goussé et al. (2016)'s search-matching model of the marriage market with labour supply, which does not use information on home production time inputs. We derive conditions under which the model is identified. We estimate different parameters for each year. This allows us to quantify how much of the changes in labour supply, wage and education by gender and marital status depends on changes in the preferences for leisure of men and women and how much depends on changes in homophily.
    Keywords: Search-matching; Sorting; Assortative matching; Collective labour supply; Structural estimation
    JEL: C78 D83 J12 J22
    Date: 2017–06
  10. By: Patrick A. Pintus (CNRS-InSHS and Aix-Marseille Univ., CNRS, EHESS, Centrale Marseille, AMSE); Yi Wen (Federal Reserve Bank of St. Louis & Tsinghua University); Xiaochuan Xing (Department of Economics, Yale University)
    Abstract: This paper stresses a new channel through which global financial linkages contribute to the co-movement in economic activity across countries. We show in a two-country setting with borrowing constraints that international credit markets are subject to self-fulfilling variations in the world real interest rate. Those expectation-driven changes in the borrowing cost in turn act as global shocks that induce strong cross-country co-movements in both financial and real variables (such as asset prices, GDP, consumption, investment and employment). When firms around the world benefit from unexpectedly low debt repayments, they borrow and invest more, which leads to excessive supply of collateral and of loanable funds at a low interest rate, thus fueling a boom in both home and foreign economies. As a consequence, business cycles are synchronized internationally. Such a stylized model thus offers one way to rationalize both the existence of a world business-cycle component, documented by recent empirical studies through dynamic factor analysis, and the factor’s intimate link to global financial markets.
    Keywords: world interest rate, international co-movement, self-fulfilling equilibria
    JEL: E21 E22 E32 E44 E63
    Date: 2018–05
  11. By: Kevin x.d. Huang (Vanderbilt University); Qinglai Meng (Oregon State University); Jianpo Xue (Renmin University of China)
    Abstract: In a closed economy setting a cash-in-advance monetary economy under money growth targeting is prone to self-fulfilling expectations and beliefs-driven fluctuations. This paper shows that such extrinsic instability is less of a problem in a small open economy integrated in the world goods and financial markets. This is because endogenous terms-of-trade movements associated with global goods trade and cross-border capital flows and endogenous international asset price adjustments associated with global financial transaction serve as an endogenous stabilizer to reduce the likelihood of sunspot equilibria. We find that for empirically reasonable parametrization of the small open economy sunspot beliefs are unlikely to become self-fulfilled.
    Keywords: self-fulfilling expectations; indeterminacy; saddle-path stability; money growth targeting; small open economy
    JEL: E3 F4
    Date: 2018–05–19
  12. By: Alfaro, Ivan (BI Norwegian Business School); Bloom, Nicholas (Stanford University); Lin, Xiaoji (Ohio State University)
    Abstract: We show how real and financial frictions amplify the impact of uncertainty shocks. We start by building a model with real frictions, and show how adding financial frictions roughly doubles the negative impact of uncertainty shocks. The reason is higher uncertainty alongside financial frictions induces the standard negative real-options effects on the demand for capital and labor, but also leads firms to hoard cash against future shocks, 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 factor price volatility. Consistent with the model we find that higher uncertainty reduces firms' investment, hiring, while increasing their cash holdings and cutting their dividend payouts, particularly for financially constrained firms. This highlights why in periods with greater financial frictions--like during the global-financial-crisis--uncertainty can be particularly damaging.
    JEL: D22 E23 E44 G32
    Date: 2017–12
  13. By: Lasitha R.C. Pathberiya (Central Bank of Sri Lanka; School of Economics, The University of Queensland)
    Abstract: In this study, I examine the robustness of an unconventional monetary policy in a cost channel economy. The unconventional monetary policy proposed by Schmitt-Grohé and Uribe (2017, American Economic Journal: Macroeconomics, SGU henceforth), recommends a tight monetary policy during a liquidity-trapped recession to stimulate the economy and to avoid jobless recovery. The results of my study show that the existence of the cost channel implies that the SGU policy induces sharp initial contractions in the employment rate and the growth rate, and a sharp increase in inflation following a negative confidence shock. Welfare is lower in cost channel economies compared to no-cost channel economies due to the SGU policy recommendation. Two alternative interest rate-based exit policies are also examined. The Overshoot interest rate policy, irrespective of the presence of the cost channel, is superior to the SGU policy with regard to welfare. The Staggered policy has lower immediate pain in the cost channel economy compared to the SGU policy or the Overshoot policy. However, welfare-wise, the Staggered policy is inferior to the other two policies examined in both economies considered.
    Keywords: cost channel of monetary policy, zero rates on interest rates, liquidity trap, jobless recovery, downward nominal wage rigidity, Taylor rule
    JEL: E31 E32 E52 E58
    Date: 2018–05–14
  14. By: Buiter, Willem H.; Sibert, Anne
    Abstract: The recent reduction in the US corporate profit tax rate from 35 percent to 21 percent has triggered renewed interest in the impact of a cut in the corporate tax rate on capital accumulation and real wages. This theoretical contribution demonstrates that the familiar proposition that a cut in the corporate profit tax rate boosts the capital intensity of production and the real wage is sensitive to a number of key assumptions. Even when the real interest rate is exogenously given, full deductibility of capital expenditure from the corporate profit tax base will result in no impact of a corporate profit tax rate cut on the incentive to invest. Adding deductibility of interest can result in a negative effect on the capital intensity of production of a corporate profit tax rate cut. When the real interest rate is endogenous, we use the "perpetual youth" OLG model to demonstrate that the effects on consumption demand of a corporate profit tax cut will reduce the impact on capital intensity of a corporate profit tax cut if the tax cut is funded by higher lump-sum taxes on "permanent income" households. We have not been able to find examples where the capital intensity impact is reversed. Alternative funding rules (e.g. lower public consumption purchases) and the introduction of "Keynesian" consumers could lead to a larger positive effect on capital intensity from a cut in the corporate profit tax rate.
    Keywords: corporate profit tax; expensing; capital expenditure; OLG model.; Public Finance; taxation
    JEL: E21 E22 E62 E63 H2 H25 H3
    Date: 2018–05

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