nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2018‒06‒25
twenty-two papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Migration and Business Cycle Dynamics By Christie Smith; Christoph Thoenissen
  3. Pollution and Growth: The Role of Pension on the Efficiency of Health and Environmental Policies By Armel Ngami; Thomas Seegmuller
  4. Fiscal Austerity in Emerging Market Economies By Dave, Chetan; Ghate, Chetan; Gopalakrishnan, Pawan; Tarafdar, Suchismita
  5. Optimal Corporate Taxation under Financial Frictions By Hebert, Benjamin; Davila, Eduardo
  6. Innovation and Trade Policy in a Globalized World By Ufuk Akcigit; Sina T. Ates; Giammario Impullitti
  7. 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
  8. Price Stickiness along the Income Distribution and the Effects of Monetary Policy By Javier Cravino; Ting Lan; Andrei A. Levchenko
  9. Optimal risk-sharing in pension funds when stock and labor markets are co-integrated By Ilja Boelaars; Roel Mehlkopf
  10. Leaning Against Housing Prices as Robustly Optimal Monetary Policy By Klaus Adam; Michael Woodford
  11. Business Cycle Uncertainty and Economic Welfare Revisited By Christopher Heiberger; Alfred Maussner
  12. Secular Stagnation in an Economy with Land By Matthias Schlegl
  13. Flexible Labour, Income Effects, and Asset Prices By Rahul Nath
  14. Fiscal Deficits as a Source of Boom and Bust under a Common Currency By Giovanni Ganelli; Neil Rankin
  15. Male reproductive health, fairness and optimal policies By Johanna Etner; Natacha Raffin; Thomas Seegmuller
  16. Male Reproductive Health, Fairness and Optimal Policies By Johanna Etner; Natacha Raffin; Thomas Seegmuller
  17. Determinants of the Natural Rate of Interest in Japan \ Approaches based on a DSGE model and OG model \ By Nao Sudo; Yosuke Okazaki; Yasutaka Takizuka
  18. Employment Targeting in a Frictional Labor Market By Ghate, Chetan; Mazumder, Debojyoti
  19. Monetary Policy Analysis when Planning Horizons are Finite By Woodford, Michael
  20. Equity Pricing New Keynesian Models with Nominal Rigidities and Investment By Rahul Nath
  21. Does the New Keynesian Model Have a Uniqueness Problem? By Lawrence Christiano; Martin S. Eichenbaum; Benjamin K. Johannsen
  22. Intangible Capital Formation, International Equity Investments, and Output Synchronization By Guido Baldi, Andre Bodmer

  1. By: Christie Smith (Reserve Bank of New Zealand); Christoph Thoenissen (Department of Economics, University of Sheffield)
    Abstract: Shocks to net migration matter for the business cycles. Using an estimated dynamic stochastic general equilibrium (DSGE) model of a small open economy and a structural vector autoregression, we find that migration shocks account for a considerable proportion of the variability of per capita GDP. Migration shocks matter for the capital investment and consumption components of per capita GDP, but they are not the most important driver. Migration shocks are also important for residential investment and real house prices, but other shocks play a larger role in driving housing market volatility. In the DSGE model, the level of human capital possessed by migrants relative to that of locals materially affects the business cycle impact of migration. The impact of migration shocks is larger when migrants have substantially different levels of human capital relative to locals. When the average migrant has higher levels of human capital than locals, as seems to be common in most OECD economies, a migration shock has an expansionary effect on per capita GDP and its components.
    Keywords: Migration, macroeconomics, business cycle fluctuations
    JEL: E44 E61 F42
  2. By: Freddy Heylen; Renaat Van de Kerckhove (-)
    Abstract: Rising pressure on the welfare state due to aging, forces governments in all OECD countries to develop effective policies to raise employment, in particular employment among older individuals and low educated individuals. Increased sensitivity to rising inequality in society has made the challenge for policy makers only greater. In this paper we evaluate alternative fiscal policy scenarios to face this challenge. We construct and use an overlapping generations model for an open economy where individuals differ not only by age, but also by innate ability and human capital. The model allows us to study effects on aggregate employment, per capita income and welfare, as well as effects for specific age and ability groups. We show that well-considered fiscal policy changes can significantly improve macroeconomic productive efficiency, without increasing intergenerational or intragenerational welfare inequality. Our results strongly prefer a reduction in the labor tax rate on older workers and on all low-wage earners, financed by an overall reduction in non-employment benefits. These results are to be seen as long-run effects for economies at potential output.
    Keywords: employment by age, employment of low educated individuals, fiscal policy, heterogeneous ability, human capital, welfare inequality, overlapping generations (OLG)
    JEL: E62 H5 I28 J22 J24
    Date: 2018–05
  3. By: Armel Ngami (Aix-Marseille Univ., CNRS, EHESS, Centrale Marseille, AMSE); Thomas Seegmuller (Aix-Marseille Univ., CNRS, EHESS, Centrale Marseille, AMSE)
    Abstract: This paper analyses the effect of a pay-as-you-go pension system on the evolution of capital and pollution, and on the efficiency of an environmental versus health policy. In an overlapping generations model (OLG), we introduce endogenous longevity that depends on pollution and health expenditures. Global dynamics may display multiple balanced growth paths (BGP). We show that by discouraging savings, a policy that promotes the pension system enlarges the environmental poverty trap. More surprisingly, the environmental policy has contrasted effects according to the significance of the pension system. If it has a low size, a raise of the environmental policy enlarges the environmental poverty trap and leads to a rise in capital over pollution at the highest stationary equilibrium. In contrast, in economies where intergenerational solidarity is well developed, capital over pollution decreases at the highest BGP. In such a case, the environmental policy does not necessarily lead to a better longevity and growth.
    Keywords: longevity, environment, Health, pension system, growth, Pollution
    Date: 2018–05
  4. By: Dave, Chetan; Ghate, Chetan; Gopalakrishnan, Pawan; Tarafdar, Suchismita
    Abstract: We build a small open economy RBC model with financial frictions to analyze expansionary fiscal consolidations in emerging market economies (EMEs). We calibrate the model to India, which we view as a proto-typical EME. When factor income tax rates are low, a contractionary fiscal shock has an expansionary effect on output. The economy's debt/GDP ratio falls, and tax revenues rise. When factor income tax rates are high, a contractionary fiscal shock has an expansionary effect on output if government spending is valued sufficiently highly relative to private consumption by households in utility. We identify the mechanisms behind these results, and their implications for actual economies undertaking fiscal reforms.
    Keywords: Expansionary Fiscal Consolidations, Fiscal Policy in Small Open Economies, Emerging Market Business Cycles, Financial Frictions.
    JEL: E32 E6 E62
    Date: 2018–05–14
  5. By: Hebert, Benjamin (New York University); Davila, Eduardo (Stanford University)
    Abstract: We study the optimal design of corporate taxation when firms are subject to financial constraints. We find that corporate taxes should be levied on unconstrained firms, since those firms value resources inside the firm less than financially constrained firms. When the government has complete information about which firms are and are not constrained, this principle is sufficient to characterize optimal corporate tax policy. When the government (and other outsiders) do not know which firms are and are not constrained, the government can use the payout policies of firms to elicit whether or not the firm is constrained, and assess taxes accordingly. Using this insight, we discuss conditions under which a tax on dividends paid is the optimal corporate tax. We then extend this result to a dynamic setting, showing that, if the government lacks commitment, the optimal sequence of tax mechanisms can be implemented with a dividend tax. With commitment, we reach a very different conclusion--a lump sum tax on firm entry is optimal. We argue that these two models demonstrate an underlying principle, that optimal corporate taxes should avoid exacerbating financial frictions, and demonstrate that the structure of the financial frictions can drastically change the optimal policy.
    JEL: G18 G33 K35
    Date: 2017–09
  6. By: Ufuk Akcigit; Sina T. Ates; Giammario Impullitti
    Abstract: How do import tariffs and R&D subsidies help domestic firms compete globally? How do these policies affect aggregate growth and economic welfare? To answer these questions, we build a dynamic general equilibrium growth model where firm innovation endogenously determines the dynamics of technology, market leadership, and trade flows, in a world with two large open economies at different stages of development. Firms’ R&D decisions are driven by (i) the defensive innovation motive, (ii) the expansionary innovation motive, and (iii) technology spillovers. The theoretical investigation illustrates that, statically, globalization (defined as reduced trade barriers) has ambiguous effects on welfare, while, dynamically, intensified globalization boosts domestic innovation through induced international competition. Accounting for transitional dynamics, we use our model for policy evaluation and compute optimal policies over different time horizons. The model suggests that the introduction of the Research and Experimentation Tax Credit in 1981 proves to be an effective policy response to foreign competition, generating substantial welfare gains in the long run. A counterfactual exercise shows that increasing tariffs as an alternative policy response improves domestic welfare only when the policymaker cares about the very short run, and only when introduced unilaterally. Tariffs generate large welfare losses in the medium and long run, or when there is retaliation by the foreign economy. Protectionist measures generate large dynamic losses by distorting the impact of openness on innovation incentives and productivity growth. Finally, our model predicts that a more globalized world entails less government intervention, thanks to innovation-stimulating effects of intensified international competition.
    Keywords: Economic growth ; Short- and long-run gains from globalization ; Foreign technological catching-up ; Innovation policy ; Trade policy ; Competition
    JEL: F13 F43 O40
    Date: 2018–06–15
  7. By: Fedor Iskhakov (Australian National University and ARC Center of Excellence in Population Ageing Research); Michael Keane (UNSW School of Economics and ARC Center of Excellence in Population Ageing Research)
    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, structural model, anticipated and unanticipated policy changes, counterfactual simulations
    JEL: J22 J24 J26 C63
    Date: 2018–05
  8. By: Javier Cravino; Ting Lan; Andrei A. Levchenko
    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 households' 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.
    JEL: E31 E52
    Date: 2018–05
  9. By: Ilja Boelaars; Roel Mehlkopf
    Abstract: A well established believe in the pension industry is that collective pension funds should take more stock market risk (compared to individual retirement accounts) since risk may be shared with future generations. We extend the OLG model of Gollier (2008) by adding labor income risk in the spirit of Benzoni, Collin-Dufresne, and Goldstein (2007) and show that this idea may be misguided. For the empirical range of parameter values reported by Benzoni et. al., we find that optimal risk-sharing actually implies that collective pension funds should take less stock market risk, not more. If labor income and dividend income are co-integrated, efficient risk-sharing policies should transfer risk from future generations to current generations instead of the other way around. Furthermore, we find that the potential welfare gains from intergenerational risk-sharing are significantly lowered.
    Keywords: Dynamic portfolio choice; Labor income risk; Pension; Retirement; Intergenerational risk-sharing; Funded pension systems
    JEL: H55 G11 G23 J26 J32
    Date: 2018–05
  10. By: Klaus Adam; Michael Woodford
    Abstract: We analytically characterize optimal monetary policy for a New Keynesian model with a housing sector. If one supposes that the private sector has rational expectations about future housing prices and inflation, optimal monetary policy can be characterized without making reference to housing price developments: commitment to a “target criterion” that refers only to inflation and the output gap is optimal, as in the standard model without a housing sector. But when a policymaker seeks to choose a policy that is robust to potential departures of private sector expectations from model-consistent ones, then the optimal target criterion must also depend on housing prices. In the empirically realistic case where housing is subsidized and where monopoly power causes output to fall short of its optimal level, the robustly optimal target criterion requires the central bank to “lean against” housing prices: following unexpected housing price increases, policy should adopt a stance that is projected to undershoot its normal targets for inflation and the output gap, and similarly aim to overshoot those targets in the case of unexpected declines in housing prices. The robustly optimal target criterion does not require that policy distinguish between “fundamental” and “non-fundamental” movements in housing prices.
    JEL: E52
    Date: 2018–05
  11. By: Christopher Heiberger (University of Augsburg, Department of Economics); Alfred Maussner (University of Augsburg, Department of Economics)
    Abstract: Cho, Cooley, and Kim (RED, 2015) (CCK) consider the welfare effects of removing multiplicative productivity shocks from real business cycle models. In a model that admits an analytical solution they argue convincingly that the positive welfare effect of removing uncertainty can be dominated by a negative mean effect arising from the optimal response of household labor supply. While the presentation of this model is quite elaborate, the details of their subsequent quantitative analysis of several versions of the standard real business cycle model remain vague. We lay out the general procedure of computing second-order accurate approximations of welfare gains or losses in the canonical dynamic stochastic general equilibrium model. In order to be able to consider mean preserving increases in the size of shocks we extend the computation of second-order approximations of the policy functions pioneered by Schmitt-Grohé and Uribe (JEDC, 2004). Our computations show that different from the results reported in CCK the mean effect never dominates the fluctuations effect. Welfare measures computed from weighted residuals methods confirm the logic behind our perturbation approach and verify the accuracy of our estimates.
    Keywords: business cycles, mean effect, second order solution, risk aversion, welfare costs
    JEL: C63 D60 E32
    Date: 2018–06
  12. By: Matthias Schlegl
    Abstract: I present a model of secular stagnation with land and infinitely-lived agents with wealth preferences. Land is the prime example of a non-producible productive asset and rules out a negative real interest rate in steady state. With standard wealth preferences, higher land prices stimulate consumption and full employment is always feasible in steady state unless the central bank follows a deflationary policy. In contrast, secular stagnation emerges as the unique equilibrium of the monetary economy if wealth preferences are insatiable. In contrast to conventional wisdom, it is very existence of land itself that prevents full employment from being feasible in this case. Increases in the inflation target are no longer effective in restoring full employment as stagnation is a real phenomenon. These conclusions hold if households require a risk premium on land. Then, a higher risk premium can restore full employment when wealth preferences are insatiable.
    Date: 2018–06
  13. By: Rahul Nath
    Abstract: This paper studies how flexible labour decisions affect asset pricing in a Real Business Cycle model. It uses Jaimovich-Rebelo preferences with internal habits in consumption and distinguishes between two income effect channels (i) the ‘habit income effect’ channel and (ii) the ‘separability income effect’ channel. I ï¬ nd that asset prices are superior when the ï¬ rst channel is strong and the second is weak, this is the case of using GHH preferences with internal habits in consumption.
    Keywords: Asset Pricing, Income Effects, Jaimovich-Rebelo Preferences
    JEL: E13 E32 E44 G12
    Date: 2018–05–31
  14. By: Giovanni Ganelli; Neil Rankin
    Abstract: We investigate in depth, using predominantly analytical, rather than numerical, methods, the mechanisms which operate following a one-period, debt-financed, fiscal deficit in a small open economy operating under a common currency. The economy incorporates the New Keynesian features of staggered price setting and overlapping generations. Unsurprisingly, these features cause the impact effect to be a boom, in the sense of a positive output gap. However we also find that the boom must later turn into a bust, or negative output gap. Moreover inflation also follows a boom-bust pattern and on average there is deflation rather than inflation.
    Keywords: staggered prices, overlapping generations, small open economy, currency union, fiscal deficits, government debt, output gap
    JEL: E62 H62
    Date: 2018–06
  15. By: Johanna Etner; Natacha Raffin; Thomas Seegmuller
    Abstract: Based on epidemiological evidence, we consider an economy where agents differ through their ability to procreate. Households with impaired fertility may incur health expenditures to increase their chances of parenthood. This health heterogeneity generates welfare inequalities that deserve to be ruled out. We explore three different criteria of social evaluation in the long-run: the utilitarian approach, which considers the wellbeing of all households, the ex-ante egalitarian criterion, which considers the expected well-being of the worst-off social group, and the ex-post egalitarian one, which only considers the realized well-being of the worstoff. In an overlapping generations model, we propose a set of economic instruments to decentralize each solution. To correct for the externality and inequalities, both a preventive (a taxation of capital) and a redistributive policy are required.
    Keywords: Reproductive health; Fairness; Egalitarianism; Optimal policy; OLG model
    JEL: I18 I31 H23 D63
    Date: 2018
  16. By: Johanna Etner (EconomiX, UPL, Univ Paris Nanterre, CNRS); Natacha Raffin (Université Rouen Normandie, CREAM and EconomiX, UPL, Univ Paris Nanterre, CNRS); Thomas Seegmuller (Aix-Marseille Univ., CNRS, EHESS, Centrale Marseille, AMSE)
    Abstract: Based on epidemiological evidence, we consider an economy where agents differ through their ability to procreate. Households with impaired fertility may incur health expenditures to increase their chances of parenthood. This health heterogeneity generates welfare inequalities that deserve to be ruled out. We explore three different criteria of social evaluation in the long-run: the utilitarian approach, which considers the well- being of all households, the ex-ante egalitarian criterion, which considers the expected well-being of the worst-off social group, and the ex-post egalitarian one, which only considers the realized well-being of the worst- off. In an overlapping generations model, we propose a set of economic instruments to decentralize each solution. To correct for the externality and inequalities, both a preventive (a taxation of capital) and a redistributive policy are required.
    Keywords: reproductive health, fairness, egalitarianism, optimal policy, OLG model
    JEL: I18 I31 H23 D63
    Date: 2018–05
  17. By: Nao Sudo (Bank of Japan); Yosuke Okazaki (Bank of Japan); Yasutaka Takizuka (Bank of Japan)
    Abstract: Since it is not directly observable, the natural rate can only be inferred from various estimates based on different methodologies. We discuss the developments and determinants of the natural rate, and the impact of the demographic landscape on its outlook, using estimates derived from structural models by Okazaki and Sudo (2018), and Sudo and Takizuka (2018). Different estimates computed by these structural models, together with other models, suggest that it is likely that the natural rate in Japan has declined continuously since the 1990s, and has currently been around 0%. According to the structural models, the decline has been brought about mostly by changes in neutral technology, but the functioning of financial intermediation has also had an important effect, indicating that these factors will remain crucial to future developments as well. While population aging is predicted to depress the natural rate, it is not likely to depress the rate drastically.
    Keywords: Natural rate of interest; DSGE model; OG model
    JEL: E20 E32 E43 E44 E52 J11
    Date: 2018–06–13
  18. By: Ghate, Chetan; Mazumder, Debojyoti
    Abstract: Governments in both developing and developed economies play an active role in labor markets in the form of providing both formal public sector jobs and employment through public workfare programs. We refer to this as employment targeting. In the context of a simple search and matching friction model, we show that the propensity for the public sector to target more employment can increase the unemployment rate in the economy and lead to an increase in the size of the informal sector. Employment targeting can therefore have perverse effects on labor market outcomes.
    Keywords: Search and Matching Frictions, Labor Markets, Employment, Informal Sector, Public Sector.
    JEL: D83 O17 O20
    Date: 2018–05–29
  19. By: Woodford, Michael
    Abstract: It is common to analyze the effects of alternative monetary policy commitments under the assumption of fully model-consistent expectations. This implicitly assumes unrealistic cognitive abilities on the part of economic decision makers. The relevant question, however, is not whether the assumption can be literally correct, but how much it would matter to model decision making in a more realistic way. A model is proposed, based on the architecture of artificial intelligence programs for problems such as chess or go, in which decision makers look ahead only a finite distance into the future, and use a value function learned from experience to evaluate situations that may be reached after a finite sequence of actions by themselves and others. Conditions are discussed under which the predictions of a model with finite-horizon forward planning are similar to those of a rational expectations equilibrium, and under which they are instead quite different. The model is used to re-examine the consequences that should be expected from a central-bank commitment to maintain a fixed nominal interest rate for a substantial period of time. "Neo-Fisherian" predictions are shown to depend on using rational expectations equilibrium analysis under circumstances in which it should be expected to be unreliable.
    Keywords: bounded rationality; forward guidance; neo-Fisherianism
    JEL: E52
    Date: 2018–06
  20. By: Rahul Nath
    Abstract: This paper derives explicitly an equity pricing relationship in a simple New Keynesian model. This relationship is used to study the equity pricing implications of New Keynesian models. I ï¬ nd that New Keynesian models suffer from the same asset pricing shortcomings as more traditional RBC versions and that this can be attributed to the presence of nominal rigidities. I then add capital adjustment costs to study how the interaction of both investment adjustment costs and capital adjustment costs affect the results.
    Keywords: Asset Pricing, New Keynesian, Nominal Rigidities, Investment Adjustment Costs, Capital Adjustment Costs
    JEL: E12 E22 E44
    Date: 2018–05–30
  21. By: Lawrence Christiano; Martin S. Eichenbaum; Benjamin K. Johannsen
    Abstract: This paper addresses whether non-uniqueness of equilibrium is a substantive problem for the analysis of fiscal policy in New-Keynesian (NK) models at the zero lower bound (ZLB). There would be a substantive problem if there were no compelling way to select among different equilibria that give different answers to critical policy questions. We argue that learnability provides such a criterion. We study a fully non-linear NK model with Calvo pricing frictions. Our main finding is that the model we analyze has a unique E-stable rational expectations equilibrium at the ZLB. That equilibrium is also stable-under-learning and inherits all of the key properties of linearized NK models for fiscal policy.
    JEL: E0 E3
    Date: 2018–05
  22. By: Guido Baldi, Andre Bodmer
    Abstract: We analyze the eects of intangible investment on international out- put synchronization. Using a dynamic stochastic general equilibrium model, we nd that an increase in the importance of intangible cap- ital leads to a higher degree of output comovement across countries. Therefore, countries in which intangible capital is more important are better suited to economic integration, such as forming a monetary union. This oers an insightful perspective on the potential relation between the considerable dierences in intangible capital among Euro- zone members and the discussion surrounding the Eurozone as a sub- optimal currency area. A high stock of intangible capital also tends to attract foreign equity investments, in particular foreign direct in- vestments. We nd that cross-border equity holdings in tangible and intangible capital further increase the degree of output synchroniza- tion. Our results imply that policy reforms to incentivize higher intan- gible capital formation and cross-border equity investments may not only foster economic growth but also improve the functioning of the monetary policy in the Eurozone.
    Keywords: International Business Cycles, Investment, Cross-country Correlations, Intangible Capital
    JEL: E22 E32 F41
    Date: 2018–06

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