nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2018‒07‒23
twelve papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. International Risk Sharing in Overlapping Generations Models By James Staveley-O'Carroll; Olena Staveley-O'Carroll
  2. Exchange rates, sunspots and cycles By Mauro Bambi; Sara Eugeni
  3. Real Business Cycles, Animal Spirits, and Stock Market Valuation By Lansing, Kevin J.
  4. Intergenerational Altruism and Transfers of Time and Money: A Life-cycle Perspective By Uta Bolt; Eric French; Jamie Hentall Maccuish; Cormac O’Dea
  5. Entrepreneurship, Labor Market Mobility and the Role of Entrepreneurial Insurance By Gaillard, Alexandre; Kankanamge, Sumudu
  6. Hopf Bifurcation from New-Keynesian Taylor Rule to Ramsey Optimal Policy By Jean-Bernard Chatelain; Kirsten Ralf
  7. The Competition Between Cash and Mobile Payments in Markets with Mobile Partnerships A Monetary Search Model Point of View By Françoise Vasselin
  8. Positive Trend In ation and Determinacy in a Medium-Sized New Keynesian Model By Jonas E. Arias; Guido Ascari; Nicola Branzoli; Efrem Castelnuovo
  9. Financing Corporate Tax Cuts with Shareholder Taxes By Alexis Anagnostopoulos; Orhan Erem Atesagaoglu; Eva Carceles-Poveda
  10. Learning Financial Shocks and the Great Recession By Patrick Pintus; Jacek Suda
  11. Financial frictions, international capital flows and welfare By Taddei, Filippo
  12. On the optimal design of a Financial Stability Fund By Arpad Abraham; Eva Carceles-Poveda; Yan Liu; Ramon Marimon

  1. By: James Staveley-O'Carroll (Babson College); Olena Staveley-O'Carroll (College of the Holy Cross)
    Abstract: We present a solution to the Backus-Smith puzzle that, instead of relying on extreme parameter values or complex modeling assumptions, simply switches the framework from in?nitely lived agents to overlapping generations. Young agents face non-diversi?able wage risk that leads to a low degree of risk sharing within each country. Subsequently, international price movements are not sufficient to achieve the high consumption-real exchange rate correlation produced in standard infinitely lived agent DSGE models.
    Keywords: Backus-Smith, international portfolio choice, overlapping generations, risk sharing
    JEL: D52 F21 F41 G11
    Date: 2018–07
  2. By: Mauro Bambi (University of York); Sara Eugeni (Durham University Business School)
    Abstract: OThe empirical evidence on nominal exchange rate dynamics shows a long-run relationship of this variable with the fundamentals of the economy, although such relationship disappears at shorter horizons ("exchange rate disconnect" puzzle). This apparently contrasting behaviour of the nominal exchange rate can be explained in an overlapping-generations model where the two currencies are not perfect substitutes. In this framework, we show that the nominal exchange rate is pinned down by the fundamentals of the economy at the monetary steady state. However, uctuations of the nominal exchange rate around its long-run value, which are not driven by shocks to fundamentals, can emerge. Firstly, we prove the existence of endogenous (deterministic) business cycles in the nominal exchange rate. Secondly, we construct stationary sunspot equilibria where random uctuations of the nominal exchange rate arise as a result of self-ful lling beliefs.
    Date: 2018–05
  3. By: Lansing, Kevin J. (Federal Reserve Bank of San Francisco)
    Abstract: This paper develops a real business cycle model with five types of fundamental shocks and one "equity sentiment shock" that captures animal spirits-driven fluctuations. The representative agent's perception that movements in equity value are partly driven by sentiment turns out to be close to self-fulfilling. I solve for the sequences of shock realizations that allow the model to exactly replicate the observed time paths of U.S. consumption, investment, hours worked, the stock of physical capital, capital's share of income, and the S&P 500 market value from 1960.Q1 onwards. The model-identified sentiment shock is strongly correlated with survey-based measures of U.S. consumer sentiment. Counterfactual scenarios with the model suggest that the equity sentiment shock has an important influence on the paths of most U.S. macroeconomic variables.
    JEL: E32 E44 O41
    Date: 2018–07–04
  4. By: Uta Bolt (University College London and Institute for Fiscal Studies); Eric French (University College London and Institute for Fiscal Studies); Jamie Hentall Maccuish (University College London); Cormac O’Dea (Yale University and Institute for Fiscal Studies)
    Abstract: Parental investments in children can take one of three broad forms: (1) Time investments during childhood and adolescence that aid child development, and in particular cognitive ability; (2) educational investments that improve school quality and hence educational outcomes; (3) cash investments in the form of inter vivos transfers and bequests. We develop a dynastic model of household decision-making with intergenerational altruism that nests a child production function, incorporates all three of these types of investments, and allows us to quantify their relative importance and estimate the strength of intergenerational altruism. Using British cohort data that follows individuals from birth to retirement, we ?nd that around 40% of di?erences in average lifetime income by paternal education are explained by ability at age 7, around 40% by subsequent divergence in ability and di?erent educational outcomes, and around 20% by inter vivos transfers and bequests received so far.
    Date: 2018–04
  5. By: Gaillard, Alexandre; Kankanamge, Sumudu
    Abstract: This paper introduces a quantitative general equilibrium model with risky entrepreneurship and search frictions designed to endogenously match the magnitude of the occupational flows between entrepreneurship, paid-employment and unemployment. The model also accounts for the general shape of these flows as well as key entrepreneurial and labor market features in the US, based mostly on micro CPS and SCF data. We use this model to examine the mitigation of the bias created by most current unemployment insurance programs in favor of paid-employment and at the expense of self-employment. We show that an entrepreneurial insurance program can significantly reduce this bias and we decompose the elements that most contribute to this reduction. Comparing this policy to an entrepreneurial subsidy, we find that entrepreneurial insurance selects more talented, wealthier, faster growing and longer lasting entrepreneurs from the unemployment pool. Finally, we find that UI system attributes have a significant impact on entrepreneurship, which might be an important additional concern for optimal UI design.
    Keywords: entrepreneurship; labor market mobility; unemployment; insurance;
    JEL: E24 E61 J68
    Date: 2018–06
  6. By: Jean-Bernard Chatelain (PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics); Kirsten Ralf (Ecole Supérieure du Commerce Extérieur - ESCE - International business school)
    Abstract: This paper compares different implementations of monetary policy in a new- Keynesian setting. We can show that a shift from Ramsey optimal policy under short term commitment (based on a negative-feed back mechanism) to a Taylor rule (based on a positive-feed back mechanism) corresponds to a Hopfbifurcation with opposite policy advice and a change of the dynamic properties. This bifurcation occurs because of the ad hoc assumption that interest rate is a forward-looking variable when policy targets (inflation and out put gap) a reforward-looking variables in the new-Keynesian theory.
    Keywords: Bifurcations,Taylor rule,Taylor principle,new-Keynesian model,Ramsey optimal policy,Finite horizon commitment
    Date: 2018–04
  7. By: Françoise Vasselin (MATISSE - Modélisation Appliquée, Trajectoires Institutionnelles et Stratégies Socio-Économiques - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)
    Abstract: A payment platform provides mobile money (M-money) to buyers who can also use cash to transact. An exogenous fraction of " traditional sellers " only accepts cash and creates no partnership with buyers while the remainder fraction consists of " mobile sellers " who accept M-money only and create partnerships with buyers to reduce search frictions. So, buyers without a partner must use cash and buyers with a partner must use M-money to trade. Buyers without a partner may hold cash, M-money, both monies or none while buyers with a partner always choose to hold M-money only or both monies. Hence, we obtain different equilibria where M-money always circulates, alone or in addition to cash. So, the partnership is a valuable coordination mechanism that makes M-money circulation permanent. Our model can explain why it may be useful to implement prescribed usages to trigger the adoption of a new payment instrument that aims to replace cash and why retailers implement partnerships through loyalty programs before the launching of their own M-money application. However, cash disappears only if traditional sellers have almost all disappeared.
    Keywords: cash,mobile payments,search theory,partnerships,investment cost,mobile money
    Date: 2018–03–03
  8. By: Jonas E. Arias (FRB Philadelphia); Guido Ascari (University of Oxford); Nicola Branzoli (Bank of Italy); Efrem Castelnuovo (University of Padova)
    Abstract: This paper studies the challenge that increasing the inflation target poses to equilibrium determinacy in a medium-sized New Keynesian model without indexation ï¬ tted to the Great Moderation era. For moderate targets of the inflation rate, such as 2 or 4 percent, the probability of determinacy is near one conditional on the monetary policy rule of the estimated model. However, this probability drops signiï¬ cantly conditional on model-free estimates of the monetary policy rule based on real-time data. The difference is driven by the larger response of the federal funds rate to the output gap associated with the latter estimates.
    Keywords: trend inflation, determinacy, monetary policy
    JEL: E52 E3 C22
    Date: 2018–06
  9. By: Alexis Anagnostopoulos; Orhan Erem Atesagaoglu; Eva Carceles-Poveda
    Abstract: We study the aggregate and distributional consequences of replacing corporate proÖt taxes with shareholder taxes, namely, taxes on dividends and capital gains, in a setting with incomplete markets and heterogeneity at both the household and the firm level. The reform yields distributional gains with a large majority of households benefiting. Moreover, if dividend and capital gains are taxed at the same rate, the reform is also efficiency-enhancing and the implied optimal corporate income tax rate is zero. In contrast, an asymmetric tax treatment of dividend and capital gains induces a trade-off between efficiency and distributional concerns that is optimally resolved at a positive optimal corporate tax rate, implying double taxation.
    Date: 2018
  10. By: Patrick Pintus (Institut des Sciences Humaines et Sociales CNRS (InSHS CNRS); Aix-Marseille Université); Jacek Suda (Narodowy Bank Polski; Szkoła Główna Handlowa; Group for Research in Applied Economics (GRAPE))
    Abstract: This paper develops a simple business-cycle model in which financial shocks have large macroeconomic effects when private agents are gradually learning the uncertain environment. Agents update their beliefs about the reduced-form structure of the economy. Because the persistence of leverage is overestimated by adaptive learners, the responses of output, investment, and other aggregates under adaptive learning are significantly larger than under rational expectations. In our benchmark case calibrated using US data on leverage, debt-to-GDP and land value-to-GDP ratios for 1996Q1-2008Q4, learning amplifies leverage shocks by a factor of about three, relative to rational expectations. When fed with actual leverage innovations observed over that period, the learning model predicts that the persistence of leverage shocks is increasingly overestimated after 2002 and that a sizeable recession occurs in 2008-10, while its rational expectations counterpart predicts a counter-factual expansion. In addition, we show that procyclical leverage reinforces the amplification due to learning and, accordingly, that macro-prudential policies that enforce countercyclical leverage dampen the effects of leverage shocks.
    Keywords: Collateral Constraints, Adaptive Learning, Financial Shocks, Great Recession
    JEL: E32 E44 G18
    Date: 2018
  11. By: Taddei, Filippo
    Abstract: The connection between the financial crisis and global imbalances is controversial. This paper argues that this relationship is likely to be connected to the existence of heterogenous financial frictions in different domestic credit markets. By developing a general equilibrium model where adverse selection and limited pledgeability coexist, this work highlights why adverse selection may play a pivotal role in determining the different (often opposing) welfare effects of international capital flows on originating and destination countries. This perspective also advances an analytical framework that is flexible enough to analyze the global effects on investment allocation of the ”Saving Glut”, of the policies facilitating financial integration and macro-prudential policy. JEL Classification: D53, E2, F3
    Keywords: asymmetric information, international capital flows, limited pledgeability, macro-prudential policy, welfare
    Date: 2018–07
  12. By: Arpad Abraham; Eva Carceles-Poveda; Yan Liu; Ramon Marimon
    Abstract: A Financial Stability Fund set by a union of sovereign countries can improve countries' ability to share risks, borrow and lend, with respect to the standard instrument used to smooth fluctuations: sovereign debt financing. Efficiency gains arise from the ability of the fund to over long-term contingent financial contracts, subject to limited enforcement (LE) and moral hazard (MH) constraints. In contrast, standard sovereign debt contracts are uncontingent and subject to untimely debt roll-overs and default risk. We develop a model of the Financial Stability Fund (Fund) as a long-term partnership with LE and MH constraints. We quantitatively compare the constrained-efficient Fund economy with the incomplete markets economy with default. In particular, we characterize how (implicit) interest rates and asset holdings differ, as well as how both economies react differently to the same productivity and government expenditure shocks. In our economies, "calibrated" to the euro area "stressed countries", substantial efficiency gains are achieved by establishing a well-designed Financial Stability Fund; this is particularly true in times of crisis. Our theory provides a basis for the design of a Fund - for example, beyond the current scope of the Euroepan Stability Mechanism (ESM) - and a theoretical and quantitative framework to assess alternative risk-sharing (shock-absorbing) facilities, as well as proposals to deal with the euro area "debt overhang problem."
    Date: 2018

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