nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2018‒10‒15
twenty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Equilibrium foreign currency mortgages By Marcin Kolasa
  2. Bubble on real estate: The role of altruism and fiscal policy By Lise Clain-Chamosset-Yvrard; Thomas Seegmuller
  3. History Remembered: Optimal Sovereign Default on Domestic and External Debt By Pablo D'Erasmo; Enrique G. Mendoza
  4. The Long-Run Non-Neutrality of Monetary Policy: A General Statement in a Dynamic General Equilibrium Model By Eric Kam; John Smithin; Aqeela Tabassum
  5. Negligible Senescence: An Economic Life Cycle Model for the Future By Davide Dragone; Holger Strulik
  6. The Price of Capital, Factor Substitutability, and Corporate Profits By Hergovich, Philipp; Merz, Monika
  7. Search and Credit Frictions in the Housing Market By Miroslav Gabrovski; Victor Ortego-Marti
  8. Turnover Liquidity and the Transmission of Monetary Policy By Ricardo Lagos; Shengxing Zhang
  9. Are habits important for the propagation of business cycle fluctuations in Bulgaria? By Vasilev, Aleksandar
  10. Life-cycle Wealth Accumulation and Consumption Insurance By Claudio Campanale; Marcello Sartarelli
  11. Inflation, Debt, and Default By Hur, Sewon; Kondo, Illenin O.; Perri, Fabrizio
  12. Labor Market Effects of Reducing the Gender Gap in Parental Leave Entitlements By Elena Del Rey; Maria Racionero; Jose I. Silva
  13. The Economic Effect of Immigration Policies: Analyzing and Simulating the U.S. Case By Andri Chassamboulli; Giovanni Peri
  14. Balanced Growth Approach to Forecasting Recessions By Marta Boczon
  15. Income Inequality and Stock Market Returns By Agnieszka (A.P.) Markiewicz; Rafal Raciborski
  16. The end of the flat tax experiment in Slovakia: An evaluation using behavioural microsimulation linked with a dynamic macroeconomic framework By Norbert Švarda
  18. Asymmetric Consumption Response of Households to Positive and Negative Anticipated Cash Flows By Brian Baugh; Itzhak Ben-David; Hoonsuk Park; Jonathan A. Parker
  19. The Neo-Fisher Effect: Econometric Evidence from Empirical and Optimizing Models By Martín Uribe
  21. Inheritance Taxation and Wealth Effects on the Labor Supply of Heirs By Fabian Kindermann; Lukas Mayr; Dominik Sachs

  1. By: Marcin Kolasa (Narodowy Bank Polski and SGH Warsaw School of Economics)
    Abstract: This paper proposes a novel explanation for why foreign currency denominated loans to households have become so popular in some emerging economies. Our argument is based on what we call the debt limit channel, which arises when multi-period contracts are offered to financially constrained borrowers against collateral that is established on newly acquired assets. Whenever the difference between domestic and foreign interest rates is positive, this effect biases borrowers’ choices towards foreign currency, even if the exchange rate is known to depreciate as implied by the interest parity condition. We demonstrate in a simple macroeconomic framework that the debt limit channel is quantitatively important and can result in dollarization of debt also when borrowing in foreign currency is risky. We next use a small open economy DSGE model and show that, if first-order effects related to the debt limit channel are neutralized by appropriate adjustment in debt contracts, the equilibrium share of foreign currency loans is small.
    Keywords: foreign currency loans, mortgages, portfolio choice, general equilibrium models.
    JEL: D58 E32 E44 F41 G11 G21
    Date: 2018
  2. By: Lise Clain-Chamosset-Yvrard (Univ Lyon, Université Lumière Lyon 2, GATE UMR 5824, F-69130 Ecully, France); Thomas Seegmuller (Aix-Marseille University, CNRS, EHESS, Centrale Marseille, AMSE)
    Abstract: In this paper, we are interested in the interplay between real estate bubble, aggregate capital accumulation and taxation in an overlapping generations economy with altruistic households. We consider a three-period overlapping generations model with three key elements: altruism, portfolio choice, and financial market imperfections. Households realise different investment decisions in terms of asset at different periods of life, face a binding borrowing constraint and leave bequests to their children. We show that altruism plays a key role on the existence of a productive real estate bubble, i.e. a bubble in real estate raising physical capital stock and aggregate output. The key mechanism relies on the fact that a real estate bubble raises income of retired households. Because of higher bequests, there children are able to invest more in productive capital. Introducing fiscal policy, we show that raising real estate taxation dampens capital accumulation.
    Keywords: Bubble, Altruism, Real estate, Credit, Overlapping generations
    JEL: E22 E44 G11
    Date: 2018
  3. By: Pablo D'Erasmo; Enrique G. Mendoza
    Abstract: Infrequent but turbulent overt sovereign defaults on domestic creditors are a “forgotten history” in Macroeconomics. We propose a heterogeneous-agents model in which the government chooses optimal debt and default on domestic and foreign creditors by balancing distributional incentives v. the social value of debt for self-insurance, liquidity, and risk-sharing. A rich feedback mechanism links debt issuance, the distribution of debt holdings, the default decision, and risk premia. Calibrated to Eurozone data, the model is consistent with key long-run and debt-crisis statistics. Defaults are rare (1.2 percent frequency), and preceded by surging debt and spreads. Debt sells at the risk-free price most of the time, but the government's lack of commitment reduces sustainable debt sharply.
    JEL: E44 E6 F34 H63
    Date: 2018–09
  4. By: Eric Kam (Department of Economics, Ryerson University, Toronto, Canada); John Smithin (Department of Economics, York University, Toronto, Canada); Aqeela Tabassum (The Business School, Humber College, Toronto, Canada)
    Abstract: This paper provides an explanation of the long-run neutrality of monetary policy in a dynamic general equilibrium model with micro-foundations. If the rate of time preference is endogenous there is no natural rate of interest. Therefore, if the central bank follows an interest rate rule this will affect the real rate of interest in financial markets and thereby the real economy. In principle, there is a negative relationship between the real rate of interest and the rate of inflation. This turns out to be nothing other than the historical “forced savings effect”, or the twentieth century Mundell-Tobin effect.
    Date: 2018–09
  5. By: Davide Dragone; Holger Strulik
    Abstract: We propose a model of aging and health deficit accumulation model with an infinite time horizon and a steady state of constant health. The time of death is uncertain and endogenous to lifestyle and health behavior. This setup can be conceptualized as a strive for immortality that is never reached. We discuss adjustment dynamics and show that the new setup is particularly useful to understand aging of the oldest old, i.e. of individuals for which morbidity and mortality have reached a plateau. We then show how the existence of a steady state can be used to perform comparative dynamics exercises analytically. As an illustration we investigate the effects of more expensive health investment and of advances in medical technology on optimal short run and long run health behavior.
    Keywords: comparative dynamics, endogenous mortality, life-expectancy, medical progress
    JEL: D91 I12 J17
    Date: 2018
  6. By: Hergovich, Philipp (Vienna Graduate School of Economics); Merz, Monika (University of Vienna)
    Abstract: The capital-to-labor ratio has steadily risen in the U.S. and elsewhere during the post-WWII period. Since the 1970s this rise has been accompanied by a rise in the level and variability of corporate profits whereas the labor share of income has declined. In this paper we ask whether these trends are related in that they can be explained by a common determinant such as the observed decline in the relative price of new capital goods, or the change in production technology towards in- creased factor substitutability. We use a dynamic stochastic equilibrium model of competitive search in the labor market augmented by a CES production function that allows firms to substitute between capital and labor at varying degrees. By assumption, firms can adjust capital more easily than labor. Profits arise from rents paid to quasi-fixed factors of production. We find that the declining relative price of capital and the increase in factor substitutability each causes the capital-to-labor ratio and the level and volatility of corporate profits to rise, but only increased factor substitutability generates the observed decrease in the labor share of income.
    Keywords: factor substitutability, quasi-fixed production factor, competitive search, profits
    JEL: E24 G32 J64
    Date: 2018–08
  7. By: Miroslav Gabrovski (University of Hawaii at Maona); Victor Ortego-Marti (University of California, Riverside)
    Abstract: This paper develops a model of the housing market with search and credit frictions. The interaction between the two frictions gives rise to a novel channel through which the financial sector affects prices and liquidity in the housing market. Furthermore, an interesting feature of the model is that both frictions combined lead to multiple equilibria. A numerical exercise suggests that credit shocks have a relatively larger impact on mortgage debt and liquidity than on prices.
    Keywords: Housing market, Credit Frictions, Search and Matching, Multiple Equilibria, Mortgages
    JEL: E2 E32 R21 R31
    Date: 2018–10
  8. By: Ricardo Lagos; Shengxing Zhang
    Abstract: We provide empirical evidence of a novel liquidity-based transmission mechanism through which monetary policy influences asset markets, develop a model of this mechanism, and assess the ability of the quantitative theory to match the evidence.
    JEL: D83 E52 G12
    Date: 2018–09
  9. By: Vasilev, Aleksandar
    Abstract: We introduce internal consumption habits into a real-business-cycle setup 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 presence of internal consumption habits motive for the propagation cyclical fluctuations in Bulgaria. Allowing for habits in consumption improves the model performance against data, and in addition this extended setup dominates the standard RBC model framework without habits, e.g., Vasilev (2009).
    Keywords: Business cycles,consumption habits,Bulgaria
    JEL: E32 E37
    Date: 2018
  10. By: Claudio Campanale (Universidad de Alicante); Marcello Sartarelli (Dpto. Fundamentos del Análisis Económico)
    Abstract: Households appear to smooth consumption in the face of income shocks much more than implied by life-cycle versions of the standard incomplete market model under reference calibrations. In the current paper we explore in detail the role played by the life-cycle pro¿le of wealth accumulation. We show that a standard model parameterized to match the latter can rationalize between 83 and more than 97 percent of the consumption insurance against permanent earnings shocks empirically estimated by Blundell, Pistaferri and Preston (2008), depending on the tightness of the borrowing limit.
    Keywords: precautionary savings, Epstein-Zin, consumption insurance coe¿cients, life-cycle.
    JEL: E21
    Date: 2018–10
  11. By: Hur, Sewon (Federal Reserve Bank of Cleveland); Kondo, Illenin O. (University of Notre Dame); Perri, Fabrizio (Federal Reserve Bank of Minneapolis)
    Abstract: We study how the co-movement of inflation and economic activity affects real interest rates and the likelihood of debt crises. First, we show that for advanced economies, periods with procyclical inflation are associated with lower real interest rates. Procyclical inflation implies that nominal bonds pay out more in bad times, making them a good hedge against aggregate risk. However, such procyclicality also increases sovereign default risk when the economy deteriorates, since the government needs to make larger (real) payments. In order to evaluate both effects, we develop a model of sovereign default on domestic nominal debt with exogenous inflation risk and domestic risk-averse lenders. Countercyclical inflation is a substitute with default, while procyclical inflation is a complement with it, by increasing default incentives. In good times, when default is unlikely, procyclical inflation yields lower real rates. In bad times, as default becomes more material, procyclical inflation can magnify default risk and trigger an increase in real rates.
    Keywords: inflation risk; domestic nominal debt; interest rates; sovereign default;
    JEL: E31 F34 G12 H63
    Date: 2018–09–28
  12. By: Elena Del Rey; Maria Racionero; Jose I. Silva
    Abstract: We explore the effect of parental leave entitlements for mothers and fathers on wages and unemployment rates. To do so we extend the labour search and matching model in Del Rey, Racionero and Silva (2017) to include two types of workers, males and females, who compete for the same jobs. We show that an increase in leave duration has an ambiguous effect both on job creation and wages. We identify the mechanisms underlying this ambiguity. Given the variety of possible final effects we calibrate the model for several countries (Denmark, France, Italy and Portugal) and simulate policy changes. In all countries considered an increase in the duration of either leave negatively affects job creation and the wage of the directly affected worker. As a result, both wages fall while unemployment rates increase in equilibrium. Finally, we explore the effect of closing the gender gap in leave duration and show that, since fathers tend to take the leave less often, increasing the duration of the male-specifc leave is less effective in closing the wage and unemployment gaps than decreasing the female-specific one.
    JEL: E24 J38
    Date: 2018–09
  13. By: Andri Chassamboulli; Giovanni Peri
    Abstract: In this paper we analyze the economic effects of changing immigration policies in a realistic institutional set-up, using a search model calibrated to the migrant flows between the US and the rest of the world. We explicitly differentiate among the most relevant channels of entry of immigrants to the US: family-based, employment-based and undocumented. Moreover we explicitly account for earning incentives to migrate and for the role of immigrant networks in generating job-related and family-related immigration opportunities. Hence, we can analyze the effect of policy changes in each channel, accounting for the response of immigrants in general equilibrium. We find that all types of immigrants generate higher surplus for US firms relative to natives, hence restricting their entry has a depressing effect on job creation and, in turn, on native labor markets. We also show that substituting a family-based entry with an employment-based entry system, and maintaining the total inflow of immigrants unchanged, job creation and natives' income increase.
    JEL: E24 F22 J64
    Date: 2018–09
  14. By: Marta Boczon
    Abstract: In this paper, we propose a hybrid alternative to Dynamic Stochastic General Equilibrium mod-els with emphasis on forecasting performance in times of rapid changes (recessions). We interprethypothetical balanced growth ratios as moving targets for economic agents that rely upon an Error-Correction Mechanism to adjust to changes in an underlying state Vector Autoregressive process.Our proposal is illustrated by an application to a pilot Real Business Cycle model for the US economy from 1948 to 2017. An extensive recursive validation exercise over the last 32 years, covering 3recessions, is used to highlight the impressive parameters invariance and 1 to 4 steps ahead forecasting performance of our hybrid model.
    Date: 2018–01
  15. By: Agnieszka (A.P.) Markiewicz (Erasmus University Rotterdam); Rafal Raciborski (European Commission)
    Abstract: In this paper, we study the relationship between income inequality and stock market returns. We develop a quantitative general equilibrium model that links shifts in both labour and capital income inequality to stock market variables. An increase of the share of capital owners’ income from risky capital leads to higher equity premium and a rise in their non-risky, labor share of income reduces it. When we calibrate our model to match the empirical size of shifts in the last five decades, we find that the negative impact of the higher labour share of income of capital owners dominates and brings the equity premium below the historical value by 0.79 percentage points, in line with the data. If both capital and total income shares of top decile would continue growing at the historical rate between 1970 and 2014, the equity premium would continue decreasing to 6.11% in 2030, 0.92 percentage point lower than historical equity premium of 7.03%. If instead only the capital share of income continues to grow, the equity premium would be higher than the historical average by 0.57 percentage point. If the labour income dispersion remains constant, the historical equity premium of 7.03% would be reached by 2030 if the capital share of income was growing by 1.4% each year.
    Keywords: Asset Pricing; Risk Premium Dynamics; Income Inequality; Computational Macroeconomics
    JEL: D31 E32 E44 H21 O33
    Date: 2018–10–07
  16. By: Norbert Švarda
    Abstract: The paper introduces a new way of linking microsimulation models with dynamic general equilibrium frameworks to obtain an evaluation of the impact of detailed tax and benefit measures on the aggregate economy. In the approach presented in this paper, income heterogeneity interacts with the macro-economy via aggregated individual labour supply decisions which influence, and are influenced by, the dynamic evolution of the real wage rate. The method involves a reduced-form representation of the information flow between the macroeconomic and microeconomic blocks. The practical usefulness of the approach is demonstrated by evaluating actual and hypothetical tax reforms that involve abandoning the flat tax system in Slovakia. A hypothetical move to a highly progressive tax structure is shown to generate some employment gains but is associated with a drop in aggregate income and tax revenue.
    Keywords: microsimulation, dynamic general equilibrium, unemployment, labour supply elasticity, tax reform, flat tax
    JEL: E24 H24 H31 J22
    Date: 2018–10–04
  17. By: Anthony Terriau (GAINS - Groupe d'Analyse des Itinéraires et des Niveaux Salariaux - UM - Le Mans Université, TEPP - Travail, Emploi et Politiques Publiques - UPEM - Université Paris-Est Marne-la-Vallée - CNRS - Centre National de la Recherche Scientifique)
    Date: 2018–09–21
  18. By: Brian Baugh; Itzhak Ben-David; Hoonsuk Park; Jonathan A. Parker
    Abstract: We use account-level data to document that households respond differently to expected transitory cash receipts than to cash payments. Consumers increase consumption spending when they receive tax refunds; however, they do not reduce their spending when they make expected tax payments. The central asymmetry in response and its pattern across liquidity and income levels is consistent with the behavior of rational consumers with liquidity constraints, but this canonical model cannot explain the lack of spending days before arrival of a refund or the lack of spending response to information about taxes around filing.
    JEL: D12 E21 H31
    Date: 2018–09
  19. By: Martín Uribe
    Abstract: This paper investigates whether permanent monetary tightenings increase inflation in the short run. It estimates, using U.S. data, an empirical and a New-Keynesian model driven by transitory and permanent monetary and real shocks. Temporary increases in the nominal interest-rate lead, in accordance with conventional wisdom, to a decrease in inflation and output and an increase in real rates. The main result of the paper is that permanent increases in the nominal interest rate lead to an immediate increase in inflation and output and a decline in real rates. Permanent monetary shocks explain more than 40 percent of inflation changes.
    JEL: E52 E58
    Date: 2018–09
  20. By: Sebastien Menard (GAINS - Groupe d'Analyse des Itinéraires et des Niveaux Salariaux - UM - Le Mans Université, TEPP - Travail, Emploi et Politiques Publiques - UPEM - Université Paris-Est Marne-la-Vallée - CNRS - Centre National de la Recherche Scientifique); Solenne Tanguy (GAINS - Groupe d'Analyse des Itinéraires et des Niveaux Salariaux - UM - Le Mans Université, TEPP - Travail, Emploi et Politiques Publiques - UPEM - Université Paris-Est Marne-la-Vallée - CNRS - Centre National de la Recherche Scientifique)
    Date: 2018–09–21
  21. By: Fabian Kindermann; Lukas Mayr; Dominik Sachs
    Abstract: The taxation of bequests can have a positive impact on the labor supply of heirs through wealth effects. This leads to an increase in future labor income tax revenue on top of direct bequest tax revenue. We first show in a theoretical model that a simple back-of-the-envelope calculation, based on existing estimates for the reduction in earnings after wealth transfers, fails: the marginal propensity to earn out of unearned income is not a sufficient statistic for the calculation of this effect because (i) heirs anticipate the reduction in net bequests and adjust their labor supply already prior to inheriting, and (ii) when bequest receipt is stochastic, even those who ex post end up not inheriting anything respond ex ante to the implied change in their distribution of net bequests. We quantitatively elaborate the size of the overall revenue effect due to labor supply changes of heirs by using a state of the art life-cycle model that we calibrate to the German economy. Besides the joint distribution of income and inheritances, quasi-experimental evidence regarding the size of wealth effects on labor supply is a key target for this calibration. We find that for each Euro of bequest tax revenue the government mechanically generates, it obtains an additional 9 Cents of labor income tax revenue (in net present value) through higher labor supply of (non-)heirs.
    JEL: C68 H22 H31 J22
    Date: 2018–09

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