nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2018‒11‒12
twenty-two papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. The government spending multiplier, fiscal stress and the zero lower bound By Strobel, Felix
  2. International Business Cycle and Financial Intermediation By Max Gillman; Tamas Csabafi; Ruthira Naraidoo
  3. Labor, Credit, and Goods Markets: The Macroeconomics of Search and Unemployment By Nicolas Petrosky-Nadeau; Etienne Wasmer
  4. Selective Hiring and Welfare Analysis in Labor Market Models By Merkl, Christian; van Rens, Thijs
  5. On the Job Search and Business Cycles By Moscarini, Giuseppe; Postel-Vinay, Fabien
  6. Sovereign Risk and Asset Market Dynamics in the Euro Area By Erica Perego
  7. Modeling Time-Variation Over the Business Cycle (1960-2017): An International Perspective By Martinez-Garcia, Enrique
  8. Non-Performing Loans, Fiscal Costs and Credit Expansion in China By Huixin Bi; Yongquan Cao; Wei Dong
  9. Unemployment Insurance Take-up Rates in an Equilibrium Search Model By Stéphane Auray; David L. Fuller; Damba Lkhagvasuren
  10. A Behavioral Model of the Credit Cycle By Barbara Annicchiarico; Silvia Surricchio; Robert J. Waldmann
  11. The German Labor Market during the Great Recession: Shocks and Institutions By Gehrke, Britta; Lechthaler, Wolfgang; Merkl, Christian
  12. Real exchange rate dynamics in New-Keynesian models – The Balassa-Samuelson effect revisited By Brede, Maren
  13. Health Shocks and the Evolution of Consumption and Income over the Life-Cycle By Michael Keane; Elena Capatina; Shiko Maruyama
  14. Paradise lost? A brief history of DSGE macroeconomics By Gulan, Adam
  15. The debunking the granular origins of aggregate fluctuations : from real business cycles back to Keynes By Giovanni Dosi; Mauro Napoletano; Andrea Roventini; Tania Treibich
  16. Vacancy Durations and Entry Wages: Evidence from Linked Vacancy-Employer-Employee Data By Kettemann, Andreas; Mueller, Andreas I.; Zweimüller, Josef
  17. International Reserves Management in a Model of Partial Sovereign Default By Ricardo Sabbadini
  18. Slow Post-Financial Crisis Recovery and Monetary Policy By Ikeda, Daisuke; Kurozumi, Takushi
  19. Business Cycle with Bank Intermediation in Oil Economies By Hamid R Tabarraei; Hamed Ghiaie; Asghar Shahmoradi
  20. Longevity and Companionship in an Overlapping-Generations Model By Gylfi Zoega; Marias H. Gestsson
  21. Bank Capital in the Short and in the Long Run By Caterina Mendicino; Kalin Nikolov; Javier Suarez; Dominik Supera
  22. Resurrecting the New-Keynesian Model: (Un)conventional Policy and the Taylor rule By Posch, Olaf

  1. By: Strobel, Felix
    Abstract: The recent sovereign debt crisis in the Eurozone was characterized by a monetary policy, which has been constrained by the zero lower bound (ZLB) on nominal interest rates, and several countries, which faced high risk spreads on their sovereign bonds. How is the government spending multiplier affected by such an economic environment? While prominent results in the academic literature point to high government spending multipliers at the ZLB, higher public indebtedness is often associated with small government spending multipliers. I develop a DSGE model with leverage constrained banks that captures both features of this economic environment, the ZLB and fiscal stress. In this model, I analyze the effects of government spending shocks. I find that not only are multipliers large at the ZLB, the presence of fiscal stress can even increase their size. For longer durations of the ZLB, multipliers in this model can be considerably larger than one.
    Keywords: Government spending multiplier,Fiscal stress,Zero lower bound,Financial frictions
    JEL: E32 E44 E62
    Date: 2018
  2. By: Max Gillman; Tamas Csabafi; Ruthira Naraidoo
    Abstract: The paper extends a standard two-country international real business cycle model to include financial intermediation by banks of loans and government bonds. The paper contributes an explanation for both the US relative to the Euro-area, and the US relative to China, of cross-country correlations of loan rates, deposit rates, and the loan premia. It shows a type of financial retrenchment for the US relative to both Europe and China following a negative bank productivity shock, such as during the 2008 crisis. After 2008, results suggest the Euro-area has been more financially integrated with the US, and China less financially integrated.
    Date: 2018–11–07
  3. By: Nicolas Petrosky-Nadeau (Département d'économie); Etienne Wasmer (Département d'économie)
    Abstract: This book offers an integrated framework to study the theoretical and quantitative properties of economies with frictions in multiple markets. Building on analyses of markets with frictions by 2010 Nobel laureates Peter A. Diamond, Dale T. Mortensen, and Christopher A. Pissarides, which provided a new theoretical approach to search markets, the book applies this new paradigm to labor, finance, and goods markets. It shows, in particular, how frictions in different markets interact with each other. The book first covers the main developments in the analysis of the labor market in the presence of frictions, offering a systematic analysis of the dynamics of this environment and explaining the notion of macroeconomic volatility. Then, building on the generality and simplicity of the search analysis, the book adapts it to other markets, developing the tools and concepts to analyze friction in these markets. The book goes beyond the traditional general equilibrium analysis of markets, which is often frictionless. It begins with the standard analysis of a single market, and then sequentially integrates more markets into the analysis, progressing from labor to financial to goods markets. Along the way, the book provides a number of useful results and insights, including the existence of a direct link between search frictions and the degree of volatility in the economy. (Publisher's abstract)
    Keywords: Labor; Credit; Unemployment; Goods Markets
    Date: 2017–11
  4. By: Merkl, Christian; van Rens, Thijs
    Abstract: Firms select not only how many, but also which workers to hire. Yet, in most labor market models all workers have the same probability of being hired. We argue that selective hiring crucially affects welfare analysis. We set up a model that is isomorphic to a search model under random hiring but allows for selective hiring. With selective hiring, the positive predictions of the model change very little, but implications for welfare are different for two reasons. First, a hiring externality occurs with random but not with selective hiring. Second, the welfare costs of unemployment are much larger with selective hiring, because unemployment risk is distributed unequally across workers.
    Keywords: labor market models; optimal unemployment insurance; welfare
    JEL: E24 J65
    Date: 2018–10
  5. By: Moscarini, Giuseppe (Yale University); Postel-Vinay, Fabien (University College London)
    Abstract: We propose a highly tractable way of analyzing business cycles in an environment with random job search both off- and and on-the-job (OJS). Ex post heterogeneity in productivity across jobs generates a job ladder. Firms Bertrand-compete for employed workers, as in the Sequential Auctions protocol of Postel-Vinay and Robin (2002). We identify three channels through which OJS amplifies and propagates aggregate shocks: (i) a higher estimated elasticity of the matching function, when recognizing that at least half of all hires are from other employers; (ii) the differential returns to hiring employed and unemployed job applicants, whose proportions naturally vary over the business cycle; (iii) within employment, the slow reallocation of workers through OJS across rungs of the job ladder, generating endogenous, slowly evolving opportunities for further poaching, which feed back on job creation incentives. Endogenous job destruction, due to either aggregate or idiosyncratic shocks, is countercyclical and thus raises the cyclical volatility of unemployment, closer to its empirical value; but it also stimulates job creation in recessions, to take advantage of the fresh batch of unemployed, and tilts the Beveridge curve up. OJS corrects this tendency and restores a vacancy-unemployment trade-off more in line with empirical observations.
    Keywords: labor reallocation, business cycles, search frictions
    JEL: E24 E32
    Date: 2018–09
  6. By: Erica Perego
    Abstract: This paper studies the behavior of euro area asset market co-movements during the period 2010-2014, through the lens of a DSGE model. The economy is a two-country world consisting of a core and a periphery and featuring an international banking sector, international equity markets, home bias in sovereign bond holdings, and sovereign default. The periphery is buffeted by a sovereign risk shock, whose process is estimated from the data. The model accounts successfully for the divergence in core-periphery correlations between stock and sovereign bond returns. The simulation results indicate that the sovereign risk shock explains 50% of the increase in sovereign and loandeposit spreads, and 8% of the decrease in global output during the sovereign debt crisis.
    Keywords: Currency Union;International Financial Markets;Sovereign Risk;General Equilibrium
    JEL: F41 F44 G15
    Date: 2018–11
  7. By: Martinez-Garcia, Enrique (Federal Reserve Bank of Dallas)
    Abstract: In this paper, I explore the changes in international business cycles with quarterly data for the eight largest advanced economies (U.S., U.K., Germany, France, Italy, Spain, Japan, and Canada) since the 1960s. Using a time-varying parameter model with stochastic volatility for real GDP growth and inflation allows their dynamics to change over time, approximating nonlinearities in the data that otherwise would not be adequately accounted for with linear models (Granger et al. (1991), Granger (2008)). With that empirical model, I document a period of declining macro volatility since the 1980s, followed by increasing (and diverging) inflation volatility since the mid-1990s. I also find significant shifts in inflation persistence and cyclicality, as well as in macro synchronization and even forecastability. The 2008 global recession appears to have had an impact on some of this. I ground my empirical strategy on the reduced-form solution of the workhorse New Keynesian model and, motivated by theory, explore the relationship between greater trade openness (globalization) and the reported shifts in international business cycles. I show that globalization has sizeable (yet nonlinear) effects in the data consistent with the implications of the model—yet globalization’s contribution is not a foregone conclusion, depending crucially on more than the degree of openness of the international economy.
    Keywords: Great Moderation; Globalization; International Business Cycles; Stochastic Volatility; Time-Varying Parameters
    JEL: E31 E32 F41 F44
    Date: 2018–10–01
  8. By: Huixin Bi; Yongquan Cao; Wei Dong
    Abstract: This paper studies how the credit expansion policy pursued by the Chinese government in an effort to stimulate its economy in the post-crisis period affects bank–firm loan contracts and the macroeconomy. We build a structural model with financial frictions in which the optimal loan contract reflects the trade-off between leverage and the probability of default. Credit expansion is introduced in the form of the government's partial guarantee on bank loans to (i) general production firms or (ii) infrastructure producers. We show that in the case of general credit expansion, more persistent credit shocks lead to higher credit multipliers at all horizons, as the benefits of persistently alleviating firms' borrowing constraint outweigh the costs associated with higher non-performing loans. We also show that a more persistent targeted credit expansion raises the production of infrastructure goods. However, higher infrastructure production not only boosts the public capital stock and generates positive externalities, it also crowds out private investment and consumption. With a short-lived targeted credit easing, the expansionary channel of public capital dominates, boosting output. As the credit expansion becomes more persistent, the contractionary channel of lower private investment starts to outweigh the expansionary channel in the medium term.
    Keywords: Credit and credit aggregates, Fiscal Policy, International topics
    JEL: E62 E44
    Date: 2018
  9. By: Stéphane Auray (CREST; ENSAI ; ULCO); David L. Fuller (University of Wisconsin-Oshkosh); Damba Lkhagvasuren (Concordia University; CIREQ)
    Abstract: From 1989-2012; on average 23% of those eligible for unemployment insurance (UI) benefits in the US did not collect them. In a search model with matching frictions; private information associated with the UI non-collectors implies the market equilibrium is not Pareto optimal. The cause of the Pareto inefeciency is characterized along with the key features of collector vs. non-collector outcomes. Non-collectors transition to employment at a faster rate and a lower wage relative to the Pareto optimal arrival rates and wages. Quantitatively; this implies 1:71% welfare loss in consumption equivalent terms for the average worker; with a 3:85% loss conditional on non-collection. With an endogenous take-up rate; the unemployment rate and average duration of unemployment respond significantly slower to changes in the UI benefit level; relative to the standard model with a 100% take-up rate.
    Keywords: Unemployment insurance, take-up, calibration, matching frictions, search.
    JEL: E61 J32 J64 J65
    Date: 2018–09–16
  10. By: Barbara Annicchiarico (DEF & CEIS,University of Rome "Tor Vergata"); Silvia Surricchio (DEF,University of Rome "Tor Vergata"); Robert J. Waldmann (DEF & CEIS,University of Rome "Tor Vergata")
    Abstract: In a behavioral variant of a New Keynesian model, in which individuals use simple heuristic rules to forecast future in ation and output gap, if there are limits on the amount of debt that economic agents are allowed to bear, we observe occasionally severe downturns. Differences in beliefs combined with borrowing constraints tend to dampen expansions, but give rise to a chain reaction that exacerbates the recessions. The model is an example of endogenous credit cycles with expansions, severe recessions, and persistent inequality in the distribution of wealth. Monetary policy can both stabilize the economy and cause increased average output.
    Keywords: Credit cycle, heuristic rules, monetary policy
    JEL: E10 E32 D83
    Date: 2018–10–30
  11. By: Gehrke, Britta (University of Erlangen-Nuremberg); Lechthaler, Wolfgang (Kiel Institute for the World Economy); Merkl, Christian (University of Erlangen-Nuremberg)
    Abstract: This paper analyzes Germany's unusual labor market experience during the Great Recession. We estimate a general equilibrium model with a detailed labor market block for post-unification Germany. This allows us to disentangle the role of institutions (short-time work, government spending rules) and shocks (aggregate, labor market, and policy shocks) and to perform counterfactual exercises. We identify positive labor market performance shocks (likely caused by labor market reforms) as the key driver for the "German labor market miracle" during the Great Recession.
    Keywords: Great Recession, search and matching, DSGE, short-time work, fiscal policy, business cycles, Germany
    JEL: E24 E32 E62 J08 J63
    Date: 2018–09
  12. By: Brede, Maren
    Abstract: This paper explores the Balassa-Samuelson effect in a New-Keynesian DSGE model of a monetary union with traded and non-traded goods. Credible sets for theoretical impulse response functions show that a model with perfect intersectoral labour mobility is unable to reproduce an appreciation of the real exchange rate caused by higher productivity in the traded sector. Allowing for imperfect intersectoral labour mobility resolves this obstacle and delivers testable restrictions for model parameters governing the labour market specification in a Bayesian estimation context.
    Keywords: Real exchange rate,Balassa-Samuelson,prior predictive analysis
    JEL: F41 F47 C51
    Date: 2018
  13. By: Michael Keane (School of Economics, UNSW Business School, UNSW Sydney); Elena Capatina (Research School of Economics, Austrlian National University); Shiko Maruyama (Economics Discipline Group, UTS Business School, University of Technology Sydney)
    Abstract: This paper studies the effects of health on earnings dynamics and on consumption inequality over the life-cycle. We build and calibrate a life-cycle model with idiosyncratic health, earnings and survival risk where individuals make labor supply and asset accumulation decisions, adding two novel features. First, we model health as a complex multi-dimensional concept. We differentiate between functional health and underlying health risk, temporary vs. persistent health shocks, and predictable vs. unpredictable shocks. Second, we study the interactions between health and human capital accumulation (learning-by-doing). These features are important in allowing the model to capture the degree to which, and the pathways through which, health impacts earnings and consumption patterns. They are also very important in estimating the value of health insurance and social insurance. A key finding is that health shocks account for roughly half of the growth in offer wage inequality over the life cycle. Eliminating health shocks leads to a 5.5% decline in the variance of the present value of earnings across all individuals.
    Keywords: Health, Income Risk, Precautionary Saving, Health Insurance, Welfare
    JEL: D91 E21 I14 I31
    Date: 2018–05
  14. By: Gulan, Adam
    Abstract: Since the Global Financial Crisis, academic economists and policymakers have had to deal with uncomfortable questions about the quality of their models and the state of macroeconomics as a profession. This note offers a summary of this discussion, focusing on the Dynamic Stochastic General Equilibrium (DSGE) framework and its underpinnings. This class of models reflects both theoretical advances and perennial modeling challenges. While DSGE modeling developed in times of scarce micro data and limited computational resources, it has much room for improvement given progress along these dimensions and advances in other branches of economics. Key tasks on the to-do-list for model improvement include the modeling on the financial sector, departures from the representative agent and rationality, as well as clarification of the empirical relevance of the Lucas critique. The framework is likely to remain a major research and policy tool, although its limitations call for greater robustness, validation and open recognition of uncertainty in drawing real-life quantitative conclusions.
    JEL: B22 E13
    Date: 2018–11–07
  15. By: Giovanni Dosi (Laboratory of Economics and Management); Mauro Napoletano (Observatoire français des conjonctures économiques); Andrea Roventini (Laboratory of Economics and Management (LEM)); Tania Treibich (Observatoire français des conjonctures économiques)
    Abstract: In this work we study the granular origins of business cycles and their possible underlying drivers. As shown by Gabaix (2011), the skewed nature of firm size distributions implies that idiosyncratic (and independent) firm-level shocks may account for a significant portion of aggregate volatility. Yet, we question the original view grounded on “supply granularity”, as proxied by productivity growth shocks – in line with the Real Business Cycle framework–, and we provide empirical evidence of a “demand granularity”, based on investment growth shocks instead. The role of demand in explaining aggregate fluctuations is further corroborated by means of a macroeconomic Agent-Based Model of the “Schumpeter meeting Keynes” family (Dosi et al., 2015). Indeed, the investigation of the possible microfoundation of RBC has led us to the identification of a sort of microfounded Keynesian multiplier.
    Keywords: Business cycles; Granular residual; Granularity hypothesis; Agent-based model; Firm dynamics; Productivity growth; Investment growth
    JEL: C63 E12 E22 E32 O4
    Date: 2018–09
  16. By: Kettemann, Andreas (University of Zurich); Mueller, Andreas I. (Columbia University); Zweimüller, Josef (University of Zurich)
    Abstract: This paper explores the relationship between the duration of a vacancy and the starting wage of a new job, using unusually informative data comprising detailed information on vacancies, the establishments posting the vacancies and the workers eventually filling the vacancies. We find that vacancy durations are negatively correlated with the starting wage and that this negative association is particularly strong with the establishment component of the starting wage. We also confirm previous findings that growing establishments fill their vacancies faster. To understand the relationship between establishment growth, vacancy filling and entry wages, we calibrate a model with directed search and ex-ante heterogeneous workers and firms. We find a strong tension between matching the sharp increase in vacancy filling for growing firms and the response of vacancy filling to firm-level wages. We discuss the implications of this finding as well as potential resolutions.
    Keywords: vacancy posting, vacancy duration, recruiting, search, wages
    JEL: E24 J31 J63
    Date: 2018–09
  17. By: Ricardo Sabbadini
    Abstract: Despite the cost imposed by the interest rate spread between sovereign debt and international reserves, emerging countries’ governments maintain stocks of both. I investigate the optimality of this joint accumulation of assets and liabilities using a quantitative model of sovereign debt, in which: i) international reserves only function to smooth consumption, before or after a default; ii) the sovereign’s decision to repudiate debt determine the spread; iii) lenders are risk-averse; and iv) default is partial. Simulated statistics from the benchmark model match their observed counterparts for average debt and spread, consumption volatility, and the main correlations among the relevant variables. Due to the presence of partial default and risk-averse lenders, the model also produces a mean reserve level of 7.7% of GDP, indicating that the optimal policy is to hold positive amounts of reserves.
    Keywords: international reserves; sovereign debt; sovereign default; partial default; interest rate spread
    JEL: E43 F31 F34 F41
    Date: 2018–10–30
  18. By: Ikeda, Daisuke (Bank of Japan); Kurozumi, Takushi (Bank of Japan)
    Abstract: Post-financial crisis recoveries tend to be slow and be accompanied by slowdowns in TFP and permanent losses in GDP. To prevent them, how should monetary policy be conducted? We address this issue by developing a model with endogenous TFP growth in which an adverse financial shock can induce a slow recovery. In the model, a welfare-maximizing monetary policy rule features a strong response to output, and the welfare gain from output stabilization is much larger than when TFP expands exogenously. Moreover, inflation stabilization results in a sizable welfare loss, while nominal GDP stabilization works well, albeit causing high interest-rate volatility.
    JEL: E52 O33
    Date: 2018–10–01
  19. By: Hamid R Tabarraei; Hamed Ghiaie; Asghar Shahmoradi
    Abstract: The structural model in this paper proposes a micro-founded framework that incorporates an active banking sector with an oil-producing sector. The primary goal of adding a banking sector is to examine the role of an interbank market on shocks, introduce a national development fund and study its link to the banking sector and the government. The government and the national development fund directly play key roles in the propagation of the oil shock. In contrast, the banking sector and the labor market, through perfect substitution between the oil and non-oil sectors, have major indirect impacts in spreading shocks.
    Keywords: Banking;Financial crises;Central banks and their policies;Oil-exporting countries, Oil-Reserve Fund, DSGE, Financial Markets and the Macroeconomy, General
    Date: 2018–10–02
  20. By: Gylfi Zoega (University of Iceland; Birkbeck, University of London); Marias H. Gestsson (University of Iceland)
    Abstract: We derive a golden rule for the level of life-extending health care when the utility of the old depends not only their level of consumption but also on the number of old people alive. While previous work has emphasized the negative pecuniary externality from longevity, we derive the effect of the positive non-pecuniary externality of being able to consume with other members of one’s cohort.
    Keywords: Longevity, health care expenditures, companionship.
    JEL: E6 E2 I1
    Date: 2018–11
  21. By: Caterina Mendicino (European Central Bank); Kalin Nikolov (European Central Bank); Javier Suarez (CEMFI); Dominik Supera (CEMFI, Centro de Estudios Monetarios y Financieros)
    Abstract: How far should capital requirements be raised in order to ensure a strong and resilient banking system without imposing undue costs on the real economy? Capital requirement increases make banks safer and are beneficial in the long run but carry transition costs because their imposition reduces aggregate demand on impact. Under accommodative monetary policy, increasing capital requirements addresses financial stability risks without imposing large transition costs on the economy. In contrast, when the policy rate hits the lower bound, monetary policy loses the ability to dampen the effects of the capital requirement increase on the real economy. The long-run benefits of higher capital requirements are larger and the transition costs are smaller when the risk that causes bank failure is high.
    Keywords: Macroprudential policy, bank fragility, financial frictions, default risk, effective lower bound, transition dynamics.
    JEL: E3 E44 G01 G21
    Date: 2018–08
  22. By: Posch, Olaf
    Abstract: This paper explores the ability of the New-Keynesian (NK) model to explain the recent periods of quiet and stable inflation at near-zero nominal interest rates. We show how (conventional and unconventional) monetary policy shocks enlarge the ability to explain the facts, such that the theory supports both a negative and a positive response of inflation. Central to our finding is that monetary policy shocks may have temporary and/or permanent components. We find that the NK model can explain the recent episodes, even if one considers an active role of monetary policy and restrict ourselves to the regions of (local) determinacy. We also show that a new global solution, capturing highly nonlinear dynamics, is necessary to generate a prolonged period of near-zero interest rates as a policy choice.
    Keywords: Continuous-time dynamic equilibrium models,Calvo price setting
    JEL: E32 E12 C61
    Date: 2018

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