nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2018‒11‒26
eighteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Optimal sovereign debt: Case of Slovakia By Zuzana Múèka; ¼udovít Ódor
  2. Monetary and Fiscal Policy in a Cash-in-advance Economy with Quasi-geometric Discounting By Daiki Maeda
  3. Capital Flows in an Aging World By Barany, Zsofia; Coeurdacier, Nicolas; Guibaud, Stéphane
  4. Highly Skilled International Migration, STEM Workers, and Innovation By Anelí Bongers; Carmen Díaz-Roldán; José L. Torres
  5. Political Distribution Risk and Aggregate Fluctuations By Thorsten Drautzburg; Jesus Fernandez-Villaverde; Pablo Guerrón-Quintana
  6. Contingent Debt and Performance Pricing in an Optimal Capital Structure Model with Financial Distress and Reorganization By Grochulski, Borys; Wong, Russell
  7. A Life Cycle Model with Housing Tenure, Constrained Mortgage Finance and a Risky Asset under Uncertainty By Zhechun He; Peter Simmons
  8. The Price of Capital, Factor Substitutability, and Corporate Profits By Hergovich, Philipp; Merz, Monika
  9. Safe Assets By Robert Barro; Jesus Fernandez-Villaverde; Oren Levintal; Andrew Mollerus
  10. The (Q,S,s) Pricing Rule: A Quantitative Analysis By Kenneth Burdett; Guido Menzio
  11. An Heterogeneous-Agent New-Monetarist Model with an Application to Unemployment By Guillaume Rocheteau; Pierre-Olivier Weill; Tsz-Nga Wong
  12. Matlab, Python, Julia: What to Choose in Economics? By Coleman, Chase; Lyon, Spencer; Maliar, Lilia; Maliar, Serguei
  13. An Horizontal Innovation Growth Model with Endogenous Time Allocation and Non-Stable Demography By Manuel Guerra; João Pereira; Miguel St. Aubyn
  14. Accounting for Macrofinancial Fluctuations and Turbulence By Francis Vitek
  15. Inheritance Taxation and Wealth Effects on the Labor Supply of Heirs By Fabian Kindermann; Lukas Mayr; Dominik Sachs
  16. Continuous vs Discrete Time Modelling in Growth and Business Cycle Theory By Omar Licandro; Luis A. Puch; Jesús Ruiz
  17. A Walrasian Theory of Sovereign Debt Auctions with Asymmetric Information By Harold L. Cole; Daniel Neuhann; Guillermo Ordonez
  18. Unconventional policies in a monetary union: a policy game approach By Manuela Mischitelli; Giovanni Di Bartolomeo

  1. By: Zuzana Múèka (Council for Budget Responsibility); ¼udovít Ódor (National Bank of Slovakia)
    Abstract: This study exploits the trade-off between government debt as an asset that can be used for self- insurance against idiosyncratic income shocks and the distortions on labor and capital supply created by taxes needed to finance debt. In deriving optimal debt level, the paper explicitly considers a trade-off between the pain of fiscal adjustment (assuming that the current debt ratio is above the steady state optimal one) and the gain from reaching the ideal steady state level. To determine the optimal quantity of public debt the study uses a heterogeneous agent closed-economy model with incomplete insurance markets and endogenous labour supply. Furthermore, the model is enriched by welfare-increasing government activity via by productive government investment and provision of public goods. The modelling framework with uninsurable idiosyncratic productivity shocks, the degree of inequality implied by the model and restricted borrowing give rise to non-trivial effects of public debt on the economy. On the one hand, higher public debt can relax borrowing constraints of households by increasing liquidity and thus facilitating consumption-smoothing. On the other hand, rising public debt crowds out private investments and therefore lowers wages and consumption in equilibrium. Therefore, a priori it is not clear which effect is stronger. The optimal public debt is determined based on welfare comparison between stationary equilibria when transitional dynamics are either ignored or accounted for. The paper shows that public investments play an important role as they generate positive spillover effects in the private sector by boosting the productivity of labor and capital. This reduces the precautionary savings motives for households, as they can rely more on labor income. Transitionary welfare effects work differently. Reduction in public debt leads to a reduction of the tax rate in the long run. However, debt reduction requires an increase in the tax rate in the short run, which has a negative effect on welfare. Therefore, ignoring these adjustment costs, optimal debt levels would be very large and negative (government accumulates assets of 130 percent of GDP) accompanied with large welfare gains (more than 20 percent) which is fully consistent with the literature on optimal public debt (Chatterjee et al. (2017), Rohrs and Winter (2017), Aiyagari and McGrattan (1998)). However, with transitional dynamics considered, the optimal debt ratio remains positive but lower than the current level of debt (27-30 percent of GDP). The corresponding consumption-equivalent welfare gains are low, between 1.91 and 2.27 percent depending on the presence of public investment. Relatively low optimal debt level is due to low level of idiosyncratic labor income volatility as a result of low empirical wealth inequality. Hence self-insurance via private capital is more than enough and higher provision of government insurance via sovereign bonds is not necessary. Furthermore, from the perspective of rapid population ageing expected in Slovakia, calls for even more prudent levels of public debt gain relevancy. The only reason why Slovakia should have public debt at all in this model is that it is painful to get rid of the existing debt. The validity of results is supported by numerous robustness check exercises: change to model calibration, different policy rule, modified tax system, impact of public goods provision on household social welfare.
    Keywords: Infrastructure, public investment, heterogeneous agents, public debt, welfare, transitional dynamics.
    JEL: E2 E6 H3 H4 H6
    Date: 2018–11
  2. By: Daiki Maeda (Graduate School of Economics, Osaka University)
    Abstract: In this paper, we analyze monetary and fiscal policies in a dynamic general equilibrium model in which households have a preference of quasi-geometric discounting and face a cash- in-advance constraint. From this policy analysis, we obtain the following two outcomes. First, when the government can control only the money supply, the Friedman rule is optimal. Second, when the government can also control income tax rates, the Friedman rule may not be optimal.
    Keywords: Quasi-geometric discounting; Friedman rule
    JEL: E21 E40
    Date: 2018–11
  3. By: Barany, Zsofia; Coeurdacier, Nicolas; Guibaud, Stéphane
    Abstract: We investigate the importance of worldwide demographic evolutions in shaping capital flows across countries and over time. Our lifecycle model incorporates cross-country differences in fertility and longevity as well as differences in countries' ability to borrow inter-temporally and across generations through social security. In this environment, global aging triggers uphill capital flows from emerging to advanced economies, while country-specific demographic evolutions reallocate capital towards countries aging more slowly. Our quantitative multi-country overlapping generations model explains a large fraction of capital flows across advanced and emerging countries and a substantial portion of the prolonged decline in the world interest rate.
    Keywords: aging; Household Saving; International Capital Flows
    JEL: E21 F21 J11
    Date: 2018–09
  4. By: Anelí Bongers (Department of Economics, University of Málaga); Carmen Díaz-Roldán (Department of Economics, University of Castilla-La Mancha); José L. Torres (Department of Economics, University of Málaga)
    Abstract: This paper studies the implications of highly skilled labor international migration in a two-country Dynamic Stochastic General Equilibrium model. The model considers three types of workers: STEM workers, non-STEM college educated workers, and non-college educated workers. Only high skilled workers can move internationally from the relative low productivity (sending) country to the high productivity (host) country. Aggregate productivity in each economy is a function of innovations, which can be produced only by STEM workers. The model predicts i) the existence of a wage premium of STEM workers relative to non-STEM college educated workers, ii) this wage premium is higher in the destination country and increases with positive technological shocks, iii) a reduction in migration costs increases output, wages and total labor in the destination country, with opposite e¤ects in the country of origin, and iv) high skilled immigrants reduce skilled native labor and do not a¤ect unskilled labor.
    Keywords: STEM workers; Migration; Dynamic Stochastic General Equilibrium models; Innovation
    JEL: F43 J61 O31
    Date: 2018–11
  5. By: Thorsten Drautzburg (Federal Reserve Bank of Philadelphia); Jesus Fernandez-Villaverde (Department of Economics, University of Pennsylvania); Pablo Guerrón-Quintana (Department of Economics, Boston College)
    Abstract: We argue that political distribution risk is an important driver of aggregate fluctuations. To that end, we document signifucant changes in the capital share after large political events, such as political realignments, modifications in collective bargaining rules, or the end of dictatorships, in a sample of developed and emerging economies. These policy changes are associated with significant fluctuations in output and asset prices. Using a Bayesian proxy-VAR estimated with U.S. data, we show how distribution shocks cause movements in output, unemployment, and sectoral asset prices. To quantify the importance of these political shocks for the U.S. as a whole, we extend an otherwise standard neoclassical growth model. We model political shocks as exogenous changes in the bargaining power of workers in a labor market with search and matching. We calibrate the model to the U.S. corporate non-financial business sector and we back up the evolution of the bargaining power of workers over time using a new methodological approach, the partial filter. We show how the estimated shocks agree with the historical narrative evidence. We document that bargaining shocks account for 34% of aggregate fluctuations.
    Keywords: Political redistribution risk, bargaining shocks, aggregate fluctuations, partial filter, historical narrative
    JEL: E32 E37 E44 J20
    Date: 2017–07–25
  6. By: Grochulski, Borys (Federal Reserve Bank of Richmond); Wong, Russell (Federal Reserve Bank of Richmond)
    Abstract: Building on the trade-off between agency costs and monitoring costs, we develop a dynamic theory of optimal capital structure with financial distress and reorganization. Costly monitoring eliminates the agency friction and thus the risk of inefficient liquidation. Our key assumption is that monitoring cannot be applied instantaneously. Rather, transitions between agency and monitoring are subject to search frictions. In the optimal contract, the firm seeks a monitoring opportunity whenever it is financially distressed, i.e., when the risk of liquidation is high. If a monitoring opportunity arrives in time, the manager is dismissed, the capital structure is reorganized as in Chapter 11 bankruptcy, and the search for a new manager begins. In agency, an optimal capital structure consists of equity, long-term debt, contingent long-term debt, and a credit line with performance pricing. In financial distress, coupon payments to contingent debt are suspended but the interest rate on the credit line is stepped-up, which gives the firm simultaneously debt relief and a steep incentive to improve its financial position. An episode of distress can end with financial recovery, transition to bankruptcy reorganization, or liquidation.
    Keywords: capital structure; contingent debt; performance pricing; monitoring costs; agency costs; dynamic incentives; liquidation; nancial restructuring; bankruptcy reorganization; search frictions; CEO compensation; CEO replacement
    JEL: C61 D82 D86 G32 G33 M52
    Date: 2018–11–14
  7. By: Zhechun He; Peter Simmons
    Abstract: We analyse optimal housing tenure choice (rent, buy or buy to let), consumption and a four asset portfolio in a life cycle model with uncertain labour income and asset returns (with a safe asset). Each period borrowing is possible only via a mortgage which is backed by housing collateral and which is itself subject to a loan to value and loan to income constraint. There is a minimum scale for house ownership. We derive some general theoretical properties of the solutions and closed-form solutions for specific preferences. To quantify the impact of uncertainty we simulate life cycle paths across random return and income realisations.
    Keywords: Divorce, housing tenure, mortgage, life cycle
    Date: 2018–11
  8. By: Hergovich, Philipp; Merz, Monika
    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 increased substitutability between capital and labor. 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 corporate profits to rise, but only increased factor substitutability generates the observed decrease in the labor share of income and increases the relative variability of profits.
    Keywords: competitive search; factor substitutability; profits; quasi-fixed production factor
    JEL: E24 G32 J64
    Date: 2018–09
  9. By: Robert Barro (Department of Economics, Harvard University); Jesus Fernandez-Villaverde (Department of Economics, University of Pennsylvania); Oren Levintal (Department of Economics, University of Pennsylvania); Andrew Mollerus (Department of Economics, Harvard University)
    Abstract: A safe asset’s real value is insulated from shocks, including declines in GDP from rare macroeconomic disasters. However, in a Lucas-tree world, the aggregate risk is given by the process for GDP and cannot be altered by the creation of safe assets. Therefore, in the equilibrium of a representative-agent version of this economy, the quantity of safe assets will be nil. With heterogeneity in coefficients of relative risk aversion, safe assets can take the form of private bond issues from low-risk-aversion to high-risk-aversion agents. The model assumes Epstein-Zin/Weil preferences with common values of the intertemporal elasticity of substitution and the rate of time preference. The model achieves stationarity by allowing for random shifts in coefficients of relative risk aversion. We derive the equilibrium values of the ratio of safe to total assets, the shares of each agent in equity ownership and wealth, and the rates of return on safe and risky assets. In a baseline case, the steady-state risk-free rate is 1.0% per year, the unlevered equity premium is 4.2%, and the quantity of safe assets ranges up to 15% of economy-wide assets (comprising the capitalized value of GDP). A disaster shock leads to an extended period in which the share of wealth held by the low-risk-averse agent and the risk-free rate are low but rising, and the ratio of safe to total assets is high but falling. In the baseline model, Ricardian Equivalence holds in that added government bonds have no effect on rates of return and the net quantity of safe assets. Surprisingly, the crowding-out coefficient for private bonds with respect to public bonds is not 0 or -1 but around -0.5, a value found in some existing empirical studies.
    Keywords: Safe assets, risk premium, risk-free rate, heterogeneous agents
    JEL: E21 G12
    Date: 2017–05–10
  10. By: Kenneth Burdett (Department of Economics, University of Pennsylvania); Guido Menzio (Department of Economics, University of Pennsylvania)
    Abstract: Are nominal prices sticky because menu costs prevent sellers from continuously adjusting their prices to keep up with inflation or because search frictions make sellers indifferent to any real price over some non-degenerate interval? The paper answers the question by developing and calibrating a model in which both search frictions and menu costs may generate price stickiness and sellers are subject to idiosyncratic shocks. The equilibrium of the calibrated model is such that sellers follow a (Q,S,s) pricing rule: each seller lets inflation erode the effective real value of the nominal prices until it reaches some point s and then pays the menu cost and sets a new nominal price with an effective real value drawn from a distribution with support [S,Q], with s
    Keywords: Search frictions, Menu costs, Sticky prices
    JEL: D11 D21 D43 E32
    Date: 2017–09–25
  11. By: Guillaume Rocheteau; Pierre-Olivier Weill; Tsz-Nga Wong
    Abstract: We develop a New Monetarist model with expenditure and unemployment risks that generates equilibria with non-degenerate distribution of money holdings. Distributional effects can overturn key insights of the model with degenerate distributions such that, e.g., the value of money depends on the income distribution, a one-time money injection raises aggregate real balances in the short run – price adjustments look sluggish; anticipated inflation can raise output and welfare; there can be a long-run trade-off between inflation and unemployment. Our model features an aggregate demand channel through which transfers to workers can raise employment and a new amplification mechanism of productivity shocks.
    JEL: E40 E50
    Date: 2018–11
  12. By: Coleman, Chase; Lyon, Spencer; Maliar, Lilia; Maliar, Serguei
    Abstract: We perform a comparison of Matlab, Python and Julia as programming languages to be used for implementing global nonlinear solution techniques. We consider two popular applications: a neoclassical growth model and a new Keynesian model. The goal of our analysis is twofold: First, it is aimed at helping researchers in economics to choose the programming language that is best suited to their applications and, if needed, help them transit from one programming language to another. Second, our collections of routines can be viewed as a toolbox with a special emphasis on techniques for dealing with high dimensional economic problems. We provide the routines in the three languages for constructing random and quasi-random grids, low-cost monomial integration, various global solution methods, routines for checking the accuracy of the solutions, etc. Our global solution methods are not only accurate but also fast. Solving a new Keynesian model with eight state variables only takes a few seconds, even in the presence of active zero lower bound on nominal interest rates. This speed is important because it then allows the model to be solved repeatedly as one would require in order to do estimation.
    Keywords: Dynamic programming; Global solution; High dimensionality; Julia; Large scale; Matlab; Nonlinear; Python; Toolkit; Value function iteration
    JEL: C6 C61 C63 C68 E31 E52
    Date: 2018–09
  13. By: Manuel Guerra; João Pereira; Miguel St. Aubyn
    Abstract: We propose a decentralized endogenous growth model in order to study the transitional dynamics associated with the process of population aging in a small open economy, that has endogenous time allocation and two growth engines: R&D and human capital accumulation. Growth of per capita output is affected negatively by the difference in the rates of growth of labor force and of the total population in the period where the weight of the labor force decreases to a new and lower level. The biggest impact on per capita output growth should be during the period where labor force grows at a lower rate than the popu- lation unless it is compensated by some other effect. Under some assumptions, a decrease in the corporate tax improves growth.
    Keywords: Endogenous Growth; Demographic Changes; Time Allocation; Human Capital; R&D
    JEL: O41 O33 J11 J22 J24
    Date: 2018–11
  14. By: Francis Vitek
    Abstract: This paper investigates the sources of macrofinancial fluctuations and turbulence within the framework of an approximate linear dynamic stochastic general equilibrium model of the world economy, augmented with structural shocks exhibiting potentially asymmetric generalized autoregressive conditional heteroskedasticity. Very strong evidence of asymmetric autoregressive conditional heteroskedasticity is found, providing a basis for jointly decomposing the levels and volatilities of key macrofinancial variables into time varying contributions from sets of shocks. Risk premia shocks are estimated to contribute disproportionately to cyclical output fluctuations and turbulence during swings in financial conditions, across the fifteen largest national economies in the world.
    Date: 2018–11–08
  15. 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.
    Keywords: bequest, taxation, life-cycle, labor-supply, dynamic scoring
    JEL: C68 D91 H22 H31 J22
    Date: 2018
  16. By: Omar Licandro (University of Nottingham and Barcelona GSE .); Luis A. Puch (Universidad Complutense de Madrid and ICAE.); Jesús Ruiz (Universidad Complutense de Madrid and ICAE.)
    Abstract: Economists model time as continuous or discrete. For long, either alternative has brought about relevant economic issues, from the implementation of the basic Solow and Ramsey models of growth and the business cycle, towards the issue of equilibrium indeterminacy and endogenous cycles. In this paper, we introduce to some of those relevant issues in economic dynamics. First, we describe a baseline continuous vs discrete time modelling setting relevant for questions in growth and business cycle theory. Then we turn to the issue of local indeterminacy in a canonical model of economic growth with a pollution externality whose size is related to the model period. Finally, we propose a growth model with delays to show that a discrete time representation implicitly imposes a particular form of time–to–build to the continuous time representation. Our approach suggests that the recent literature on continuous time models with delays should help to bridge the gap between continuous and discrete time representations in economic dynamics.
    Keywords: Discrete Time, Continuous Time, Solow model, Ramsey model, Indeterminacy, Time–to–Build, Delay Differential Equations.
    JEL: O40 Q50 E10 E22
    Date: 2018–10
  17. By: Harold L. Cole (Department of Economics, University of Pennsylvania); Daniel Neuhann (Department of Economics, Columbia University); Guillermo Ordonez (Department of Economics, University of Pennsylvania)
    Abstract: Sovereign bonds are highly divisible, usually of uncertain quality, and auctioned in large lots to a large number of investors. This leads us to assume that no individual bidder can affect the bond price, and to develop a tractable Walrasian theory of Treasury auctions in which investors are asymmetrically informed about the quality of the bond. We characterize the price of the bond for different degrees of asymmetric information, both under discriminatory-price (DP) and uniform-price (UP) protocols. We endogenize information acquisition and show that DP protocols are likely to induce multiple equilibria, one of which features asymmetric information, while UP protocols are unlikely to sustain equilibria with asymmetric information. This result has welfare implications: asymmetric information negatively affects the level, dispersion and volatility of sovereign bond prices, particularly in DP protocols.
    Date: 2017–05–01
  18. By: Manuela Mischitelli (La Sapienza); Giovanni Di Bartolomeo (La Sapienza)
    Abstract: How does the availability of fiscal and unconventional monetary measures modify the composition of the optimal policy mix, in a monetary union, when ZLB is binding? In order to answer to this question, we have built a simply three-period generalized New Keynesian model, in which we have assumed that non-money assets are not perfect substitutes. Following Friedman (2013), private agents' choice is responsive to a sort of long run interest rate.We have proved that in a monetary union, greater is the number of member countries adopting autonomous fiscal policy, greater will be public spending and more moderate will be the use of unconventional policies measures by central bank. Anyway, deviations in output and inflation decrease with the enlargement of the monetary union.
    Keywords: Unconventional Monetary policies, ZLB, Fiscal policy, Quantitative Easing, Forward Guidance, Policy game
    JEL: C70 E52 E60
    Date: 2018–10

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