nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2018‒12‒24
thirty-six papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Quantifying the Benefits of Labor Mobility in a Currency Union By Christopher L. House; Christian Proebsting; Linda L. Tesar
  2. On Financing Retirement, Health, and Long-term Care in Japan By Ellen R. McGrattan; Kazuaki Miyachi; Adrian Peralta-Alva
  3. Flexible Retirement and Optimal Taxation By Ndiaye, Abdoulaye
  4. Welfare consequences of rising wage risk in the United States: Self-selection into risky jobs and family labor supply adjustments By Park, Seonyoung; Shin, Donggyun
  5. Money Markets, Collateral and Monetary Policy By Fiorella De Fiore; Marie Hoerova; Harald Uhlig
  6. Macroprudential capital regulation in general equilibrium By Nelson, Benjamin; Pinter, Gabor
  7. Informality over the life-cycle By Julien Albertini; Anthony Terriau
  8. Bank Recapitalizations, Credit Supply, and the Transmission of Monetary Policy By Mark Mink; Sebastiaan Pool
  9. The Role of Corporate Saving over the Business Cycle: Shock Absorber or Amplifier? By Xiaodan Gao; Shaofeng Xu
  10. Immigration, Skill Acquisition and Fiscal Redistribution in a Search-Equilibrium Model By Ikhenaode, Bright Isaac
  11. Debt Hangover in the Aftermath of the Great Recession By Stéphane Auray; Aurélien Eyquem; Paul Gomme
  12. A Promised Value Approach to Optimal Monetary Policy By Timothy S. Hills; Taisuke Nakata; Takeki Sunakawa
  13. Money and Capital in a Persistent Liquidity Trap By Philippe Bacchetta; Yannick Kalantzis
  14. The Baby Boomers and the Productivity Slowdown By Vandenbroucke, Guillaume
  15. Spending Multipliers with Distortionary Taxes: Does the Level of Public Debt Matter? By Rym Aloui; Aurélien Eyquem
  16. Banks, Sovereign Risk and Unconventional Monetary Policies By Stéphane Auray; Aurélien Eyquem; Xiaofei Ma
  17. Optimal Capital Taxation Revisited By Chari, V. V.; Nicolini, Juan Pablo; Teles, Pedro
  18. Growth and Welfare Gains from Financial Integration Under Model Uncertainty By Luo, Yulei; Nie, Jun; Young, Eric R.
  19. Gambling traps By Ari, Anil
  20. Pigouvian Cycles By Faccini, Renato; Melosi, Leonardo
  21. Asset Pricing with Endogenously Uninsurable Tail Risk By Ai, Hengjie; Bhandari, Anmol
  22. Dynamic Programming with Recursive Preferences: Optimality and Applications By Guanlong Ren; John Stachurski
  23. Is Nepotism Inevitable Under Search and Matching Friction? By Mazumder, Debojyoti; Biswas, Rajit
  24. Quantitative Easing By Cui, Wei; Sterk, Vincent
  25. Credit Risk and Fiscal Inflation By Li, Bing; Pei, Pei; Tan, Fei
  26. Collateral booms and information depletion By Vladimir Asriyan; Luc Laeven; Alberto Martin
  27. Women, Wealth Effects, and Slow Recoveries By Masao Fukui; Emi Nakamura; Jón Steinsson
  28. Gains from Wage Flexibility and the Zero Lower Bound By Roberto M. Billi; Jordi Galí
  29. The Gold Standard and the Great Depression: a Dynamic General Equilibrium Model By Luca Pensieroso; Romain Restout
  30. A progressive consumption tax: an important instrument for stabilizing business cycles, or just an exotic idea? By Vasilev, Aleksandar
  31. The Gilded Bubble Buffer By Xavier Freixas; David Perez-Reyna
  32. Re-use of collateral: leverage, volatility, and welfare By Brumm, Johannes; Grill, Michael; Kubler, Felix; Schmedders, Karl
  33. Macroeconomic Effects of Japan’s Demographics: Can Structural Reforms Reverse Them? By Mariana Colacelli; Emilio Fernández Corugedo
  34. The Propagation of Monetary Policy Shocks in a Heterogeneous Production Economy By Ernesto Pasten; Raphael S. Schoenle; Michael Weber
  35. The Optimal Monetary Instrument and the (Mis)Use of Causality Tests By Keating, John W.; Smith, Andrew Lee
  36. Organizational Equilibrium with Capital By Bassetto, Marco; Huo, Zhen; Rios-Rull, Jose-Victor

  1. By: Christopher L. House; Christian Proebsting; Linda L. Tesar
    Abstract: Unemployment differentials are bigger in Europe than in the United States. Migration responds to unemployment differentials, though the response is smaller in Europe. Mundell (1961) argued that factor mobility is a precondition for a successful currency union. We use a multi-country DSGE model with cross-border migration and search frictions to quantify the benefits of increased labor mobility in Europe and compare this outcome to a case of fully flexible exchange rates. Labor mobility and flexible exchange rates both work to reduce unemployment and per capita GDP differentials across countries provided that monetary policy is sufficiently responsive to national output.
    JEL: E24 E42 E52 E58 F15 F16 F22 F33
    Date: 2018–12
  2. By: Ellen R. McGrattan; Kazuaki Miyachi; Adrian Peralta-Alva
    Abstract: Japan faces the problem of how to finance retirement, health, and long-term care expenditures as the population ages. This paper analyzes the impact of policy options intended to address this problem by employing a dynamic general equilibrium overlapping generations model, specifically parameterized to match both the macroeconomic and microeconomic level data of Japan. We find that financing the costs of aging through gradual increases in the consumption tax rate delivers a better macroeconomic performance and higher welfare for most individuals than other financing options, including those of raising social security contributions, debt financing, and a uniform increase in health and long-term care copayments.
    Date: 2018–11–28
  3. By: Ndiaye, Abdoulaye (Federal Reserve Bank of Chicago)
    Abstract: This paper studies optimal insurance against private idiosyncratic shocks in a life-cycle model with intensive labor supply and endogenous retirement. In this environment, the optimal labor tax is hump-shaped in age: insurance benefits of taxation push for increasing-in-age taxes while rising labor supply elasticities and optimal late retirement of highly productive workers push for lowering taxes for old workers. In calibrated numerical simulations, the optimum achieves sizable welfare gains that age-dependent taxes do not deliver under the status quo US Social Security. Nevertheless, an optimal combination of age-dependent linear taxes with increasing-in-age retirement benefits generates welfare gains close to optimal.
    Keywords: Retirement; Optimal Taxation; Social Security; Continuous- Time; Optimal Stopping
    JEL: H21 H55 J26
    Date: 2017–11–03
  4. By: Park, Seonyoung; Shin, Donggyun
    Abstract: We investigate the welfare consequences of the increase in wage volatility in the United States from the early 1970s to the 2000s. Several important questions are jointly addressed to fully assess the welfare cost of the increase in the variance of wage shocks: whether the increased wage shocks resulted from heterogeneous workers’ risk choices, whether they were anticipated, and whether the affected individuals were insured against the changes. We provide a quantitative assessment of the welfare cost using a general equilibrium model with incomplete markets. Heterogeneous risk preferences, job heterogeneity in wage risk, and gender differences in wage dynamics constitute unique features of the model. The results show that the welfare cost is significantly overstated by neglecting heterogeneity in individual risk preferences and workers’ risk choices. The welfare cost remains substantial at 3.80 percent (in life-time consumption equivalent) even when increases in wage shocks are anticipated, heterogeneous workers self-select into risky jobs, and various insurance mechanisms are allowed in the model. Family labor supply adjustments reduce the welfare cost more effectively when borrowing and saving behavior is allowed. It is also found that wives increase their labor supply significantly in response to anticipated increases in the variance of husbands’ permanent wage shocks, and this ‘added-worker’ effect is mostly accounted for by wives’ labor supply adjustments on the extensive margin.
    Keywords: Heterogeneity, Insurance, Wage shock, Welfare costs, Labor supply,
    Date: 2018
  5. By: Fiorella De Fiore; Marie Hoerova; Harald Uhlig
    Abstract: Interbank money markets have been subject to substantial impairments in the recent decade, such as a decline in unsecured lending and substantial increases in haircuts on posted collateral. This paper seeks to understand the implications of these developments for the broader economy and monetary policy. To that end, we develop a novel general equilibrium model featuring heterogeneous banks, interbank markets for both secured and unsecured credit, and a central bank. The model features a number of occasionally binding constraints. The interactions between these constraints - in particular leverage and liquidity constraints - are key in determining macroeconomic outcomes. We find that both secured and unsecured money market frictions force banks to either divert resources into unproductive but liquid assets or to de-lever, which leads to less lending and output. If the liquidity constraint is very tight, the leverage constraint may turn slack. In this case, there are large declines in lending and output. We show how central bank policies which increase the size of the central bank balance sheet can attenuate this decline.
    JEL: E44 E58
    Date: 2018–11
  6. By: Nelson, Benjamin (Rokos Capital); Pinter, Gabor (Bank of England)
    Abstract: We examine macroprudential bank capital policy in a macroeconomic model with a financial accelerator originating in the banking sector. Under Ramsey-optimal policy, the bank capital buffer tracks closely a model-based measure of the credit gap, defined as the gap between equilibrium credit in the economy featuring financial frictions and that in a hypothetical frictionless economy. Simple rules that vary the capital buffer in response to the credit gap perform worse than Ramsey policy, but only modestly so. When monetary policy controls inflation less aggressively, optimal macroprudential responses are smaller. Optimal macroprudential policy operates at a lower frequency than monetary policy.
    Keywords: Macroprudential policy; bank capital; monetary policy
    JEL: E50 G20
    Date: 2018–12–07
  7. By: Julien Albertini (Univ Lyon, Université Lumière Lyon 2, GATE UMR 5824, F-69130 Ecully, France); Anthony Terriau (Univ Lyon, Université Lumière Lyon 2, GATE UMR 5824, F-69130 Ecully, France)
    Abstract: In developing countries, informality is mainly concentrated on younger and older workers. In this paper, we propose a dual labor market theory that highlights how frictions and taxation in the formal sector as well as educational choices interact to shape the informality rate over the life-cycle. We develop a life-cycle model with search frictions, skill heterogeneities, and endogenous educational choices. We carry out a numerical analysis and show that our model reproduces remarkably well the life-cycle patterns of informality, non-employment and formal employment in Argentina. We analyze several public policies and show that an educational grant reduces both informality and non-employment and may be fully financed by the extra tax revenues generated by the increase in formal employment and wages. Lowering taxes may achieve similar results but is detrimental for the government budget, in the case of Argentina, despite increasing the base on which they are levied.
    Keywords: Informality, Search and Matching, Life-cycle, Public policy, Laffer curve
    JEL: E26 O17 J64
    Date: 2018
  8. By: Mark Mink; Sebastiaan Pool
    Abstract: We integrate a banking sector in a standard New-Keynesian DSGE model, and examine how government policies to recapitalize banks after a crisis affect the supply of credit and the transmission of monetary policy. We examine two types of recapitalizations: immediate and delayed ones. In the steady state, both policies cause the banking sector to charge inefficiently low lending rates, which leads to an inefficiently large capital stock. Raising bank equity requirements reduces this dynamic inefficiency and increases lifetime utility. After the banking sector suffered large losses, a delay in recapitalizations creates banking sector debt-overhang. This debt-overhang leads to inefficiently high lending rates, which reduces the supply of credit and weakens the transmission of monetary policy to inflation (the transmission to output is largely unchanged). Raising bank equity requirements under these circumstances can cause lifetime utility to decline. Hence, the timing of bank recapitalizations after a crisis has several macro-economic implications.
    Keywords: bank recapitalizations; credit supply; monetary policy transmission; bank equity requirements; NK-DSGE models
    JEL: E30 E44 E52 E61
    Date: 2018–12
  9. By: Xiaodan Gao; Shaofeng Xu
    Abstract: We document countercyclical corporate saving behavior with the degree of countercyclicality varying nonmonotonically with firm size. We then develop a dynamic stochastic general equilibrium model with heterogeneous firms to explain the pattern and study its implications for business cycles. In the presence of financial frictions and fixed operating costs, a persistent negative productivity shock signals low future income and prompts firms to hold more cash in order to preserve financial flexibility and maintain normal operations. This countercyclicality exhibits a hump-shaped relation to firm size. Compared with mediumsized firms, small firms have a higher marginal product of capital and thus better investment opportunities, which compete for resources with cash, while large firms have more pledgeable assets and demand less cash. We find that, on average, firms accumulate cash by cutting investment and employment in recessions, which reduces aggregate output and increases economic fluctuations. Corporate saving, therefore, amplifies aggregate shocks.
    Keywords: Business fluctuations and cycles, Economic models
    JEL: E20 E22 E32 G31 G32
    Date: 2018
  10. By: Ikhenaode, Bright Isaac
    Abstract: Focusing on a selected group of 19 OECD countries, we analyze the effects of immigration on natives welfare, labor market outcomes and fiscal redistribution. To this end, we build and simulate a search and matching model that allows for endogenous natives skill acquisition and intergenerational transfers. The obtained results are then compared with different variations of our benchmark model, allowing us to assess to what extent natives skill adjustment and age composition affect the impact of immigration. Our comparative statics analysis suggests that when natives adjust their skill in response to immigration, they successfully avoid, under most scenarios, any potential displacement effect in the labor market. Moreover, taking into account age composition plays a key role in assessing the fiscal impact of immigration, which turns out to be positive when we include retired workers that receive intergenerational transfers. Finally, we find that, under any scenario, our model yields more optimistic welfare effects than a standard search model that abstracts from skill decision and intergenerational redistribution. These welfare effects are found to be overall particularly positive when the migration flows comprise high-skilled workers.
    Keywords: Immigration, Welfare, Unemployment, Skill Acquisition, Fiscal Redistribution.
    JEL: F22 J24 J61 J64
    Date: 2018–11–08
  11. By: Stéphane Auray (CREST-Ensai and ULCO); Aurélien Eyquem (Univ Lyon, Université Lumière Lyon 2, GATE UMR 5824, F-69130 Ecully, France ; Institut Universitaire de France); Paul Gomme (Concordia University and CIREQ)
    Abstract: Following the Great Recession, U.S. government debt levels exceeded 100% of output. We develop a macroeconomic model to evaluate the role of various shocks during and after the Great Recession; labor market shocks have the greatest impact on macroeconomic activity. We then evaluate the consequences of using alternative fiscal policy instruments to implement a fiscal austerity program to return the debt-output ratio to its pre-Great Recession level. Our welfare analysis reveals that there is not much difference between applying fiscal austerity through government spending, the labor income tax, or the consumption tax; using the capital income tax is welfare-reducing.
    Keywords: Fiscal policies, tax reforms, government debt, government deficits
    JEL: E24 E37 E62
    Date: 2018
  12. By: Timothy S. Hills; Taisuke Nakata; Takeki Sunakawa
    Abstract: This paper characterizes optimal commitment policy in the New Keynesian model using a novel recursive formulation of the central bank's infinite horizon optimization problem. In our recursive formulation motivated by Kydland and Prescott (1980), promised inflation and output gap---as opposed to lagged Lagrange multipliers---act as pseudo-state variables. Using three well known variants of the model---one featuring inflation bias, one featuring stabilization bias, and one featuring a lower bound constraint on nominal interest rates---we show that the proposed formulation sheds new light on the nature of the intertemporal trade-off facing the central bank.
    Keywords: Commitment ; Inflation bias ; Optimal policy ; Ramsey plans ; Stabilization bias ; Zero lower bound
    JEL: E61 E63 E52 E32 E62
    Date: 2018–12–03
  13. By: Philippe Bacchetta; Yannick Kalantzis
    Abstract: In this paper we analyze the implications of a persistent liquidity trap in a monetary model with asset scarcity. We show that a liquidity trap may lead to an increase in real cash holdings and be associated with a decline in output in the medium term. This medium-term impact is a supply-side effect that may arise when agents are heterogeneous. It occurs in particular with a persistent deleveraging shock, leading investors to hold cash yielding a low return. Policy implications differ from shorter-run analyses implied by nominal rigidities. Quantitative easing leads to a deeper liquidity trap. Exiting the trap by increasing expected inflation or applying negative interest rates does not solve the asset scarcity problem.
    Keywords: Zero lower bound, liquidity trap, asset scarcity, deleveraging.
    JEL: E40 E22 E58
    Date: 2018
  14. By: Vandenbroucke, Guillaume (Federal Reserve Bank of St. Louis)
    Abstract: The entry of baby boomers into the labor market in the 1970s slowed growth for physical and human capital per worker because young workers have little of both. Thus, the baby boom could have contributed to the 1970s productivity slowdown. I build and calibrate a model a la Huggett et al. (2011) with exogenous population and TFP to evaluate this theory. The baby boom accounts for 75% of the slowdown in the period 1964-69, 25% in 1970-74 and 2% in 1975-79. The retiring of baby boomers may cause a 2.8pp decline in productivity growth between 2020 and 2040, ceteris paribus.
    Keywords: Demography; baby boom; aggregate productivity; productivity slowdown; human capital
    JEL: E24 J11 J24
    Date: 2018–12–01
  15. By: Rym Aloui (Univ Lyon, Université Lumière Lyon 2, GATE UMR 5824, F-69130 Ecully, France); Aurélien Eyquem (Univ Lyon, Université Lumière Lyon 2, GATE UMR 5824, F-69130 Ecully, France ; Institut Universitaire de France)
    Abstract: We investigate the link between the size of government indebtedness and the effectiveness of government spending shocks in normal times and at the Zero Lower Bound (ZLB). We develop a New Keynesian model with capital, distortionary taxes and public debt in which the ZLB constraint on the nominal interest rate may be binding. In normal times, high steady-state levels of government debt to GDP lead to reduced output multipliers. After a negative capital quality shock that pushes the economy at the ZLB however, high steadystate debt levels produce larger output multipliers. Our results rely on the fact that fiscal policy becomes self-financing at the ZLB, and that distortionary taxes rise (respectively fall) after a spending shock at the steady state (resp. ZLB). Our results have non-trivial consequences on the design of optimized spending policies in the event of large economic downturns.
    Keywords: Zero Lower Bound, Fiscal Policy, Distortionary Taxes, Public Debt
    JEL: E62 E32
    Date: 2018
  16. By: Stéphane Auray (CREST-Ensai and ULCO); Aurélien Eyquem (Univ Lyon, Université Lumière Lyon 2, GATE UMR 5824, F-69130 Ecully, France ; Institut Universitaire de France); Xiaofei Ma (CREST-Ensai and Université d'Evry;)
    Abstract: We develop a two-country model with an explicitly microfounded interbank market and sovereign default risk. Calibrated to the core and the periphery of the Euro Area, the model gives rise to a debt-banks-credit loop that substantially amplifies the effects of financial shocks, especially for the periphery. We use the model to investigate the effects of a stylized public asset purchase program at the steady state and during a crisis. We find that it is more effective in stimulating the economy during a crisis, in particular for the periphery.
    Keywords: Recession, Interbank Market, Sovereign Default Risk, Asset Purchases
    JEL: E32 E44 E58 F34
    Date: 2018
  17. By: Chari, V. V. (Federal Reserve Bank of Minneapolis); Nicolini, Juan Pablo (Federal Reserve Bank of Minneapolis); Teles, Pedro (Banco de Portugal)
    Abstract: We revisit the question of how capital should be taxed. We allow for a rich set of tax instruments that consists of taxes widely used in practice, including consumption, dividend, capital, and labor income taxes. We restrict policies to respect promises that the government has made in the previous period regarding the current value of wealth. We show that capital should not be taxed if households have preferences that are standard in the macroeconomics literature. We show that Ramsey outcomes that must respect such promises are time consistent. We show that the presumption in the literature that capital should be taxed for some length of time arises because the tax system is restricted.
    Keywords: Capital income tax; Time consistency; Production efficiency
    JEL: E60 E61 E62
    Date: 2018–09–28
  18. By: Luo, Yulei; Nie, Jun (Federal Reserve Bank of Kansas City); Young, Eric R.
    Abstract: We build a robustness (RB) version of the Obstfeld (1994) model to study the effects of financial integration on growth and welfare. Our model can account for the empirically observed heterogeneity in the relationship between growth and volatility for different countries. The calibrated model shows that financial integration leads to significantly larger gains in growth and welfare for advanced countries than developing countries, with some developing countries experiencing growth and welfare loss in financial integration. Our analytical solutions help uncover the key mechanisms by which this happens.
    Keywords: Robustness; Model Uncertainty; Financial Integration; Risk Sharing; Economic Growth; Welfare
    JEL: C61 D81 E21
    Date: 2018–12–07
  19. By: Ari, Anil
    Abstract: I propose a dynamic general equilibrium model in which strategic interactions between banks and depositors may lead to endogenous bank fragility and slow recovery from crises. When banks’ investment decisions are not contractible, depositors form expectations about bank risk-taking and demand a return on deposits according to their risk. This creates strategic complementarities and possibly multiple equilibria: in response to an increase in funding costs, banks may optimally choose to pursue risky portfolios that undermine their solvency prospects. In a bad equilibrium, high funding costs hinder the accumulation of bank net worth and lead to a “gambling trap” with a persistent drop in investment and output. I bring the model to bear on the European sovereign debt crisis, in the course of which under-capitalized banks in default-risky countries experienced an increase in funding costs and raised their holdings of domestic government debt. The model is quantied using Portuguese data and accounts for macroeconomic dynamics in Portugal in 2010-2016. Policy interventions face a trade-off between alleviating banks’ funding conditions and strengthening risk-taking incentives. Liquidity provision to banks may perpetuate gambling traps when not targeted. Targeted interventions have the capacity to eliminate adverse equilibria. JEL Classification: E44, F30, F34, G01, G21, G28, H63
    Keywords: banking crises, financial constraints, risk-taking, sovereign debt crises
    Date: 2018–12
  20. By: Faccini, Renato; Melosi, Leonardo
    Abstract: Low-frequency variations in current and expected unemployment rates are important to identify TFP news shocks and to allow a general equilibrium rational expectations model to generate Pigouvian cycles: a large fraction of the comovement of output, consumption, investment, employment, and real wages is explained by changes in expectations unrelated to TFP fundamentals. The model predicts that the start (end) of most U.S. recessions is associated with agents realizing that previous enthusiastic (lukewarm) expectations about future TFP would not be met.
    Date: 2018–12
  21. By: Ai, Hengjie (University of Minnesota); Bhandari, Anmol (Federal Reserve Bank of Minneapolis)
    Abstract: This paper studies asset pricing in a setting in which idiosyncratic risk in human capital is not fully insurable. Firms use long-term contracts to provide insurance to workers, but neither side can commit to these contracts; furthermore, worker-firm relationships have endogenous durations owing to costly and unobservable effort. Uninsured tail risk in labor earnings arises as a part of an optimal risk-sharing scheme. In the general equilibrium, exposure to the resulting tail risk generates higher risk premia, more volatile returns, and variations in expected returns across firms. Model outcomes are consistent with the cyclicality of factor shares in the aggregate, and the heterogeneity in exposures to idiosyncratic and aggregate shocks in the cross section.
    Keywords: Equity premium puzzle; Dynamic contracting; Tail risk; Limited commitment
    JEL: E3 G1
    Date: 2018–08–22
  22. By: Guanlong Ren; John Stachurski
    Abstract: This paper provides an alternative approach to the theory of dynamic programming, designed to accommodate the recursive preference specifications commonly used in modern economic analysis while still supporting traditional additively separable rewards. The approach exploits the theory of monotone convex operators, which turns out to be well suited to dynamic maximization. The intuition is that convexity is preserved under maximization, so convexity properties found in preferences extend naturally to the Bellman operator.
    Date: 2018–12
  23. By: Mazumder, Debojyoti; Biswas, Rajit
    Abstract: The present article develops a search and matching framework to model political nepotism in the job market. The model argues that labor market friction generates incentives for the political leaders to provide nepotism under a democratic set up. Both the leaders optimally choose nepotism when the labor market friction is higher. It is shown that even for a relatively lesser labor market friction at least one leader would always choose nepotism. The results of the basic model remain robust in an extension where followers can pay a price and choose their allegiance, to any one of the political parties.
    Keywords: search and matching, nepotism, political regime change
    JEL: D72 J64 J71
    Date: 2018–11–02
  24. By: Cui, Wei; Sterk, Vincent
    Abstract: Abstract Is Quantitative Easing (QE) an effective substitute for conventional monetary policy? We study this question using a quantitative heterogeneous-agents model with nominal rigidities, as well as liquid and partially liquid wealth. The direct effect of QE on aggregate demand is determined by the difference in marginal propensities to consume out of the two types of wealth, which is large according to the model and empirical studies. A comparison of optimal QE and interest rate rules reveals that QE is indeed a very powerful instrument to anchor expectations and to stabilize output and inflation. However, QE interventions come with strong side effects on inequality, which can substantially lower social welfare. A very simple QE rule, which we refer to as Real Reserve Targeting, is approximately optimal from a welfare perspective when conventional policy is unavailable. We further estimate the model on U.S. data and find that QE interventions greatly mitigated the decline in output during the Great Recession.
    Keywords: HANK; Large-scale asset purchases; monetary policy
    JEL: E21 E30 E50 E58
    Date: 2018–11
  25. By: Li, Bing; Pei, Pei; Tan, Fei
    Abstract: Is inflation ‘always and everywhere a monetary phenomenon’ or is it fundamentally a fiscal phenomenon? This article augments a standard monetary model to incorporate fiscal details and credit market frictions. These ingredients allow for both interpretations of the inflation process in a financially constrained environment. We find that adding financial frictions to the model generates important identifying restrictions on the observed pattern between inflation and measures of financial and fiscal stress, to the extent that it can overturn existing findings about which monetary-fiscal policy regime produced the pre-crisis U.S. data.
    Keywords: monetary and fiscal policy, financial frictions, marginal likelihood
    JEL: C52 E44 E62 E63 H63
    Date: 2018–04–03
  26. By: Vladimir Asriyan; Luc Laeven; Alberto Martin
    Abstract: We develop a new theory of information production during credit booms. In our model, entrepreneurs need credit to undertake investment projects, some of which enable them to divert resources towards private consumption. Lenders can protect themselves from such diversion in two ways: collateralization and costly screening, which generates durable information about projects. In equilibrium, the collateralization-screening mix depends on the value of aggregate collateral. High collateral values raise investment and economic activity, but they also raise collateralization at the expense of screening. This has important dynamic implications. During credit booms driven by high collateral values (e.g. real estate booms), the economy accumulates physical capital but depletes information about investment projects. As a result, collateral-driven booms end in deep crises and slow recoveries: when booms end, investment is constrained both by the lack of collateral and by the lack of information on existing investment projects, which takes time to rebuild. We provide new empirical evidence using US rm-level data in support of the model's main mechanism.
    Keywords: Credit booms, collateral, information production, crises, misallocation.
    JEL: E32 E44 G01 D80
    Date: 2018–11
  27. By: Masao Fukui; Emi Nakamura; Jón Steinsson
    Abstract: Business cycle recoveries have slowed in recent decades. This slowdown comes entirely from female employment: as women's employment rates converged towards men's over the past half-century, the growth rate of female employment slowed. We ask whether this slowdown in female employment caused the slowdown in overall employment during recent business cycle recoveries. Standard macroeconomic models with “balanced growth preferences” imply that this cannot be the cause, since the entry of women “crowds out” men in the labor market almost one-for-one. We estimate the extent of crowd out of men by women in the labor market using state-level panel data and find that it is small, contradicting the standard model. We show that a model with home production by women can match our low estimates of crowd out. This model – calibrated to match our cross-sectional estimate of crowd out – implies that 70% of the slowdown in recent business cycle recoveries can be explained by female convergence.
    JEL: E24 E32 J21
    Date: 2018–11
  28. By: Roberto M. Billi; Jordi Galí
    Abstract: We analyze the welfare impact of greater wage flexibility while taking into account explicitly the existence of the zero lower bound (ZLB) constraint on the nominal interest rate. We show that the ZLB constraint generally amplifies the adverse effects of greater wage flexibility on welfare when the central bank follows a conventional Taylor rule. When demand shocks are the driving force, the presence of the ZLB implies that an increase in wage flexibility reduces welfare even under the optimal monetary policy with commitment.
    Keywords: labor market flexibility, Nominal rigidities, optimal monetary policy with commitment, Taylor rule, ZLB
    JEL: E24 E32 E52
    Date: 2018–12
  29. By: Luca Pensieroso (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES)); Romain Restout (Université de Lorraine, Université de Strasbourg, CNRS, BETA)
    Abstract: Was the Gold Standard a major determinant of the onset and the protracted character of the the Great Depression of the 1930s in the United States and Worldwide? In this paper, we model the ‘Gold-Standard hypothesis’ in a dynamic general equilibrium framework. We show that encompassing the international and monetary dimensions of the Great Depression is important to understand what happened in the 1930s, especially outside the United States. Contrary to what is often maintained in the literature, our results suggest that the vague of successive nominal exchange rate devaluations coupled with the monetary policy implemented in the United States did not act as a relief. On the contrary, they made the Depression worse.
    Keywords: Gold Standard, Great Depression, Dynamic General Equilibrium
    JEL: N10 E13 N01
    Date: 2018–12–03
  30. By: Vasilev, Aleksandar
    Abstract: We introduce progressive consumption taxation 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 of progressive taxation of consumption expenditures for the stabilization of cyclical fluctuations in Bulgaria. We find the quantitative effect of such a tax to be very small, and thus not important for either business cycle stabilization, or public finance issues.
    Keywords: business cycles,progressive consumption taxation,Bulgaria
    JEL: E24 E32
    Date: 2018
  31. By: Xavier Freixas; David Perez-Reyna
    Abstract: We provide a microfounded framework for the welfare analysis of macroprudential policy by means of an overlapping generation model where productivity and credit supply are subject to random shocks in order to analyze rational bubbles that can be fueled by banking credit. We find that credit financed bubbles may be welfare improving because of their role as a buffer in channeling excessive credit supply and inefficient investment at the firms' level, but can cause systemic risk. Therefore macroprudential policy plays a key role in improving efficiency while preserving financial stability. Our approach allows us to compare the efficiency of alternative macroprudential policies. Contrarily to conventional wisdom, we show that macroprudential policy may be efficient even in the absence of systemic risk, that it has to be contingent on productivity shocks, to take into account real interest rates.
    Keywords: Bank, bubble, macroprudential regulation
    JEL: E44 E60 G18 G21 G28
    Date: 2018–10
  32. By: Brumm, Johannes; Grill, Michael; Kubler, Felix; Schmedders, Karl
    Abstract: We assess the quantitative implications of collateral re-use on leverage, volatility, and welfare within an infinite-horizon asset-pricing model with heterogeneous agents. In our model, the ability of agents to reuse frees up collateral that can be used to back more transactions. Re-use thus contributes to the buildup of leverage and significantly increases volatility in financial markets. When introducing limits on re-use, we find that volatility is strictly decreasing as these limits become tighter, yet the impact on welfare is non-monotone. In the model, allowing for some re-use can improve welfare as it enables agents to share risk more effectively. Allowing re-use beyond intermediate levels, however, can lead to excessive leverage and lower welfare. So the analysis in this paper provides a rationale for limiting, yet not banning, re-use in financial markets. JEL Classification: D53, G01, G12, G18
    Keywords: heterogeneous agents, leverage, re-use of collateral, volatility, welfare
    Date: 2018–12
  33. By: Mariana Colacelli; Emilio Fernández Corugedo
    Abstract: Yes, partly. This paper studies the potential role of structural reforms in improving Japan’s outlook using the IMF’s Global Integrated Monetary and Fiscal Model (GIMF) with newly-added demographic features. Implementation of a not-fully-believed path of structural reforms can significantly offset the adverse effect of Japan’s demographic headwinds — a declining and ageing population — on real GDP (by about 15 percent in the next 40 years), but would not boost inflation or contribute substantially to stabilizing public debt. Alternatively, implementation of a fully-credible structural reform program can contribute significantly to stabilizing public debt because of the resulting increase in inflation towards the Bank of Japan’s target, while achieving the same positive long-run effects on real GDP. If no reforms are implemented, severe demographic headwinds are expected to reduce Japan’s real GDP by over 25 percent in the next 40 years.
    Keywords: Asia and Pacific;Japan;Government expenditures and health;Structural reforms, demographics, OLG models, Forecasting and Simulation, General, General, Contracts: Specific Human Capital, Matching Models, Efficiency Wage Models, and Internal Labor Markets
    Date: 2018–11–28
  34. By: Ernesto Pasten; Raphael S. Schoenle; Michael Weber
    Abstract: We study the transmission of monetary policy shocks in a model in which realistic heterogeneity in price rigidity interacts with heterogeneity in sectoral size and input-output linkages, and derive conditions under which these heterogeneities generate large real effects. Empirically, heterogeneity in the frequency of price adjustment is the most important driver behind large real effects, whereas heterogeneity in input-output linkages contributes only marginally, with differences in consumption shares in between. Heterogeneity in price rigidity further is key in determining which sectors are the most important contributors to the transmission of monetary shocks, and is necessary but not sufficient to generate realistic output correlations. In the model and data, reducing the number of sectors decreases monetary non-neutrality with a similar impact response of inflation. Hence, the initial response of inflation to monetary shocks is not sufficient to discriminate across models and for the real effects of nominal shocks.
    Keywords: input-output linkages, multi-sector, Calvo model, monetary policy
    JEL: E30 E32 E52
    Date: 2018
  35. By: Keating, John W.; Smith, Andrew Lee (Federal Reserve Bank of Kansas City)
    Abstract: This paper uses a New-Keynesian model with multiple monetary assets to show that if the choice of instrument is based solely on its propensity to predict macroeconomic targets, a central bank may choose an inferior policy instrument. We compare a standard interest rate rule to a k-percent rule for three alternative monetary aggregates determined within our model: the monetary base, the simple sum measure of money, and the Divisia measure. Welfare results are striking. While the interest rate dominates the other two monetary aggregate k-percent rules, the Divisia k-percent rule outperforms the interest rate rule. Next we study the ability of Granger Causality tests – in the context of data generated from our model – to correctly identify welfare improving instruments. All of the policy instruments considered, except for Divisia, Granger Cause both output and prices at extremely high levels of significance. Divisia fails to Granger Cause prices despite the Divisia rule stabilizing inflation better than these alternative policy instruments. The causality results are robust to using a popular version of the Sims Causality test for which we show standard asymptotics remain valid when the variables are integrated, as in our case.
    Keywords: Monetary Policy Instrument; Monetary Aggregates; Granger Causality
    JEL: C32 C43 E37 E44 E52
    Date: 2018–11–28
  36. By: Bassetto, Marco (Federal Reserve Bank of Chicago); Huo, Zhen (Yale University); Rios-Rull, Jose-Victor (University of Pennsylvania)
    Abstract: This paper proposes a new equilibrium concept - organizational equilibrium - for models with state variables that have a time inconsistency problem. The key elements of this equilibrium concept are: (1) agents are allowed to ignore the history and restart the equilibrium; (2) agents can wait for future agents to start the equilibrium. We apply this equilibrium concept to a quasi-geometric discounting growth model and to a problem of optimal dynamic fiscal policy. We find that the allocation gradually transits from that implied by its Markov perfect equilibrium towards that implied by the solution under commitment, but stopping short of the Ramsey outcome. The feature that the time inconsistency problem is resolved slowly over time rationalizes the notion that good will is valuable but has to be built gradually.
    Keywords: Capital; fiscal policy; Markov equilibrium; Quasi-geometry
    JEL: C62 E22 E62
    Date: 2018–11–30

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