nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2019‒01‒07
25 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. DSGE Model of the Russian Economy with the Banking Sector By Dmitry Kreptsev; Sergei Seleznev
  2. Continuous Time Versus Discrete Time in the New Keynesian Model: Closed-Form Solutions and Implications for Liquidity Trap By Maliar, Lilia
  3. The (intertemporal) equity-efficiency trade-off of fiscal consolidation By Sakkas, Stelios; Varthalitis, Petros
  4. A model of endogenous financial inclusion: implications for inequality and monetary policy By Mohammed Ait Lahcen; Pedro Gomis-Porqueras
  5. Non-Linear Pattern of International Capital Flows By Hung Ly-Dai
  6. Innovation and Trade Policy in a Globalized World By Ufuk Akcigit; Sina T. Ates; Giammario Impullitti
  7. Real Interest Rates and Productivity in Small Open Economies By Tommaso Monacelli; Luca Sala; Daniele Siena
  8. Limited Commitment, Endogenous Credibility and the Challenges of Price-level Targeting By Gino Cateau; Malik Shukayev
  9. International Business Cycle and Financial Intermediation By Tamas Csabafi; Max Gillman; Ruthira Naraidoo
  11. Is the Output Growth Rate in NIPA a Welfare Measure? By Jorge Duran; Omar Licandro
  12. Dynamic Stochastic General Equilibrium With Financial Accelerator: The Case Of Indonesia By Kindy R. Sjahrir
  13. Forward Guidance: Is It Useful After the Crisis? By Maliar, Lilia; Taylor, John B.
  14. The Effects of Collecting Income Taxes on Social Security Benefits By John Bailey Jones; Yue Li
  15. The Optimal Inflation Rate with Discount Factor Heterogeneity By Antoine Lepetit
  16. Real Interest Rates, Inflation, and Default By Hur, Sewon; Kondo, Illenin O.; Perri, Fabrizio
  17. Gains from wage flexibility and the zero lower bound By Roberto M. Billi; Jordi Galí
  18. Monetary Independence and Rollover Crises By Javier Bianchi; Jorge Mondragon
  19. The changing structure of goverment consumption spending By Alessio Moro; Omar Rachedi
  20. I shouldn't eat this donut: Self-control, body weight, and health in a life cycle model By Strulik, Holger
  21. International Capital Flows in Club of Convergence By Hung Ly-Dai
  22. Real Interest Rates, Inflation, and Default By Hur, Sewon; Kondo, Illenin; Perri, Fabrizio
  23. Lending Relationships and Optimal Monetary Policy By Guillaume Rocheteau; Tsz-Nga Wong; Cathy Zhang
  24. Impactos do Direcionamento de Crédito Sobre a Economia Brasileira: uma abordagem de equilíbrio geral By Gabriel A. Madeira; Mailliw Serafim; Sergio Mikio Koyama; Fernando Kuwer
  25. The Reversal Interest Rate By Markus K. Brunnermeier; Yann Koby

  1. By: Dmitry Kreptsev (Bank of Russia, Russian Federation); Sergei Seleznev (Bank of Russia, Russian Federation)
    Abstract: This paper presents the DSGE model of the Russian economy with the banking sector which the Bank of Russia uses for simulation experiments. We show how the introduction of the banking sector changes impulse responses of a standard DSGE model of a small open economy. We also demonstrate that the model has fairly good predictive power. The model enables us to study the effect of banking sector-specific shocks on the economy. Estimation on Russian data has led us to conclude that in this model such shocks did not have a significant effect on the real economy’s variables in the period under observation spanning years from 2006 to 2016.
    Keywords: DSGE, BVAR, Russia’s economy, financial frictions, banking sector.
    JEL: C61 E37 E47 G10
    Date: 2017–12
  2. By: Maliar, Lilia
    Abstract: Economists often use interchangeably the discrete- and continuous-time versions of the Keynesian model. In the paper, I ask whether or not the two versions effectively lead to the same implications. I analyze several alternative monetary policies, including a Taylor rule, discretionary interest rate choice and forward guidance. I show that the answer depends on a specific scenario and parameterization considered. In particular, in the presence of liquidity trap, the discrete-time analysis helps overcome some negative implications of the continuous-time model, such as excessively strong impact of price stickiness on inflation and output, unrealistically large government multipliers, as well as implausibly large effects of forward guidance.
    Keywords: closed-form solution; continuous time; forward guidance; New Keynesian Model; ZLB. liquidity trap
    JEL: C61 C63 C68 E31 E52
    Date: 2018–12
  3. By: Sakkas, Stelios; Varthalitis, Petros
    Abstract: We build a dynamic general equilibrium model with heterogeneous households and capital-skill complementarity in the production function to study aggregate and distributional effects of fiscal consolidation policies when government uses a rich set of productivity-enhancing spending instruments along with utility-enhancing spending and tax fiscal instruments. Fiscal policy is conducted through simple fiscal rules. We study both ad-hoc and optimized fiscal rules. Our main results indicate that ad-hoc fiscal consolidation policies, either through spending cuts or tax increases, are recessionary and entail an equity-efficiency trade-off in the short- and medium-run. That is spending-based consolidation policies are less recessionary but come at a higher distributional cost; whereas tax-based consolidation policies result in sharper output losses but have smoother distributional effects. In addition, fiscal consolidation policies through optimized fiscal rules can be expansionary and social welfare enhancing while at the same time balance the equity-efficiency trade-off.
    Keywords: Debt consolidation, distributional effects, fiscal policy, optimized fiscal rules
    JEL: E62 H52 H53
    Date: 2018–12–31
  4. By: Mohammed Ait Lahcen; Pedro Gomis-Porqueras
    Abstract: We propose a monetary dynamic general equilibrium model with endogenous credit market participation to study the impact of financial inclusion on welfare and inequality. We find that significant consumption inequality can result from limited access to basic financial services. In this environment, monetary policy has distributional consequences as agents face different liquidity constraints. This heterogeneity generates a pecuniary externality which can result in overconsumption of financially included agents above the socially efficient level. We conduct a quantitative assessment for the case of India. Our simple model is able to account for approximately a third of the observed consumption inequality. We analyze various policies aimed at increasing financial inclusion. As a result of pecuniary externalities, interest rate policies can result in a decrease in welfare and an increase in consumption inequality. Moreover, we find that a direct benefit transfer to bank account owners is superior to interest rate policies as it can increase welfare and reduce consumption inequality despite a decrease in individual consumption.
    Keywords: Money, credit, banking, financial inclusion, inequality
    JEL: E40 E50
    Date: 2018–12
  5. By: Hung Ly-Dai (VNU - Vietnam National University [Hanoï])
    Abstract: We establish one non-linear pattern of international capital flows by building up one two-country OLG economy. With symmetric growth and asymmetric interest rate wedges across countries, net total capital inflows are either decreasing or increasing on productivity growth rate. However, with asymmetric growth and asymmetric wedges, they follow one U-shaped curve by first decreasing and then increasing on growth. The turning point of the curve is built on world average growth rate and wedges. Our proposed model can provide an explanation for inconsistencies between theories (i.e, Lucas paradox, uphill capital flows, and allocation puzzle) about the pattern of international capital flows.
    Keywords: Allocation Puzzle,Capital Flows,Financial Frictions,Productivity Growth
    Date: 2018–10
  6. By: Ufuk Akcigit; Sina T. Ates; Giammario Impullitti
    Abstract: How do import tariffs and R&D subsidies help domestic firms compete globally? How do these policies affect aggregate growth and economic welfare? To answer these questions we build a dynamic general equilibrium growth model where firm innovation endogenously determines the dynamics of technology, market leadership and trade flows, in a world with two large open economies at different stages of development. Firms R&D decisions are driven by (i) the defensive innovation motive, (ii) the expansionary innovation motive, and (iii) technology spillovers. The theoretical investigation illustrates that, statistically, globalization boosts domestic innovation through induced international competition. Accounting for transitional dynamics, we use our model for policy evaluation and compute optimal policies over different time horizons. The model suggests that the introduction of the Research and Experimentation Tax Credit in 1981 proves to be an effective policy response to foreign competition, generating substantial welfare gains in the long run. A counterfactual exercise shows that increasing tariffs as an alternative policy response improves domestic welfare only when the policymaker cares about the very short run, or when there is retaliation by the foreign economy. Protectionist measures generate large dynamic losses by distorting the impact of openness on innovation incentives and productivity growth. Finally our model predicts that a more globalized world entails less government intervention, thanks to innovation-stimulating effects of intensified international competition.
    Keywords: economic growth, short- and long-run gains from globalization, foreign technological catching-up, innovation policy, trade policy, competition
    JEL: F13 F43 O40
    Date: 2018–12
  7. By: Tommaso Monacelli; Luca Sala; Daniele Siena
    Abstract: In emerging market economies (EMEs), capital inflows are associated to productivity booms. However, the experience of advanced small open economies (AEs), like the ones of the Euro Area periphery, points to the opposite, i.e., capital inflows lead to lower productivity, possibly because of entry of less productive firms. We measure capital flow shocks as exogenous variations in world real interest rates. We show that, in the data, lower real interest rates lead to lower productivity only in AEs, whereas the opposite holds for EMEs. We build a business cycle model with firms' heterogeneity, financial imperfections and endogenous productivity. The model combines a cleansing effect, stemming from capital outflows (inflows), with an original sin effect, whereby capital outflows (inflows), via a real exchange rate depreciation (appreciation), decreases (increases) the opportunity cost of producing for less productive firms and the borrowing ability of the incumbent, marginally more productive firms. The estimation of the model reveals that a low trade elasticity combined with high (low) firms' productivity dispersion in EMEs (AEs) are crucial ingredients to account for the different effects of capital flows across groups of countries. The relative balance of the cleansing and the original sin effect is able to simultaneously rationalize the evidence in both EMEs and AEs.
    Keywords: World Interest Rates, Financial Frictions, Firms' Heterogeneity, Small Open Economies.
    JEL: F32 F41
    Date: 2018
  8. By: Gino Cateau; Malik Shukayev
    Abstract: This paper studies the cost of limited commitment when a central bank has the discretion to adjust policy whenever the costs of honoring its past commitments become high. Specifically, we consider a central bank that seeks to implement optimal policy in a New Keynesian model by committing to a price-level target path. However, the central bank retains the flexibility to reset the target path if the cost of adhering to it exceeds a social tolerance threshold. We find that endowing the central bank with such discretion undermines the credibility of the price-level target and weakens its effectiveness to stabilize the economy through expectations. The endogenous nature of credibility also brings novel results relative to models with exogenous timing of target resets. A much higher degree of credibility is needed to realize the stabilization benefits of commitment. Multiple equilibria also emerge, including a low credibility equilibrium with frequent target resets and high volatility.
    Keywords: Credibility, Inflation targets, Monetary policy framework
    JEL: E31 E52
    Date: 2018
  9. By: Tamas Csabafi (University of Missouri-St. Louis - Department of Economics); Max Gillman (University of Missouri-St. Louis; IEHAS, Budapest; CERGE-EI, Prague); Ruthira Naraidoo (Department of Economics - University of Pretoria, South Africa)
    Abstract: The paper extends a standard two-country international real business cycle model to include financial intermediation by banks of loans and government bonds. Taking in household deposits from home and abroad, the loans are produced by the bank in a Cobb-Douglas production approach such that a bank productivity shock can explain financial data moments. 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 provides a sense in which financial retrenchment resulted in the US following the 2008 bank crisis, and how the Euro-area and China reacted. The paper contributes evidence of how the Euro-area has been more financially integrated with the US, and China less financially integrated, with the Euro-area becoming more financially integrated after the 2008 crisis, and China becoming less so integrated.
    Keywords: International Real Business Cycles, Financial Intermediation, Credit Spread, Bank Productivity, 2008 Crisis
    JEL: E13 E32 E44 F41
    Date: 2018–11
  10. By: Mieke Dujardin; Freddy Heylen (-)
    Abstract: Raising employment, especially among low skilled workers, stands high on the agenda of policy makers in many OECD countries. They can rely on a huge body of literature that has studied the impact of fiscal policy and wage formation on employment. We contribute to this literature by studying within one coherent framework not only the employment effects of (targeted) changes in tax rates, unemployment benefits and wage setting, but also their effects on inequality and poverty. Our methodological framework is a fourperiod overlapping generations model that portrays two key characteristics: households differ by innate ability and there is an imperfect labor market (union wage floor) for individuals of low ability, causing unemployment. The model explains employment, per capita income and welfare at the aggregate level, as well as for specific ability and age groups. Our main findings are as follows. Unilateral fiscal actions, such as a reduction of labor taxes financed by lower unemployment benefits, can have clear positive effects on employment of (mainly) low ability individuals, but they raise poverty among those who remain unemployed. Achieving higher employment without increasing inequality and poverty, requires combined efforts of fiscal policy makers (labor tax cuts) and unions (wage moderation). Depending on the policy maker’s priority for either employment or lower inequality, a reduction of labor taxes on employers or on employees is preferable. If more progress is to be made in ameliorating inequality and poverty, union wage moderation may be supplemented by a transfer to all individuals below the poverty line, conditional on their active participation on the labor market. All our results assume employability of the unemployed, and are therefore to be seen as long-run effects, which may require complementary policies.
    Keywords: employment of low educated individuals, fiscal policy, heterogeneous ability, welfare inequality, poverty, overlapping generations (OLG)
    JEL: E62 H5 I28 J22 J24
    Date: 2018–12
  11. By: Jorge Duran (European Commission); Omar Licandro (University of Nottingham, IAE-CSIC & Barcelona GSE)
    Abstract: Bridging modern macroeconomics and the economic theory of index numbers, this paper shows that real output growth as measured by National Income and Product Accounts (NIPA) is a welfare based measure. In a two-sector dynamic general equilibrium model of heterogeneous households, recursive preferences and quasi-concave technology, individual welfare depends on present and future consumption. In this context, the Bellman equation provides a representation of preferences over current consumption and investment. Applying standard index number theory to this representation of preferences, it is shown that the Fisher-Shell true quantity index is equal to the Divisia index in turn well approximated by the Fisher ideal chain index used in NIPA.
    Keywords: growth measurement, quantity indexes, equivalent variation, NIPA, Fisher-Shell index, Divisia index, embodied technical change
    JEL: C43 D91 O41 O47
    Date: 2018–11
  12. By: Kindy R. Sjahrir (Fiscal Policy Office, Ministry of Finance. Republic of Indonesia)
    Abstract: In the last two decades shows that the Indonesian macroeconomic instability has found its roots from the financial sector's (banking's) pro-cyclicality. A number of economic and financial crisis preceded pro-cyclicality level of the financial sector in Indonesia is quite high. Indicators of real credit growth faster than GDP in the period of expansion, and the decline is far greater than the decline in GDP in the period of contraction is indicative of the high pro- cyclicality. This paper manuscript look neutrality or differences in response to the impact of fiscal and monetary policy mix as a result of the calculation of the non-conformance of the business cycle, both of which exist in the prior period as a result of the policy or the policy itself as a research problem. Neutrality impact of the response of fiscal and monetary policy mix in Indonesia in 2013 is a strategic issue of management of economic stability. With the high pro-cyclicality, then the policy is not precisely calibrated to the updated business cycle in the period may have the effect of turbulence. Fiscal policy has the potential to affect the business cycle. Monetary policy has the potential to support the stability of the financial system through its ability to affect the financial condition and behavior of financial markets, through the transmission company and the bank's balance sheet and risk-taking behavior. However, the condition of the financial system also has the potential to influence monetary stability. This paper research aims to (1) identify, analyze, and explain the phenomenon of complications response of fiscal and monetary policy mix in Indonesia; and (2) assess the methods applied to modeling the business cycle of macroeconomic stabilization policy mix that is more suitable for Indonesia as a small-open-economy in the condition (state) of stochastic uncertainty of the external economy. Finally, the results of this study recommends a systematic policy of intervention in the foreign exchange market through the feedback rule is a policy that is superior to every framework of the monetary policy rule. This is an appropriate reason for the stylized facts governance of the exchange rate as a basis for modeling framework of a small open economy with the data Indonesia. Results of this research with the data Indonesia would be generalized for the modeling framework of small open economy, provided that endogenous risk premium depends on the level of debt.
    Keywords: Dynamic Stochastic General Equilibrium, New Keynesian Macroeconomics, Monetary Policy, Fiscal Policy, Financial Sector Accelerator, Macroeconomic Policy Mix, New Keynesian Macroeconomic, Dynamic Stochastic General Equilibrium, Financial Friction, Macroeconomic Policy Mix,, Macroprudential
    JEL: G28
    Date: 2018–12
  13. By: Maliar, Lilia; Taylor, John B.
    Abstract: During recent economic crisis, when nominal interest rates were at their effective lower bounds, central banks used forward guidance -- announcements about future policy rates -- to conduct their monetary policy. Many policymakers believe that forward guidance will remain in use after the end of the crisis, however, there is uncertainty about its effectiveness. In this paper, we study the impact of forward guidance in a stylized new Keynesian economy away from the effective lower bound on nominal interest rates. Using closed-form solutions, we show that the impact of forward guidance on the economy depends critically on a specific monetary policy rule, ranging from non-existing to immediate and unrealistically large, the so-called forward guidance puzzle. We show that the puzzle occurs under very special -- empirically implausible and socially suboptimal -- monetary policy rules, whereas empirically relevant Taylor rules lead to sensible implications.
    Keywords: forward guidance; New Keynesian Model
    JEL: C61 C63 C68 E31 E52
    Date: 2018–12
  14. By: John Bailey Jones (Federal Reserve Bank of Richmond and University at Albany); Yue Li (University at Albany)
    Abstract: Since 1983, Social Security benefits have been subject to income taxation, a provision that can significantly increase the marginal income tax rate for older individuals. To assess the impact of this tax, we construct and calibrate a detailed life-cycle model of labor supply, saving, and Social Security claiming. We find that in a long-run stationary environment, replacing the taxation of Social Security benefits with a revenue-equivalent change in the payroll tax would increase labor supply, consumption, and welfare. From an ex-ante perspective an equally desirable reform would be to make the portion of benefits subject to income taxes completely independent of other income.
    Keywords: Social Security, Labor Supply, Taxation
    JEL: E21 H24 H55 I38
  15. By: Antoine Lepetit
    Abstract: This paper shows that deviations from long-run price stability are optimal in the presence of price stickiness whenever profit and utility flows are discounted at a different rate. In that case, a monetary authority acting under commitment will choose a path for the inflation rate that ends with a non-zero value. Such a property is relevant in a wide range of macroeconomic environments. I first illustrate this by studying optimal monetary policy in a New Keynesian model with a perpetual youth structure. In this setting, profit flows are discounted more heavily than utility flows and the optimal inflation target is equal to 3.2 percent in a baseline calibration of the model. I also show that this property leads to a positive long-run inflation rate in models with firm entry and exit and in environments with search and matching frictions in the labor market and another form of nominal rigidity, wage stickiness.
    Keywords: Discount factor heterogeneity ; Inflation target ; Optimal inflation rate ; Optimal monetary policy ; Perpetual youth ; Sticky prices
    JEL: E31 E32 E52
    Date: 2018–12
  16. By: Hur, Sewon (Federal Reserve Bank of Cleveland); Kondo, Illenin O. (University of Notre Dame); Perri, Fabrizio (Federal Reserve Bank of Minneapolis)
    Abstract: This paper argues that the comovement between inflation and economic activity is an important determinant of real interest rates over time and across countries. First, we show that for advanced economies, periods with more procyclical inflation are associated with lower real rates, but only when there is no risk of default on government debt. Second, we present a model of nominal sovereign debt with domestic risk-averse lenders. With procyclical inflation, nominal bonds pay out more in bad times, making them a good hedge against aggregate risk. In the absence of default risk, procyclical inflation yields lower real rates. However, procyclicality implies that the government needs to make larger (real) payments when the economy deteriorates, which could increase default risk and trigger an increase in real rates. The patterns of real rates predicted by the model are quantitatively consistent with those documented in the data.
    Keywords: Inflation risk; Government debt; Nominal bonds; Sovereign default
    Date: 2018–12–12
  17. By: Roberto M. Billi; Jordi Galí
    Abstract: We analyze the welfare impact of greater wage áexibility 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 ampliÖes the adverse e§ects of greater wage áexibility 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 áexibility 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
  18. By: Javier Bianchi; Jorge Mondragon
    Abstract: This paper shows that the inability to use monetary policy for macroeconomic stabilization leaves a government more vulnerable to a rollover crisis. We study a sovereign default model with self-fulfilling rollover crises, foreign currency debt, and nominal rigidities. When the government lacks monetary autonomy, lenders anticipate that the government will face a severe recession in the event of a liquidity crisis, and are therefore more prone to run on government bonds. By contrast, a government with monetary autonomy can stabilize the economy and can easily remain immune to a rollover crisis. In a quantitative application, we find that the lack of monetary autonomy played a central role in making the Eurozone vulnerable to a rollover crisis. A lender of last resort can help ease the costs from giving up monetary independence.
    JEL: E4 E5 F34 G15
    Date: 2018–12
  19. By: Alessio Moro (University of Cagliari); Omar Rachedi (Banco de España)
    Abstract: We document a secular increase in the share of purchases from the private sector in government consumption spending: over time the government purchases relatively more private-sector goods, and relies less on its own production of value added. We build a general equilibrium model in which investment-specifi c technological change accounts for the changing structure of government spending. The model predicts that this secular process alters the transmission of government spending shocks by raising the response of private value added, while dampening the response of hours. We validate these results with novel empirical evidence on the effects of government spending across countries.
    Keywords: government gross output, government wage bill, fi scal multiplier
    JEL: E62 H10 O41
    Date: 2018–11
  20. By: Strulik, Holger
    Abstract: In this paper I discuss overweight and obesity and their repercussions on health deficit accumulation and longevity in a life cycle model. Individual decisions are conceptualized as the partial control of impulsive desires of a short-run self (the limbic system) by a rationally forward-looking long-run self (the prefrontal cortex). The short-run self-strives for immediate gratification through consumption of food and other goods. The long-run self reflects the consequences of eating behavior on weight gain and health, exercises to lose weight, invests money to improve health and saves for health expenditure in old age. Not conceding to short-run desires, however, entails an idiosyncratic utility cost of self-control. The model is calibrated to match food expenditure, exercise, and other choices of an average U.S. American. The results suggest that imperfect self-control reduces average lifetime by up to five years. I use the model to analyze the role of self-control, income, food prices, energy density, and medical progress in explaining obesity and to develop a test on whether obesity is driven by excessive desire for food or lack of self-control.
    Keywords: self-control,overweight,obesity,physical exercise,health investments,aging,longevity
    JEL: D11 D91 E21 I10 I12
    Date: 2018
  21. By: Hung Ly-Dai (VNU - Vietnam National University [Hanoï])
    Abstract: We explain U-shape pattern of international capital inflows by one multi-country OLG economy and one cross-section data sample. The theory proves that capital inflows are decreasing on distance to frontier, which is measured by ratio of domestic productivity level over United States' level. The evidences not only confirm the theory but also reveal that growth is decreasing on distance to frontier for club of convergence but increasing for club of unconvergence. Therefore, Neo-Classical growth model's implication, that capital inflows are positively correlated to growth, applies for club of convergence. However, Allocation puzzle, that capital inflows are negatively correlated to growth, works for club of unconvergence. The turning point of U-shape pattern is the productivity growth rate at world technology frontier.
    Keywords: International Capital Flows,Productivity Growth,Relative Convergence
    Date: 2018–07
  22. By: Hur, Sewon; Kondo, Illenin; Perri, Fabrizio
    Abstract: This paper argues that the comovement between inflation and economic activity is an important determinant of real interest rates over time and across countries. First, we show that for advanced economies, periods with more procyclical inflation are associated with lower real rates, but only when there is no risk of default on government debt. Second, we present a model of nominal sovereign debt with domestic risk-averse lenders. With procyclical inflation, nominal bonds pay out more in bad times, making them a good hedge against aggregate risk. In the absence of default risk, procyclical inflation yields lower real rates. However, procyclicality implies that the government needs to make larger (real) payments when the economy deteriorates, which could increase default risk and trigger an increase in real rates. The patterns of real rates predicted by the model are quantitatively consistent with those documented in the data.
    Keywords: Government Debt; Inflation risk; nominal bonds; sovereign default
    JEL: E31 F34 G12 H63
    Date: 2018–12
  23. By: Guillaume Rocheteau; Tsz-Nga Wong; Cathy Zhang
    Abstract: We study optimal monetary policy in a monetary model of internal and external finance with bank entry and endogenous formation of lending relationships through search and bargaining. Following an unanticipated destruction of relationships, optimal monetary policy under com- mitment lowers the interest rate in the aftermath of the shock and uses forward guidance to promote bank entry and rebuild relationships. Absent commitment, forward guidance fails to anchor inflation expectations and optimal policy is subject to a deflationary bias that delays recovery. If there is a temporary freeze in relationship creation, the interest rate is set at the zero lower bound for some period of time.
    Keywords: credit relationships, banks, optimal monetary policy
    JEL: D83 E32 E51
    Date: 2018–12
  24. By: Gabriel A. Madeira; Mailliw Serafim; Sergio Mikio Koyama; Fernando Kuwer
    Abstract: In Brazil, about 40% of the credit to firms originates from earmarking credit policies. These loans are heavily subsidized, with interest rates substantially lower than the others. Only about 18% of formal firms are benefited by these loans. However, these firms receive about 80% of total corporate credit from banks. It is reasonable to assume that the effects of these policies on the economy are substantial. To evaluate them, we elaborate a general equilibrium model with heterogeneous agents and credit restrictions that incorporates the credit earmarking policies practiced in Brazil. Using theoretical and numerical resources recently incorporated into the economic literature, we adjusted the model to the Brazilian data in order to simulate the effects of the removal of credit earmarking policies. Our simulations indicate that the extinction of earmarked credit programs would generate several positive effects, such as increased output and productivity, reduced inequality and financial inclusion. Next, we simulate variations in earmarking policies, evaluating the impacts of giving greater focus to poorer or more productive entrepreneurs. While these changes can lead to improvements, our simulations indicate smaller gains than the mere removal of earmarking programs.
    Date: 2018–12
  25. By: Markus K. Brunnermeier; Yann Koby
    Abstract: The “reversal interest rate” is the rate at which accommodative monetary policy reverses its intended effect and becomes contractionary for lending. It occurs when banks' asset revaluation from duration mismatch is more than offset by decreases in net interest income on new business, lowering banks' net worth and tightening their capital constraints. The determinants of the reversal interest rate are 1) banks' fixed-income holdings, 2) the strictness of capital constraints, 3) the degree of pass-through to deposit rates, and 4) the initial capitalization of banks. Furthermore, quantitative easing increases the reversal interest rate and should only be employed after interest rate cuts are exhausted. Over time the reversal interest rate creeps up since asset revaluation fades out as fixed-income holdings mature while net interest income stays low. We calibrate a New Keynesian model that embeds our banking frictions and show that the economics behind the reversal interest rate carry through general equilibrium.
    JEL: E43 E44 E52 G21
    Date: 2018–12

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