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on Dynamic General Equilibrium |
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Issue of 2019‒01‒21
fourteen papers chosen by Christian Zimmermann Federal Reserve Bank of St. Louis |
| By: | Boris Chafwehé (Universit´e Catholique de Louvain and FNRS); Rigas Oikonomou (Universit´e Catholique de Louvain); Romanos Priftis (Bank of Canada); Lukas Vogel (Directorate General for Economic and Financial Affairs. European Commission) |
| Abstract: | We propose a novel framework where forward guidance (FG) is endogenously determined. Our model assumes that a monetary authority solves an optimal policy problem under com- mitment at the zero-lower bound. FG derives from two sources: 1. from commiting to keep interest rates low at the exit of the liquidity trap, to stabilize inflation today. 2. From debt sustainability concerns, when the planner takes into account the consolidated budget constraint in optimization. Our model is tractable and admits an analytical solution for interest rates in which 1 and 2 show up as separate arguments that enter additively to the standard Taylor rule. In the case where optimal policy reflects debt sustainability concerns (satisfies the consoli- dated budget) monetary policy becomes subservient to fiscal policy, giving rise to more volatile inflation, output and interest rates. Liquidity trap (LT) episodes are longer, however, the impact of interest rate policy commitments on inflation and output are moderate. ’Keeping interest rates low’ for a long period, does not result in positive inflation rates during the LT, in contrast our model consistently predicts negative inflation at the onset of a LT episode. In contrast, in the absence of debt concerns, LT episodes are shorter, but the impact of commitments to keep interest rates low at the exit from the LT, on inflation and output is substantial. In this case monetary policy accomplishes to turn inflation positive at the onset of the episode, through promising higher inflation rates in future periods. We embed our theory into a DSGE model and estimate it with US data. Our findings suggest that FG during the Great Recession may have partly reflected debt sustainability concerns, but more likely policy reflected a strong commitment to stabilize inflation and the output gap. Our quantitative findings are thus broadly consistent with the view that the evolution of debt aggregates may have had an impact on monetary policy in the Great Recession, but this impact is likely to be small. |
| Keywords: | Bayesian estimationDSGE modelfiscal policyforward guidanceinflationLiquidity trapmonetary policy |
| JEL: | E31 E52 E58 E62 C11 |
| Date: | 2018–10 |
| URL: | http://d.repec.org/n?u=RePEc:nbb:reswpp:201810-354&r=all |
| By: | Alvarez, Fernando (University of Chicago); Atkeson, Andrew (Federal Reserve Bank of Minneapolis) |
| Abstract: | We develop a new general equilibrium model of asset pricing and asset trading volume in which agents’ motivations to trade arise due to uninsurable idiosyncratic shocks to agents’ risk tolerance. In response to these shocks, agents trade to rebalance their portfolios between risky and riskless assets. We study a positive question — When does trade volume become a pricing factor? — and a normative question — What is the impact of Tobin taxes on asset trading on welfare? In our model, economies in which marketwide risk tolerance is negatively correlated with trade volume have a higher risk premium for aggregate risk. Likewise, for a given economy, we find that assets whose cash flows are concentrated on states with high trading volume have higher prices and lower risk premia. We then show that Tobin taxes on asset trade have a first-order negative impact on ex-ante welfare, i.e., a small subsidy to trade leads to an improvement in ex-ante welfare. Finally, we develop an alternative version of our model in which asset trade arises from uninsurable idiosyncratic shocks to agents’ hedging needs rather than shocks to their risk tolerance. We show that our positive results regarding the relationship between trade volume and asset prices carry through. In contrast, the normative implications of this specification of our model for Tobin taxes or subsidies depend on the specification of agents’ preferences and non-traded endowments. |
| Keywords: | Liquidity; Trade volume; Asset pricing; Tobin taxes |
| JEL: | G12 |
| Date: | 2018–12–31 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmsr:577&r=all |
| By: | Chahrour, Ryan; Ulbricht, Robert |
| Abstract: | We study the quantitative potential of DSGE models with incomplete information. In contrast to existing literature, we offer predictions that are robust across all possible private information structures that agents may have. Our approach maps DSGE models with information-frictions into a parallel economy where deviations from fullinformation are captured by time-varying wedges. We derive exact conditions that ensure the consistency of these wedges with some information structure. We apply our approach to an otherwise frictionless business cycle model where firms and households have incomplete information. We show how assumptions about information interact with the presence of idiosyncratic shocks to shape the potential for confidence-driven fluctuations. For a realistic calibration, we find that correlated confidence regarding idiosyncratic shocks (aka “sentiment shocks”) can account for up to 51 percent of U.S. business cycle fluctuations. By contrast, confidence about aggregate productivity can account for at most 3 percent. |
| Keywords: | Business cycles; DSGE models; incomplete-information; information-robust predictions |
| JEL: | D84 E32 |
| Date: | 2018–11 |
| URL: | http://d.repec.org/n?u=RePEc:tse:wpaper:33124&r=all |
| By: | Óscar Arce (Banco de España); Galo Nuño (Banco de España); Dominik Thaler (Banco de España); Carlos Thomas (Banco de España) |
| Abstract: | The quantitative easing (QE) policies implemented in recent years by central banks have had a profound impact on the working of money markets, giving rise to large excess reserves and pushing down key interbank rates against their floor – the interest rate on reserves. With macroeconomic fundamentals improving, central banks now face the dilemma as to whether to maintain this large balance sheet/floor system, or else to reduce their balance sheet size towards pre-crisis trends and operate traditional corridor systems. We address this issue using a New Keynesian model featuring heterogeneous banks that trade funds in an interbank market characterized by matching frictions. In this environment, balance sheet expansions push market rates towards their floor by slackening the interbank market. A large balance sheet regime is found to deliver ampler “policy space” by widening the steady-state distance between the interest on reserves and its effective lower bound (ELB). Nonetheless, a lean-balance-sheet regime that resorts to temporary but prompt QE in response to recessions severe enough for the ELB to bind achieves similar stabilization and welfare outcomes as a large-balance-sheet regime in which interest-rate policy is the primary adjustment margin thanks to the larger policy space. |
| Keywords: | central bank balance sheet, interbank market, search and matching frictions, reserves, zero lower bound |
| JEL: | E42 E44 E52 G21 |
| Date: | 2018–12 |
| URL: | http://d.repec.org/n?u=RePEc:bde:wpaper:1851&r=all |
| By: | Elizaveta Lukmanova (KU Leuven, Faculty of Economics and Business, Department of Economics); Katrin Rabitsch (Department of Economics, Vienna University of Economics and Business) |
| Abstract: | We augment a standard monetary VAR on output growth, inflation and the nominal interest rate with the central bank's inflation target, which we estimate from a New Keynesian DSGE model. Inflation target shocks give rise to a simultaneous increase in inflation and the nominal interest rate in the short run, at no output expense, which stands at the center of an active current debate on the Neo-Fisher effect. In addition, accounting for persistent monetary policy changes reflected in inflation target changes improves identification of a standard temporary nominal interest rate shock in that it strongly alleviates the price puzzle. |
| Keywords: | Monetary policy, Neo-Fisher effect, Time-varying inflation target, DSGE, VAR |
| JEL: | E12 E31 E52 E58 |
| Date: | 2018–11 |
| URL: | http://d.repec.org/n?u=RePEc:wiw:wiwwuw:wuwp274&r=all |
| By: | Biais, Bruno; Bisière, Christophe; Bouvard, Matthieu; Casamatta, Catherine; Menkveld, Albert J. |
| Abstract: | We offer an overlapping generations equilibrium model of cryptocurrency pricing and confront it to new data on bitcoin transactional benefits and costs. The model emphasizes that the fundamental value of the cryptocurrency is the stream of net transactional benefits it will provide, which depend on its future prices. The link between future and present prices implies that returns can exhibit large volatility unrelated to fundamentals. We construct an index measuring the ease with which bitcoins can be used to purchase goods and services, and we also measure costs incurred by bitcoin owners. Consistent with the model, estimated transactional net benefits explain a statistically significant fraction of bitcoin returns. |
| Date: | 2018–12 |
| URL: | http://d.repec.org/n?u=RePEc:tse:wpaper:33141&r=all |
| By: | Victor Filipe Martins da Rocha (EESP - Sao Paulo School of Economics - FGV - Fundacao Getulio Vargas [Rio de Janeiro], CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - Université Paris-Dauphine - CNRS - Centre National de la Recherche Scientifique); Yiannis Vailakis (Adam Smith Business School - University of Glasgow) |
| Abstract: | The paper aims at improving our understanding of self-enforcing debt in competitive dynamic economies with lack of commitment when default induces a permanent loss of access to international credit markets. We show, by means of examples, that a sovereign's creditworthiness is not necessarily limited by the ability to repay out of its future resources. Self-enforcing debt grows at the same rate as interest rates. If a sovereign's endowment growth rates are lower than interest rates, then debt limits eventually exceed the natural debt limits. This implies that there is asymptotic borrowing in present value terms. We show that this can be compatible with lending incentives when credible borrowers facilitate inter-temporal exchange, acting as pass-through intermediaries that alleviate the lenders' credit restrictions. |
| Keywords: | Limited Commitment,Self-enforcing Debt,Natural Debt Limit |
| Date: | 2017–01–02 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-01249202&r=all |
| By: | Cairo, Isabel (Board of Governors of the Federal Reserve System); Fujita, Shigeru (Federal Reserve Bank of Philadelphia); Morales-Jimenez, Camilo (Board of Governors of the Federal Reserve System) |
| Abstract: | Using a representative-household search and matching model with endogenous labor force participation, we study the interactions between extensive-margin labor supply elasticities and the cyclicality of labor force participation flows. Our model successfully replicates salient business-cycle features of all transition rates between three labor market states, the unemployment rate, and the labor force participation rate, while using values of elasticities consistent with micro evidence. Our results underscore the importance of the procyclical opportunity cost of employment, together with wage rigidity, in understanding the cyclicality of labor market flows and stocks. |
| Keywords: | Labor force participation; labor market transitions; labor supply elasticity; unemployment |
| JEL: | E24 J64 |
| Date: | 2019–01–09 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:19-3&r=all |
| By: | João Pereira |
| Abstract: | We calibrate an endogenous overlapping generations model of a small open economy to study the effects of population aging and population decline. In an invariant scenario public and foreign debt explode and GDP growth decreases markedly. Among the tested policies to control public nances, the best for the individuals is an increase in the retirement age, which needs to increase 6 years, a similar magnitude as the increase in life expectancy at birth. However, this increase has to happen before the increase in life expectancy materi- alizes itself. Aging has a stronger negative impact on public debt than population decline. We find a positive, but quantitatively modest, behavioral effect in reaction to a higher life expectancy with an impact on the GDP growth rate of only 2 basis points. |
| Keywords: | Open Economy; Time Allocation; PAYG pensions; Debt |
| JEL: | J11 J22 H55 H63 |
| Date: | 2019–01 |
| URL: | http://d.repec.org/n?u=RePEc:ise:remwps:wp0632019&r=all |
| By: | Davide Debortolii (Universitat Pompeu Fabra and Barcelona GSE); Ricardo Nunes (University of Surrey and CIMS); Pierre Yared (Columbia University and NBER) |
| Abstract: | This paper considers optimal fiscal policy in a deterministic Lucas and Stokey (1983) economy in the absence of government commitment. In every period, the government chooses a labor income tax and issues any unconstrained maturity structure of debt as a function of its outstanding debt portfolio. We find that the solution under commitment cannot always be sustained through the appropriate choice of debt maturities, a result which contrasts with previous conclusions in the literature. This is because a government today cannot commit future governments to a particular side of the Laffer curve, even if it can commit them to future revenues. We find that the unique stable debt maturity structure under no commitment is at, with the government owing the same amount of resources to the private sector at all future dates. We present examples in which the maturity structure converges to such a at distribution over time. In cases where the commitment and no-commitment solutions do not coincide, debt converges to the natural debt limit. |
| JEL: | H63 H21 E62 |
| Date: | 2019–01 |
| URL: | http://d.repec.org/n?u=RePEc:sur:surrec:0119&r=all |
| By: | Karine Constant (ERUDITE - Equipe de Recherche sur l’Utilisation des Données Individuelles en lien avec la Théorie Economique - UPEM - Université Paris-Est Marne-la-Vallée - UPEC UP12 - Université Paris-Est Créteil Val-de-Marne - Paris 12); Marion Davin (CEE-M - Centre d'Economie de l'Environnement - Montpellier - FRE2010 - INRA - Institut National de la Recherche Agronomique - UM - Université de Montpellier - CNRS - Centre National de la Recherche Scientifique - Montpellier SupAgro - Institut national d’études supérieures agronomiques de Montpellier) |
| Abstract: | In this paper, we consider the unequal distribution of climate change damages in the world and we examine how the underlying costs can spread from a vulnerable to a non-vulnerable country through international trade. To focus on such indirect effects, we treat this topic in a North-South trade overlapping generations model in which the South is vulnerable to the damages entailed by global pollution while the North is not. We show that the impact of climate change in the South can be a source of welfare loss for northern consumers, in both the short and the long run. In the long run, an increase in the South's vulnerability can reduce the welfare in the North economy even in the case in which it improves its terms of trade. In the short run, the South's vulnerability can also represent a source of intergenerational inequity in the North. Therefore, we emphasize the strong economic incentives for non-vulnerable - and a fortiori less-vulnerable - economies to reduce the climate change damages on - more - vulnerable countries. |
| Keywords: | international trade,heterogeneous damages,climate change,overlapping generations |
| Date: | 2018–12–07 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-01947416&r=all |
| By: | Chiara Punzo (Department of Economics and Finance, Università Cattolica del Sacro Cuore); Lorenza Rossi (Department of Economics and Management, University of Pavia) |
| Abstract: | This paper analyzes the redistributive channel of a money fi?nanced fiscal stimulus (MFFS). It shows that the way in which this regime is implemented is crucial to determine its redistributive effects and consequently its effectiveness. In normal times, the most effective regime is a MFFS with no additional intervention by the Central Bank to stabilize the real public debt using in?fation, whereas a MFFS accompanied by real debt stabilization - through the adjustment of seigniorage - is the most effective one in a ZLB scenario. In a TANK model this regime is so effective to avoid the recessionary effects implied by the ZLB. This result does not hold in a RANK model, where the redistributive channel is absent. Remarkably, contrary to the common wisdom a MFFS is followed by a moderate increase of infl?ation, which is only temporarily higher than the target. |
| Date: | 2019–01 |
| URL: | http://d.repec.org/n?u=RePEc:pav:demwpp:demwp0168&r=all |
| By: | Francesco Bianchi; Howard Kung; Mikhail Tirskikh |
| Abstract: | We construct and estimate a dynamic stochastic general equilibrium model that features demand- and supply-side uncertainty. Using term structure and macroeconomic data, we find sizable effects of uncertainty on risk premia and business cycle fluctuations. Both demand-side and supply-side uncertainty imply large contractions in real activity and an increase in term premia, but supply-side uncertainty has larger effects on inflation and investment. We introduce a novel analytical decomposition to illustrate how multiple distinct risk propagation channels account for these differences. Supply and demand uncertainty are strongly correlated in the beginning of our sample, but decouple in the aftermath of the Great Recession. |
| JEL: | C11 C32 E32 G12 |
| Date: | 2018–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:25386&r=all |
| By: | Marco Bassetto; Zhen Huo; José-Víctor Ríos-Rull |
| 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. |
| JEL: | C73 E61 E62 |
| Date: | 2018–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:25376&r=all |