nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2019‒02‒18
nineteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. An Operationalizing Theoretical Framework for the Analysis of Universal Health Coverage Reforms: First Test on an Archetype Developing Economy By Sameera Awawda; Mohammad Abu-Zaineh
  2. Job Heterogeneity and Aggregate Labor Market Fluctuations By Krolikowski, Pawel
  3. File-URL: Capital shares and the intergenerational consequences of international financial integration By Sara Eugeni
  4. File-URL: Internal Habit Formation and Optimality By Mauro Bambi; Fausto Gozzi
  5. VAT Treatment of the Financial Services: Implications for the Real Economy By Fatih Yilmaz; Ýsmail Baydur
  6. Identification Versus Misspecification in New Keynesian Monetary Policy Models By Adolfson, Malin; Laséen, Stefan; Lindé, Jesper; Ratto, Marco
  7. Trend Growth Shocks and Asset Prices By Nam Gang Lee
  8. Tax Evasion as Contingent Debt By Christos Kotsogiannis; Xavier Mateos-Planas
  9. Floating-rate bonds and monetary policy effectiveness: insights from a DSGE model By Paulo de Carvalho Lins; Marcio Issao Nakane
  10. An Equilibrium Model of the African HIV/AIDS Epidemic By Jeremy Greenwood; Philipp Kircher; Cezar Santos; Michèle Tertilt
  11. Inflation Targeting with Sovereign Default Risk By Cristina Arellano; Yan Bai; Gabriel Mihalache
  12. The euro-area output gap through the lens of a DSGE model By Lorenzo Burlon; Paolo D'Imperio
  13. Should Monetary Policy Lean against the Wind? An Evidence from a DSGE Model with Occasionally Binding Constraint By Jan Zacek
  14. Empowering central bank asset purchases: The role of financial policies By Darracq Pariès, Matthieu; Körner, Jenny; Papadopoulou, Niki
  15. Inequality in Parental Transfers, Borrowing Constraints, and Optimal Higher Education Subsidies By Youngmin Park
  16. FDI asymmetries in emerging economies:the case of Colombia. By José U Mora Mora; Celso J Costa Junior
  17. Role of expectations in a liquidity trap By Kohei Hasui; Yoshiyuki Nakazono; Yuki Teranishi
  18. A Consideration for the Euler Equation in Macroeconomics By Taro Ikeda
  19. The Macroeconomic Effects of Trade Tariffs: Revisiting the Lerner Symmetry Result By Lindé, Jesper; Pescatori, Andrea

  1. By: Sameera Awawda (AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - Ecole Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique); Mohammad Abu-Zaineh (AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - Ecole Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique)
    Abstract: This paper presents an operationalizing theoretical framework to analyze the potential effects of universal health coverage (UHC) using dynamic stochastic general equilibrium (DSGE) model. The DSGE encapsulates a set of heterogeneous households that optimize their intertemporal utility of consumption, health capital, and leisure. The model is calibrated to capture the salient features of an archetype developing economy. The model is, then, used to simulate alternative UHC-financing policies. The theoretical framework we propose can be easily adapted to assess the implementation of UHC in a particular developing country setting. When applied to a hypothetical country, results show that the implementation of UHC can indeed improve access to healthcare for the population while offering households financial protection against future uncertainty. However, the degree of financial risk protection appears to vary across heterogeneous households and UHC-financing policies, depending on the associated benefits and the additional burden borne by each group.
    Keywords: universal health coverage,financial risk protection,dynamic stochastic general equilibrium model,developing countries
    Date: 2019–02
  2. By: Krolikowski, Pawel (Federal Reserve Bank of Cleveland)
    Abstract: This paper disciplines a model with search over match quality using microeconomic evidence on worker mobility patterns and wage dynamics. In addition to capturing these individual data, the model provides an explanation for aggregate labor market patterns. Poor match quality among first jobs implies large fluctuations in unemployment due to a responsive job destruction margin. Endogenous job destruction generates a burst of layoffs at the onset of a recession and, together with on-the-job search, generates a negative comovement between unemployment and vacancies. A significant job ladder, consistent with the empirical wage dispersion, provides ample scope for the propagation of vacancies and unemployment.
    Keywords: Unemployment; job destruction; amplification; match-quality;
    JEL: E24 E32 J63 J64
    Date: 2019–02–01
  3. By: Sara Eugeni (Durham University Business School)
    Abstract: We revisit the welfare consequences of international financial integration (IFI) in a two-country OLG model where countries differ in the capital share of national income. We establish four main results: (i) the country with the highest capital share is the net recipient of capital flows as its output per effective units of labour is lower in autarky (i.e. developing economy), consistently with empirical evidence; (ii) on aggregate, IFI brings a 10% increase in consumption for the developing economy; (iii) IFI has uneven effects across generations: the first generation in the developing (developed) economy incurs a welfare loss (gain), while the remaining generations gain (lose) from IFI; (iv) labour (capital) should be taxed in the developing (developed) country to ensure that IFI is Pareto superior to financial autarky.
    Date: 2018–08
  4. By: Mauro Bambi (Durham University Business School); Fausto Gozzi (Luiss University)
    Abstract: Carroll et al. [7] establish that in a model with internal habits, an increase in economic growth may cause a positive change in savings. The optimality of this result has been recently questioned by several contributions in the literature which have observed that the parametrization used in [7] implies a utility function not jointly concave in consumption and habits. In this short paper, we revisit this issue: firstly we explain that it can be solved only through advanced techniques in Dynamic Programming and then we prove, using them, how the candidate optimal control found in [7] is indeed the unique optimal control
    Keywords: Endogenous Growth; Habit Formation, Sufficient Conditions of Optimality, Dynamic Programming, Viscosity Solution.
    JEL: C61 D91 E21 O40
    Date: 2019–01
  5. By: Fatih Yilmaz; Ýsmail Baydur
    Abstract: Financial institutions are exempt from the Value-Added Tax in most countries. We develop a general equilibrium model with endogenous firm entry and a banking sector to accommodate three key distortions related to exempt treatment: (i) self-supply bias in the banking sector, (ii) under-taxation of payment services, and (iii) input distortions in the business sector and tax cascading. We calibrate our model to the average of Germany, France and the U.K data. Our results show that repealing exempt treatment always increases tax revenues. However, welfare gains occur only at low VAT rates due to the hump-shaped VAT Laffer curve.
    Keywords: VAT, Financial services, Exempt treatment, Laffer curve, Heterogeneous firms
    JEL: G20 H21 H24 H25 H30
    Date: 2018
  6. By: Adolfson, Malin (Research Department, Central Bank of Sweden); Laséen, Stefan (Monetary Policy Department, Central Bank of Sweden); Lindé, Jesper (Research Department, Central Bank of Sweden); Ratto, Marco (Financial Stability Department, Central Bank of Sweden)
    Abstract: In this paper, we study identification and misspecification problems in standard closed and open-economy empirical New-Keynesian DSGE models used in monetary policy analysis. We find that problems with model misspecification still appear to be a first-order issue in monetary DSGE models, and argue that it is problems with model misspecification that may bene.t the most from moving from a classical to a Bayesian framework. We also argue that lack of identification should neither be ignored nor be assumed to affect all DSGE models. Fortunately, identification problems can be readily assessed on a case-by-case basis, by applying recently developed pre-tests of identification.
    Keywords: Bayesian estimation; Monte-Carlo methods; Maximum Likelihood Estimation; DSGE Model; Closed economy; Open economy
    JEL: C13 C51 E30
    Date: 2018–11–01
  7. By: Nam Gang Lee (Economic Research Institute, Bank of Korea)
    Abstract: This paper addresses the link between shocks to productivity trend growth and long-run consumption risk in a production economy model with recursive utility. Quantifying trend growth shocks, I find that persistent fluctuations in trend growth are the key driver of sizable long-run consumption risk. I compare this result to two conventional assumptions on a productivity process: 1) a deterministic trend with a cycle and 2) a random walk with drift. Persistent trend growth shocks generate larger long-run consumption risk than both highly persistent cycle shocks and random walk shocks. As a result, agents in the face of the trend growth shocks tend to save more and demand a higher equity premium. In addition, fluctuations in aggregate productivity growth is largely attributable to movements in trend growth.
    Keywords: Long-run consumption risk, stochastic trend growth, equity premium, production economy, exact initial Kalman filter
    JEL: E21 E23 E30 G12
    Date: 2019–01–25
  8. By: Christos Kotsogiannis (Tax Administration Research Centre (TARC); University of Exeter); Xavier Mateos-Planas (Centre for Macroeconomics (CFM); Queen Mary University of London)
    Abstract: This paper studies income-tax evasion in a quantitative incomplete-markets setting with heterogeneous agents. A central aspect is that, realistically, evaded taxes are a form of contingent debt. Since evasion becomes part of a portfolio decision, risk and credit considerations play a central part in shaping it. The model calibrated to match estimated average levels of evasion does a good job in producing observed cross-sectional average evasion rates that decline with age and with earnings. The model also delivers implications for how evasion varies in the cross sectional distribution of wealth and tax arrears. Evasion has substantial effects on macroeconomic variables and welfare, and agent heterogeneity and general equilibrium are very important elements in the explanation. The analysis also considers the response of evasion to a flat-tax policy reform. In spite of the direct incentives to evade less under a flat tax rate, the reform causes households to save more, rendering the change in overall evasion modest.
    Keywords: Tax evasion, Contingent debt, Incomplete markets with heterogeneous agents, Portfolio choice, Risk sharing, Tax progressivity
    JEL: E2 E62 H3
    Date: 2019–01
  9. By: Paulo de Carvalho Lins; Marcio Issao Nakane
    Abstract: In Brazil, there exists a government bond whose return is directly indexed to short-term interest rate set by the Central Bank. Some economists suggest that its existence decreases the effectiveness of monetary policy, mainly by clogging the wealth transmission channel. We introduce a floating-rate bond as a new financial asset in a canonical DSGE model and analyze its effects on the model dynamics. The new bond does not seem to change the dynamics of any variable, even in the presence of rule-of-thumb agents. We interpret these results as evidence against the argument that floating-rate bonds lead to a weaker monetary policy.
    Keywords: Monetary Policy; Public Debt; Fiscal Policy; Letras Financeiras do Tesouro
    JEL: E52 E63 H63
    Date: 2019–02–13
  10. By: Jeremy Greenwood; Philipp Kircher; Cezar Santos; Michèle Tertilt
    Abstract: Twelve percent of the Malawian population is HIV infected. Eighteen percent of sexual encounters are casual. A condom is used a third of the time. To analyze the Malawian epidemic, a choice-theoretic general equilibrium search model is constructed. In the developed framework, people select between different sexual practices while knowing the inherent risk. The calibrated model is used to study several policy interventions; namely, ART, circumcision, better condoms, and the treatment of other STDs. The efficacy of public policy depends upon the induced behavioral changes and equilibrium effects. The framework complements the insights from epidemiological studies and small-scale field experiments.
    Keywords: ART, circumcision, condoms, disease transmission, epidemiological studies, HIV/AIDS, knowledge about HIV, Malawi, marriage, policy intervention, search, small field experiments, STDs, sex markets
    JEL: I18 J12 O11 O55
    Date: 2018–02
  11. By: Cristina Arellano; Yan Bai; Gabriel Mihalache
    Abstract: Since the early 2000s, many emerging markets have adopted inflation targeting as their monetary policy, against a background of recurring sovereign debt crises. We develop a framework that integrates inflation targeting monetary policy with sovereign default risk and identify important interactions. Monetary policy alters incentives for international borrowing and sovereign default risk leads to more volatile nominal interest rates, needed to target inflation. We show that this framework replicates the positive co-movements of sovereign interest rate spreads with domestic nominal rates and inflation, a salient feature of emerging markets data. Our framework rationalizes the experience of Brazil during the 2015 downturn, which featured high inflation, high nominal rates, and high sovereign spreads. Our counterfactual experiment suggests that by raising the domestic rate the Brazilian central bank not only reduced inflation but also alleviated the debt crisis.
    Date: 2018
  12. By: Lorenzo Burlon (Bank of Italy); Paolo D'Imperio (Sapienza University of Rome)
    Abstract: The paper provides estimates of the euro-area output gap, based on a relatively standard medium scale DSGE model estimated recursively with Bayesian techniques over the period 1985-2016. The main findings can be summarized as follows. First, our measure of output gap identifies episodes of expansion and recession generally in line with the official business cycle dating of the CEPR. Second, unlike measures of output gap obtained by means of statistical filtering techniques, real-time DSGE-based estimates are remarkably stable and hence are less prone to ex-post revisions. According to our results, the euro-area output gap was -3.4% in 2016, more negative than assessed by most economic analysts and institutions (spanning a range between from 0 and to -2%), but arguably more consistent with the still weak dynamics of both labour costs and core inflation.
    Keywords: output gap, potential output, DSGE modelling, Bayesian estimation, euro area
    JEL: C11 E32 E37 E66
    Date: 2019–01
  13. By: Jan Zacek (Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nabrezi 6, 111 01 Prague 1, Czech Republic)
    Abstract: This research paper studies the performance of the Taylor-type rules augmented with output and asset prices, and compares their performance in a model with an eternally and occasionally binding constraint. The rules are examined under the optimisation of a central bank's loss function and a welfare maximisation of the economic agents. The analysis delivers the following results. The model with occasionally binding constraint has more favourable properties regarding the hump-shaped and asymmetric impulse responses compared to the eternally binding constraint model. The best rule regarding the lowest value of the central banks' loss function proves to be the rule augmented with asset prices. The optimal reactions are, however, shock- and model-dependent. Moreover, a chosen specification of the loss function plays a significant role. The welfare maximisation reveals that reacting to asset prices might not be welfare-improving for both types of economic agents – households and entrepreneurs. This result is, however, model-dependent.
    Keywords: asset prices, DSGE, leaning-against-the-wind, monetary policy, non-linearities, Taylor Rule
    JEL: E30 E44 E50
    Date: 2018–12
  14. By: Darracq Pariès, Matthieu; Körner, Jenny; Papadopoulou, Niki
    Abstract: This paper contributes to the debate on the macroeconomic effectiveness of expansionary non-standard monetary policy measures in a regulated banking environment. Based on an estimated DSGE model, we explore the interactions between central bank asset purchases and bank capital-based financial policies (regulatory, supervisory or macroprudential) through its influence on bank risk-shifting motives. We find that weakly-capitalised banks display excessive risk-taking which reinforces the credit easing channel of central bank asset purchases, at the cost of higher bank default probability and risks to financial stability. In such a case, adequate bank capital demand through higher minimum capital requirements curtails the excessive credit origination and restores a more efficient propagation of central bank asset purchases. As supervisors can formulate further capital demands, uncertainty about the supervisory oversight provokes precautionary motives for banks. They build-up extra capital buffer attenuating non-standard monetary policy. Finally, in a weakly-capitalised banking system, countercyclical macroprudential policy attenuates banks risk-taking and dampens the excessive persistence of the non-standard monetary policy impulse. On the contrary, in a well-capitalised banking system, macroprudential policy should look through the effects of central bank asset purchases on bank capital position, as the costs in terms of macroeconomic stabilisation seem to outweigh the marginal financial stability benefits. JEL Classification: E44, E52, F40
    Keywords: asset purchases, bank capital regulation, effective lower bound, non-standard monetary policy, regulatory uncertainty, risk-taking
    Date: 2019–02
  15. By: Youngmin Park (University of Western Ontario)
    Abstract: This paper studies optimal education subsidies when parental transfers are unequally distributed across students and cannot be publicly observed. After documenting substantial inequality in parental transfers among US college students with similar family resources, I examine its implications for how the education subsidy should vary with schooling level and family resources to minimize inefficiencies generated by borrowing constraints. Unobservable heterogeneity in parental transfers creates a force to heavily subsidize low schooling levels chosen by borrowing-constrained students with low parental transfers. This force is stronger for rich families, but it is weakened if heterogeneity in returns to schooling also leads to different schooling choices. These mechanisms are quantified using a calibrated model. Quantitative analysis suggests a reform that reallocates public spending toward the first two years of college. The reform also reduces the gap in subsidy amounts by parental income during early years of college.
    Keywords: education subsidies, higher education, public spending on college
    JEL: I24 D13 H52
    Date: 2019–02
  16. By: José U Mora Mora; Celso J Costa Junior (Faculty of Economics and Management, Pontificia Universidad Javeriana Cali)
    Abstract: We build a DSGE model to study the asymmetries of FDI shocks in an economy like Colombia. Besides nominal wage and price rigidities, we use the fact that Colombia has two productive and differentiated regions, Bogota that produces more than 25% of Colombia GDP (DANE, 2016) and the rest of the country, Ricardian and non-Ricardian agents, habit formation, capital adjustment costs, and modeled an entire foreign sector. Empirical results show that even when in the long run results are not very different in terms of real output, the short run effects are asymmetric implying that a shock to FDI in the rest of the country might cause important microeconomic adjustments that could improve the distribution of income throughout the country. The version here presented corresponds to the updated study.
    Keywords: Asymmetries, DSGE models, foreign direct investment
    JEL: F21 E17 E30
    Date: 2018–12
  17. By: Kohei Hasui; Yoshiyuki Nakazono; Yuki Teranishi
    Abstract: A number of previous studies suggest that inflation expectations are important in considering the effectiveness of monetary policy in a liquidity trap. However, the role of inflation expectations can be very different, depending on the type of monetary policy that a central bank implements. This paper reveals how a private agent forms inflation expectation affects the effectiveness of monetary policy under the optimal commitment policy, the Taylor rule, and a simple rule with price-level targeting. We examine two expectation formations: (i) different degrees of anchoring, and (ii) different degrees of forward-lookingness. We show that how to form inflation expectations is less relevant when a central bank implements the optimal commitment policy, while it is critical when the central bank adopts the Taylor rule or a simple rule with price-level targeting. Even for the Japanese economy, the effects of monetary policy on economic dynamics significantly change according to expectation formations under rules other than the optimal commitment policy.
    Keywords: Expectations, Liquidity Trap, Monetary Policy
    JEL: E31 E52 E58 E61
    Date: 2019–02
  18. By: Taro Ikeda (Graduate School of Economics, Kobe University)
    Abstract: This paper considers the problem of the Euler equation in the infinite horizon optimization problem in dynamic macroeconomics. We show that the assumption of the two-period Euler equation in the infinite horizon problem yields the Euler equation for the one-period optimization problem.
    Date: 2019–02
  19. By: Lindé, Jesper (Research Department, Central Bank of Sweden); Pescatori, Andrea (IMF)
    Abstract: We study the robustness of the Lerner symmetry result in an open economy New Keynesian model with price rigidities. While the Lerner symmetry result, i.e. the absence of allocative and trade-.ow effects of an equally-sized change in import tariff and export subsidy, holds up approximately for a number of alternative assumptions, we obtain quantitatively important long-term deviations under complete international asset markets. Direct pass-through of tariffs and subsidies to prices and slow exchange rate adjustment can also generate significant short-term deviations from Lerner. De- viations from symmetry, however, do not necessarily imply an impact on global output and are often limited to a redistribution of production and consumption across coun- tries. Finally, we quantify the macroeconomic costs of a trade war and find that they can be substantial, with permanently lower income and trade volumes. However, a fully symmetric retaliation to an unilaterally imposed border adjustment tax can prevent any sizable adverse real or nominal effects.
    Keywords: Import Tariffs; Export Subsidies; Lerner Condition; Incomplete Markets; Complete Markets; Border Adjustment Tax; Trade War; New Keynesian open-economy model
    JEL: E52 E58
    Date: 2018–12–01

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