nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2019‒02‒25
twenty-one papers chosen by

  1. The Fiscal Theory of the Price Level in Overlapping Generations Models By Farmer, Roger E A; Zabczyk, Pawel
  2. The Distributional Effects of Conventional Monetary Policy and Quantitative Easing: Evidence from an Estimated DSGE Model By Stefan Hohberger; Romanos Priftis; Lukas Vogel
  3. Policy Distortions and Aggregate Productivity with Endogenous Establishment-Level Productivity By Jose-Maria Da-Rocha; Diego Restuccia; Marina M. Tavares
  4. The Term Premium in a Small Open Economy: A Micro-Founded Approach By Alex Ilek; Irit Rozenshtrom
  5. The Origins and Effects of Macroeconomic Uncertainty By Bianchi, Francesco; Kung, Howard; Tirskikh, Mikhail
  6. Inflation in the Great Recession and New Keynesian Models: Comment By Ray C. Fair
  7. Identification Versus Misspecification in New Keynesian Monetary Policy Models By Laséen, Stefan; Lindé, Jesper; Ratto, Marco
  8. Union Debt Management By Equiza-Goni, J.; Faraglia, E.; Oikonomou, R.
  9. Capital Flows in an Aging World By Zsofia Barany; Nicolas Coeurdacier; Stéphane Guibaud
  10. Money markets, collateral and monetary policy By De Fiore, Fiorella; Hoerova, Marie; Uhlig, Harald
  11. Assessing U.S. aggregate fluctuations across time and frequencies By Lubik, Thomas A.; Matthes, Christian; Verona, Fabio
  12. Frictional Capital Reallocation I: Ex Ante Heterogeneity By Randall Wright; Sylvia Xiaolin Xiao; Yu Zhu
  13. Evaluating the macroeconomic effects of the ECB’s unconventional monetary policies By Sarah Mouabbi; Jean-Guillaume Sahuc
  14. Monetary Policy, Macroprudential Policy, and Financial Stability By Martinez-Miera, David; Repullo, Rafael
  15. Optimal Social Insurance and Rising Labor Market Risk By Krebs, Tom; Scheffel, Martin
  16. Endogenous Repo Cycles By Vyacheslav Arbuzov; Yu Awaya; Hiroki Fukai; Makoto Watanabe
  17. Corporate Debt Composition and Business Cycles By Jelena Zivanovic
  18. Quantifying Reduced-Form Evidence on Collateral Constraints By Sylvain Catherine; Thomas Chaney; Zongbo Huang; David Sraer; David Thesmar
  19. Asset dynamics, liquidity and inequality in decentralized markets By Maurizio Iacopetta; Raoul Minetti
  20. Macroprudential Policy with Capital Buffers By Josef Schroth
  21. The Dynamics of the U.S. Trade Balance and Real Exchange Rate: The J Curve and Trade Costs? By George A. Alessandria; Horag Choi

  1. By: Farmer, Roger E A; Zabczyk, Pawel
    Abstract: We demonstrate that the Fiscal Theory of the Price Level (FTPL) cannot be used to determine the price level uniquely in the overlapping generations (OLG) model. We provide two examples of OLG models, one with three 3-period lives and one with 62-period lives. Both examples are calibrated to an income profile chosen to match the life-cycle earnings process in U.S. data estimated by Guvenen et al. (2015). In both examples, there exist multiple steady-state equilibria. Our findings challenge established views about what constitutes a good combination of fiscal and monetary policies. As long as the primary deficit or the primary surplus is not too large, the fiscal authority can conduct policies that are unresponsive to endogenous changes in the level of its outstanding debt. Monetary and fiscal policy can both be active at the same time.
    Keywords: FTPL; Indeterminacy; Monetary and Fiscal Policy; monetary policy; OLG model
    JEL: E31 E52 E58 H62
    Date: 2019–01
  2. By: Stefan Hohberger; Romanos Priftis; Lukas Vogel
    Abstract: This paper compares the distributional effects of conventional monetary policy and quantitative easing (QE) within an estimated open-economy DSGE model of the euro area. The model includes two groups of households: (i) wealthier households, who own financial assets and can smooth consumption over time, and (ii) poorer households, who only receive labor and transfer income and live “hand to mouth.” We compare the impact of policy shocks on constructed measures of income and wealth inequality (net disposable income, net asset position, and relative per-capita income). Except for the short term, expansionary conventional policy and QE shocks tend to mitigate income and wealth inequality between the two population groups.
    Keywords: Economic models; Interest rates; Monetary Policy; Transmission of monetary policy
    JEL: E44 E52 E53 F41
    Date: 2019
  3. By: Jose-Maria Da-Rocha; Diego Restuccia; Marina M. Tavares
    Abstract: What accounts for differences in output per capita and total factor productivity (TFP) across countries? Empirical evidence points to resource misallocation across heterogeneous production units as an important factor. We study misallocation in a general equilibrium model of establishment productivity where the distribution of productivity is characterized in closed form and responds to the same policy distortions that create misallocation. In this framework, policy distortions not only misallocate resources across a given set of productive units (static effect), but also create disincentives for productivity improvement thereby altering the productivity distribution and equilibrium prices (dynamic effect), further lowering aggregate output and TFP. The dynamic effect is substantial contributing to a doubling of the static misallocation effect. Reducing the dispersion in distortions by 25 percentage points to the level of the U.S. benchmark economy implies an increase in relative aggregate output of 123 percent, where 54 percent arises from factor misallocation (static effect).
    Keywords: distortions, misallocation, investment, endogenous productivity, establishments.
    JEL: O11 O3 O41 O43 O5 E0 E13 C02 C61
    Date: 2019–02–07
  4. By: Alex Ilek (Bank of Israel); Irit Rozenshtrom (Bank of Israel)
    Abstract: We study the term premium on nominal and real government bonds in a small open economy within a micro-founded DSGE model with Epstein- Zin preferences. We solve the model using a third-order approximation to allow for time-varying risk premia. We thus extend previous work on closed economies to the case of a small open economy. We find that tech- nological spillovers from the global economy to the small open economy are essential for the ability of the model to produce concurrently a sub- stantial positive nominal term premium, realistic variability of the main macroeconomic variables, and high correlations between the global and domestic economies as evident in the data. We use the model to study the effect of the openness of the economy on bond risk premia. We identify two opposing effects of the openness of the economy on the nominal term premium. The better ability of the open economy to accommodate domes- tic shocks works to decrease the term premium in the open economy. By contrast, in the presence of technological spillovers from the global econ- omy to the small open economy, the foreign technological shock generates a higher term premium in the open economy compared to a closed one. Quantitatively, in our model these effects roughly offset each other so that the term premium in the open economy is similar to the premium in an otherwise similar economy that is closed to trade in goods and financial assets.
    Date: 2017–07
  5. By: Bianchi, Francesco; Kung, Howard; Tirskikh, Mikhail
    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.
    Keywords: Business Cycles; Term Structure of Interest Rates; time-varying risk premia; Uncertainty shocks
    JEL: C11 C32 E32 G12
    Date: 2019–01
  6. By: Ray C. Fair (Cowles Foundation, Yale University)
    Abstract: This comment points out mismeasurement of three of the variables in the DSGE model in Del Negro, Giannoni, and Schorfheide (2015). These errors began with the model in Smets and Wouters (2007), and they also exist in other models that use the Smets-Wouters model as a benchmark. The mismeasurement appears serious enough to call into question the reliability of empirical results using these variables.
    Keywords: DSGE models, Macro data
    JEL: E12 E32
    Date: 2019–02
  7. By: Laséen, Stefan; Lindé, Jesper; Ratto, Marco
    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 benefit 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; Closed economy; DSGE model; Maximum Likelihood Estimation; Monte-Carlo methods; Open economy
    JEL: C13 C51 E30
    Date: 2019–01
  8. By: Equiza-Goni, J.; Faraglia, E.; Oikonomou, R.
    Abstract: We study the role of government debt maturity in currency unions to identify whether debt management can help governments hedge their budgets against spending shocks. We first use a novel and detailed dataset of debt portfolios of five Euro Area countries to run a battery of VARs, estimating the responses of holding period returns to fiscal shocks. We find that government portfolios, which in our sample comprise mainly of nominal assets, have not been effective in absorbing idiosyncratic fiscal risks, whereas they have been very effective in absorbing aggregate risks. To shed light on this finding, as well as to investigate what types of debt are optimal in a currency area in the presence of both aggregate and idiosyncratic shocks, we setup a formal model of optimal debt management with two countries, benevolent governments and distortionary taxes. Our key finding is that governments should focus on issuing inflation indexed long term debt since this allows them to take full advantage of fiscal hedging. When we look at the data we find a stark increase in the issuance of real long term debt since the beginning of the Euro in many of the countries in our sample, which our model explains as an optimal response of governments to the introduction of the common currency.
    Keywords: Debt Management, Fiscal Policy, Government Debt, Maturity Structure, Tax Smoothing
    JEL: E43 E62 H63
    Date: 2019–02–11
  9. By: Zsofia Barany (Département d'économie); Nicolas Coeurdacier (Département d'économie); Stéphane Guibaud (Département d'économie)
    Abstract: We investigate the importance of worldwide demographic evolutions in shaping capital flows across countries and over time. Our lifecycle model incorporates cross-country differences in fertility and longevity as well as differences in countries’ ability to borrow inter-temporally and across generations through social security. In this environment, global aging triggers uphill capital flows from emerging to advanced economies, while country-specific demographic evolutions reallocate capital towards countries aging more slowly. Our quantitative multi-country overlapping generations model explains a large fraction of long-term capital flows across advanced and emerging countries.
    Keywords: Aging; Household Saving; International Capital Flows
    JEL: E21 F21 J11
    Date: 2018–12
  10. By: De Fiore, Fiorella; Hoerova, Marie; Uhlig, Harald
    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 Classification: G10, G20, E44, E52, E58
    Keywords: collateral, liquidity, monetary policy, money markets
    Date: 2019–02
  11. By: Lubik, Thomas A.; Matthes, Christian; Verona, Fabio
    Abstract: We study the behavior of key macroeconomic variables in the time and frequency domain. For this purpose, we decompose U.S. time series into various frequency components. This allows us to identify a set of stylized facts: GDP growth is largely a high-frequency phenomenon whereby infl ation and nominal interest rates are characterized largely by low-frequency components. In contrast, unemployment is a medium-term phenomenon. We use these decompositions jointly in a structural VAR where we identify monetary policy shocks using a sign restriction approach. We fi nd that monetary policy shocks affect these key variables in a broadly similar manner across all frequency bands. Finally, we assess the ability of standard DSGE models to replicate these fi ndings. While the models generally capture low-frequency movements via stochastic trends and business cycle fl uctuations through various frictions they fail at capturing the medium-term cycle.
    JEL: C32 C51 E32
    Date: 2019–02–20
  12. By: Randall Wright; Sylvia Xiaolin Xiao; Yu Zhu
    Abstract: This paper studies dynamic general equilibrium models where firms trade capital in frictional markets. Gains from trade arise due to ex ante heterogeneity: some firms are better at investment, so they build capital in the primary market; others acquire it in the secondary market. Cases are considered with random search and bargaining, or directed search and posting. For each, we provide results on existence, uniqueness, efficiency and comparative statics. Monetary and fiscal policy are discussed at length. We also discuss how productivity dispersion can be countercyclical while capital reallocation and its price are procyclical.
    Keywords: Monetary Policy
    JEL: E22 E44
    Date: 2019
  13. By: Sarah Mouabbi; Jean-Guillaume Sahuc
    Abstract: We quantify the macroeconomic effects of the European Central Bank’s unconventional monetary policies using a DSGE model which includes a set of shadow interest rates. Extracted from the yield curve, these shadow rates provide unconstrained measures of the overall stance of monetary policy. Counterfactual analyses show that, without unconventional measures, the euro area would have suffered (i) a substantial loss of output since the Great Recession and (ii) a period of deflation from mid-2015 to early 2017. Specifically, year-on-year inflation and GDP growth would have been on average about 0.61% and 1.09% below their actual levels over the period 2014Q1-2017Q2, respectively.
    Keywords: Unconventional monetary policy, shadow policy rate, DSGE model, euro area
    JEL: E32 E44 E52
    Date: 2019
  14. By: Martinez-Miera, David; Repullo, Rafael
    Abstract: This paper reexamines from a theoretical perspective the role of monetary and macroprudential policies in addressing the build-up of risks in the financial system. We construct a stylized general equilibrium model in which the key friction comes from a moral hazard problem in firms' financing that banks' equity capital serves to ameliorate. Tight monetary policy is introduced by open market sales of government debt, and tight macroprudential policy by an increase in capital requirements. We show that both policies are useful, but macroprudential policy is more effective in terms of financial stability and leads to higher social welfare.
    Keywords: Bank monitoring; Capital requirements; Financial Stability; intermediation margin; macroprudential policy; monetary policy
    JEL: E44 E52 G21 G28
    Date: 2019–02
  15. By: Krebs, Tom (University of Mannheim); Scheffel, Martin (University of Cologne)
    Abstract: This paper analyzes the optimal response of the social insurance system to a rise in labor market risk. To this end, we develop a tractable macroeconomic model with risk-free physical capital, risky human capital (labor market risk) and unobservable effort choice affecting the distribution of human capital shocks (moral hazard). We show that constrained optimal allocations are simple in the sense that they can be found by solving a static social planner problem. We further show that constrained optimal allocations are the equilibrium allocations of a market economy in which the government uses taxes and transfers that are linear in household wealth/income. We use the tractability result to show that an increase in labor market (human capital) risk increases social welfare if the government adjusts the tax-and-transfer system optimally. Finally, we provide a quantitative analysis of the secular rise in job displacement risk in the US and find that the welfare cost of not adjusting the social insurance system optimally can be substantial.
    Keywords: labor market risk, social insurance, moral hazard
    JEL: E21 H21 J24
    Date: 2019–01
  16. By: Vyacheslav Arbuzov; Yu Awaya; Hiroki Fukai; Makoto Watanabe
    Abstract: This paper presents a simple and tractable equilibrium model of repos, where collateralized credit emerges under limited commitment. We show that even if there is no time variation in fundamentals, repo markets can fluctuate endogenously over time. In our theory, repo market fragilities are associated with endogenous fluctuations in trade probabilities, collateral values, and debt limits. We show that the collateral premium of a durable asset will become the lowest right before a recession and the highest right after the recession, and that secured credit is acyclical.
    Keywords: collateral, search, endogenous credit market fluctuations
    JEL: E30 E50 C73
    Date: 2019
  17. By: Jelena Zivanovic
    Abstract: Based on empirical evidence, I propose a dynamic stochastic general equilibrium model with two financial sectors to analyze the role of corporate debt composition (bank versus bond financing) in the transmission of economic shocks. It is shown that in the presence of monetary and financial shocks, cyclical changes in corporate debt composition significantly attenuate the effects on investment and output. An additional result of the theoretical model is that a bank-dependent economy is more affected by financial shocks, which is in line with empirical results by Gambetti and Musso (2016), who report stronger real effects of loan supply shocks in Europe (with an excessive reliance on bank debt) than in the US.
    Keywords: Business fluctuations and cycles; Financial Institutions; Financial markets; Recent economic and financial developments
    JEL: E32 E44
    Date: 2019
  18. By: Sylvain Catherine; Thomas Chaney (Département d'économie); Zongbo Huang (Chinese University of Hong Kong (CUHK)); David Sraer (Princeton University); David Thesmar (Sloan School of Management (MIT Sloan))
    Abstract: While a mature literature shows that credit constraints causally affect firm level investment, this literature provides little guidance to quantify the economic effects implied by these findings. Our paper attempts to fill this gap in two ways. First, we use a structural model of firm dynamics with collateral constraints, and estimate the model to match the firm-level sensitivity of investment to collateral values. We estimate that firms can only pledge about 19% of their collateral value. Second, we embed this model in a general equilibrium framework and estimate that, relative to first-best, collateral constraints are responsible for 11% output losses.
    Date: 2018–05
  19. By: Maurizio Iacopetta (Observatoire français des conjonctures économiques); Raoul Minetti (Michigan State University)
    Abstract: The Kiyotakiand Wright model has exerted a considerable influence on the monetary search literature. We argue that the model also delivers important insights into abroader range of macroeconomic and development issues. The analysis studies howmarket frictions and the liquidity of assets affect the distribution of income. Experimentsillustrate how the economy adjusts to shocks to asset returns and to the matchingtechnology. They also deal with long-run transition. An experiment interprets thereversal of fortune hypothesis as a situation in which an economy with a low-returnasset takes over a similar economy with a high-return asset
    JEL: C61 C63 E41 E27
    Date: 2019–01
  20. By: Josef Schroth
    Abstract: This paper studies optimal bank capital requirements in a model of endogenous bank funding conditions. I find that requirements should be higher during good times such that a macroprudential “buffer” is provided. However, whether banks can use buffers to maintain lending during a financial crisis depends on the capital requirement during the subsequent recovery. The reason is that a high requirement during the recovery lowers bank shareholder value during the crisis and thus creates funding-market pressure to use buffers for deleveraging rather than for maintaining lending. Therefore, buffers are useful if banks are not required to rebuild them quickly.
    Keywords: Credit and credit aggregates; Financial stability; Financial system regulation and policies; Business fluctuations and cycles; Credit risk management; Lender of last resort
    JEL: E13 E32 E44
    Date: 2019
  21. By: George A. Alessandria; Horag Choi
    Abstract: We study how changes in trade barriers contributed to the dynamics of the US trade balance and real exchange rate since 1980 - a period when trade tripled. Using two dynamic trade models, we decompose fluctuations in the trade balance into terms related to trade integration (global and unilateral) and business cycle asymmetries. We find three main results. First, the relatively large US trade deficits as a share of GDP in the 2000s compared to the 1980s mostly reflect a rise in the trade share of GDP. Second, controlling for trade, only about 60 percent of net trade flows are due to business cycle asymmetries. And third, about two-thirds of the contribution of business-cycle asymmetries are a lagged response. For instance, the short-run Armington elasticity is about 0.2 while the long-run is closer to 1.12 with only 6.9 percent of the gap closed per quarter. We show that a two-country IRBC model with a dynamic exporting decision, pricing-to-market, and trade cost shocks can account for the dynamics of the US trade balance, real exchange rate, and trade integration. The model clarifies how permanent and transitory changes in trade barriers affect the trade balance and how to identify changes in trade barriers. We also show the effect of temporary trade policies on the trade balance depends on whether they induce a trade war.
    JEL: E32 F4
    Date: 2019–02

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