nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2019‒03‒04
twenty-two papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Don’t Tax Capital — Optimal Ramsey Taxation in Heterogeneous Agent Economies with Quasi-Linear Preferences By Chien, YiLi; Wen, Yi
  2. Slow Recoveries and Unemployment Traps: Monetary Policy in a Time of Hysteresis By Acharya, Sushant; Bengui, Julien; Dogra, Keshav; Wee, Shu Lin
  3. The Natural Rate of Interest in a Nonlinear DSGE Model By Yasuo Hirose; Takeki Sunakawa
  4. Macroprudential Interventions in Liquidity Traps By William John Tayler; Roy Zilberman
  5. Labor Market Frictions and Moving Costs of the Employed and Unemployed By Ransom, Tyler
  6. A Dynamic Model of Intermediated Consumer Credit and Liquidity By Gomis-Porqueras, Pedro; Sanches, Daniel R.
  7. Temperature Volatility Risk By Michael Donadelli; Marcus Jüppner; Antonio Paradiso; Christian Schlag
  8. Organizational Equilibrium with Capital By Bassetto, Marco; Huo, Zhen; Ríos-Rull, José-Víctor
  9. Monetary policy implications of state-dependent prices and wages By Costain, James; Nakov, Anton; Petit, Borja
  10. Higher Education Subsidy Policy and R&D-based Growth By Takaaki Morimoto; Ken Tabata
  11. Buy to let. Investment buyers in a housing search model By Erlend Eide Bø
  12. Optimal Social Insurance and Rising Labor Market Risk By Tom Krebs; Martin Scheffel
  13. The Declining Labor Market Prospects of Less-Educated Men By Ariel J. Binder; John Bound
  14. Optimal Capital Taxation in an Economy with Innovation-Driven Growth By Chen, Ping-ho; Chu, Angus C.; Chu, Hsun; Lai, Ching-Chong
  15. The Societal Benefits of Money and Interest Bearing Debt By Luis Araujo; Leo Ferraris
  16. Rational inattention in hiring decisions By Acharya, Sushant; Wee, Shu Lin
  17. An Inquiry into the Same Movement Pattern in Two Cases of Labor Supply By Fujio Takata
  18. Price Manipulation, Dynamic Informed Trading and Tame Equilibria: Theory and Computation By Shino Takayama
  19. Preference Heterogeneity, Inflation, and Welfare By Michael Patrick Curran; Scott J. Dressler
  20. Monetary Policy with Non-Separable Government Spending By Troug, Haytem
  21. Labor Market Dynamics in Urban China and the Role of the State Sector By Shuaizhang Feng; Naijia Guo
  22. The Effectiveness of Hiring Credits By Pierre Cahuc; Stéphane Carcillo; Thomas Le Barbanchon

  1. By: Chien, YiLi (Federal Reserve Bank of St. Louis); Wen, Yi (Federal Reserve Bank of St. Louis)
    Abstract: We build a tractable infinite-horizon Aiyagari-type model with quasi-linear preferences to address a set of long-standing issues in the optimal Ramsey taxation literature. The tractability of our model enables us to analytically prove the existence of Ramsey steady states and establish several strong and novel results: (i) Depending on the government’s capacity to issue debts, there can exist different types of Ramsey steady state and their existence depends critically on model parameter values. (ii) The optimal capital tax is exclusively zero in a Ramsey steady state regardless of the modified golden rule and government debt limits. (iii) Along the transition path toward a Ramsey steady state, optimal capital tax depends positively on the elasticity of intertemporal substitution. (iv) When a Ramsey steady state (featuring a non-binding government debt limit) does not exist but is erroneously assumed to exist, the modified golden rule always “holds” and the implied “optimal” long-run capital tax is strictly positive, reminiscent of the result obtained by Aiyagari (1995). (v) Whether the modified golden rule holds depends critically on the government’s capacity to issue debts, but has no bearing on the planner’s long-run capital tax scheme. (vi) The optimal debt-to-GDP ratio in the absence of a binding debt limit, however, is determined by a positive wedge times the modified-golden-rule saving rate; the wedge is decreasing in the strength of the individual self-insurance position and approaches zero when the idiosyncratic risk vanishes or markets are complete. The key insight behind our results is the Ramsey planner’s ultimate concern for self-insurance. Since taxing capital in the steady state permanently hinders individuals’ self-insurance positions, the Ramsey planner prefers (i) issuing debt rather than imposing a steady-state capital tax to correct the capital-overaccumulation problem under precautionary saving motives, and (ii) taxing capital only in the short run regardless of its debt positions. Thus, in sharp contrast to Aiyagari’s argument, permanent capital taxation is not the optimal tool to achieve aggregate allocative efficiency despite overaccumulation of capital, and the modified golden rule can fail to hold in a Ramsey equilibrium whenever the government encounters a debt-limit.
    Keywords: Optimal Capital Taxation; Ramsey Problem; Incomplete Markets
    JEL: E13 E62 H21 H30
    Date: 2019–02–22
  2. By: Acharya, Sushant; Bengui, Julien; Dogra, Keshav; Wee, Shu Lin
    Abstract: We analyze monetary policy in a model where temporary shocks can permanently scar the economy's productive capacity. Unemployed workers' skill losses generate multiple steady-state unemployment rates. When monetary policy is constrained by the zero bound, large shocks reduce hiring to a point where the economy recovers slowly at best â?? at worst, it falls into a permanent unemployment trap. Since monetary policy is powerless to escape such traps ex-post, it must avoid them ex-ante. The model quantitatively accounts for the slow U.S. recovery following the Great Recession, and suggests that lack of swift monetary accommodation helps explain the European periphery's stagnation.
    Keywords: hysteresis; monetary policy; multiple steady states; path dependence; skill depreciation
    JEL: E24 E3 E5 J23 J64
    Date: 2018–12
  3. By: Yasuo Hirose; Takeki Sunakawa
    Abstract: This paper investigates how and to what extent nonlinearities, including the zero lower bound on the nominal interest rate, affect the estimate of the natural rate of interest in a dynamic stochastic general equilibrium model with sticky prices and wages. The estimated natural rate of interest in a nonlinear model is substantially different from that in its linear counterpart because of a contractionary effect of the zero lower bound. Price and wage dispersion, from which a linear model abstracts, play a minor role in identifying the natural rate.
    Date: 2019–02
  4. By: William John Tayler; Roy Zilberman
    Abstract: We characterize the joint optimal implementation of macroprudential and monetary policies in a New Keynesian model where endogenous supply-side financial frictions generate inflationary credit spreads. State-contingent macroprudential interventions help to stabilize volatile spreads, and substantially alter the transmission of optimal monetary policy under both discretion and commitment. In 'normal times', macroprudential policies replicate the first-best allocation. In liquidity traps, financial interventions remove the zero lower bound restriction on the nominal policy rate, thus minimizing output costs following both deflationary (inflationary) demand (financial) shocks. Discretionary and commitment policies with macroprudential taxes deliver equivalent welfare gains.
    Keywords: financial taxation, monetary policy, optimal policy, credit cost channel, credit spreads, zero lower bound
    JEL: E32 E44 E52 E58 E63
    Date: 2019
  5. By: Ransom, Tyler (University of Oklahoma)
    Abstract: This paper examines the role of labor market frictions and moving costs in explaining the migration behavior of US workers by employment status. Using data on low-skilled workers from the Survey of Income and Program Participation (SIPP), I estimate a dynamic model of individual labor supply and migration decisions. The model incorporates a reduced-form search model and allows for migration for non-market reasons. My estimates show that moving costs are substantial and that labor market frictions primarily inhibit migration of the employed. I use the model to study migration responses to local labor market shocks and to a moving subsidy. Workers' preferences for non-market amenities, coupled with substantial moving costs and employment frictions, grant market power to incumbent employers. Large moving costs also likely affect employers' recruiting behavior.
    Keywords: migration, job search, dynamic discrete choice
    JEL: C35 E32 J22 J61 J64 R23
    Date: 2019–02
  6. By: Gomis-Porqueras, Pedro (Deakin University); Sanches, Daniel R. (Federal Reserve Bank of Philadelphia)
    Abstract: We construct a model of consumer credit with payment frictions, such as spatial separation and unsynchronized trading patterns, to study optimal monetary policy across different interbank market structures. In our framework, intermediaries play an essential role in the functioning of the payment system, and monetary policy influences the equilibrium allocation through the interest rate on reserves. If interbank credit markets are incomplete, then monetary policy plays a crucial role in the smooth operation of the payment system. Specifically, an equilibrium in which privately issued debt claims are not discounted is shown to exist provided the initial wealth in the intermediary sector is sufficiently large relative to the size of the retail sector. Such an equilibrium with an efficient payment system requires setting the interest rate on reserves sufficiently close to the rate of time preference.
    Keywords: Intermediation; liquidity; payments system; rediscounting
    JEL: E42 E58 G21
    Date: 2019–02–20
  7. By: Michael Donadelli (Department of Economics, University Of Venice Cà Foscari); Marcus Jüppner (Deutsche Bundesbank; Faculty of Economics and Business Administration, Goethe University Frankfurt); Antonio Paradiso (Department of Economics, University Of Venice Cà Foscari); Christian Schlag (Faculty of Economics and Business Administration and Research Center SAFE, Goethe University Frankfurt)
    Abstract: We produce novel empirical evidence on the relevance of temperature volatility shocks for the dynamics of macro aggregates and asset prices. Using two centuries of UK temperature data, we document that the relationship between temperature volatility and the macroeconomy varies over time. First, the sign of the causality from temperature volatility to TFP growth is negative in the post-war period (i.e., 1950-2015) and positive before (i.e., 1800-1950). Second, over the pre-1950 (post-1950) period temperature volatility shocks positively (negatively) affect TFP growth. In the post-1950 period, temperature volatility shocks are also found to undermine equity valuations and other main macro aggregates. More importantly, temperature volatility shocks are priced in the cross section of returns and command a positive premium. We rationalize these findings within a production economy featuring long-run productivity and temperature volatility risk. In the model temperature volatility shocks generate non-negligible welfare costs. Such costs decrease (increase) when associated with immediate technology adaptation (capital depreciation).
    Keywords: Temperature volatility, TFP, asset prices, and welfare costs
    JEL: E30 G12 Q0
    Date: 2019
  8. By: Bassetto, Marco; Huo, Zhen; Ríos-Rull, José-Víctor
    Abstract: This paper proposes a new equilibrium concept - organizational equilibrium - for models with state variables that have a time-inconsistency problem. The key elements of this equilibrium concept are: (1) agents are allowed to ignore the history and restart the equilibrium; (2) agents can wait for future agents to start the equilibrium. We apply this equilibrium concept to a quasi-geometric discounting growth model and to a problem of optimal dynamic fiscal policy. We find that the allocation gradually transits from that implied by its Markov perfect equilibrium towards that implied by the solution under commitment, but stopping short of the Ramsey outcome. The feature that the time inconsistency problem is resolved slowly over time rationalizes the notion that good will is valuable but has to be built gradually.
    Keywords: Capital-Income Taxation; Quasi-Geometric Discounting; Renegotiation; reputation; Time Inconsistency
    JEL: C73 E61 E62
    Date: 2018–12
  9. By: Costain, James; Nakov, Anton; Petit, Borja
    Abstract: This paper studies the dynamic general equilibrium effects of monetary shocks in a "control cost" model of state-dependent retail price adjustment and state-dependent wage adjustment. Suppliers of retail goods and of labor are both monopolistic competitors that face idiosyncratic productivity shocks and nominal rigidities. Stickiness arises because precise choice is costly: decision-makers tolerate errors both in the timing of adjustments, and in the new level at which the price or wage is set, because making these choices with perfect precision would be excessively costly. The model is calibrated to microdata on the size and frequency of price and wage changes. We find that the impact multiplier of a money growth shock on consumption and labor in our calibrated state-dependent model is similar to that in a Calvo model with the same adjustment frequencies, though the response is less persistent than it would be under the Calvo mechanism. Wage rigidity accounts for most of the nonneutrality that occurs in a model where both prices and wages are sticky; hence, a model with both rigidities produces substantially larger real effects of monetary shocks than does a model with sticky prices only. We find that the state-dependence of nominal rigidity strongly decreases the slope of the Phillips curve as trend inflation declines. This result is not driven by downward wage rigidity; adjustment costs are symmetric in our model. Here, instead, price- and wage-setters prefer to adjust less frequently when trend inflation is low, making short-run inflation less reactive to shocks.
    Keywords: control costs; logit equilibrium; near rationality; state-dependent adjustment; sticky prices; sticky wages
    JEL: C73 D81 E31
    Date: 2018–12
  10. By: Takaaki Morimoto (Graduate School of Economics, Osaka University,Institute of Social and Economic Research, Osaka University, Japan); Ken Tabata (School of Economics, Kwansei Gakuin University)
    Abstract: We examine how a subsidy policy for encouraging more individuals to pursue higher education affects economic growth in an overlapping generations model of R&D-based growth, including both product development and process innovation. We show that such a policy may have a negative effect on the long-run economic growth rate. When the market structure adjusts partially in the short run, the effect of an education subsidy on economic growth is ambiguous and depends on the values of the parameters. However, when the market structure adjusts fully in the long run, the education subsidy expands the number of firms but reduces economic growth. These unfavorable predictions of an education subsidy on economic growth are partly consistent with the empirical findings that mass higher education does not necessarily lead to higher economic growth.
    Keywords: Higher Education, Occupational Choice, R&D, Product Development, Process Innovation
    Date: 2018–02
  11. By: Erlend Eide Bø (Statistics Norway)
    Abstract: In this paper, I explore and explain how buy-to-let investors affect housing price dynamics. The impact of buy-to-let investors on the housing market is much discussed by policy makers, but previously not considered in the literature. I develop a structural search model that allows housing owners to buy second houses to let out, and let rents be determined endogenously. To motivate the model, I present empirical evidence from the city of Oslo showing that a significant share of buyers are buy-to-let investors, and both rents and the share of second house buyers are positively correlated with housing prices. The model introduces two mechanisms that affect volatility compared to a model with no landlords and constant rents. First, the endogenous correlation of rents and housing prices makes it attractive for non-owners to buy in “hot” markets, to avoid paying high rents. Second, the increased incentives to become landlords in high rent periods further increase the number of buyers and amplify the effect of high rents on housing prices and transaction volumes. The model is calibrated using data from Oslo, and is able to match quantitatively the high investor share and housing price volatility of a housing boom.
    Keywords: Housing; Search; Rental market
    JEL: D83 R21 R31
    Date: 2019–02
  12. By: Tom Krebs (Universitat Mannheim); Martin Scheffel (Karlsruhe Institute of Technology)
    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: 2019–02
  13. By: Ariel J. Binder; John Bound
    Abstract: Over the last half century, U.S. wage growth stagnated, wage inequality rose, and the labor-force participation rate of prime-age men steadily declined. In this article, we examine these labor market trends, focusing on outcomes for males without a college education. Though wages and participation have fallen in tandem for this population, we argue that the canonical neo-classical framework, which postulates a labor demand curve shifting inward across a stable labor supply curve, does not reasonably explain the data. Alternatives we discuss include adjustment frictions associated with labor demand shocks and effects of the changing marriage market—that is, the fact that fewer less-educated men are forming their own stable families—on male labor supply incentives. Our observations lead us to be skeptical of attempts to attribute the secular decline in male labor-force participation to a series of separately-acting causal factors. We argue that the correct interpretation probably involves complicated feedback between falling labor demand and other factors which have disproportionately affected men without a college education.
    JEL: E24 J12 J21 J22 J23 J31
    Date: 2019–02
  14. By: Chen, Ping-ho; Chu, Angus C.; Chu, Hsun; Lai, Ching-Chong
    Abstract: This paper examines whether the Chamley-Judd result of a zero optimal capital tax rate is valid in an innovation-driven growth model. We examine how the optimal capital tax rate varies with externalities associated with R&D and innovation. Our results show that the optimal capital tax rate is higher when (i) the "stepping on toes effect" is smaller, (ii) the "standing on shoulders effect" is stronger, or (iii) the extent of creative destruction is greater. By calibrating our model to the US economy, we find that the optimal capital tax rate is positive, at a rate of around 11.9 percent. We also find that a positive optimal capital tax rate is more likely to be the case when there is underinvestment in R&D.
    Keywords: Optimal capital taxation; R&D externalities; innovation
    JEL: E62 O31 O41
    Date: 2019–02
  15. By: Luis Araujo (Michigan State University and Sao Paulo School of Economics-FGV); Leo Ferraris (DEF & CEIS,University of Rome "Tor Vergata")
    Abstract: A long standing issue in monetary theory is whether money and interest bearing debt may both play a beneficial role in facilitating transactions. This paper identifies in the misallocation of liquidity a key element to provide an answer. In a search model of money, we show that there exists an equilibrium which resembles a liquidity trap, in which debt and money are used interchangeably to trade goods and debt carries no interest, and a Pareto superior equilibrium in which money is used to trade goods and interest bearing debt to reshuffle misallocated liquidity. Monetary policy has no effect in the liquidity trap, and a liquidity e¤ect in the Pareto superior equilibrium.
    Keywords: Money,Debt,Bonds,Monetary Policy
    JEL: E40
    Date: 2019–02–19
  16. By: Acharya, Sushant (Federal Reserve Bank of New York); Wee, Shu Lin (Carnegie Mellon University)
    Abstract: We provide an information-based theory of matching efficiency fluctuations. Rationally inattentive firms have limited capacity to process information and cannot perfectly identify suitable applicants. During recessions, higher losses from hiring unsuitable workers cause firms to be more selective in hiring. When firms cannot obtain sufficient information about applicants, they err on the side of caution and accept fewer applicants to minimize losses from hiring unsuitable workers. Pro-cyclical acceptance rates drive a wedge between meeting and hiring rates, explaining fluctuations in matching efficiency. Quantitatively, our model replicates the joint behavior of unemployment rates and matching efficiency observed since the Great Recession.
    Keywords: rational inattention; hiring behavior; matching efficiency; composition of unemployed
    JEL: D8 E32 J63 J64
    Date: 2019–02–01
  17. By: Fujio Takata (Graduate School of Economics, Kobe University)
    Abstract: Let us consider movement patterns in an economy based on a Ramsey type model, as do many papers in the R.B.C. school. We focus on how labor supply is determined and on how this determination affects the movement patterns. We discuss two kinds of labor supply, namely, an intensive arrangement and an extensive one. We conclude that the labor supply in both arrangements is similar from the viewpoint of a macro economy. This leads us to conjecture that the two forms of labor supply do not affect the movement pattern.
    Keywords: Divisible labor; Indivisible labor; Movement patterns
    JEL: E20 E24 E32
    Date: 2019–02
  18. By: Shino Takayama (School of Economics, The University of Queensland)
    Abstract: This paper studies the manipulation of prices by using a dynamic version of the Glosten and Milgrom (1985) model with a long-lived informed trader. We make a fundamental contribution by clarifying the conditions under which a unique equilibrium exists, and in what situations this equilibrium involves manipulation of prices by the informed trader. Furthermore, within the unique equilibrium, we characterize bid–ask spreads and show that bid and ask prices are monotonically increasing in the market maker’s prior belief. Finally, we propose a computational method to find equilibria in the model. Our simulation results confirm our theoretical findings and find multiple equilibria in some cases.
    Keywords: Market microstructure; Glosten–Milgrom; Insider trading; Dynamic trading; Price formation; Sequential trade; Asymmetric information; Bid–ask spreads.
    JEL: D82 G12
    Date: 2018–10–02
  19. By: Michael Patrick Curran (Department of Economics, Villanova School of Business, Villanova University); Scott J. Dressler (Department of Economics, Villanova School of Business, Villanova University)
    Abstract: This paper assesses the welfare implications of long-run inflation in an environment with essential money, a competing illiquid asset, and potential ex-ante heterogeneity of households with respect to their behavioral measures of risk aversion and elasticity of intertemporal substitution. The results show that the relative liquidity position of households’ portfolio as well as potential inter-cohort transfers of resources can deliver fewer welfare costs to inflation than has been previously reported, and in some instances net welfare benefits to low levels of positive inflation. These results hold in versions of the model calibrated to both US and euro area data.
    Keywords: Inflation; Welfare; Recursive Preferences
    JEL: E21 E41 E50
    Date: 2019–02
  20. By: Troug, Haytem
    Abstract: The significant role of government consumption in affecting economic conditions raises the necessity for monetary policy to take into account the behaviour of fiscal policy and to also take into account how the presence of the fiscal sector might affect the transmission mechanism of monetary policy in the economy. To test for this, we build an otherwise standard New Keynesian model that incorporates non-separable government consumption. The simulations of the model show that when government consumption has a crowding in effect on private consumption, it will dampen the transmission mechanism of monetary policy, and vice versa. The empirical estimations of the paper also support the theoretical findings of the model, as the panel regression show that, in OECD countries, government consumption dampens the effect of the policy rate on private consumption. These results are robust to the zero lower bound era.
    Keywords: New Keynesian Models, Business Cycle, Monetary Policy, Joint Analysis of Fiscal and Monetary Policy.
    JEL: E12 E32 E52 E63
    Date: 2019–02–22
  21. By: Shuaizhang Feng (Jinan University); Naijia Guo (The Chinese University of Hong Kong)
    Abstract: This paper studies the effect of state-owned enterprises on the dynamics of the Chinese urban labor market. Using longitudinal monthly panel data, we document very low dynamics in the labor market, especially in the state sector. We develop and calibrate an equilibrium search and matching model with three differences between the state and the non-state sector: labor productivity, labor adjustment cost, and workers’ bargaining power. Counterfactual analysis shows that the lack of dynamics is mainly driven by the strong bargaining power of state-sector workers. Eliminating the differences between the two sectors substantially reduces the unemployment rate and long-term unemployment rate.
    Keywords: state sector, labor market dynamics, search and matching, China, long-term unemployment
    JEL: J64 J45 P23
    Date: 2019–02
  22. By: Pierre Cahuc (École polytechnique (X)); Stéphane Carcillo (Département d'économie); Thomas Le Barbanchon (Centre de Recherche en Économie et Statistique (GENES))
    Abstract: This paper analyzes the effectiveness of hiring credits. Using comprehensive administrative data, we show that the French hiring credit, implemented during the Great Recession, had significant positive employment effects and no effects on wages. Relying on the quasi-experimental variation in labor cost triggered by the hiring credit, we estimate a structural search and matching model. Simulations of counterfactual policies show that the effectiveness of the hiring credit relied to a large extent on three features: it was nonanticipated, temporary and targeted at jobs with rigid wages. We estimate that the cost per job created by permanent hiring credits, either countercyclical or time-invariant, in an environment with flexible wages would have been much higher.
    Keywords: Hiring credit; Labor demand; Search and matching model
    JEL: C31 C93 J6
    Date: 2017–12

This nep-dge issue is ©2019 by Christian Zimmermann. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.