nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2019‒04‒08
23 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. FIR-GEM: A SOE-DSGE Model for fiscal policy analysis in Ireland By VARTHALITIS, PETROS
  2. Monetary policy in a Model with Commodity and Financial Markets By Vo Phuong Mai Le; Ruthira Naraidoo
  3. Limited Participation, Capital Accumulation and Optimal Monetary Policy By Xavier Ragot
  4. Optimal Fiscal Policy with Heterogeneous Agents and Aggregate Shocks By François Le Grand; Xavier Ragot
  5. On the Macroeconomic and Fiscal Effects of the Tax Cuts and Jobs Act By Lieberknecht, Philipp; Wieland, Volker
  6. Macroprudential Policies in the EAGLE FLI Model Calibrated for Hungary By Gábor Fukker; Lóránt Kaszab
  7. Sovereign Default and Liquidity: the Case for a World Safe Asset By François Le Grand; Xavier Ragot
  8. The Demographic Transition in a Unified Growth Modelof the English Economy By Foreman-Peck, James; Zhou, Peng
  9. Immigration, Social Networks and Occupational Mismatch By Alaverdyan, Sevak; Zaharieva, Anna
  10. Marriage market dynamics, gender, and the age gap By Andrew Shephard
  11. Policy Trade-Offs in Building Resilience to Natural Disasters: The Case of St. Lucia By Alessandro Cantelmo; Leo Bonato; Giovanni Melina; Gonzalo Salinas
  12. Labor Market Power By David W. Berger; Kyle F. Herkenhoff; Simon Mongey
  13. Sovereigns and Financial Intermediaries Spillovers By Hamid R Tabarraei; Abdelaziz Rouabah; Olivier Pierrard
  14. Can a small New Keynesian model of the world economy with risk-pooling match the facts? By Minford, Patrick; Ou, Zhirong; Zhu, Zheyi
  15. Bad Jobs and Low Inflation By Faccini, Renato; Melosi, Leonardo
  16. Real interest policy and the housing cycle By Benjamin Eden
  17. Capital Income Taxation and Aggregate Instability By Kevin x.d. Huang; Qinglai Meng; Jianpo Xue
  18. Two-Sided Market, R&D and Payments System Evolution By Bin Grace Li; James McAndrews; Zhu Wang
  19. Robust Monetary Policy Under Uncertainty About the Lower Bound By Peter Tillmann
  20. Life-Cycle Portfolios, Unemployment and Human Capital Loss By Fabio C. Bagliano; Carolina Fugazza; Giovanna Nicodano
  21. Inequality, Business Cycles, and Monetary-Fiscal Policy By Anmol Bhandari; David Evans; Mikhail Golosov; Thomas J. Sargent
  22. News shocks and consumer expectations: evidence for Brazil By Thales A. J. T. T. Maion; Marcio Issao Nakane
  23. Turbulence and Unemployment in Matching Models By Isaac Baley; Lars Ljungqvist; Thomas J. Sargent

    Abstract: This paper presents FIR-GEM: Fiscal IRish General Equilibrium Model. FIR-GEM is a small open economy DSGE model designed as fiscal toolkit for fiscal policy analysis in Ireland. To illustrate the model's potential for fiscal policy analysis, we conduct three types of experiments. First, we analyse the fiscal transmission mechanism through which Irish fiscal policy affects the Irish economy. Second, we compute fiscal multipliers for the main tax-spending instruments, namely government consumption, public investment, public wage bill, public transfers, consumption, labour and capital tax. We focus on a fiscal policy stimulus that is either implemented through spending increases or tax cuts. Third, we perform robustness analysis on key structural characteristics that can affect quantitatively the size of fiscal multipliers. We find that the size of fiscal multipliers in the Irish economy heavily depends on its degree of openness, the method of fiscal financing employed, the elasticity of the sovereign risk premia to Irish debt dynamics and the flexibility of Irish labour and product markets.
    Keywords: Keywords: Fiscal policy, DSGE, Ireland, Openness.
    JEL: E62 F41 F42
    Date: 2019–04
  2. By: Vo Phuong Mai Le (Cardiff Business School, Aberconway Building, Cardiff University, Colum Drive, Cardiff, Wales, United Kingdom, CF 10 3EU); Ruthira Naraidoo (Department of Economics, University of Pretoria, Pretoria, South Africa)
    Abstract: This paper builds a small open economy model for a net commodity exporter to consider financial frictions and monetary policies in order to investigate the main determinants of business cycles. Since we make a distinction to the access of financial markets between the commodity and non-commodity sectors, we notice that as usual, a commodity price shock benefits the competitiveness of the economy and its borrowing terms. We outline a novel effect in this paper which we dub the “financial market effect” following a positive commodity price shock that decreases the credit premium and hence exacerbate the commodity price boom. However, the negative sectoral downturn affects entrepreneur credit together with disinflationary pressures of a real exchange rate appreciation. This opens the role for stabilization policies which we analyze comparing three types of monetary regimes. Estimating the model on South Africa, a major commodity exporting economy with inflation targeting regime, we find as conventional wisdom suggests that a hypothetical Taylor rule targeting the price-level allows for adjustment in inflation expectations that can dampen disinflationary pressures. Furthermore, due to smoother change in nominal rate of interest, there is lesser variability in financial markets.
    Keywords: Business cycles, Small open economy, Commodity prices, Financial frictions, Emerging markets, Monetary policy, Price-level targeting, South Africa economy
    JEL: E32 E44 E58 F41 F44 O16
    Date: 2019–03
  3. By: Xavier Ragot (Département d'économie)
    Abstract: Motivated by recent empirical findings on money demand, the paper presents a general equilibrium model where agents have limited participation in financial markets and use money to smooth consumption. In such setup, investment is not optimal because only a fraction of households participate in financial markets in each period. Optimal monetary policy substantially increases welfare by changing investment decisions over the business cycle, but adverse redistributive effects limit the scope for an active monetary policy. Recent developments in the heterogeneous-agents literature are used to develop a tractable framework with aggregate shocks, where optimal monetary policy can be analyzed.
    Keywords: Limited participation; Incomplete markets; Optimal policy
    JEL: E41 E52 E32
    Date: 2018
  4. By: François Le Grand (EMLYON Business School); Xavier Ragot (Département d'économie)
    Abstract: We provide a theory of truncation for incomplete insurance-market economies with aggregate shocks, which is shown to be a consistent representation of standard incomplete-market economies. This representation allows deriving optimal policies with capital and aggregate shock. We apply this framework to an economy where the government can use capital and labor taxes, positive transfers and public debt to smooth aggregate shocks. The average capital tax is shown to be positive if and only if credit constraints are binding for some households. In a quantitative exercise, the capital tax appears to be more volatile than the labor tax and public debt is countercyclical and mean-reverting.
    Keywords: Incomplete markets; Optimal policy; Public debt
    JEL: E21 E44 D91 D31
    Date: 2017–07
  5. By: Lieberknecht, Philipp; Wieland, Volker
    Abstract: There is substantial disagreement about the consequences of the Tax Cuts and Jobs Act (TCJA) of 2017, which constitutes the most extensive tax reform in the United States in more than 30 years. Using a large-scale two-country dynamic general equilibrium model with nominal rigidities, we find that the TCJA increases GDP by about 2% in the medium-run and by about 2.5% in the long-run. The short-run impact depends crucially on the degree and costs of variable capital utilization, with GDP effects ranging from 1 to 3%. At the same time, the TCJA does not pay for itself. In our analysis, the reform decreases tax revenues and raises the debt-to-GDP ratio by about 15 percentage points in the medium-run until 2025. We show that combining the TCJA with spending cuts can dampen the increase in government indebtedness without reducing its expansionary effect.
    Keywords: fiscal policy transmission; macroconomic modeling; Tax Cuts; tax reform; TJCA
    JEL: E1 E62 E63
    Date: 2019–03
  6. By: Gábor Fukker (Magyar Nemzeti Bank (Central Bank of Hungary)); Lóránt Kaszab (Magyar Nemzeti Bank (Central Bank of Hungary))
    Abstract: In this paper we develop the Hungarian version of the EAGLE FLI (Euro Area GLobal Economy model with Financial LInkages) model which is the EAGLE model enriched with financial frictions and country-specific banking sector. The EAGLE FLI features the intermediation of loanable funds (ILF) view in banking whereby the creation of new loans requires banks to collect additional deposits. Households and firms borrow in the model using housing as collateral. We find that macroprudential policies such as an increase in capital requirements, decreases in the loan-to-value ratio or loan-to-income ratio of borrower households (and firms) limits banks’ credit creation with negative spillover effects to the real economy due to the financial accelerator mechanism in the model. On the other hand, these policies strengthen banks’ capital and limit the vulnerability of households and firms to negative financial shocks.
    Keywords: macroprudential policy, multi-country DSGE, capital requirements, loan-to-value ratio, loan-to-income ratio
    JEL: E12 E13 E52 E58 F11 F41
    Date: 2019
  7. By: François Le Grand (EMLYON Business School); Xavier Ragot (Département d'économie)
    Abstract: We present a general equilibrium model of the world economy where sovereigns face idiosyncratic risks and can default on their debt. In this model, the world interest rate is determined through the global financial market equilibrium, the amount of safe asset is endogenous and determines international risk sharing. Non-trivial multiple equilibria naturally arise, due to the endogeneity of the interest rate. These equilibria can be ranked according to their aggregate welfare, such that equilibria with a higher quantity of safe assets correspond to higher welfare. Due to a shortage in the safe asset supply, even the equilibrium with the highest welfare is not constrained-efficient. Finally, we prove that a world fund issuing a safe asset can reach the constrained-efficient aggregate welfare. With a standard calibration, the size of the fund is found to be around 4.1% of the world GDP. Its relationship with the Special Drawing Rights of the IMF is discussed.
    Date: 2017–10
  8. By: Foreman-Peck, James (Cardiff Business School); Zhou, Peng (Cardiff Business School)
    Abstract: A dynamic stochastic unified growth model is estimated from English economy data for almost a millennium. At the core of the (seven) overlapping generations, rational expectations structure is household choice about target number and quality of children. The trends of births, deaths, population and, the real wage, are closely matched by the estimated model. In the 19th century English fertility transition, the model shows how the generalized child price relative to the child quality price rose. The rising opportunity cost of education was as decisive for the transition as the parental shift to child quality.
    Keywords: Economic Development, Demography, Unified Growth, Overlapping Generations, English Economy
    JEL: O11 J11 N13
    Date: 2019–03
  9. By: Alaverdyan, Sevak (Center for Mathematical Economics, Bielefeld University); Zaharieva, Anna (Center for Mathematical Economics, Bielefeld University)
    Abstract: In this study we investigate the link between the job search channels that workers use to find employment and the probability of occupational mismatch in the new job. Our specific focus is on differences between native and immigrant workers. We use data from the German Socio-Economic Panel (SOEP) over the period 2000-2014. First, we document that referral hiring via social networks is the most frequent single channel of generating jobs in Germany; in relative terms referrals are used more frequently by immigrant workers compared to natives. Second, our data reveals that referral hiring is associated with the highest rate of occupational mismatch among all channels in Germany. We combine these findings and use them to develop a theoretical search and matching model with two ethnic groups of workers (natives and immigrants), two search channels (formal and referral hiring) and two occupations. When modeling social networks we take into account ethnic and professional homophily in the link formation. Our model predicts that immigrant workers face stronger risk of unemployment and often rely on recommendations from their friends and relatives as a channel of last resort. Furthermore, higher rates of referral hiring produce more frequent occupational mismatch of the immigrant population compared to natives. We test this prediction empirically and confirm that more intensive network hiring contributes significantly to higher rates of occupational mismatch among immigrants. Finally, we document that the gaps in the incidence of referrals and mismatch rates are reduced among second generation immigrants indicating some degree of integration in the German labour market.
    Keywords: job search, referrals, social networks, occupational mismatch, immigration
    Date: 2019–03–29
  10. By: Andrew Shephard (Department of Economics, University of Pennsylvania)
    Abstract: We present a general discrete choice framework for analyzing household formation and dissolution decisions in an equilibrium limited-commitment collective framework that allows for marriage both within and across birth cohorts. Using Panel Study of Income Dynamics and American Community Survey data, we apply our framework to empirically implement a time allocation model with labor market earnings risk, human capital accumulation, home production activities, fertility, and both within- and across-cohort marital matching. Our model replicates the bivariate marriage distribution by age, and explains some of the most salient life-cycle patterns of marriage, divorce, remarriage, and time allocation behavior. We use our estimated model to quantify the impact of the significant reduction in the gender wage gap since the 1980s on marriage outcomes.
    Keywords: Marriage, divorce, collective household models, life-cycle, search and matching, intrahousehold allocation, structural estimation
    JEL: C78 D13 D83 J12 J16 J22 J24 J31
    Date: 2019–03–15
  11. By: Alessandro Cantelmo; Leo Bonato; Giovanni Melina; Gonzalo Salinas
    Abstract: Resilience to climate change and natural disasters hinges on two fundamental elements: financial protection —insurance and self-insurance— and structural protection —investment in adaptation. Using a dynamic general equilibrium model calibrated to the St. Lucia’s economy, this paper shows that both strategies considerably reduce the output loss from natural disasters and studies the conditions under which each of the two strategies provides the best protection. While structural protection normally delivers a larger payoff because of its direct dampening effect on the cost of disasters, financial protection is superior when liquidity constraints limit the ability of the government to rebuild public capital promptly. The estimated trade-off is very sensitive to the efficiency of public investment.
    Date: 2019–03–08
  12. By: David W. Berger; Kyle F. Herkenhoff; Simon Mongey
    Abstract: What are the welfare implications of labor market power? We provide an answer to this question in two steps: (1) we develop a tractable quantitative, general equilibrium, oligopsony model of the labor market, (2) we estimate key parameters using within-firm-state, across-market differences in wage and employment responses to state corporate tax changes in U.S. Census data. We validate the model against recent evidence on productivity-wage pass-through, and new measurements of the distribution of local market concentration. The model implies welfare losses from labor market power that range from 2.9 to 8.0 percent of lifetime consumption. However, despite large contemporaneous losses, labor market power has not contributed to the declining labor share. Finally, we show that minimum wages can deliver moderate, and limited, welfare gains by reallocating workers from smaller to larger, more productive firms.
    JEL: E2 J2 J42
    Date: 2019–03
  13. By: Hamid R Tabarraei; Abdelaziz Rouabah; Olivier Pierrard
    Abstract: We examine the spillover effects between sovereigns and banks in a model with a heterogeneous banking system. An increase in sovereign’s default risk affects financial intermediaries through two channels in this model. First, banks’ funding costs might increase, inducing higher interest rates on loans and bonds and a cut back in these assets. Second, financial regulator’s risk-weighted asset framework would assign higher weights to lower quality assets, implying a portfolio rebalancing and more deleveraging. While capital adequacy requirements weaken the impact of shocks emerging from the real economy, they amplify the effect of shocks on banks’ balance sheets.
    Keywords: Central banks;Interest rates on loans;Bank capital;Market interest rates;Bank liquidity;Sovereign risk;Contagion;Interbank market;interbank;deposit rate;leverage ratio;order condition;bank 's balance
    Date: 2019–02–27
  14. By: Minford, Patrick (Cardiff Business School); Ou, Zhirong (Cardiff Business School); Zhu, Zheyi (Cardiff Business School)
    Abstract: We ask whether a model of the US and Europe trading with the rest of the world can match the facts of world behaviour in a powerful indirect inference test. One version has uncovered interest parity (UIP), the other risk-pooling. Both pass the test but the most probable is risk-pooling. This is consistent with risk-pooling failing a number of single equation tests, as has been found in past work; we show that these tests will typically reject risk-pooling when it in fact prevails. World economic behaviour under risk-pooling shows much stronger spillovers than under UIP with opposite monetary responses to the exchange rate. We argue that the risk-pooling model therefore demands more attention from policy-makers.
    Keywords: Opene conomy, UIP, risk-pooling, test, Indirect Inference
    JEL: C12 E12 F41
    Date: 2019–04
  15. By: Faccini, Renato; Melosi, Leonardo
    Abstract: In a dynamic general equilibrium model with a job ladder, inflation rises when most workers are employed in high-productivity jobs because in this case, poaching leads to wage increases that are not backed by changes in productivity. The model predicts that the post-Great Recession drop in the job-to-job flow rate has significantly slowed the pace at which the U.S. labor market turns low-productivity jobs into high-productivity ones. As a result, inflation has fallen below trend for an entire decade, despite the marked decline in the unemployment rate. The impaired process of reallocation over the job ladder accounts for a one-percentage-point reduction in U.S. labor productivity relative to trend, contributing to explain the stagnant productivity of the current economic recovery.
    Keywords: Cyclical Misallocation; Job Ladder; labor productivity; Phillips curve
    JEL: C78 E24 E31
    Date: 2019–03
  16. By: Benjamin Eden (Vanderbilt University)
    Abstract: I use a model of rational bubbles to discuss the effects of government loans and its real interest policy on the possibility of cycles. Cycles occur when the government is willing to lend to the young generation. Cycles do not occur if the government does not lend and the interest rate is sufficiently high. The level of interest required to discourage cycles (in the no lending case) is high when the rate of technological change in the non-housing sector is high relative to the rate of technological change in the housing sector.
    Keywords: Housing-cycles, Interest Rate, Bubbles, Government loans
    JEL: E3 E6
    Date: 2019–03–25
  17. By: Kevin x.d. Huang (Vanderbilt University); Qinglai Meng (Oregon State University); Jianpo Xue (Renmin University of China)
    Abstract: This paper overturns the conventional wisdom that reliance on capital tax rate adjustment to ensure fiscal sustainability is immune to extrinsic uncertainty. The interaction of capital taxation and endogenous capital utilization generates fiscal increasing returns and factor share redistribution to induce sunspots expectations. Capital depreciation allowance debilitates this mechanism to preempt policy induced instability while achieving budget objective. Self-fulfilling fluctuations can occur in real-world economies, unless their depreciation allowances are sufficiently higher or income tax rates lower than the current levels. This adds a short-run motivation to the long-run approach to capital taxation and the supply-side view of fiscal policy reforms.
    Keywords: Capital income taxation, Depreciation allowance, Endogenous utilization, Fiscal increasing returns, Self-fulfilling prophecies
    JEL: E6 E3
    Date: 2019–03–27
  18. By: Bin Grace Li; James McAndrews; Zhu Wang
    Abstract: It takes many years for more efficient electronic payments to be widely used, and the fees that merchants (consumers) pay for using those services are increasing (decreasing) over time. We address these puzzles by studying payments system evolution with a dynamic model in a twosided market setting. We calibrate the model to the U.S. payment card data, and conduct welfare and policy analysis. Our analysis shows that the market power of electronic payment networks plays important roles in explaining the slow adoption and asymmetric price changes, and the welfare impact of regulations may vary significantly through the endogenous R&D channel.
    Date: 2019–03–18
  19. By: Peter Tillmann (Justus-Liebig-University Giessen)
    Abstract: Central banks face uncertainty about the true location of the effective lower bound (ELB) on nominal interest rates. We model optimal discretionary monetary policy during a liquidity trap when the central bank designs policy that is robust with respect to the location of the ELB. If the central bank fears the worst-case location of the ELB, monetary conditions will be more expansionary before the liquidity trap occurs.
    Keywords: optimal monetary policy, discretion, robust control, uncertainty, liquidity trap
    JEL: E31 E32 E58
    Date: 2019
  20. By: Fabio C. Bagliano (Department of Economics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino, Italy); Carolina Fugazza (Department of Economics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino, Italy); Giovanna Nicodano (Department of Economics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino, Italy)
    Abstract: The recent Great Recession highlighted that long-term unemployment spells may entail persistent losses in workers' human capital. This paper extends the life-cycle model of savings and portfolio choice with unemployment risk, by allowing the possibility of permanent reductions in expected earnings following long-term unemployment. The optimal risky portfolio share becomes flat in age due to the resolution of uncertainty about future returns to human capital that occurs as the worker ages. This may help explaining the observed relatively flat, or only moderately increasing, risky share of investors during working life, and have important consequences for the design of optimal life-cycle portfolios by investment funds.
    Keywords: life-cycle portfolio choice, unemployment risk, human capital depreciation, age rule.
    JEL: E21 G11
    Date: 2019–03
  21. By: Anmol Bhandari; David Evans; Mikhail Golosov; Thomas J. Sargent
    Date: 2018
  22. By: Thales A. J. T. T. Maion; Marcio Issao Nakane
    Abstract: Consumer confidence/expectation indexes are frequently used by the media and the market in order to forecast the behavior of the economy. Agents’ expectations are believed to explain output and employment fluctuations, either moderate or drastic as the “.com†and the American subprime crisis. In Brazil, more attention has been drawn to this topic due to the recent economic crisis. The estimation of a VAR with Brazilian data for consumption, output and expectations suggests that innovations to the expectation indexes do have impact on aggregate consumption and GDP in the medium/long-run, as well as the indexes themselves. Inspired by this evidence, a DSGE model is used in order to assess how much of these impacts are due to anticipation of future economic fundamentals and how much are due to animal spirits. The results indicate that animal spirits and index-specific noise are responsible for a non-negligible amount of fluctuations up to 2 quarters, whereas news of future economic conditions prevail on lower frequencies.
    Keywords: Business cycles; Consumer confidence; News shocks; Brazilian economy
    JEL: D12 D83 D84 E32
    Date: 2019–03–22
  23. By: Isaac Baley; Lars Ljungqvist; Thomas J. Sargent
    Date: 2018

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