nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2019‒04‒15
twenty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Sticky Price versus Sticky Information Price: Empirical Evidence in the New Keynesian Setting By Drissi, Ramzi; Ghassan, Hassan B.
  2. Endogenous Demographic Change, Retirement and Social Security By Cipriani, Giam Pietro; Fioroni, Tamara
  3. On the credit and exchange rate channels of central bank asset purchases in a monetary union By Darracq Pariès, Matthieu; Papadopoulou, Niki
  4. Fiscal Policy Multipliers in Small States By Ali Alichi; Ippei Shibata; Kadir Tanyeri
  5. Macroprudential policy in a monetary union with cross-border banking By Darracq Pariès, Matthieu; Kok, Christoffer; Rancoita, Elena
  6. On the relationship between domestic saving and the current account: Evidence and theory for developing countries By Markus Brueckner; Wojtek Paczos; Evi Pappa
  7. On the Interaction between Public Sector Employment and Minimum Wage in a Search and Matching Model By Lucas Navarro; Mauricio Tejada
  8. On sunspot fluctuations in variable capacity utilization models By Frederic Dufourt; Alain Venditti; Rémi Vivès
  9. Modeling the Internal Revenue Code in a heterogeneous-agent framework: An application to TCJA By Moore, Rachel; Pecoraro, Brandon
  10. Investment in children, social security, and intragenerational risk sharing By FAN Simon,; PANG Yu,; PESTIEAU Pierre,
  11. A Baseline Medium-Scale NK DSGE Model for Policy Analysis By Xu, Wenli
  12. An inverted-U effect of patents on economic growth in an overlapping generations model By Yuta Nakabo; Ken Tabata
  13. Macroeconomic Effects of Taxes on Banking By J. E. Boscá; R. Doménech; J. Ferri; J. Rubio-Ramirez
  14. Pricing under Fairness Concerns By Erik Eyster; Kristof Madarasz; Pascal Michaillat
  15. Tax Rules to Prevent Expectations-driven Liquidity Trap By Yoichiro Tamanyu
  16. Modeling the drugs and guns trade in a two-country model with endogenous growth By King Yoong Lim; Diego Morris
  17. Police spending and economic stabilization in a monetary economy with crime and differential human capital By King Yoong Lim; Pengfei Jia
  18. Demographics and the natural real interest rate: historical and projected paths for the euro area By Papetti, Andrea
  19. Resource Abundance, Market Size, and the Choice of Technology By Zhou, Haiwen
  20. "Optimal Monetary Policy for the Masses: a presentation at the Center for Research on the Wisconsin Economy, University of Wisconsin-Madison, Madison, Wis. By Bullard, James B.; DiCecio, Riccardo
  21. Frictional Intermediation in Over-the-Counter Markets By Julien Hugonnier; Benjamin R. Lester; Pierre-Olivier Weill

  1. By: Drissi, Ramzi; Ghassan, Hassan B.
    Abstract: In order to model the inflation dynamics, we investigated various combinations of nominal rigidities. For this purpose, we analyze two adjustment-of-prices hypotheses as in the new Keynesian literature, namely the price stickiness and the sticky information, within a Dynamic Stochastic General Equilibrium (DSGE) model. For each model, we compare the responses of inflation and output to shocks. We found that sticky information modeling correctly reproduces some important stylized facts after monetary shocks, but with hump-shaped responses. The sticky price model, considering that some fixed prices lead to that Phillips curve, does not correctly reproduce the dynamic inflation response to monetary shocks. We show that single indexation does not add persistence to the two specifications, and the choice of rigidity structure appears to be more important than the presence or absence of lagged values of inflation in the dynamics.
    Keywords: DSGE model; Phillips curve; Sticky information; Sticky prices; Inflation
    JEL: C11 E31 E32
    Date: 2018–03
  2. By: Cipriani, Giam Pietro (University of Verona); Fioroni, Tamara (University of Verona)
    Abstract: In this paper, we analyse the effects of demographic change on a PAYG pension system, financed with a defined contribution scheme. In particular we examine the relationship between retirement, fertility and pensions in a three-period overlapping generations model. We focus on both the case of mandatory retirement and the case where the retirement age is freely chosen. In the case of mandatory retirement, increasing longevity has an unambiguously negative impact on fertility and pension payouts and a positive effect on the level of physical capital in the steady state. On the other hand, when agents choose the time of retirement, an increase in life expectancy positively affects physical capital only when the tax rate is sufficiently low and can have a positive impact on pension benefits because agents may find it optimal to retire later and to decrease fertility less. Finally, the effects of the social security tax on capital per worker are negative with mandatory retirement, however they could be positive in the optimal retirement case.
    Keywords: PAYG pensions, endogenous fertility, aging, retirement
    JEL: J13 H2 H8 H55
    Date: 2019–03
  3. By: Darracq Pariès, Matthieu; Papadopoulou, Niki
    Abstract: Through the euro area crisis, financial fragmentation across jurisdictions became a prime concern for the single monetary policy. The ECB broadened the scope of its instruments and enacted a series of non-standard measures to engineer an appropriate degree of policy accommodation. The transmission of these measures through the currency union remained highly dependent on the financial structure and conditions prevailing in various regions. This paper explores the country-specific macroeconomic transmission of selected non-standard measures from the ECB using a global DSGE model with a rich financial sector: we extend the six-region multi-country model of Darracq Pariès et al. (2016), introducing credit and exchange rate channels for central bank asset purchases. The portfolio rebalancing frictions are calibrated to match the sovereign yield and exchange rate responses after ECB's Asset Purchase Programme (APP) first announcement. The domestic transmission of the APP through the credit intermediation chain is significant and quite heterogenous across the largest euro area countries. The introduction of global portfolio frictions on euro area government bond holdings by international investors opens up for a larger depreciation of the euro. The interaction between international and domestic channels affect the magnitude and the cross-country distribution of the APP impact. JEL Classification: E4, E5, F4
    Keywords: banking, bank lending rates, cross-country spillovers, DSGE models, financial regulation, non-standard measures
    Date: 2019–03
  4. By: Ali Alichi; Ippei Shibata; Kadir Tanyeri
    Abstract: Government debt in many small states has risen beyond sustainable levels and some governments are considering fiscal consolidation. This paper estimates fiscal policy multipliers for small states using two distinct models: an empirical forecast error model with data from 23 small states across the world; and a Dynamic Stochastic General Equilibrium (DSGE) model calibrated to a hypothetical small state’s economy. The results suggest that fiscal policy using government current primary spending is ineffective, but using government investment is very potent in small states in affecting the level of their GDP over the medium term. These results are robust to different model specifications and characteristics of small states. Inability to affect GDP using current primary spending could be frustrating for policymakers when an expansionary policy is needed, but encouraging at the current juncture when many governments are considering fiscal consolidation. For the short term, however, multipliers for government current primary spending are larger and affected by imports as share of GDP, level of government debt, and position of the economy in the business cycle, among other factors.
    Date: 2019–03–26
  5. By: Darracq Pariès, Matthieu; Kok, Christoffer; Rancoita, Elena
    Abstract: We analyse the interaction between monetary and macroprudential policies in the euro area by means of a two-country DSGE model with financial frictions and cross-border spillover effects. We calibrate the model for the four largest euro area countries (i.e. Germany, France, Italy, and Spain), with particular attention to the calibration of cross-country financial and trade linkages and country specific banking sector characteristics. We find that countercyclical macroprudential interventions are supportive of mon-etary policy conduct through the cycle. This complementarity is significantly reinforced when there are asymmetric financial cycles across the monetary union, which provides a case for targeted country-specific macroprudential policies to help alleviate the burden on monetary policy. At the same time, our findings point to the importance of taking into account cross-border spillover effects of macroprudential measures within the Monetary Union. JEL Classification: E32, E44, E52, F36, F41
    Keywords: banking, DSGE, macroprudential policy, monetary policy
    Date: 2019–03
  6. By: Markus Brueckner; Wojtek Paczos; Evi Pappa
    Abstract: We examine the relationship between domestic saving and the current account in developing countries. Our three main findings are that: (i) domestic saving has a small effect on the current account; (ii) domestic saving has a significant positive effect on the trade balance – this effect is much larger than the effect that domestic saving has on the current account; (iii) domestic saving has a significant negative effect on net-current transfers. We use countries in the sub-Saharan African region as a laboratory for an instrumental variables approach. The IV approach enables to obtain estimates of casual effects. Underlying the IV approach is the significant positive first-stage response of domestic saving to plausibly exogenous annual rainfall: an unanticipated, transitory supply-side shock. We construct a small open-economy DSGE model with debt adjustment costs and endogenous current transfers to match the empirical findings. The model enables to examine the relationship between domestic saving and the current account for different types of shocks. An important message of our paper is that, for developing countries, estimates of the relationship between domestic saving and domestic investment are not informative for answering the question how domestic saving effects a country’s accumulation of net foreign assets.
    Keywords: Domestic Saving, Current Account, Current Transfers, Small Open Economy Model, Financial Frictions, Feldstein-Horioka Puzzle
    Date: 2019–04
  7. By: Lucas Navarro (ILADES – Universidad Alberto Hurtado); Mauricio Tejada (ILADES – Universidad Alberto Hurtado)
    Abstract: This paper incorporates a minimum wage to a search and matching model of the labor market with private and public sectors and two types of workers, high and low skilled. The model is structurally estimated using recent data for Chile, a country with a large fraction of employment in the public sector and a well known binding minimum wage. Results suggest a sizable productivity gap in favor of the private sector that, by a general equilibrum effect, is the main determinant of the bite of the minimum wage in both sectors observed in the data. Indeed, counterfactual experiments show that increasing productivity levels in the public sector to match those in the private sector has a large aggregate and distributive impact, reducing the fraction of minimum wage earners in the private sector almost by half. Our results highlight a previously unexplored margin of the effect of the minimum wage on the labor market.
    Keywords: Search Frictions, Public Sector Employment, Minimum Wage
    JEL: C51 J45 J64
    Date: 2017–08
  8. By: Frederic Dufourt (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); Alain Venditti (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); Rémi Vivès (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: We investigate the extent to which standard one sector RBC models with positive externalities and variable capacity utilization can account for the large hump-shaped response of output when the model is submitted to a pure sunspot shock. We refine the Benhabib and Wen (2004) model considering a general type of additive separable preferences and a general production function. We provide a detailed theoretical analysis of local stabilities and local bifurcations as a function of various structural parameters. We show that, when labor is infinitely elastic, local indeterminacy occurs through Flip and Hopf bifurcations for a large set of values for the elasticity of intertemporal substitution in consumption, the degree of increasing returns to scale and the elasticity of capital-labor substitution. Finally, we provide a detailed quantitative assessment of the model and conclude with mixed results. We show that although the model is able theoretically to generate a hump-shaped dynamics of output following an i.i.d. sunspot shock under realistic parameter values, the hump is too persistent for the model to be considered fully satisfactory from an empirical point of view.
    Date: 2018–05
  9. By: Moore, Rachel; Pecoraro, Brandon
    Abstract: Macroeconomic models used for tax policy analysis often simultaneously abstract from two features of the US tax code: special tax treatment for preferential capital income, and the joint tax treatment of ordinary capital and labor income. In this paper, we explore the extent to which explicitly accounting for these tax details has macroeconomic implications within a heterogeneous-agent model. We do this by expanding the Moore and Pecoraro (2018) overlapping generations model to include distinct corporate and non-corporate firms so that the business income distributed to households can be separated into ordinary and preferred capital income. Household income tax treatment is then determined by an internal tax calculator that fully accounts for interaction among income bases while conditioning on idiosyncratic household characteristics. Relative to a conventional approach where household income taxation is determined by independent labor and capital income tax functions that do not distinguish between ordinary and preferred capital income, we find that our innovations have implications for household behavior and economic aggregates - especially the tax consequences of changes to the returns to labor and capital - when analyzing a subset of tax provisions from the recently enacted “Tax Cuts and Jobs Act”. Our findings imply that the abstracting from tax detail may come at the expense of correctly accounting for incentives and estimating macroeconomic responses to tax policy changes.
    Keywords: dynamic scoring; tax policy modeling; heterogeneous agents
    JEL: C63 E62 H30
    Date: 2019–04–05
  10. By: FAN Simon, (Lingnan University, Hong Kong); PANG Yu, (Macau University of Science and Technology); PESTIEAU Pierre, (Université de Liège, CORE, UCLouvain and Toulouse School of Economics)
    Abstract: We analyze the role of pay-as-you-go social security in intragenerational risk sharing in an overlapping-generations model with individual heterogeneity. Parents invest in their children’s education in exchange for old-age support financed by a fraction of their children’s future earnings. Due to random factors such as luck in the job market, children may have different earning capacities even if they receive the same education. Without social security, a parent receives a transfert payment from her own child, so the received amount is uncertain as it depends on the child’s earnings. The social security scheme of pooling transfer contributions from all children and then returning them equally to each parent insures parents against the riks of educational investments. Our models shows that social security stimulates educational spending, increases labor earnings, and improves social welfare (as measured by ex ante individual utility). However, it worsens ex post intragenerational income equality (as measured by the Gini coefficient for lifetime income).
    Keywords: old-age insurance, social security, public education, income inequality
    JEL: D81 H20 H55 I24
    Date: 2019–01–29
  11. By: Xu, Wenli
    Abstract: A Baseline Medium-Scale NK DSGE Model for Policy Analysis
    Keywords: DSGE Model ,Fiscal Policy ,Monetary Policy
    JEL: E6
    Date: 2019–04–08
  12. By: Yuta Nakabo (Faculty of Social Studies, Nara University); Ken Tabata (School of Economics, Kwansei Gakuin University)
    Abstract: This paper analyzes how patent protection affects economic growth in a continuous-time overlapping generations model with lab-equipment type R&D-based growth. We show that increasing patent breadth may generate an inverted-U effect of patents on economic growth, an effect which is partly consistent with an empirically observed nonmonotonic relationship between patent protection and economic growth. This paper also shows that the combinations of heterogeneous households with finite lifetimes and the lab-equipment type R&D specification are relevant for deriving the inverted-U effect of patent protection on economic growth.
    Keywords: Innovations, Patents, Overlapping Generations
    JEL: O31 O34 O40
    Date: 2019–04
  13. By: J. E. Boscá; R. Doménech; J. Ferri; J. Rubio-Ramirez
    Abstract: This paper evaluates the macroeconomic effects of taxes on banking in a small open economy in a currency union for three tax alternatives: an additional tax on profits, on deposits, and on loans. We propose a DSGE model with a rich detail of taxes and a banking sector and show that these three taxes are equivalent in their effects on macroeconomic variables. Banks react to higher taxes by increasing their markups and by transferring part of the fiscal cost to households and firms through higher interest rates on loans. The increase in government revenues comes at a cost of a long-run decrease of GDP, an increase in loans interest rates, and a reduction in the volume of credit, deposits and bank capital. Our simulation exercises show that the trade-off between government revenues and economic activity is well captured by a multiplier of GDP to ex post government revenue close to -0.9, which is virtually independent of the tax rate.
    Date: 2019–04
  14. By: Erik Eyster; Kristof Madarasz; Pascal Michaillat
    Abstract: This paper proposes a theory of pricing consistent with two well-documented patterns: customers care about fairness, and firms take these concerns into account when they set prices. The theory assumes that customers find a price unfair when it carries a high markup over cost, and that customers dislike unfair prices. Since markups are not observable, customers must extract them from prices. The theory assumes that customers infer less than rationally: when a price rises after an increase in marginal cost, customers partially misattribute the higher price to a higher markup---which they find unfair. Firms anticipate this response and trim their price increases, which reduces the passthrough of marginal costs into prices below one: prices are somewhat rigid. Embedded in a New Keynesian model---as a replacement of Calvo pricing---our theory produces monetary nonneutrality. When monetary policy loosens and inflation rises, customers misperceive markups as higher and feel unfairly treated; firms mitigate the perceived unfairness of prices by reducing their markups, which in general equilibrium leads to higher output.
    Date: 2019–04
  15. By: Yoichiro Tamanyu (Graduate School of Economics, Keio University)
    Abstract: This paper demonstrates that a simple Ricardian tax policy responding to inflation can prevent expectations-driven liquidity trap (ELT) using a standard New Keynesian model. I show that the extent to which tax rates must respond to inflation is affected by the persistence of remaining at the ELT and higher persistence requires larger response to inflation. I further find that if the ELT is assumed to be recurrent, the tax rate needs to respond to inflation by a larger extent compared to the case where the targeted regime is assumed to be absorbing. This last finding indicates that it is crucial for the fiscal authority to entertain the possibility of moving back to the ELT when it sets their policy parameters.
    Keywords: Expectations-driven Liquidity Trap, Fiscal Policy, Monetary Policy, Regime Switching, Zero Lower Bound
    JEL: E61 E62 E63
    Date: 2019–01–29
  16. By: King Yoong Lim; Diego Morris
    Abstract: This paper develops a two-country, dynamic general equilibrium model of endogenous growth with illicit drugs and guns trade. With a trade framework that unies both drug-control policies in consuming- and producing-country, as well as explicit modeling of firearm trade, the model is solved and parameterized to study the dynamic trade-off and growth effects of various drug-control policies. A production-consumption growth trade-off not previously documented in the literature is found. Further, under different conditions, and depending on the resulting gain in formal trade expansion, there are economic rationale to either a prohibitive or liberalization drug-control policy.
    Keywords: Endogenous Growth, Drugs, Illicit Trade, Organized Crime
    JEL: E26 F59 O41 O54
    Date: 2019–01
  17. By: King Yoong Lim; Pengfei Jia
    Abstract: This paper presents a dynamic model with crime, differential human capital, credit market imperfection, and police spending to examine the role of the latter in stabilizing shock arisen from formal educational quality uncertainty. Based on a stylized parameterization, we find formal and illegal human capital accumulation to share a common cyclical property. There is a case for the use of a rule-based approach to police spending as it smoothens out the fluctuations arisen from formal educational uncertainty, while contributing to a decoupling of the two types of human capital. This nonetheless comes with a cost of greater propagation of the financial accelerator effect due to credit market imperfection, and therefore necessitates the use of a supplementary monetary smoothing regime to negate these negative effects.
    Keywords: Crime, Credit Imperfection, Financial Accelerator, Human Capital Investment, Police Spending
    JEL: H39 H50 K42 E44 E61
    Date: 2019–01
  18. By: Papetti, Andrea
    Abstract: This paper employs an aggregate representation of an overlapping generation (OLG) model quantifying a decrease of the natural real interest rate in the range of -1.7 and -0.4 percentage points in the euro area between 1990 and 2030 due to demographics alone. Two channels contribute to this downward impact: the increasing scarcity of effective labor input and the increasing willingness to save by individuals due to longer life expectancy. The decrease of the aggregate saving rate as individuals retire has an upward impact which is never strong enough. Mitigating factors are: higher substitutability between labor and capital, higher intertemporal elasticity of substitution in consumption, reforms aiming at increasing the relative productivity of older cohorts, the participation rate and the retirement age. The simulated path of the natural real interest rate is consistent with recent econometric estimates: an upward trend in the 70s and 80s and a prolonged decline afterward. JEL Classification: E17, E21, E43, E52, J11
    Keywords: aging, demographic transition, euro area, natural interest rate, secular stagnation
    Date: 2019–03
  19. By: Zhou, Haiwen
    Abstract: How resource abundance and market size affect the choice of increasing returns technologies is studied in an overlapping-generations general equilibrium model in which manufacturing firms engage in oligopolistic competition. The model is surprisingly tractable. First, for the steady state, the wage rate, the level of technology, and capital stock are not affected by the amount of natural resources. An increase in the share of agricultural revenue going to natural resources leads to a lower wage rate and firms choose less advanced technologies. Second, an increase in market size increases the equilibrium wage rate, level of technology, and capital stock. Finally, other things equal, a country with a lower endowment of natural resources or a higher market size has a comparative advantage in producing the manufactured good.
    Keywords: Technology choice, resource abundance, specific-factors model, overlapping-generations model, increasing returns
    JEL: F10 N60 O14
    Date: 2019–04–04
  20. By: Bullard, James B. (Federal Reserve Bank of St. Louis); DiCecio, Riccardo (Federal Reserve Bank of St. Louis)
    Abstract: In a presentation at the University of Wisconsin-Madison, St. Louis Fed President James Bullard highlighted his recent working paper, which examines whether monetary policy can be conducted in a way that benefits all households even in a world with substantial income, financial wealth and consumption inequality. In the paper, nominal GDP targeting constitutes “optimal monetary policy for the masses,” he said.
    Date: 2019–03–28
  21. By: Julien Hugonnier (Swiss Federal Institute of Technology Lausanne - Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute); Benjamin R. Lester (Federal Reserve Banks - Federal Reserve Bank of Philadelphia); Pierre-Olivier Weill (University of California, Los Angeles; National Bureau of Economic Research (NBER))
    Abstract: We extend Duffie, Garleanu, and Pedersen’s (2005) search-theoretic model of over-the-counter asset markets, allowing for a decentralized inter-dealer market with arbitrary heterogeneity in dealers’ valuations or inventory costs. We develop a solution technique that makes the model fully tractable and allows us to derive, in closed form, theoretical formulas for key statistics analyzed in empirical studies of the intermediation process in OTC market. A calibration to the market for municipal securities reveals that the model can generate trading patterns and prices that are quantitatively consistent with the data. We use the calibrated model to compare the gains from trade that are realized in this frictional market with those from a hypothetical, frictionless environment, and to distinguish between the quantitative implications of various types of heterogeneity across dealers.
    Keywords: Over-the-Counter Markets, Search Frictions, Bargaining, Heterogeneous Agents, Intermediation
    JEL: G11 G12 G21
    Date: 2018–08

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