nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2019‒06‒24
23 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. The distributional effects of conventional monetary policy and quantitative easing: Evidence from an estimated DSGE model By Hohberger, Stefan; Priftis, Romanos; Vogel, Lukas
  2. Property Rights and Long-Run Capital By Julio Davila
  3. Real consequences of open market operations: the role of limited commitment By Carli, Francesco; Gomis Porqueras, Pedro
  4. A Bewley-Huggett model with many consumption goods By Bar Light
  5. Do Unemployment Benefit Extensions Explain the Emergence of Jobless Recoveries? By Mitman, Kurt; Rabinovich, Stanislav
  6. Wage Employment, Unemployment and Self-Employment across Countries By Poschke, Markus
  7. Generational War on Inflation: Optimal Inflation Rates for the Young and the Old By FUJIWARA Ippei; HORI Shunsuke; WAKI Yuichiro
  8. Tax evasion as contingent debt By Kotsogiannis, Christos; Mateos-Planas, Xavier
  9. The Macroeconomics of the Greek Depression By Gabriel Chodorow-Reich; Loukas Karabarbounis; Rohan Kekre
  10. Equilibrium trade in automobile markets By Kenneth Gillingham; Fedor Iskhakov; Anders Munk-Nielsen; John Rust; Bertel Schjerning
  11. Self-fulfilling debt crises, fiscal policy and investment By Galli, Carlo
  12. Commodity booms and busts in emerging economies By Drechsel, Thomas; Tenreyro, Silvana
  13. Budget Rules, Distortionnary Taxes, and Aggregate Instability: A reappraisal By Maxime Menuet; Alexandru Minea; Patrick Villieu
  14. Redistributive Effects of Different Pension Systems When Longevity Varies by Socioeconomic Status By Miguel Sánchez-Romero; Ronald D. Lee; Alexia Prskawetz
  15. Fiscal rule and shock amplification : A stochastic endogenous growth model By Maxime Menuet
  16. Learning Through Hiring: Knowledge From New Workers as an Explanation of Endogenous Growth By Kirker, Michael
  17. Optimal Positive Capital Taxes at Interior Steady States By Jess Benhabib; Bálint Szőke
  18. Unemployment dynamics and endogenous unemployment insurance extensions By Rujiwattanapong, W. Similan
  19. Distributional effects of surging housing costs under Schwabe's Law By Volker Grossmann; Benjamin Larin; Hans Torben Löfflad; Thomas Steger
  20. On the Solution of High-Dimensional Macro Models with Distributional Channels By Luca MAzzone
  21. Inequality and education choice By Uchida, Yuki; Ono, Tetsuo
  22. Immigration and Secular Stagnation By Kaz Miyagiwa; Yoshiyasu Ono
  23. Unemployment (fears) and deflationary spirals By Den Haan, Wouter J.; Rendahl, Pontus; Riegler, Markus

  1. By: Hohberger, Stefan (European Commission – JRC); Priftis, Romanos (Bank of Canada); Vogel, Lukas (European Commission)
    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 are able to smooth consumption over time, and (ii) poorer households, who only receive labor and transfer income and live ‘hand to mouth’. We use the model to 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. In light of the coarse dichotomy of households that abstracts from richer income and wealth dynamics at the individual level, the analysis emphasizes the functional distribution of income.
    Keywords: Bayesian estimation; distributional effects; open-economy DSGE model; portfolio rebalancing; quantitative easing
    JEL: E44 E52 E53 F41
    Date: 2018–12
  2. By: Julio Davila (Center for Operations Research and Econometrics CORE - UCL - Université Catholique de Louvain, CES - Centre d'économie de la Sorbonne - CNRS - Centre National de la Recherche Scientifique - UP1 - Université Panthéon-Sorbonne)
    Abstract: The fact that some proprietary capital gradually falls into the public domain (e.g. patents) or is taxed to fund productive public spending (e.g. public infrastructures and the institutional framework) inefficiently decreases capital accumulation, impacting households' consumption. Specifically, for a neoclassical infinitely-lived agents economy with constant returns to scale the planner's steady state consumption is 4.6%-9.1% higher than the market one —for standard empirically supported parameters. For a similarly parametrised overlapping generations economy it is around 10.5%. A tax and subsidy balanced policy able to decentralise the planner's steady consists of (i) subsidising the rental rate of private capital by an amount equal to its depreciation by (ii) taxing households' net position between, on the one hand, firm and depreciated capital ownership and, on the other, borrowing against future dividends and its resale value. From standard functions and parameterisations of the OG setup it follows that the savings rate decentralising the planner's steady state is close to 61.5% —of which ⅓ in loans to firms and ⅔ in real monetary balances and assets ownership net of borrowing against the latter— and that the tax rate on household net debt is smaller the bigger are monetary real balances and debt.
    Keywords: Property rights,capital accumulation
    Date: 2019–05
  3. By: Carli, Francesco; Gomis Porqueras, Pedro
    Abstract: We study how limited commitment in credit markets affects the implementation of open market operations and characterize when they result in real indeterminacies and when they have real effects. To do so, we consider a frictional and incomplete market framework where agents face stochastic trading opportunities and limited commitment in some markets. When limited commitment does not constraint agents’ choices, we find necessary and sufficient conditions for the existence of a unique monetary equilibrium. However, real indeterminacies are possible when buyers face a binding no-default constraint. We also show that when the no-default constraint binds and bonds are not priced fundamentally, open market operations generically have real effects. A sale of government bonds can increase or decrease interest rates, depending on the nature of equilibria. The direction of the interest rate effects critically depend on the size of the liquidity premium on government bonds. Finally, government bonds purchases can be used to rule out real indeterminacies, thus finding another rationale for such policy.
    Keywords: taxes; inflation; liquidity premium.
    JEL: E26 E40 E61 H21
    Date: 2019–05–21
  4. By: Bar Light
    Abstract: We study a pure-exchange incomplete markets model with heterogeneous agents. In each period, the agents choose how much to save and which bundle of goods to consume while their endowments are fluctuating. We focus on a competitive stationary equilibrium (CSE) in which the wealth distribution is invariant, the agents maximize their expected discounted utility, and both the prices of goods and the interest rate are market-clearing. Our main contribution is to extend some general equilibrium results to an incomplete markets setting. Under mild conditions on the agents' preferences, we show that the aggregate demand for goods depends only on their relative prices and we prove the existence of a CSE. When the agents' preferences can be represented by a CES (constant elasticity of substitution) utility function with an elasticity of substitution that is higher than or equal to one, we prove that the CSE is unique. Under the same preferences, we show that a higher inequality of endowments does not change the equilibrium prices of goods, and decreases the equilibrium interest rate.
    Date: 2019–06
  5. By: Mitman, Kurt (Stockholm University); Rabinovich, Stanislav (University of North Carolina, Chapel Hill)
    Abstract: Countercyclical unemployment benefit extensions in the United States act as a propagation mechanism, contributing to both the high persistence of unemployment and its weak correlation with productivity. We show this by modifying an otherwise standard frictional model of the labor market to incorporate a stochastic and state-dependent process for unemployment insurance estimated on US data. Accounting for movements in both productivity and unemployment insurance, our calibrated model is consistent with unemployment dynamics of the past 50 years. In particular, it explains the emergence of jobless recoveries in the 1990's as well as their absence in previous recessions, the low correlation between unemployment and labor productivity, and the apparent shifts in the Beveridge curve following recessions. Next, we embed this mechanism into a medium-scale DSGE model, which we estimate using standard Bayesian methods. Both shocks to unemployment benefits and their systematic component are shown to be important for the sluggish recovery of employment following recessions, in particular the Great Recession, despite the fact that shocks to unemployment benefits account for little of the overall variance decomposition. If we also incorporate other social safety nets, such as food stamps (SNAP), the estimated model assigns an even bigger role to policy in explaining sluggish labor market recovery. We also find that unemployment benefit extensions prevented deflation in the last three recessions, thus acting similarly to a wage markup shock.
    Keywords: unemployment insurance, business cycles, jobless recoveries
    JEL: E24 E32 J65
    Date: 2019–05
  6. By: Poschke, Markus (McGill University)
    Abstract: Poor countries have low rates of wage employment and high rates of self-employment. This paper shows that they also have high rates of unemployment relative to wage employment, and that self-employment is particularly high where the unemployment-wage employment ratio is high. I interpret high unemployment-employment ratios as evidence of labor market frictions, and develop a simple heterogeneous-firm search and matching model with choice between job search and self-employment to analyze their effect. Quantitative analysis of the model, separately calibrated to eight countries, shows that variation in labor market frictions can explain almost the entire variation in not only unemployment, but also wage employment and self-employment across the calibration countries. The model generates joint variation in unemployment and self-employment accounting for at least a third of their relationship in the data. Labor market frictions reduce output not only by affecting employment, but also by pushing searchers into low-productivity own-account work.
    Keywords: entrepreneurship, occupational choice, labor market frictions, self-employment, unemployment, wage employment, firm size, productivity
    JEL: O40 L26 J64 J23
    Date: 2019–05
  7. By: FUJIWARA Ippei; HORI Shunsuke; WAKI Yuichiro
    Abstract: How does a grayer society affect the political decision making regarding inflation rates? Is deflation preferred as society ages? In order to answer these questions, we compute the optimal inflation rates for the young and the old respectively and explore how they change with demographic factors, by using a New Keynesian model with overlapping generations. According to our simulation results, there indeed exists a tension between the young and the old on the optimal inflation rates. The optimal inflation rates are different between the young and the old. Also, they can be significantly different from zero, in particular, when heterogeneous impacts from inflation via nominal asset holdings are considered. The optimal inflation rates for the old can be largely negative, reflecting their positive nominal asset holdings as well as lower effective discount factor. Societal aging may exert downward pressure on inflation rates through a politico-economic mechanism.
    Date: 2019–03
  8. By: Kotsogiannis, Christos; Mateos-Planas, Xavier
    Abstract: This paper studies income-tax evasion in a quantitative incomplete-markets setting with heterogeneous agents. A central aspect is that, realistically, evaded taxes are a form of contingent debt. Since evasion becomes part of a portfolio decision, risk and credit considerations play a central part in shaping it. The model calibrated to match estimated average levels of evasion does a good job in producing observed cross-sectional average evasion rates that decline with age and with earnings. The model also delivers implications for how evasion varies in the cross sectional distribution of wealth and tax arrears. Evasion has substantial effects on macroeconomic variables and welfare, and agent heterogeneity and general equilibrium are very important elements in the explanation. The analysis also considers the response of evasion to a flat-tax policy reform. In spite of the direct incentives to evade less under a flat tax rate, the reform causes households to save more, rendering the change in overall evasion modest.
    Keywords: Tax evasion; contingent debt; incomplete markets with heterogeneous agents; portfolio choice; risk sharing; tax progressivity
    JEL: E20 E62 H30
    Date: 2019–01–18
  9. By: Gabriel Chodorow-Reich; Loukas Karabarbounis; Rohan Kekre
    Abstract: The Greek economy experienced a boom until 2007, followed by a prolonged depression resulting in a 25 percent shortfall of GDP by 2016. Informed by a detailed analysis of macroeconomic patterns in Greece, we develop and estimate a rich dynamic general equilibrium model to assess quantitatively the sources of the boom and bust. Lower external demand for traded goods and contractionary fiscal policies account for the largest fraction of the Greek depression. A decline in total factor productivity, due primarily to lower factor utilization, substantially amplifies the depression. Given the significant adjustment of prices and wages observed throughout the cycle, a nominal devaluation would only have short-lived stabilizing effects. By contrast, shifting the burden of adjustment from taxes toward spending or from capital taxes toward other taxes would generate significant longer-term production and consumption gains.
    JEL: E20 E32 E44 E62 F41
    Date: 2019–05
  10. By: Kenneth Gillingham; Fedor Iskhakov; Anders Munk-Nielsen; John Rust; Bertel Schjerning
    Abstract: We introduce a computationally tractable dynamic equilibrium model of the automobile market where new and used cars of multiple types (e.g. makes/models) are traded by heterogeneous consumers. Prices and quantities are determined endogenously to equate supply and demand for all car types and vintages, along with the ages at which cars are scrapped. The model allows for transactions costs, taxes, flexible specifications of car characteristics, consumer preferences, and heterogeneity. We apply the model to two examples: a revenue-neutral replacement of the new vehicle registration tax with a higher fuel tax and a hypothetical “merger to monopoly” in an oligopolistic new car market. We show substantial gains in consumer welfare from the tax policy change, as well as important effects on government revenues, automobile prices, driving, fuel consumption and CO2 emissions, while the merger leads to substantial welfare losses.
    Keywords: secondary markets, trade, consumer heterogeneity, transactions costs, dynamic programming, extreme value distribution, dynamic discrete choice, multinomial logit model, stationary equilibrium, Markov chains, invariant distributions
    JEL: D43 D61 H21 H23 L90 Q40 Q58
    Date: 2019
  11. By: Galli, Carlo
    Abstract: This paper studies the circular relationship between sovereign credit risk, government fiscal and debt policy, and output. I consider a sovereign default model with fiscal policy and private capital accumulation. I show that, when fiscal policy responds to borrowing conditions in the sovereign debt market, multiple equilibria exist where the expectations of lenders are self-fulfilling. In the bad equilibrium, pessimistic beliefs make sovereign debt costly. The government substitutes borrowing with taxation, which depresses private investment and future output, increases default probabilities and verifies lenders’ beliefs. This result is reminiscent of the European debt crisis of 2010-12: while recessionary, fiscal austerity may be the government best response to excessive borrowing costs during a confidence crisis.
    Keywords: Self-fulfilling debt crises; sovereign default; multiple equilibria; fiscal austerity
    JEL: E44 E62 F34
    Date: 2019–02–21
  12. By: Drechsel, Thomas; Tenreyro, Silvana
    Abstract: Emerging economies, particularly those dependent on commodity exports, are prone to highly disruptive economic cycles. This paper proposes a small open economy model for a net commodity exporter to quantitatively study the triggers of these cycles. The economy consists of two sectors, one of which produces commodities with prices subject to exogenous international fluctuations. These fluctuations affect both the competitiveness of the economy and its borrowing terms, as higher commodity prices are associated with lower spreads between the country's borrowing rate and world interest rates. Both effects jointly result in strongly positive effects of commodity price increases on GDP, consumption, and investment, and a negative effect on the total trade balance. Furthermore, they generate excess volatility of consumption over output and a large volatility of investment. Besides explicitly incorporating a double role of commodity prices, the model structure nests the various candidate sources of shocks proposed in previous work on emerging economy business cycles. Estimating the model on Argentine data, we find that the contribution of commodity price shocks to fluctuations in post-1950 output growth is in the order of 38%. In addition, commodity prices account for around 42% and 61% of the variation in consumption and investment growth, respectively. We find transitory productivity shocks to be an important driver of output fluctuations, exceeding the contribution of shocks to the trend, which, though smaller, is not negligible
    Keywords: 681664-Research on Macroeco-nomic Fluctuations and Trade
    JEL: N0
    Date: 2018–05–01
  13. By: Maxime Menuet (CERDI - Centre d'Études et de Recherches sur le Développement International - UdA - Université d'Auvergne - Clermont-Ferrand I - CNRS - Centre National de la Recherche Scientifique); Alexandru Minea (CERDI - Centre d'Études et de Recherches sur le Développement International - UdA - Université d'Auvergne - Clermont-Ferrand I - CNRS - Centre National de la Recherche Scientifique); Patrick Villieu
    Abstract: In a seminal contribution, Schmitt-Grohé and Uribe (JPE, 1997), showed that the balanced-budget rule (BBR) produces aggregate instability in an exogenous growth model with labor tax-based adjustment. The present paper challenges this result in an endogenous growth framework with a more general budget rule, involving deficit and debt in the long-run and making the BBR a special case. We show that the emergence of aggregate instability dramatically depends on the level of public spending. In particular, low public spending ensures determinacy. However, in the case of high public spending, multiplicity arises, with four potential equilibria: two high-growth BGPs, a low-growth trap, and a "catastrophic" equilibrium where the economy asymptotically collapses. In addition, when the ratio of public spending is sufficiently large, a subcritical Hopf bifurcation appears around the low-growth trap, giving rise to a homoclinic orbit going around the neighborhood of the catastrophic equilibrium. A calibration exercise confirms that these results are obtained for realistic values of parameters.
    Keywords: Distortionary taxation,Indeterminacy,Budget rules,Public Debt,Endogenous growth,Bifurcation
    Date: 2019–06–12
  14. By: Miguel Sánchez-Romero; Ronald D. Lee; Alexia Prskawetz
    Abstract: We propose a general analytical framework to model the redistributive features of alternative pension systems when individuals face ex ante differences in mortality. Differences in life expectancy between high and low socioeconomic groups are often large and have widened recently in many countries. Such longevity gaps affect the actuarial fairness and progressivity of public pension systems. However, behavioral responses to longevity and policy complicate analysis of possible reforms. Here we consider how various pension systems would perform in a general equilibrium OLG setting with heterogeneous longevity and ability. We evaluate redistributive effects of three Notional Defined Contribution plans and three Defined Benefit plans, calibrated on the US case. Compared to a benchmark non-redistributive plan that accounts for differences in mortality, US Social Security reduces regressivity from longevity differences, but would require group-specific life tables to achieve progressivity. Moreover, without separate life tables, despite apparent accounting gains, lower income groups would suffer welfare losses and higher income groups would enjoy welfare gains through indirect effects of pension systems on labor supply.
    JEL: H55 J1 J11 J14 J18 J26
    Date: 2019–06
  15. By: Maxime Menuet (CERDI - Centre d'Études et de Recherches sur le Développement International - UdA - Université d'Auvergne - Clermont-Ferrand I - CNRS - Centre National de la Recherche Scientifique)
    Abstract: This paper develops a discrete-time stochastic endogenous growth model to study the amplification role of fiscal rules. In our model, transitory shocks exert permanent effects on the level of variables in equilibrium (hysteresis), and can be strongly amplified by the public debt adjustment, leading to a procyclical amplification mechanism (the "public debt accelerator"). This procyclical stance depends on the speed of adjustment of the debt-to-GDP ratio under a fixed-fiscal rule. A cold turkey strategy removes the public debt shock, but at the risk of destabilizing other variables, while a gradualist strategy has a stabilization effect, with detrimental consequences in the long-run. Finally, we show that a flexible-fiscal rule helps smooth aggregate variables by limiting the cuts in productive public spending.
    Keywords: Endogenous growth model,Hysteresis,Fiscal Rules
    Date: 2019–06–12
  16. By: Kirker, Michael
    Abstract: This paper develops an endogenous growth model in which the job-to-job transition of workers provides a channel for the spillover of knowledge between firms. Workers learn some of the productive knowledge used by their employer while working on the job. When a worker moves to another firm, they are able to adapt some of this knowledge for use at the hiring firm. Firms endogenously control their exposure to new knowledge by choosing the intensity that they post vacancies in a search-and-matching labor market. It is shown that under a set of assumptions regarding the initial distribution of firm types and the vacancy posting cost function, the competitive equilibrium leads to a balanced growth path that has a constant growth rate and stationary distribution of firm size.
    Keywords: Endogenous growth; productivity; labor mobility; search and matching market; knowledge diffusion
    JEL: J60 O33 O40
    Date: 2019–06–15
  17. By: Jess Benhabib; Bálint Szőke
    Abstract: We generalize recent results of Bassetto and Benhabib (2006) and Straub and Werning (2018) in a model with endogenous labor-leisure choice where all agents are allowed to save and accumulate capital. In particular, using a neoclassical infinite horizon model with standard balanced growth preferences and agents heterogeneous in their initial wealth holdings, we provide a sufficient condition under which optimal redistributive capital taxes can remain at their allowed upper bound forever, even if the resulting equilibrium trajectory converges to a unique steady state with positive and finite consumption, capital, and labor. We first generate some simple parametric examples which satisfy our sufficient condition and for which closed form solutions exist. We then provide an interpretation of our sufficient condition for equilibria induced by general constant returns neo-classical production functions. Using recent evidence on wealth distribution in the United States, we argue that our sufficient condition is empirically plausible.
    JEL: E62 H21 H23
    Date: 2019–05
  18. By: Rujiwattanapong, W. Similan
    Abstract: This paper investigates the impact of endogenous unemployment insurance (UI) extensions on the dynamics of unemployment and its duration structure in the US. Using a search and matching model with worker heterogeneity, I allow for the maximum UI duration to depend on unemployment and for UI benefits to depend on worker characteristics. UI extensions have a large effect on long-term unemployment during the Great Recession via job search responses and a moderate effect on total unemployment via job separations. Disregarding rational expectations about the timing of UI extensions implies an overestimation of the unemployment rate by over 2 percentage points.
    Keywords: Business cycles; long-term unemployment; unemployment insurance; unemployment duration; rational expectations
    JEL: E24 E32 J24 J64 J65
    Date: 2019–05–01
  19. By: Volker Grossmann; Benjamin Larin; Hans Torben Löfflad; Thomas Steger
    Abstract: The upward sloping trend of rents and house prices has initiated a debate on the consequences of surging housing costs for wealth inequality and welfare. We employ a frictionless two-sectoral macroeconomic model with a housing sector to investigate the dynamics of wealth inequality and the determinants of welfare. Households have non-homothetic preferences, implying that the poor choose a higher housing expenditure share, which is compatible with Schwabe’s Law. We first examine the isolated effects of increasing housing costs in partial equilibrium. The model is closed by introducing a production sector that enables us to analyze the general equilibrium consequences of a widely discussed policy option, which aims at dampening the growth of housing costs. Abolishing zoning regulations triggers a slower rent growth and reduces wealth inequality by 0.7 percentage points (measured by the top 10 percent share). Average welfare increases by 0.5 percent. The household-specific welfare effects are asymmetric. The poor benefit more than the rich, and the richest wealth decile is even worse off.
    Keywords: macroeconomics and housing, long-term growth, Schwabe’s Law, wealth inequality, welfare
    JEL: E10 E20 O40
    Date: 2019
  20. By: Luca MAzzone (Swiss Finance Institute; University of Zurich)
    Abstract: Importance of distributional channels in macroeconomic dynamics has been the object of considerable attention in empirical studies. Despite significant amount of effort aimed at incorporating heterogeneity into macroeconomics, however, their explicit inclusion in the standard policy toolbox is far from widespread. A relevant obstacle, in such cases, is the computation of equilibria. I propose a global solution method for the computation of infinite-horizon, heterogeneous agent macroeconomic models with aggregate uncertainty. Details of the algorithm are illustrated by presenting its application to a an example model: in it, aggregate dynamics depends explicitly on firm entry and exit, and individual choices are often constrained by a form of market incompleteness. Existing computational strategies are either unfeasible or provide inaccurate solutions. Moreover, global solutions are computationally expensive because the minimal representation of the aggregate state space - and thus the aggregate law of motion - faces the curse of dimensionality. The proposed strategy thus combines adaptive sparse grids with a cross-sectional density approximation, and introduces a framework for solving the more general class of dynamic models with firm or household heterogeneity accurately.
    JEL: C63 E32
    Date: 2019–01
  21. By: Uchida, Yuki; Ono, Tetsuo
    Abstract: This study presents a two-class successive generations model with human capital accumulation and the choice to opt out of public education. The model demonstrates the mutual interaction between inequality and education choice and shows that this interaction leads to two locally stable steady-state equilibria. The existence of multiple stable equilibria implies a negative association between inequality and public education enrollment, which is consistent with evidence from Organisation for Economic Co-operation and Development (OECD) countries. This study also presents a welfare analysis using data from OECD countries and shows that introducing a compulsory public education system leaves the first generation worse off, although it realizes an equal society and improves welfare for future generations of lower-class individuals.
    Keywords: Public education, opting out, inequality
    JEL: D70 H52 I24
    Date: 2019–02–13
  22. By: Kaz Miyagiwa; Yoshiyasu Ono
    Abstract: We examine the effect of immigration on the host-country economy in the dynamic model that can deal with secular unemployment. Immigration has contrasting effects, depending on the economic state of the host country. If it suffers from unemployment, an influx of immigrants worsens unemployment and decreases consumption by natives. If instead the host country has full employment, immigration boosts native consumption while maintaining full employment, provided that immigrants are not too numerous. An influx of too many immigrants however can trigger stagnation. We also find that immigrants’ remittances are harmful to natives under full employment but beneficial under secular stagnation.
    Date: 2019–05
  23. By: Den Haan, Wouter J.; Rendahl, Pontus; Riegler, Markus
    Abstract: The interaction of incomplete markets and sticky nominal wages is shown to magnify business cycles even though these two features – in isolation – dampen them. During recessions, fears of unemployment stir up precautionary sentiments which induces agents to save more. The additional savings may be used as investments in both a productive asset (equity) and an unproductive asset (money). The rise in demand for the unproductive asset has important consequences. In particular, the desire to hold money puts deflationary pressure on the economy which, provided that nominal wages are sticky, increases labor costs and reduces firm profits. Lower profits repress the desire to save in equity, which increases (the fear of) unemployment, and so on. This is a powerful mechanism which causes the model to behave differently from its complete markets version. In our framework, the deflationary pressure yields a mean- reverting reduction in the price level, which implies an increase in expected inflation and a decrease in the expected real interest rate even if the policy rate does not adjust. Thus, our mechanism is different from the one emphasized in the zero lower bound literature. Due to the deflationary spiral our model also behaves differently from its incomplete market version without aggregate uncertainty, especially in terms of the impact of unemployment insurance on average employment levels.
    Keywords: ES/L500343/1; 649396
    JEL: N0 R14 J01
    Date: 2018–10–01

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