nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2019‒07‒08
twenty-two papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Implications of Increasing College Attainment for Aging in General Equilibrium By Juan Carlos Conesa; Timothy J. Kehoe; Vegard M. Nygaard; Gajendran Raveendranathan
  2. The Lucas Imperfect Information Model with Imperfect Common Knowledge By Ui, Takashi
  3. Rethinking capital regulation: the case for a dividend prudential target By Muñoz, Manuel
  4. Why Do Americans Spend So Much More on Health Care than Europeans? (REVISED) By Hui He; Kevin X.D. Huang; Lei Ning
  5. Back to the real economy: the effects of risk perception shocks on the term premium and bank lending By Bluwstein, Kristina; Yung, Julieta
  6. The Beveridge curve and labour market flows - a reinterpretation By Nils Gottfries; Karolina Stadin
  7. Revisiting the Hypothesis of High Discounts and High Unemployment By J. Paolo Martellini; Guido Menzio; Ludo Visschers
  8. Inflation and Social Welfare in a New Keynesian Model: The Case of Japan and the U.S. By Tomohide Mineyama; Wataru Hirata; Kenji Nishizaki
  9. Delayed Collection of Unemployment Insurance in Recessions By Xie, Zoe
  10. Classic Policy Benchmarks for Heterogeneous-Agent Economies By Bullard, James B.; DiCecio, Riccardo
  11. Does the Early Retirement Policy Really Benefit Women? By Hyun Lee; Kai Zhao; Fei Zou
  12. The Reversal Interest Rate By Markus K. Brunnermeier; Yann Koby
  13. Monetary Policy, Inflation Target and the Great Moderation: An Empirical Investigation By Qazi Haque
  14. Monetary policy, inflation target and the great moderation: An empirical investigation By Qazi Haque
  15. Monetary Policy and Macroeconomic Stability Revisited By Hirose, Yasuo; Van Zandweghe, Willem; Kurozumi, Takushi
  16. "Classic Policy Benchmarks for Heterogeneous Agent Economies," Monetary Policy and Heterogeneity Conference, Hong Kong Monetary Authority and Federal Reserve Bank of New York, Hong Kong, China. By Bullard, James B.; DiCecio, Riccardo
  17. Financial Stability Implications of Policy Mix in a Small Open Commodity-Exporting Economy By Irina Kozlovtceva; Alexey Ponomarenko; Andrey Sinyakov; Stas Tatarintsev
  18. Capital Income Taxation and Aggregate Instability By Kevin X.D. Huang; Qinglai Meng; Jianpo Xue
  19. Asset Liquidity and Indivisibility By Han Han; Benoit Julien; Asgerdur Petursdottir; Liang Wang
  20. Business Cycles and Production Networks By Olsson, Maria
  21. Demographic change and climate change By Michael Rauscher
  22. A Model-Based Assessment of the Distributional Impact of Structural Reforms By Werner Roeger; Janos Varga; Jan in 't Veld; Lukas Vogel

  1. By: Juan Carlos Conesa; Timothy J. Kehoe; Vegard M. Nygaard; Gajendran Raveendranathan
    Abstract: We develop and calibrate an overlapping generations general equilibrium model of the U.S. economy with heterogeneous consumers who face idiosyncratic earnings and health risk to study the implications of exogenous trends in increasing college attainment, decreasing fertility, and increasing longevity between 2005 and 2100. While all three trends contribute to a higher old age dependency ratio, increasing college attainment has different macroeconomic implications because it increases labor productivity. Decreasing fertility and increasing longevity require the government to increase the average labor tax rate from 32.0 to 44.4 percent. Increasing college attainment lowers the required tax increase by 10.1 percentage points. The required tax increase is higher under general equilibrium than in a small open economy with a constant interest rate because the reduction in the interest rate lowers capital income tax revenues.
    Keywords: college attainment, aging, health care, taxation, general equilibrium
    JEL: H20 H51 H55 I13 J11
    Date: 2019–06
  2. By: Ui, Takashi
    Abstract: In the Lucas Imperfect Information model, output responds to unanticipated monetary shocks. We incorporate more general information structures into the Lucas model and demonstrate that output also responds to (dispersedly) anticipated monetary shocks if the information is imperfect common knowledge. Thus, the real effects of money consist of the unanticipated part and the anticipated part, and we decompose the latter into two effects, an imperfect common knowledge effect and a private information effect. We then consider an information structure composed of public and private signals. The real effects disappear when either signal reveals monetary shocks as common knowledge. However, when the precision of private information is fixed, the real effects are small not only when a public signal is very precise but also when it is very imprecise. This implies that a more precise public signal can amplify the real effects and make the economy more volatile.
    Keywords: real effects, neutrality of money, iterated expectations, the Lucas model, imperfect, common knowledge
    Date: 2019–06
  3. By: Muñoz, Manuel
    Abstract: The paper investigates the effectiveness of dividend-based macroprudential rules in complementing capital requirements to promote bank soundness and sustained lending over the cycle. First, some evidence on bank dividends and earnings in the euro area is presented. When shocks hit their profits, banks adjust retained earnings to smooth dividends. This generates bank equity and credit supply volatility. Then, a DSGE model with key financial frictions and a banking sector is developed to assess the virtues of what shall be called dividend prudential targets. Welfare-maximizing dividend-based macroprudential rules are shown to have important properties: (i) they are effective in smoothing the financial and the business cycle by means of less volatile bank retained earnings, (ii) they induce welfare gains associated to a Basel III-type of capital regulation, (iii) they mainly operate through their cyclical component, ensuring that long-run dividend payouts remain unaffected, (iv) they are flexible enough so as to allow bank managers to optimally deviate from the target (conditional on the payment of a sanction), and (v) they are associated to a sanctions regime that acts as an insurance scheme for the real economy. JEL Classification: E44, E61, G21, G28, G35
    Keywords: bank dividends, capital requirements, dividend prudential target, financial stability, macroprudential regulation
    Date: 2019–07
  4. By: Hui He (International Monetary Fund); Kevin X.D. Huang (Vanderbilt University); Lei Ning (Shanghai University of Finance and Economics)
    Abstract: Empirical evidence shows that both leisure and medical care are important for maintaining health. And taxation may affect the allocation of these two inputs. We build a life-cycle overlapping-generations model in which taxation and relative health care price are key determinants of the composition of the two inputs in the endogenous accumulation of health capital. In the model, a lower tax wedge leads to using relatively more medical care and less leisure in maintaining health, while a higher relative health care price implies an opposite substitution in quantity (away from medical care towards leisure) that weakens the direct bearing of the higher price on overall health spending. We show that differences in taxation and in relative health care price between the US and Europe can jointly account for a bulk of their differences in health expenditure- GDP ratio and in leisure time allocated for health production, with the taxation channel playing a quantitatively more significant role.
    Keywords: Macro-health, Taxation, Relative health care price, Health care expenditure, Time allocation, Life cycle, Overlapping generations
    JEL: E6 H2
    Date: 2019–04–09
  5. By: Bluwstein, Kristina (Bank of England); Yung, Julieta (Bates College)
    Abstract: We develop a dynamic stochastic general equilibrium framework that can account for important macroeconomic and financial moments, given Epstein-Zin preferences, heterogeneous banking and third-order approximation methods that yield a time-varying term premium that feeds back to the real economy. A risk perception shock increases term premia, lowers output, and reduces short-term credit in the private sector in response to higher loan rates and constrained borrowers, as banks rebalance their portfolios. A ‘bad’ credit boom, driven by investors mispricing risk, leads to a more severe recession and is less supportive of economic growth than a ‘good’ credit boom based on fundamentals.
    Keywords: Stochastic discount factor; DSGE; long-term interest rate; risk mispricing; macro-financial linkages; bank lending
    JEL: E43 E44 E58 G12
    Date: 2019–06–21
  6. By: Nils Gottfries; Karolina Stadin
    Abstract: According to search-matching theory, the Beveridge curve slopes downward because vacancies are filled more quickly when unemployment is high. Using monthly panel data for local labour markets in Sweden we find no (or only weak) evidence that high unemployment makes it easier to fill vacancies. Instead, there are few vacancies when unemployment is high because there is a low inflow of new vacancies. We construct a simple model with on-the-job search and show that it is broadly consistent with the cyclical behaviour of stocks and flows in the labour market also without search frictions. In periods of high unemployment, fewer employed job seekers find new jobs and this leads to a smaller inflow of new vacancies.
    Keywords: Beveridge curve, frictional unemployment, matching function, turnover, mismatch, vacancy chain
    JEL: E24 J23 J62 J63 J64
    Date: 2019
  7. By: J. Paolo Martellini (Department of Economics, University of Pennsylvania); Guido Menzio (Department of Economics, New York University); Ludo Visschers (School of Economics, University of Edinburgh)
    Abstract: We revisit the hypothesis that labor market ?uctuations are driven by shocks to the discount rate. Using a model in which the UE and the EU rates are endogenous, we show that an increase in the discount rate leads to a decline in both the UE and the EU rates. In the data, though, the UE and EU rates move against each other at business cycle frequency. Using a lifecycle model with human capital accumulation on the job, we show that an increase in the discount rate does indeed lead to a decline in the aggregate UE rate and to an increase in the aggregate EU rate. However, the decline in the UE rate is larger for younger workers than for older workers and the EU rate increases only for younger workers. In the data, ?uctuations in the UE and EU rates at the business cycle frequency are nearly identical across age groups.
    Keywords: Unemployment Fluctuations, Discount Rate, Human Capital, Lifecycle Earnings
    JEL: E24 J63 J64
    Date: 2019–06–20
  8. By: Tomohide Mineyama (Bank of Japan); Wataru Hirata (Bank of Japan); Kenji Nishizaki (Bank of Japan)
    Abstract: In this paper, we investigate the steady-state inflation rate that maximizes social welfare in a New Keynesian model. We calibrate the model on the Japanese and the U.S. economies, and we solve the model employing a computation method that addresses the non-linear dynamics associated with four major factors affecting the costs and benefits of inflation: (i) nominal price rigidity; (ii) money holdings; (iii) downward nominal wage rigidity (DNWR); and (iv) the zero lower bound of the nominal interest rates (ZLB). The calibrated model suggests the steady-state inflation rate that maximizes social welfare is close to two percent for both Japan and the U.S., though the main driver differs by country: the ZLB for Japan, but the DNWR for the U.S. In addition, around one percentage point absolute deviation from the close-to-two-percent rate induces only a minor change in social welfare. We also find that the lower-end of the range that is acceptable in terms of welfare losses is reduced when we introduce forward guidance in monetary policy through which private agents anticipate a prolonged zero interest rate once the ZLB binds. The estimates of the steady-state inflation rate are subject to a considerable margin of error due to parameter uncertainty in ZLB parameterization.
    Keywords: Inflation; Social welfare; New Keynesian model; Downward nominal wage rigidity; Zero lower bound; Forward guidance
    JEL: E31 E43 E52
    Date: 2019–06–27
  9. By: Xie, Zoe (Federal Reserve Bank of Atlanta)
    Abstract: Using variations in unemployment insurance policies over time and across U.S. states, this paper provides evidence that allowing unemployed workers to delay the collection of benefits increases their job-finding rate. In a model with discrete job take-up decisions, benefit entitlement, wage-indexed benefits, and heterogeneous job types, I demonstrate that the policy can increase an unemployed worker's willingness to work, even though more benefits in general reduce the relative value of employment. In a calibrated quantitative model, I find that allowing delayed benefit collection increases the overall job finding rates and may lower the unemployment rate both in a steady state stationary economy and over a transition path during 2008–12.
    Keywords: health; frailty index; life cycle profiles
    JEL: E24 J65
    Date: 2019–06–01
  10. By: Bullard, James B. (Federal Reserve Bank of St. Louis); DiCecio, Riccardo (Federal Reserve Bank of St. Louis)
    Abstract: Increasing interest in large-scale heterogeneous-agent DSGE models. Realistic degrees of heterogeneity—approaching observed Gini coefficients in U.S. data. What is the role of monetary policy in such a model?
    Date: 2019–06–22
  11. By: Hyun Lee (University of Connecticut); Kai Zhao (University of Connecticut); Fei Zou (University of Connecticut)
    Abstract: China’s mandatory retirement policy requires most female workers to retire five years earlier than their male counterparts. The conventional wisdom behind this policy is that it benefits women by relieving them from work earlier and providing them with more years of public pension benefits than men. However, is the early retirement policy really welfare-improving for women? In this paper, we quantitatively evaluate the welfare consequence of China’s gender-specific mandatory retirement policy using a calibrated Overlapping-Generation model with heterogeneous agents and incomplete markets. We find that the early mandatory retirement reduces welfare for women. An important reason behind this welfare result is that China’s public pension benefits are only partially indexed to growth, and therefore women who retire earlier also benefit less from economic growth than men. Our quantitative results suggest that equalizing the retirement age across gender can generate a welfare gain for both men and women.
    Keywords: Social Security, China, Mandatary Retirement, Gender
    JEL: E20 E60 H30
    Date: 2019–07
  12. By: Markus K. Brunnermeier (Department of Economics, Princeton University (E-mail:; Yann Koby (Department of Economics, Princeton University (E-mail:
    Abstract: The reversal interest rate is the rate at which accommodative monetary policy reverses and becomes contractionary for lending. Its determinants are 1) banks' fixed-income holdings, 2) the strictness of capital constraints, 3) the degree of pass-through to deposit rates, and 4) the initial capitalization of banks. Quantitative easing increases the reversal interest rate and should only be employed after interest rate cuts are exhausted. Over time the reversal interest rate creeps up since asset revaluation fades out as fixed-income holdings mature while net interest income stays low. We calibrate a New Keynesian model that embeds our banking frictions.
    Keywords: Monetary Policy, Lower Bound, Negative Rates, Banking
    JEL: E43 E44 E52 G21
    Date: 2019–06
  13. By: Qazi Haque (The University of Western Australia and Centre for Applied Macroeconomic Analysis)
    Abstract: This paper estimates a New Keynesian model with trend inflation and contrasts Taylor rules featuring fixed versus time-varying inflation target while allowing for passive monetary policy. The estimation is conducted over the Great Inflation and the Great Moderation periods. Time-varying inflation target empirically fits better and active monetary policy prevails in both periods, thereby ruling out sunspots as an explanation of the Great Inflation episode. Counterfactual simulations suggest that the decline in inflation volatility since the mid-1980s is mainly driven by monetary policy, while the reduction in output growth variability is explained by the reduced volatility of technology shocks.
    Date: 2019
  14. By: Qazi Haque
    Abstract: This paper estimates a New Keynesian model with trend inflation and contrasts Taylor rules featuring fixed versus time-varying inflation target while allowing for passive monetary policy. The estimation is conducted over the Great Inflation and the Great Moderation periods. Time-varying inflation target empirically fits better and active monetary policy prevails in both periods, thereby ruling out sunspots as an explanation of the Great Inflation episode. Counterfactual simulations suggest that the decline in inflation volatility since the mid-1980s is mainly driven by monetary policy, while the reduction in output growth variability is explained by the reduced volatility of technology shocks.
    Keywords: Monetary policy, Trend Inflation, Inflation Target, Indeterminacy, Great Inflation, Great Moderation, Sequential Monte Carlo
    JEL: C11 C52 C62 E31 E32 E52
    Date: 2019–06
  15. By: Hirose, Yasuo (Keio University); Van Zandweghe, Willem (Federal Reserve Bank of Cleveland); Kurozumi, Takushi (Bank of Japan)
    Abstract: A large literature has established that the Fed’ change from a passive to an active policy response to inflation led to US macroeconomic stability after the Great Inflation of the 1970s. This paper revisits the literature’s view by estimating a generalized New Keynesian model using a full-information Bayesian method that allows for equilibrium indeterminacy and adopts a sequential Monte Carlo algorithm. The model empirically outperforms canonical New Keynesian models that confirm the literature’s view. Our estimated model shows an active policy response to inflation even during the Great Inflation. More importantly, a more active policy response to inflation alone does not suffice for explaining the US macroeconomic stability, unless it is accompanied by a change in either trend inflation or policy responses to the output gap and output growth. This extends the literature by emphasizing the importance of the changes in other aspects of monetary policy in addition to its response to inflation.
    Keywords: Monetary policy; Great Inflation; Indeterminacy; Trend inflation; Sequential Monte Carlo;
    JEL: C11 C52 C62 E31 E52
    Date: 2019–06–27
  16. By: Bullard, James B. (Federal Reserve Bank of St. Louis); DiCecio, Riccardo (Federal Reserve Bank of St. Louis)
    Abstract: There has been increasing interest in large-scale heterogeneous agent DSGE models. These models have realistic degrees of heterogeneity—approaching observed Gini coefficients in U.S. data. They more directly address issues around income, financial wealth and consumption inequality. What is the role of monetary policy?
    Date: 2019–05–23
  17. By: Irina Kozlovtceva (Bank of Russia, Russian Federation); Alexey Ponomarenko (Bank of Russia, Russian Federation); Andrey Sinyakov (Bank of Russia, Russian Federation); Stas Tatarintsev (Bank of Russia, Russian Federation)
    Abstract: In this paper, we study how systematic monetary policy under inflation targeting in a commodity-exporting economy not fully isolated from commodity price volatility by fiscal policy may contribute to financial instability by fueling the credit cycle when commodity prices increase or by amplifying the credit crunch when commodity prices decline. We report several empirical observations that illustrate the potential procyclicality (relative to credit developments) of inflation targeting policy where commodity price fluctuations are the main drivers of macroeconomic developments. Namely, we find that relative prices in commodity-exporting economies are much more volatile than in other countries. The length of periods when relative prices grow or decline is comparable to the monetary policy horizon of most inflation targeters (2-3 years). Note that the central banks that target inflation, including those of the commodity-exporting countries, usually target the headline CPI. This index accommodates relative price changes by design. We proceed with formal statistical testing using panel structural VARs and local projection models. The tests support the procyclicality of inflation targeting, but only in a group of emerging market economies, which in practice have more procyclical fiscal policy than advanced economies: monetary policy eases in response to a higher price of an exported commodity while real credit grows. Counterfactual exercises show that endogenous monetary policy responses to commodity shocks explain around 20% on average of the real credit growth in a group of commodity exporting countries for which the reaction of policy rates to commodity shocks is statistically significant. We cross-check the empirical findings by reviewing a collection of papers with estimated DSGE models and analysing impulse responses of real policy rates to commodity price changes. We also conduct a theoretical analysis and compare stabilization properties (while accounting for financial stability risks) of the inflation-targeting policy rule and the ‘leaning against the wind’ policy rules. Notably, we do this exercise conditionally on the role of commodity price shocks for the economy. For this purpose, we use the DSGE with financial frictions and a banking sector estimated basing for the Russian economy and measure the efficiency of policy results with different sensitivity to credit developments (the ‘leaning against the wind’ rules) under different variance of oil price shocks (which may be interpreted also as different efficiency of fiscal policy in insulating the economy from a given oil price volatility). Results show that when commodity price volatility is relatively high (fiscal policy is not countercyclical), leaning against the wind outperforms pure inflation targeting, thus supporting our empirical findings. Interestingly, even when the financial stability risks associated with the volatility of credit developments are negligible, a moderate leaning against the wind policy is still preferable. As policy implication, we point that a commodity-exporting economy should have countercyclical fiscal policy for inflation targeting to become countercyclical in a commodity cycle.
    Keywords: systematic monetary policy, optimal central bank policy, inflation targeting, macroprudential policy, relative prices, credit cycle, financial frictions, leaning against the wind, commodity prices
    JEL: E31 E52 E58 F41 F47
    Date: 2019–06
  18. 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
  19. By: Han Han (School of Economics Peking University); Benoit Julien (UNSW Australia); Asgerdur Petursdottir (University of Bath); Liang Wang (University of Hawaii Manoa and NSD/CCER)
    Abstract: We study asset liquidity in a search-theoretic framework where divisible assets can facilitate exchange for an indivisible consumption good. The distinctive characteristics of our theory are that the asset dividend can be either positive or negative and buyers can choose whether or not to carry the asset and trade for the indivisible good. Buyers' participation determines the demand for asset liquidity and hence asset price carries a component of liquidity premium to reflect its function of trade facilitation. The economy features multiple equilibria when the asset dividend is negative, due to the trade-off between the probability of trade and the endogenous cost of holding the asset.
    Keywords: Asset, Indivisibility, Liquidity, Search
    JEL: D51 E40 G12
    Date: 2019–06
  20. By: Olsson, Maria (Department of Economics)
    Abstract: Where do business cycles originate? The traditional view is that a business cycle is the result of shocks correlated across sectors. This view is complemented by a recently emerging literature showing that idiosyncratic shocks to large or highly interconnected sectors contribute to aggregate variation. This paper addresses the relative empirical importance of these two channels of business cycle variation. Results indicate that up to one-third of the business cycle is driven by idiosyncratic productivity variation together with network amplifications.
    Keywords: Production Networks; Micro to Macro; Aggregate Volatility; Sectoral Distortions
    JEL: D52 D57 E32 L11
    Date: 2019–02–14
  21. By: Michael Rauscher
    Abstract: The paper uses a continuous-time overlapping-generations model with endogenous growth and pollution accumulation over time to study the link between longevity and global warming. It is seen that increasing longevity accelerates climate change in a business-as-usual scenario without climate policy. If a binding emission target is set exogenously and implemented via a cap-and-trade system, the price of emission permits is increasing in longevity. Longevity has no effect on the optimal solution of the climate problem if perfect intergenerational transfers are feasible. If these transfers are absent, the impact of longevity is ambiguous.
    JEL: Q56 O44 O41 J11 J19
    Date: 2019
  22. By: Werner Roeger; Janos Varga; Jan in 't Veld; Lukas Vogel
    Abstract: This paper studies the effects of structural reforms on the functional distribution of income in EU Member States. To study this mechanism we use a DSGE model (Roeger et al. 2008) with households supplying three types of labour, low-, medium- and high-skilled. We assume that households receive income from labour, tangible capital, intangible capital, financial wealth and transfers and we trace how structural reforms affect these types of incomes. The quantification of structural reforms is based on changes in structural indicators that can significantly close the gap of a country’s average income towards the best performing countries in the EU. We find a general trade-off between an increase in employment of a particular group and the income of the average group member relative to income per capita. In general, reforms which aim at increasing employment of low skilled workers are associated with a fall in wages relative to income per capita. Capital owners generally benefit from labour market reforms, with an increasing share in total income, due to limited entry into the final goods production sector. This suggests that labour market re-forms may lead to suboptimal distributional effects if there are rigidities in goods markets present, a finding which confirms the importance of ensuring that such reforms are accompanied or preceded by product market reforms.
    JEL: C53 E10 F47 O20 O30 O41
    Date: 2019–02

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