nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2019‒07‒22
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 Conesa, Juan Carlos; Kehoe, Timothy J.; Nygard, Vegard; Raveendranathan, Gajendran
  2. The debt multiplier By Alice, Albonico; Guido, Ascari; Alessandro, Gobbi
  3. Limited Asset Market Participation and the Euro Area Crisis. An Empirical DSGE Model By Alice, Albonico; Alessia, Paccagnini; Patrizio, Tirelli
  4. On the Credit and Exchange Rate Channels of Central Bank Asset Purchases in a Monetary Union By Matthieu Darracq Paries; Niki Papadopoulou
  5. International Welfare Spillovers of National Pension Schemes By James Staveley-O'Carroll; Olena Staveley-O'Carroll
  6. A Rational Inattention Unemployment Trap By Ellison, Martin; Macaulay, Alistair
  7. On Financing Retirement, Health Care, and Long-Term Care in Japan By McGrattan, Ellen R.; Miyachi, Kazuaki; Peralta-Alva, Adrian
  8. Evaluating an old-age voluntary saving scheme under incomplete rationality By Artur Rutkowski
  9. Revisiting the Hypothesis of High Discounts and High Unemployment By Martellini, Paolo; Menzio, Guido; Visschers, Ludo
  10. Slow Convergence in Economies with Organization Capital By Luttmer, Erzo G. J.
  11. Empowering Central Bank Asset Purchases: The Role of Financial Policies By Matthieu Darracq Paries; Jenny Korner; Niki Papadopoulou
  12. Charge-offs, Defaults and U.S. Business Cycles By Christopher M. Gunn; Alok Johri; Marc-Andre Letendre
  13. Banking Panic Risk and Macroeconomic Uncertainty By Mikkelsen, Jakob; Poeschl, Johannes
  14. Emergent inequality and endogenous dynamics in a simple behavioral macroeconomic model By Yuki M. Asano; Jakob J. Kolb; Jobst Heitzig; J. Doyne Farmer
  15. Technological Changes, Offshoring, and the Labor Share By Weicheng Lian
  16. Costs and Benefits of Inflation: A Model Analysis of Japan and the U.S. By Tomohide Mineyama; Wataru Hirata; Kenji Nishizaki
  17. Competition and Inequality: Aiyagari meets Bertrand and Cournot By Andrea, Colciago; Rajssa, Mechelli
  18. Mitigating the Cost of Stricter Macroprudential Policies By Pervin Dadashova; Magnus Jonsson
  19. Disinflation in Closed and Small Open Economies By Oleksandr Faryna; Magnus Jonsson; Nadiia Shapovalenko
  20. Forward Guidance: Is It Useful Away from the Lower Bound? By Lilia Maliar; John B. Taylor
  21. Asset price bubbles with low interest rates: not all bubbles are alike By Jacopo Bonchi
  22. Emerging Economy Business Cycles: Interest Rate Shocks vs Trend Shocks By Marc-Andre Letendre; Sabreena Obaid

  1. By: Conesa, Juan Carlos (Stony Brook University); Kehoe, Timothy J. (Federal Reserve Bank of Minneapolis); Nygard, Vegard (Federal Reserve Bank of Minneapolis); Raveendranathan, Gajendran (McMaster University)
    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: 2019–05–08
  2. By: Alice, Albonico; Guido, Ascari; Alessandro, Gobbi
    Abstract: This paper studies the debt multiplier, that is, the effects of a temporary and pure change in government debt on economic activity. Contrary to an infinitely-lived representative agent model, in an overlapping generations (OLG) framework output increases even after a temporary increase in debt due to a lump-sum tax reduction that is totally reversed in the future. When nominal interest rates are positive, the debt multiplier is generally quite small. However, the debt multiplier is much larger when the nominal interest rate is at the zero lower bound. Hence, the call for fiscal consolidation in recession times seems ill-advised. Moreover, the steady state level of debt matters in an OLG framework. Multipliers tend to increase with the level of debt in steady state. A rise in the steady state debt-to-GDP level increases the steady state real interest rate and thus it provides an alternative route to increase the room for manoeuvre for monetary policy facing de flationary shocks.
    Keywords: Fiscal Policy, Public Debt, Multiplier, Overlapping Generations.
    JEL: E52 E62 H63
    Date: 2018–12–20
  3. By: Alice, Albonico; Alessia, Paccagnini; Patrizio, Tirelli
    Abstract: We estimate a medium scale DSGE model for the Euro area with Limited Asset Market Participation (LAMP). Our results suggest that in the recent EMU years LAMP is particularly sizeable (39% during 1993-2012) and important to understand business cycle features. The Bayes factor and the forecasting performance show that the LAMP model is preferred to its representative household counterpart. In the RA model the risk premium shock is the main driver of output volatility in order to match consumption correlation with output. In the LAMP model this role is played by the investment-specific shock, because Non-Ricardian households introduce a Keynesian multiplier effect and raise the correlation between consumption and investments. We also detect contractionary role of monetary policy shocks during the post-2007 years. In this period consumption of Non-Ricardian households fell dramatically, but this outcome might have been avoided by a more aggressive policy stance.
    Keywords: DSGE, Limited Asset Market Participation, Bayesian Estimation, Euro Area, Business Cycle
    JEL: C11 C13 C32 E21 E32 E37
    Date: 2018–11
  4. By: Matthieu Darracq Paries (European Central Bank); Niki Papadopoulou (Central Bank of Cyprus)
    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 Paries 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 heterogeneous 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.
    Keywords: DSGE models; banking; financial regulation; cross-country spillovers; bank lending rates; non-standard measures
    JEL: E4 E5 F4
    Date: 2019–03
  5. By: James Staveley-O'Carroll (Babson College); Olena Staveley-O'Carroll (College of the Holy Cross)
    Abstract: We employ a two-country overlapping-generations model to explore the international dimension of household portfolio choices induced by the asymmetric provision of government-run pensions. We study the resulting patterns of risk-sharing and the corresponding welfare effects on both home and foreign agents. Introducing the de?fined benefi?ts pay-as-you-go system at home increases the welfare of all other agents at the expense of the home workers and improves the degree of intergenerational risk sharing abroad. Conversely, a defi?ned contributions system leads to welfare losses of both home cohorts accompanied by gains abroad, but does increase the extent of intergenerational risk sharing at home.
    Keywords: welfare, pay-as-you-go system, international portfolio choice, OLG model
    JEL: D52 F21 F41 G11 H55
    Date: 2019–07
  6. By: Ellison, Martin; Macaulay, Alistair
    Abstract: We show that introducing rational inattention into a model with uninsurable unemployment risk can generate multiple steady states, when the same model with full information has a unique steady state. The model features heterogeneity and persistence in household labour market expectations, consistent with survey evidence. In a heterogeneous agent New Keynesian model, we find that rational inattention to the future hiring rate generates a high employment steady state with moderate inflation, and an unemployment trap with very low (but positive) inflation and a low job hiring rate.
    Keywords: multiple equilibria; rational inattention; unemployment
    JEL: D83 E10 E24
    Date: 2019–05
  7. By: McGrattan, Ellen R. (Federal Reserve Bank of Minneapolis); Miyachi, Kazuaki (Asia Pacific Department, International Monetary Fund); Peralta-Alva, Adrian (International Monetary Fund)
    Abstract: Japan is facing the problem of how to finance retirement, health care, and long-term care expenditures as the population ages. This paper analyzes the impact of policy options intended to address this problem by employing a dynamic general equilibrium overlapping generations model, specifically parameterized to match both the macro- and microeconomic level data of Japan. We find that financing the costs of aging through gradual increases in the consumption tax rate delivers better macroeconomic performance and higher welfare for most individuals relative to other financing options, including raising social security contributions, debt financing, and a uniform increase in health care and long-term care copayments.
    Keywords: Retirement; Health care; Taxation; Aging; Japan
    JEL: E62 H51 H55 I13
    Date: 2019–06–07
  8. By: Artur Rutkowski
    Abstract: We provide ex ante welfare, fiscal and general macroeconomic evaluation of the voluntary old-age saving scheme recently introduced in Poland (Pracownicze Plany Kapita³owe, Employees’ Capital Plans). ECPs provide tax redemptions as well as lump-sum transfers with the objective to foster old-age savings. Reduction in capital income tax revenues and a rise in expenditure needs to be compensated through adjustment in other taxes. We employ an overlapping generations model (OLG) to gauge the plausible magnitude of the macroeconomic and welfare effects and provide insights in terms of microfoundations of these adjustments. Our OLG model features voluntary participation and innovates relative to the literature by introducing agents with hand-to-mouth preferences. We find relatively high crowding out of private savings. In our preferred specification roughly 0.08 to 0.09 PLN of each 1 PLN allocated to ECPs are actually new savings, the rest being displaced from unincentivized private voluntary savings. The plausible values of the effective capital growth range between 0.03 and 0.42 of 1 PLN in ECPs. ECPs reduce welfare of the fully rational agents, unless they offer a sufficiently large annuity. ECPs provide consumption smoothing and interest income to HTM agents.
    Keywords: overlapping generations, ECPs, incomplete rationality
    JEL: C68 D63 E17 E21 H55
    Date: 2019–07
  9. By: Martellini, Paolo (University of Pennsylvania); Menzio, Guido (New York University); Visschers, Ludo (University of Edinburgh)
    Abstract: We revisit the hypothesis that labor market fluctuations 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, fluctuations 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
  10. By: Luttmer, Erzo G. J. (Federal Reserve Bank of Minneapolis)
    Abstract: Most firms begin very small, and large firms are the result of typically decades of persistent growth. This growth can be understood as the result of some form of organization capital accumulation. In the US, the distribution of firm size k has a right tail only slightly thinner than 1/k. This is shown to imply that incumbent firms account for most aggregate organization capital accumulation. And it implies potentially extremely slow aggregate convergence rates. A benchmark model is proposed in which managers can use incumbent organization capital to create new organization capital. Workers are a specific factor for producing consumption, and they require managerial supervision. Through the lens of the model, the aftermath of the Great Recession of 2008 is unsurprising if the events of late 2008 and early 2009 are interpreted as a destruction of organization capital, or as a belief shock that made consumers want to reduce consumption and accumulate more wealth instead.
    Keywords: Business cycles; Firm size distribution; Slow recoveries; Zipf’s law
    JEL: E32 L11
    Date: 2019–06–26
  11. By: Matthieu Darracq Paries (European Central Bank); Jenny Korner (d-fine - analytical. quantitative. tech.); Niki Papadopoulou (Central Bank of Cyprus)
    Abstract: This paper contributes to the debate on the macroeconomic effectiveness of expansionary non-standard monetary policy measures in a regulated banking environment. Based on an estimated DSGE model, we explore the interactions between central bank asset purchases and bank capital-based financial policies (regulatory, supervisory or macroprudential) through its influence on bank risk-shifting motives. We find that weakly-capitalised banks display excessive risk-taking which reinforces the credit easing channel of central bank asset purchases, at the cost of higher bank default probability and risks to financial stability. In such a case, adequate bank capital demand through higher minimum capital requirements curtails the excessive credit origination and restores a more efficient propagation of central bank asset purchases. As supervisors can formulate further capital demands, uncertainty about the supervisory oversight provokes precautionary motives for banks. They build-up extra capital buffer attenuating non-standard monetary policy. Finally, in a weakly-capitalised banking system, countercyclical macroprudential policy attenuates banks risk-taking and dampens the excessive persistence of the non-standard monetary policy impulse. On the contrary, in a well-capitalised banking system, the macroeconomic stabilisation with central bank asset purchases outweigh the marginal financial stability benefits with macroprudential policy.
    Keywords: non-standard monetary policy; asset purchases; bank capital regulation; risk-taking; regulatory uncertainty; effective lower bound
    JEL: E44 E52 E58
    Date: 2019–02
  12. By: Christopher M. Gunn; Alok Johri; Marc-Andre Letendre
    Abstract: We uncover a new fact: U.S. banks counter-cyclically vary the ratio of charge-offs to defaulted loans. The variance of this ratio is roughly 15 times larger than that of GDP. Canonical financial accelerator models cannot explain this variance. We show that introducing stochastic default costs into the model helps to resolve the discrepancy with the data. Estimating the augmented model using Bayesian techniques reveals that the estimated default cost shocks not only help account for the variance of the banking data but also help account for a significant fraction of the U.S. business cycle between 1984 and 2015.
    Keywords: Charge-offs and defaults, default cost shocks, financial accelerator models, business cycles.
    JEL: E3 E44
    Date: 2019–07
  13. By: Mikkelsen, Jakob; Poeschl, Johannes
    Abstract: We show that systemic risk in the banking sector breeds macroeconomic uncertainty. In a production economy with a banking sector, financial constraints of banks can lead to disastrous banking panics. We find that a higher probability of a banking panic increases uncertainty in the aggregate economy. We explore the implications of this banking panic-driven uncertainty for business cycles, asset prices and macroprudential regulation. Banking panic-driven uncertainty amplifies business cycle volatility, increases risk premia on asset prices and yields a new benefit from countercyclical bank capital buffers.
    Keywords: Banking Panics, Systemic Risk, Endogenous Uncertainty, Macroprudential Policy
    JEL: E44 G12 G21 G28
    Date: 2019–06–27
  14. By: Yuki M. Asano; Jakob J. Kolb; Jobst Heitzig; J. Doyne Farmer
    Abstract: Standard macroeconomic models assume that households are rational in the sense that they are perfect utility maximizers, and explain economic dynamics in terms of shocks that drive the economy away from the stead-state. Here we build on a standard macroeconomic model in which a single rational representative household makes a savings decision of how much to consume or invest. In our model households are myopic boundedly rational heterogeneous agents embedded in a social network. From time to time each household updates its savings rate by copying the savings rate of its neighbor with the highest consumption. If the updating time is short, the economy is stuck in a poverty trap, but for longer updating times economic output approaches its optimal value, and we observe a critical transition to an economy with irregular endogenous oscillations in economic output, resembling a business cycle. In this regime households divide into two groups: Poor households with low savings rates and rich households with high savings rates. Thus inequality and economic dynamics both occur spontaneously as a consequence of imperfect household decision making. Our work here supports an alternative program of research that substitutes utility maximization for behaviorally grounded decision making.
    Date: 2019–07
  15. By: Weicheng Lian
    Abstract: Existing studies on the downward trend in the labor share of income mostly focus on changes within individual countries. I document, however, that half of the global decline in the labor share of income can be traced to the relocation of activities between countries. I develop a two-country model to show that when the relative price of investment goods falls, production activities with a small elasticity of substitution between capital and labor tend to get offshored from high- to low-wage countries. The model provides an explanation as to why such relocation may drive the labor share down in both developed and developing economies, as well as globally.
    Date: 2019–07–02
  16. By: Tomohide Mineyama (Bank of Japan); Wataru Hirata (Bank of Japan); Kenji Nishizaki (Bank of Japan)
    Abstract: Analyzing the costs and benefits of inflation has been a primary subject in monetary economics. This article presents a summary of Mineyama, Hirata, and Nishizaki (2019), which investigates the relationship between inflation and social welfare expressed as the economic satisfaction of households for Japan and the U.S. The authors' analysis employs a New Keynesian model which embeds the major factors affecting the costs and benefits of inflation. The analysis suggests (1) social welfare is maximized when the steady-state inflation rate, the level to which the inflation rate converges in the long run, is close to two percent for both Japan and the U.S.; and (2) around one percentage point absolute deviation from the close-to-two-percent rate induces only a minor change in social welfare. Note, however, that the estimates are subject to a considerable margin of error due to parameter uncertainty in the zero lower bound of nominal interest rates.
    Keywords: Inflation; Social welfare; New Keynesian model; Downward nominal wage rigidity; Zero lower bound; Forward guidance
    JEL: E31 E43 E52
    Date: 2019–07–09
  17. By: Andrea, Colciago; Rajssa, Mechelli
    Abstract: This paper provides an incomplete markets model with oligopolistic competition among an endogenous number of producers. The model matches the empirical distribution of income and wealth in the United States. The interaction between oligopolistic competition and incomplete markets reconciles the increase in the profit share of income with the decrease in the labor share of income and the increase in income inequality observed over the last three decades in the United States. Welfare costs associated with an increase in market power are large and unequally distributed across households.
    Date: 2019–01
  18. By: Pervin Dadashova (National Bank of Ukraine); Magnus Jonsson (Sveriges Riksbank)
    Abstract: We examine how to implement macroprudential policies – stricter capital requirements and loan-tovalue limits – in order to mitigate the output loss of corporate debt deleveraging. The analysis is performed in a dynamic general equilibrium model calibrated to fit the U.S. economy. Stricter capital requirements are generally costlier in terms of output losses than stricter loan-to-value limits. For both instruments, the output loss is a convex function of the debt-to-GDP ratio. Finally, the output loss can be significantly reduced by implementing the requirements gradually, and by activating a countercyclical capital buffer.
    Keywords: capital requirements, loan-to-value requirements, output loss, gradual implementation
    JEL: C54 E44 G28 G38
    Date: 2019–06
  19. By: Oleksandr Faryna (National Bank of Ukraine); Magnus Jonsson (Sveriges Riksbank); Nadiia Shapovalenko (National Bank of Ukraine)
    Abstract: This paper examines the cost of disinflation as measured by the sacrifice ratio and the central bank loss function in closed and small open economies. We show that the sacrifice ratio is slightly higher in the small open economy if monetary policy in both economies follow identical Taylor rules. However, if monetary policies follow optimized simple rules the sacrifice ratio becomes slightly lower in the small open economy. The cost in terms of the central bank loss is higher in the small open economy irrespective of monetary policies. Imperfect central bank credibility changes the results quantitatively, but not qualitatively. Finally, in both economies, the optimal implementation horizon is approximately two quarters in advance and approximately four quarters if central bank credibility is imperfect.
    Keywords: disinflation, small open economy, new Keynesian model, imperfect credibility, implementation
    JEL: E31 E5 F41
    Date: 2019–03
  20. By: Lilia Maliar; John B. Taylor
    Abstract: During the recent economic crisis, when nominal interest rates were at their effective lower bounds, central banks used forward guidance announcements about future policy rates to conduct their monetary policy. Many policymakers believe that forward guidance will remain in use after the end of the crisis; however, there is uncertainty about its effectiveness. In this paper, we study the impact of forward guidance in a stylized new Keynesian economy away from the effective lower bound on nominal interest rates. Using closed-form solutions, we show that the impact of forward guidance on the economy depends critically on a specific monetary policy rule, ranging from non-existing to immediate and unrealistically large, the so-called forward guidance puzzle. We show that the size of the smallest root (or eigenvalue) captures model dynamics better than the underlying parameters. We argue that the puzzle occurs under very special empirically implausible and socially sub-optimal monetary policy rules, whereas empirically relevant Taylor rules lead to sensible implications.
    JEL: C5 E4 E5
    Date: 2019–07
  21. By: Jacopo Bonchi
    Abstract: I extend a standard two-period OLG model to investigate the interplay between the risks of a binding zero lower bound and asset price bubbles in a low interest rates environment. The nature of the bubble is crucial when the risk-free real interest rate is low because there is a negative natural interest rate. Bubbles are fully leveraged when they are sustained by borrowers, or they are fully unleveraged when they are sustained by lenders. Leveraged bubbles emerge naturally when there is a negative natural interest rate, and they are more likely to collapse. Unleveraged bubbles appear, in contrast, if the natural rate of interest is extremely low and the probability of the bubble bursting is not extremely high. Both bubbles are more likely to emerge with a high inflation target and will potentially be larger, but only leveraged bubbles substantially mitigate the risk of a zero lower bound episode by raising the natural rate of interest
    Keywords: zero lower bound, low interest rates, asset price bubbles, inflation target
    JEL: E43 E44 E52
    Date: 2019–01–23
  22. By: Marc-Andre Letendre; Sabreena Obaid
    Abstract: The recent literature studying the source of business cycles in emerging market economies (EMEs) has debated the relative importance of productivity trend shocks versus interest rate shocks coupled with financial frictions. Importantly, the papers where an important role was assigned to interest rate shocks did not force their models to match the historical paths of the world or country interest rate. This could have led to poorly identified interest rate shocks and inaccurate measures of contributions of shocks to EME business cycles. To address this issue, we estimate a small open economy model for Argentina and Mexico using Bayesian methods where world and country interest rate series are included as observables. This estimation strategy brings quantitative accuracy by imposing discipline on the estimated shocks. Although we find evidence in favour of both shocks, including interest rates as observables, shifts explanatory power away from trend shocks towards interest rate shocks.
    Keywords: Business Fluctuations; Cycles; Financial Markets and the Macroeconomy
    JEL: F44 E44
    Date: 2019–07

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