nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2019‒07‒29
33 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Monetary Policy and Sovereign Risk in Emerging Economies (NK-Default)* By Cristina Arellano; Yan Bai
  2. Sticky Price versus Sticky Information Price: Empirical Evidence in the New Keynesian Setting By Drissi, Ramzi; Ghassan, Hassan B.
  3. Quantifying the Benefits of Labor Mobility in a Currency Union By Christopher L. House; Christian Proebsting; Linda L. Tesar
  4. Austerity in the Aftermath of the Great Recession By Christopher L. House; Christian Proebsting; Linda L. Tesar
  5. A Model for International Spillovers to Emerging Markets By Romain Houssa; Jolan Mohimont; Chris Otrok
  6. Multinational Expansion in Time and Space By Stefania Garetto; Lindsay Oldenski; Natalia Ramondo
  7. Schooling Investment, Mismatch,and Wage Inequality By Andrew Shephard; Modibo Sidibe
  8. Confidence Collapse in a Multi-Household, Self-Reflexive DSGE Model By Federico Guglielmo Morelli; Michael Benzaquen; Marco Tarzia; Jean-Philippe Bouchaud
  9. Bank Assets, Liquidity and Credit Cycles By Lubello, Frederico; Petrella, Ivan; Santoro, Emiliano
  10. History Remembered: Optimal Sovereign Default on Domestic and External Debt By D'Erasmo, Pablo; Mendoza, Enrique G.
  11. Selective Hiring and Welfare Analysis in Labor Market Models By Merkl, Christian; Rens, Thijs van
  12. Online Estimation of DSGE Models By Michael Cai; Marco Del Negro; Edward Herbst; Ethan Matlin; Reca Sarfati; Frank Schorfheide
  13. Political Economy of Taxation, Debt Ceilings, and Growth By Uchida, Yuki; Ono, Tetsuo
  14. Evaluating Central Banks' Tool Kit: Past, Present, and Future By Eric R. Sims; Jing Cynthia Wu
  15. Samuelson's Contributions to Population Theory and Overlapping Generations in Economics By Lee, Ronald D.
  16. Foreign Direct Investment as a Determinant of Cross-Country Stock~Market Comovement By Alexis Anagnostopoulos; Orhan Erem Atesagaoglu; Elisa Faraglia; Chryssi Giannitsarou
  17. Bounded Rationality, Monetary Policy, and Macroeconomic Stability By Francisco Ilabaca; Greta Meggiorini; Fabio Milani
  18. The Four Equation New Keynesian Model By Eric R. Sims; Jing Cynthia Wu
  19. Existence and Uniqueness of Solutions to the Stochastic Bellman Equation with Unbounded Shock By Juan Pablo Rinc\'on-Zapatero
  20. The Wife's Protector: The Effect of Contraception on Marriage during the 20th Century By Jeremy Greenwood; Nezih Guner; Karen A. Kopecky
  21. Robots or Workers? A Macro Analysis of Automation and Labor Markets By Leduc, Sylvain; Liu, Zheng
  22. On the Heterogeneous Welfare Gains and Losses from Trade By Carroll, Daniel R.; Hur, Sewon
  23. Sovereign Default and Imperfect Tax Enforcement By Francesco Pappadà; Yanos Zylberberg
  24. Fear of taxes By Leal-Ordoñez Julio C.; Mandujano Javier
  25. Global Capital Flows and the Role of Macroprudential Policy By Sudipto Karmakar; Diogo Lima
  26. Regional Effects of Exchange Rate Fluctuations By Christopher L. House; Christian Proebsting; Linda L. Tesar
  27. Partial Default By Cristina Arellano; Xavier Mateos-Planas; Jose-Victor Rios-Rull
  28. Imperfect Risk-Sharing and the Business Cycle By David W. Berger; Luigi Bocola; Alessandro Dovis
  29. The Real Interest Rate Channel is Structural in Contemporary New-Keynesian Models By Joshua Brault; Hashmat Khan
  30. Risk Pooling, Leverage, and the Business Cycle By Pietro Dindo; Andrea Modena; Loriana Pelizzon
  31. Data and the Aggregate Economy By Laura Veldkamp
  32. Macro as Explicitly Aggregated Micro By Emmanuel Farhi
  33. Quantifying Market Power By Jan Eeckhout

  1. By: Cristina Arellano; Yan Bai
    Abstract: This paper develops a New Keynesian model with sovereign debt and default. We focus on domestic interest rules governing monetary policy and external foreign currency government debt that is defaultable. Monetary policy and default risk interact as they both impact domestic consumption and production. We find that default risk generates monetary frictions, which amplify the monetary response to shocks. Large sovereign default risk depresses domestic consumption and production. These monetary frictions in turn discipline sovereign borrowing, resulting in slower debt accumulation and lower spreads. Our framework replicates the positive co-movements of sovereign spreads with domestic nominal rates and inflation, a salient feature of emerging markets data, and can rationalize the experience of Brazil during the 2015 downturn, with high inflation, nominal rates, and sovereign spreads. A counterfactual experiment shows that, by raising the domestic rate, the Brazilian central bank not only reduced inflation but also alleviated the debt crisis.
    Date: 2019
  2. 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
  3. By: Christopher L. House (University of Michigan & NBER); Christian Proebsting (Ecole Polytechnique Federale de Lausanne); Linda L. Tesar (University of Michigan & NBER)
    Abstract: Unemployment differentials are bigger in Europe than in the United States. Migration responds to unemployment differentials, though the response is smaller in Europe. Mundell (1961) argued that factor mobility is a precondition for a successful currency union. We use a multi-country DSGE model with cross-border migration and search frictions to quantify the benefits of increased labor mobility in Europe and compare this outcome to a case of fully flexible exchange rates. Labor mobility and flexible exchange rates both work to reduce unemployment and per capita GDP differentials across countries provided that monetary policy is sufficiently responsive to national output.
    Keywords: Labor mobility, currency union, unemployment
    JEL: E24 E42 E52 E58 F15 F16 F22 F33
    Date: 2018–12
  4. By: Christopher L. House (University of Michigan & NBER); Christian Proebsting (Ecole Polytechnique Federale de Lausanne); Linda L. Tesar (University of Michigan & NBER)
    Abstract: Cross-country differences in austerity, defined as government purchases below forecast, account for 75 percent of the observed cross-sectional variation in GDP in advanced economies during 2010-2014. Statistically, austerity is associated with lower GDP, lower inflation and higher net exports. A multi-country DSGE model calibrated to 29 advanced economies generates effects of austerity consistent with the data. Counterfactuals suggest that eliminating austerity would have substantially reduced output losses in Europe. Austerity was so contractionary that debt-to-GDP ratios in some countries increased as a result of endogenous reductions in GDP and tax revenue.
    Keywords: Austerity, Fiscal Policy, Multi-Country DSGE Model
    JEL: E62 F41 F44
    Date: 2019–02–07
  5. By: Romain Houssa; Jolan Mohimont; Chris Otrok
    Abstract: This paper develops a small open economy (SOE) dynamic stochastic general equilibrium (DSGE) model that helps to explain business cycle synchronization between an emerging market and advanced economies. The model captures the specificities of both economies (e.g. primary commodity, manufacturing, intermediate inputs, and credit) that are most relevant for understanding the importance as well as the transmission mechanisms of a wide range of domestic and foreign (supply, demand, monetary policy, credit, primary commodity) shocks facing an emerging economy. We estimate the model with Bayesian methods using quarterly data from South Africa, the US and G7 countries. In contrast to the predictions of standard SOE models, we are able to replicate two stylized facts. First, our model predicts a high degree of business cycle synchronization between South Africa and advanced economies. Second, the model is able to account for the influence of foreign shocks in South Africa. We are also able to demonstrate the specific roles these shocks played during key historical episodes such as the global financial crisis in 2008 and the commodity price slump in 2015. The ability of our framework to capture endogenous responses of commodity and financial sectors to structural shocks is crucial to identify the importance of these shocks in South Africa.
    Keywords: macroeconomic policies, emerging markets, SOE, DSGE, Bayesian, foreign shocks, monetary policy
    JEL: E30 E43 E52 C51 C33
    Date: 2019
  6. By: Stefania Garetto (BU, CEPR, and NBER); Lindsay Oldenski (Georgetown University); Natalia Ramondo (UCSD and NBER)
    Abstract: This paper studies the expansion patterns of the multinational enterprise (MNE) in time and space. Using a long panel of US MNEs, we document that: MNE affiliates grow by exporting to new markets; the activities of MNE affiliates persist during the affiliate’s life, usually starting with sales to their host market and eventually expanding to export markets; and MNE affiliates’ entry into new locations does not depend on the location of preexisting affiliates. Informed by these facts, we develop a multi-country quantitative dynamic model of the MNE that features heterogeneity in firm-level productivity, persistent aggregate shocks, and a rich structure of costs that affect MNE expansion. Importantly, MNE affiliates can decouple their locations of production and sales, and endogenously choose to enter or exit the host and the export markets. We introduce a compound option formulation that allows us to capture in a tractable way the rich heterogeneity that is observed in the data and that is necessary for quantitative analysis. Using the calibrated model, our quantitative application to Brexit reveals that export platforms are important for understanding the reallocation of MNE activity in time and space, and that the nature of the frictions to MNE activities matters for aggregate firm dynamics.
    Keywords: Economic Growth, Innovation, Credit Constraints, Convergence, Policy Analysis, Money, Inflation
    JEL: O11 O23 O31 O33 O38 O42
    Date: 2019–04
  7. By: Andrew Shephard (Department of Economics, University of Pennsylvania); Modibo Sidibe (Department of Economics, Duke University)
    Abstract: This paper examines how policies, aimed at increasing the supply of education in the economy, affect the matching between workers and firms, and the wages of various skill groups. We build an equilibrium model where workers endogenously invest in education, while firms direct their technology toward skill intensive production activities. Search frictions induce mismatch on both extensive (unemployment) and intensive (over-education) margins, with ensuing wage consequences. We estimate the model using NLSY and O*NET data, and propose an ex-ante evaluation of prominent educational policies. We find that higher education cost subsidies boost college attainment, produce substantial welfare gains in general equilibrium, but increase wage inequality. These changes are associated with a substantial upward shift in the distribution of job complexity, which leads to worse allocations for high-school graduates who end up under-educated in less productive firms, while highly-educated workers match with more productive firms and experience less over-education during their careers.
    Keywords: Human capital, education policy, wage inequality, job search, technology choice, equilibrium
    JEL: I22 I24 J6 J21 J23 J24 J31 J64
    Date: 2019–07–17
  8. By: Federico Guglielmo Morelli; Michael Benzaquen; Marco Tarzia; Jean-Philippe Bouchaud
    Abstract: We investigate a multi-household DSGE model in which past aggregate consumption impacts the confidence, and therefore consumption propensity, of individual households. We find that such a minimal setup is extremely rich, and leads to a variety of realistic output dynamics: high output with no crises; high output with increased volatility and deep, short lived recessions; alternation of high and low output states where relatively mild drop in economic conditions can lead to a temporary confidence collapse and steep decline in economic activity. The crisis probability depends exponentially on the parameters of the model, which means that markets cannot efficiently price the associated risk premium. We conclude by stressing that within our framework, {\it narratives} become an important monetary policy tool, that can help steering the economy back on track.
    Date: 2019–07
  9. By: Lubello, Frederico (Bank Centrale du Luxembourg); Petrella, Ivan (University of Warwick); Santoro, Emiliano (University of Copenhagen)
    Abstract: We study how bank collateral assets and their pledgeability affect the amplitude of credit cycles. To this end, we develop a tractable model where bankers intermediate funds between savers and borrowers. If bankers default, savers acquire the right to liquidate bankers’assets. However, due to the vertically integrated structure of our credit economy, savers anticipate that liquidating financial assets (i.e., loans) is conditional on borrowers being solvent on their debt obligations. This friction limits the collateralization of bankers’financial assets beyond that of real assets (i.e., capital). In this context, increasing the pledgeability of financial assets eases more credit and reduces the spread between the loan and the deposit rate, thus attenuating capital misallocation as it typically emerges in credit economies à la Kiyotaki and Moore (1997). We uncover a close connection between the collateralization of bank loans, macroeconomic amplification and the degree of procyclicality of bank leverage.
    Keywords: banking ; bank collateral; liquidity ; capital misallocation; macroprudential policy;
    JEL: E32 E44 G21 G28
    Date: 2019
  10. By: D'Erasmo, Pablo (Federal Reserve Bank of Philadelphia); Mendoza, Enrique G. (University of Pennsylvania)
    Abstract: Infrequent but turbulent overt sovereign defaults on domestic creditors are a “for- gotten history” in macroeconomics. We propose a heterogeneous-agents model in which the government chooses optimal debt and default on domestic and foreign creditors by balancing distributional incentives versus the social value of debt for self-insurance, liquidity, and risk-sharing. A rich feedback mechanism links debt issuance, the distribution of debt holdings, the default decision, and risk premia. Calibrated to Eurozone data, the model is consistent with key long-run and debt-crisis statistics. Defaults are rare (1.2 percent frequency) and preceded by surging debt and spreads. Debt sells at the risk-free price most of the time, but the government’s lack of commitment reduces sustainable debt sharply.
    Keywords: public debt; sovereign default; debt crisis; European crisis
    JEL: E44 E6 F34 H63
    Date: 2019–07–22
  11. By: Merkl, Christian (Friedrich-Alexander-University Erlangen-Nuremberg, CESifo and IZA); Rens, Thijs van (University of Warwick, Centre for Macroeconomics, IZA and CEPR)
    Abstract: Firms select not only how many, but also which workers to hire. Yet, in most labor market models all workers have the same probability of being hired. We argue that selective hiring crucially a⁄ects welfare analysis. We set up a model that is isomorphic to a search model under random hiring but allows for selective hiring. With selective hiring, the positive predictions of the model change very little, but implications for welfare are di⁄erent for two reasons. First, a hiring externality occurs with random but not with selective hiring. Second, the welfare costs of unemployment are much larger with selective hiring, because unemployment risk is distributed unequally across workers.
    Keywords: labor market models ; welfare ; optimal unemployment insurance
    JEL: E24 J65
    Date: 2019
  12. By: Michael Cai (Northwestern University); Marco Del Negro (FRB New York); Edward Herbst (Federal Reserve Board); Ethan Matlin (FRB New York); Reca Sarfati (FRB New York); Frank Schorfheide (Department of Economics, University of Pennsylvania)
    Abstract: This paper illustrates the usefulness of sequential Monte Carlo (SMC) methods in approximating DSGE model posterior distributions. We show how the tempering schedule can be chosen adaptively, explore the benefits of an SMC variant we call generalized tempering for \online" estimation, and provide examples of multimodal posteriors that are well captured by SMC methods. We then use the online estimation of the DSGE model to compute pseudo-out-of-sample density forecasts of DSGE models with and without financial frictions and document the benefits of conditioning DSGE model forecasts on nowcasts of macroeconomic variables and interest rate expectations. We also study whether the predictive ability of DSGE models changes when we use priors that are substantially looser than those that are commonly adopted in the literature.
    Keywords: Adaptive algorithms, Bayesian inference, density forecasts, online estimation, sequential Monte Carlo methods
    JEL: C11 C32 C53 E32 E37 E52
    Date: 2019–07–22
  13. By: Uchida, Yuki; Ono, Tetsuo
    Abstract: This study presents voting on policies including public education, taxes, and public debt in an overlapping-generations model with physical and human capital accumulation and analyzes the effects of a debt ceiling on the government's policy formation and its impact on growth and welfare. The debt ceiling induces the government to shift the tax burdens from the older to younger generations and increase public education spending, resulting in a higher growth rate. However, it creates a trade-off between generations in terms of welfare. Alternatively, the debt ceiling is measured from the viewpoint of a benevolent planner; lowering the debt ceiling makes it possible for the government to approach the planner's allocation in an aging society.
    Keywords: Debt ceiling; Probabilistic voting, Public debt, Economic growth, Overlapping generations
    JEL: D70 E24 H63
    Date: 2019–07–15
  14. By: Eric R. Sims; Jing Cynthia Wu
    Abstract: We develop a structural DSGE model to systematically study the principal tools of unconventional monetary policy – quantitative easing (QE), forward guidance, and negative interest rate policy (NIRP) – as well as the interactions between them. To generate the same output response, the requisite NIRP and forward guidance interventions are twice as large as a conventional policy shock, which seems implausible in practice. In contrast, QE via an endogenous feedback rule can alleviate the constraints on conventional policy posed by the zero lower bound. Quantitatively, QE1-QE3 can account for two thirds of the observed decline in the “shadow” Federal Funds rate. In spite of its usefulness, QE does not come without cost. A large balance sheet has consequences for different normalization plans, the efficacy of NIRP, and the effective lower bound on the policy rate.
    JEL: E10 E32 E5 E52 E58
    Date: 2019–07
  15. By: Lee, Ronald D. (University of California, Berkeley)
    Abstract: Paul Samuelson made a series of important contributions to population theory for humans and other species, evolutionary theory, and the theory of age structured life cycles in economic equilibrium and growth. The work is highly abstract but much of it was intended to illuminate issues of compelling policy importance, such as declining fertility and population aging. While his work in population economics has been very influential, his work in population and evolution appears to have been largely overlooked, perhaps because he seldom published in demographic journals or went to population meetings. Here I discuss his many contributions in all these areas, but give particular attention to demographic aspects of his famous work on overlapping generation models, social security systems, and population growth.
    Keywords: Samuelson, overlapping generations, social security, population growth rate, reproductive value, population cycles, intergenerational transfers, predator-prey, altruism
    JEL: J11 J18 Q57 H55 D64
    Date: 2019–06
  16. By: Alexis Anagnostopoulos; Orhan Erem Atesagaoglu; Elisa Faraglia; Chryssi Giannitsarou
    Abstract: We develop a theoretical framework in order to investigate the link between two recent trends: (i) the rise in cross-country stock market correlations over the past three decades, and (ii) the increase in global foreign direct investment (FDI) positions over the same period. Our objective is twofold: first, we investigate empirically the channel through which the rise in global stock market correlations is associated with the observed increase in global FDI. Second, we develop a two-country stochastic asset pricing model with multinational firms that allows us to quantify the extent to which the recent rise in global FDI can account for the observed increase in cross-country stock market comovement. Calibrating three versions of the model (finnancial autarky, incomplete markets and complete markets) to the US and the rest-of-the-world, we find that a permanent inrcease in FDI positions, as observed from mid 1990s to mid 2000s, leads to substantial increase in cross-country stock market comovements. Increases in FDI alone can account for approximately one third of the observed increase in stock market correlations. We also discuss the role of portfolio diversification and, more generally, asset market integration.
    Date: 2019
  17. By: Francisco Ilabaca; Greta Meggiorini; Fabio Milani
    Abstract: This paper estimates a Behavioral New Keynesian model to revisit the evidence that passive US monetary policy in the pre-1979 sample led to indeterminate equilibria and sunspot-driven fluctuations, while active policy after 1982, by satisfying the Taylor principle, was instrumental in restoring macroeconomic stability. The model assumes “cognitive discounting”, i.e., consumers and firms pay less attention to variables further into the future. We estimate the model allowing for both determinacy and indeterminacy. The empirical results show that determinacy is preferred both before and after 1979. Even if monetary policy is found to react only mildly to inflation pre-Volcker, the substantial degrees of bounded rationality that we estimate prevent the economy from falling into indeterminacy.
    Keywords: Behavioral New Keynesian model, cognitive discounting, estimation under determinacy and indeterminacy, Taylor principle, active vs passive monetary policy
    JEL: E31 E32 E52 E58
    Date: 2019
  18. By: Eric R. Sims; Jing Cynthia Wu
    Abstract: This paper develops a New Keynesian model featuring financial intermediation, short and long term bonds, credit shocks, and scope for unconventional monetary policy. The log-linearized model reduces to four key equations – a Phillips curve, an IS equation, and policy rules for the short term nominal interest rate and the central bank's long bond portfolio (QE). The four equation model collapses to the standard three equation New Keynesian model under a simple parameter restriction. Credit shocks and QE appear in both the IS and Phillips curves. Optimal monetary policy entails adjusting the short term interest rate to offset natural rate shocks, but using QE to offset credit market disruptions. The ability of the central bank to engage in QE significantly mitigates the costs of a binding zero lower bound.
    JEL: E1 E50 E52
    Date: 2019–07
  19. By: Juan Pablo Rinc\'on-Zapatero
    Abstract: In this paper we develop a general framework to analyze stochastic dynamic problems with unbounded utility functions and correlated and unbounded shocks. We obtain new results of the existence and uniqueness of solutions to the Bellman equation through a general fixed point theorem that generalizes known results for Banach contractions and local contractions. We study an endogenous growth model as well as the Lucas asset pricing model in an exchange economy, significantly expanding their range of applicability.
    Date: 2019–07
  20. By: Jeremy Greenwood (University of Pennsylvania); Nezih Guner (Centro de Estudios Monetarios y Financieros (CEMFI)); Karen A. Kopecky (Federal Reserve Bank of Atlanta)
    Abstract: The 19th and 20th centuries saw a transformation in contraceptive technologies and their take up. This led to a sexual revolution, which witnessed a rise in premarital sex and out-of-wedlock births, and a decline in marriage. The impact of contraception on married and single life is analyzed here both theoretically and quantitatively. The analysis is conducted using a model where people search for partners. Upon finding one, they can choose between abstinence, marriage, and a premarital sexual relationship. The model is confronted with some stylized facts about premarital sex and marriage over the course of the 20th century. Some economic history is also presented.
    Keywords: age of marriage, contraceptive technology, never-married population, number of partners, out-of-wedlock births, premarital sex, singles
    Date: 2019–07
  21. By: Leduc, Sylvain (Federal Reserve Bank of San Francisco); Liu, Zheng (Federal Reserve Bank of San Francisco)
    Abstract: We study the implications of automation for labor market fluctuations in a Diamond-Mortensen-Pissarides (DMP) framework that is generalized to incorporate automation decisions. If a job opening is not filled with a worker, a firm can choose to automate that position and use a robot instead of a worker to produce output. The threat of automation strengthens the firm's bargaining power against job seekers in wage negotiations, depressing equilibrium real wages in a business cycle boom. The option of automation also increases the value of a vacancy, raising the incentive for job creation, and thereby amplifying fluctuations in vacancies and unemployment relative to the standard DMP framework. Since automation improves labor productivity while muting wage increases, it implies a countercyclical labor income share, as observed in the data.
    JEL: E32 J63 J64
    Date: 2019–07–18
  22. By: Carroll, Daniel R. (Federal Reserve Bank of Cleveland); Hur, Sewon (Federal Reserve Bank of Cleveland)
    Abstract: How are the gains and losses from trade distributed across individuals within a country? First, we document that tradable goods and services constitute a larger fraction of expenditures for low-wealth and low-income households. Second, we build a trade model with nonhomothetic preferences—to generate the documented relationship between tradable expenditure shares, income, and wealth—and uninsurable earnings risk—to generate heterogeneity in income and wealth. Third, we use the calibrated model to quantify the differential welfare gains and losses from trade along the income and wealth distribution. In a numerical exercise, we permanently reduce trade costs so as to generate a rise in import share of GDP commensurate with that seen in the data from 2001 to 2014. We find that households in the lowest wealth decile experience welfare gains over the transition, measured by permanent consumption equivalents, that are 67 percent larger than those in the highest wealth decile.
    Keywords: trade gains; inequality; consumption;
    JEL: E21 F10 F13
    Date: 2019–07–19
  23. By: Francesco Pappadà; Yanos Zylberberg
    Abstract: We show that, in many countries, tax compliance is volatile and markedly responds to fiscal policy. To explore the consequence of this novel stylized fact, we build a model of sovereign debt with limited commitment and imperfect tax enforcement. Fiscal policy persistently affects the size of the informal economy, which impact future fiscal revenues and thus default risk. This mechanism captures one key empirical regularity of economies with imperfect tax enforcement: the low sensitivity of debt price to fiscal consolidations. The interaction of imperfect tax enforcement and limited commitment strongly constrains the dynamics of optimal fiscal policy. During default crises, high tax distortions force the government towards extreme fiscal policies, notably including costly austerity spells.
    Keywords: sovereign default, imperfect tax enforcement, informal economy, fiscal policy
    JEL: E02 E32 E62 F41 H20
    Date: 2019
  24. By: Leal-Ordoñez Julio C.; Mandujano Javier
    Abstract: This paper documents that Mexican households anticipated the fiscal reform of 2014 several months before enacted. This change in expectations is documented using a novel source of information available in Google Trends, among other sources. It then analyzes the economic consequences of this change using a general equilibrium growth model with taxes and uncertainty. The model also considers the presence of generic distortions in the form of wedges in the first order conditions to isolate the effect of taxation. The paper provides an explanation for the unusual trajectories of investment and GDP of the Mexican economy around 2013.
    Keywords: business cycles;expectations;taxes;investment
    JEL: E30 E22 E62
    Date: 2019–06
  25. By: Sudipto Karmakar; Diogo Lima
    Abstract: Can countercyclical bank capital requirements reduce the negative effects ofglobal liquidity shocks? We use the Lehman Brothers bankruptcy as a natural experiment to document the role of the banking system as a transmission channel of global financial disturbances to domestic economies. Using granular and confidential data from the Bank of Portugal, our results suggest that in the aftermath of the Lehman collapse, domestic firms cut investment by 14% and employment by 2.3%.In order to evaluate the effectiveness of macroprudential regulation, we model an open-economy with a banking sector borrowing from domestic and in-ternational depositors. We show that, during a financial crises, in an economy with counter cyclical bank capital requirements(compared with an economy with constant capital requirements):(i) gross domestic product falls 5 p.p. less and (ii)the fall in investment is 3 p.p. lower. We show that imposing countercyclical capital requirements entails a trade-off between lower volatility and lower economic activity.Overall, we find that countercyclical bank capital requirements may not be welfare improving for the Portuguese economy.
    Date: 2019–07
  26. By: Christopher L. House (University of Michigan & NBER); Christian Proebsting (Ecole Polytechnique Federale de Lausanne); Linda L. Tesar (University of Michigan & NBER)
    Abstract: We exploit differences across U.S. states in terms of their exposure to trade to study the effects of changes in the exchange rate on economic activity at the business cycle frequency. We find that a depreciation in the state-specific trade-weighted real exchange rate is associated with an increase in exports, a decline in unemployment and an increase in hours worked. The effect is particularly strong in periods of economic slack. We develop a multi-region model with inter-state trade and labor flows and calibrate it to match the state-level orientation of exports and the extent of labor migration and trade between states. The model replicates the relationship between exchange rates and unemployment. Counterfactuals show that the high degree of interstate trade plays a dominant role in transmitting shocks across states in the first year, whereas interstate migration shapes cross-sectional patterns in following years. The model suggests that a 25% Chinese import tariff on U.S. goods would be felt throughout the United States, even in states with small direct linkages to China, raising unemployment rates by 0.2 to 0.7 percentage points in the short run.
    Keywords: Regions, exchange-rate fluctuations
    JEL: F22 F41
  27. By: Cristina Arellano (Federal Reserve Bank of Minneapolis; University of Minnesota; NBER); Xavier Mateos-Planas (Queen Mary University of London; Centre for Macroeconomics); Jose-Victor Rios-Rull (University of Pennsylvania; UCL; CAERP; CEPR; NBER)
    Abstract: In the data sovereign default is always partial and varies in its duration. Debt levels during default episodes initially increase and do not experience reductions upon resolution. This paper presents a theory of sovereign default that replicates these properties, which are absent in standard sovereign default theory. Partial default is a flexible way to raise funds as the sovereign chooses its intensity and duration. Partial default is also costly because it amplifies debt crises as the defaulted debt accumulates and interest rate spreads increase. This theory is capable of rationalizing the large heterogeneity in partial default, its comovements with spreads, debt levels, and output, and the dynamics of debt during default episodes. In our theory, as in the data, debt grows during default episodes, and large defaults are longer, and associated with higher interest rate spreads, higher debt levels, and deeper recessions.
    Date: 2019–07
  28. By: David W. Berger; Luigi Bocola; Alessandro Dovis
    Abstract: This paper studies the aggregate implications of imperfect risk-sharing implied by a class of New Keynesian models with idiosyncratic income risk and incomplete financial markets. The models in this class can be equivalently represented as an economy with a representative household that has state-dependent preferences. These preference “shocks” are functions of households’ consumption shares and relative wages in the original economy with heterogeneous agents, and they summarize all the information from the cross-section that is relevant for aggregate fluctuations. Our approach is to use this representation as a measurement device: we use the Consumption Expenditure Survey to measure the preference shocks, and feed them into the equivalent representative-agent economy to perform counterfactuals. We find that deviations from perfect risk-sharing were an important determinant of the behavior of aggregate demand during the US Great Recession.
    JEL: E32 E44
    Date: 2019–07
  29. By: Joshua Brault (Department of Economics, Carleton University); Hashmat Khan (Department of Economics, Carleton University)
    Abstract: The monetary transmission mechanism in a New-Keynesian model with contemporary features is put to scrutiny. In contrast to Rupert and Sustek (2019), we find that the real interest rate channel is structural when the model contains empirically realistic frictions on the flow of investment. A monetary contraction (expansion) is always followed by an increase (decrease) in the real interest rate. The monetary transmission mechanism indeed operates through the real interest rate channel in this class of models.
    Keywords: New-Keynesian models, monetary transmission mechanism, real interest rate
    JEL: E24 E32 E43
    Date: 2019–07–06
  30. By: Pietro Dindo (Department of Economics, University Of Venice Cà Foscari); Andrea Modena (Department of Economics, University Of Venice Cà Foscari); Loriana Pelizzon (Department of Economics, University Of Venice Cà Foscari; SAFE-Goethe University Frankfurt)
    Abstract: This paper investigates the interdependence between the risk-pooling activity of the financial sector and: output, consumption, risk-free rate, and Sharpe ratio in a dynamic general equilibrium model of a productive economy. Due to their exposure to idiosyncratic shocks and market segmentation, heterogeneous households/entrepreneurs (h/entrepreneurs) are willing to mitigate their risk through a financial sector. The financial sector pools risky claims issued by different firms within its assets, faces an associated intermediation cost and, via leverage, provides a risk-free asset to h/entrepreneurs. Exogenous systematic shocks change the relative size of the financial sector, and thus the equilibrium amount of pooled risk, making financial leverage state-dependent and counter-cyclical. We study how this mechanism endogenously channels amplification of consumption and mitigation of output fluctuations. In equilibrium, financial sector leverage also determines counter-cyclical Sharpe ratios and pro-cyclical risk-free interest rates. Last, we investigate the relationship between the size of the financial sector, leverage, and welfare. We show that limiting financial sector leverage determines a sub-optimal pooling of idiosyncratic risk but fosters the growth rate of the h/entrepreneurs' consumption. On the other side, when the financial sector is too large, it destroys too many resources after intermediation costs. Therefore, the h/entrepreneurs benefit the most when the financial sector is neither too small nor too big.
    Keywords: Amplification, Business Cycle, Financial Frictions, Leverage, Risk Pooling
    JEL: E13 E32 E69 G12
    Date: 2019
  31. By: Laura Veldkamp (Columbia University)
    Abstract: Slides for plenary talk delivered at the annual meeting of the Society for Economic Dynamics.
    Date: 2019
  32. By: Emmanuel Farhi (Harvard University)
    Abstract: Slides for plenary talk delivered at the annual meeting of the Society for Economic Dynamics.
    Date: 2019
  33. By: Jan Eeckhout (Universitat Pompeu Fabra)
    Abstract: Slides for plenary talk delivered at the annual meeting of the Society for Economic Dynamics.
    Date: 2019

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