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on Dynamic General Equilibrium |
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Issue of 2019‒08‒19
eighteen papers chosen by Christian Zimmermann Federal Reserve Bank of St. Louis |
| By: | Michinao Okachi (Economist, Institute for Monetary and Economic Studies, Bank of Japan (currently, Department of Economics, Graduate School of Economics and Management, Tohoku University, E-mail: michinao.okachi.e5@tohoku.ac.jp)) |
| Abstract: | The Greek sovereign default episode in 2012 was characterized by its high debt-to-GDP ratio and the severe economic contraction following the default. Conventional strategic default models designed to analyze a government's incentive to default often fail to replicate these characteristics. To address this issue, we provide a dynamic stochastic general equilibrium (DSGE) model where a sovereign default is triggered by the government's inability to repay its debt. We show that the inability-to-repay model replicates the empirical features observed in Greece, while the conventional strategic default model calibrated to the Greek economy does not. |
| Keywords: | Sovereign Default, Dynamic Stochastic General Equilibrium, Inability to Repay Debt, Strategic Decision to Default, Fiscal Limit, Laffer Curve |
| JEL: | E32 E44 F34 H63 |
| Date: | 2019–07 |
| URL: | http://d.repec.org/n?u=RePEc:ime:imedps:19-e-10&r=all |
| By: | Julio A. Carrillo (Banco de México (E-mail: jcarrillo@banxico.org.mx)); Enrique G. Mendoza (University of Pennsylvania (E-mail: egme@sas.upenn.edu)); Victoria Nuguer (Inter-American Development Bank (E-mail: victorian@iadb.org)); Jessica Roldán-Peña (Banco de México (E-mail: jroldan@banxico.org.mx)) |
| Abstract: | Violations of Tinbergen's Rule and strategic interaction undermine monetary and financial policies significantly in a New Keynesian model with the Bernanke-Gertler accelerator. Welfare costs of risk shocks are large because of efficiency losses and income effects of costly monitoring, but they are larger under a simple Taylor rule (STR) and a Taylor rule augmented with credit spreads (ATR) than under a dual rules regime (DRR) with a Taylor rule and a financial rule targeting spreads, by 264 and 138 basis points respectively. ATR and STR are tight money-tight credit regimes that respond too much to inflation and not enough to spreads, and yield larger fluctuations in response to risk shocks. Reaction curves display shifts from strategic substitutes to complements in the choice of policy-rule elasticities. The Nash equilibrium is also a tight money-tight credit regime, with welfare 30 basis points lower than in Cooperative equilibria and the DRR, but still sharply higher than in the ATR and STR regimes. |
| Keywords: | Monetary policy, Financial frictions, Macroprudential policy, Leaning against the wind, Policy coordination |
| JEL: | E3 E44 E52 G18 |
| Date: | 2019–07 |
| URL: | http://d.repec.org/n?u=RePEc:ime:imedps:19-e-08&r=all |
| By: | Hirose, Yasuo (Keio University); Kurozumi, Takushi (Bank of Japan) |
| Abstract: | The empirical importance of news shocks—anticipated future shocks—in business cycle fluctuations has been explored by using only actual data when estimating models augmented with news shocks. This paper additionally exploits forecast data to identify news shocks in a canonical dynamic stochastic general equilibrium model. The estimated model shows new empirical evidence that technology news shocks are a major source of fluctuations in U.S. output growth. Exploiting the forecast data not only generates more precise estimates of news shocks and other parameters in the model, but also increases the contribution of technology news shocks to the fluctuations. |
| Keywords: | Business Cycle Fluctuation; Technology Shock; Technology News Shock; Forecast Data; Bayesian Estimation |
| JEL: | E30 E32 |
| Date: | 2019–05–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:feddgw:366&r=all |
| By: | Rangan Gupta (Department of Economics, University of Pretoria, Pretoria, South Africa); Philton Makena (Department of Economics, University of Pretoria, Pretoria, South Africa) |
| Abstract: | We develop an overlapping generations monetary endogenous growth (generated by productive public expenditures) model with inflation targeting, characterized by relocation shocks for young agents, which in turn generates a role for money (even in the presence of the return-dominating physical capital) and financial intermediaries. Based on this model, we show that two distinct growth paths emerge conditional on a threshold value of the share of physical capital in the production function. Along one path, we find convergence to a single stable equilibrium, and on the other path, we find multiple equilibria: a stable low-growth and an unstable high-growth, with the stable low-growth equilibrium found to be locally indeterminate. Since, government expenditure is productive in our model, a higher inflation-target would translate into higher growth, but under multiple equilibria, this is not necessarily always the case. |
| Keywords: | Endogenous Growth, Inflation Targeting, Growth Dynamics |
| JEL: | C62 O41 O42 |
| Date: | 2019–08 |
| URL: | http://d.repec.org/n?u=RePEc:pre:wpaper:201960&r=all |
| By: | Francesco Bianchi; Giovanni Nicolo |
| Abstract: | We propose a novel approach to deal with the problem of indeterminacy in Linear Rational Expectations models. The method consists of augmenting the original state space with a set of auxiliary exogenous equations to provide the adequate number of explosive roots in presence of indeterminacy. The solution in this expanded state space, if it exists, is always determinate, and is identical to the indeterminate solution of the original model. The proposed approach accommodates determinacy and any degree of indeterminacy, and it can be implemented even when the boundaries of the determinacy region are unknown. Thus, the researcher can estimate the model using standard packages without restricting the estimates to the determinacy region. We apply our method to estimate the New-Keynesian model with rational bubbles by Galí (2017) over the period 1982:Q4 until 2007:Q3. We find that the data support the presence of two degrees of indeterminacy, implying that the central bank was not reacting strongly enough to the bubble component. |
| Keywords: | Bayesian methods ; General Equilibrium ; Indeterminacy ; Solution method |
| JEL: | C19 C63 C51 C62 |
| Date: | 2019–05 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2019-33&r=all |
| By: | Jang, Youngsoo |
| Abstract: | How do defaults and bankruptcies affect optimal health insurance policy? I answer this question using a life-cycle model of health investment with the option to default on emergency room (ER) bills and financial debts. I calibrate the model for the U.S. economy and compare the optimal health insurance in the baseline economy with that in an economy with no option to default. With no option to default, the optimal health insurance is similar to the health insurance system in the baseline economy. In contrast, with the option to default, the optimal health insurance system (i) expands the eligibility of Medicaid to 22 percent of the working-age population, (ii) replaces 72 percent of employer-based health insurance with a private individual health insurance plus a progressive subsidy, and (iii) reforms the private individual health insurance market by improving coverage rates and preventing price discrimination against people with pre-existing conditions. This result implies that with the option to default, households rely on bankruptcies and defaults on ER bills as implicit health insurance. More redistributive healthcare reforms can improve welfare by reducing the dependence on this implicit health insurance and changing households’ medical spending behavior to be more preventative. |
| Keywords: | Credit, Default, Bankruptcy, Optimal Health Insurance |
| JEL: | E21 H51 I13 K35 |
| Date: | 2019–07 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:95397&r=all |
| By: | Philip Coyle; Taisuke Nakata |
| Abstract: | In expectations-driven liquidity traps, a higher inflation target is associated with lower inflation and consumption. As a result, introducing the possibility of expectations-driven liquidity traps to an otherwise standard model lowers the optimal inflation target. Using a calibrated New Keynesian model with an effective lower bound (ELB) constraint on nominal interest rates, we find that even a very small probability of falling into an expectations-driven liquidity trap lowers the optimal inflation target nontrivially. Our analysis provides a reason to be cautious about the argument that central banks should raise their inflation targets in light of a higher likelihood of hitting the ELB. |
| Keywords: | Liquidity Traps ; Optimal Inflation Target ; Sunspot Shock ; Zero Lower Bound |
| JEL: | E52 E63 E32 E62 E61 |
| Date: | 2019–05–17 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2019-36&r=all |
| By: | Saki Bigio (University of California, Los Angeles and NBER); Yuliy Sannikov (Stanford Business School and NBER) |
| Abstract: | A model integrates a modern implementation of monetary policy (MP) into an incomplete markets monetary economy. Policy sets corridor rates and conducts open-market operations and fiscal transfers. These tools grant independent control over credit spreads and inflation. We study the implementation of spreads and inflation via different MP instruments. Through its influence on spreads, MP affects the evolution of real credit, interests, output, and wealth distribution (both in the long and the short run). We decompose effects through different transmission channels. We study the optimal spread management and find that the active management of spreads is a desirable target. |
| Keywords: | Monetary Economics, Monetary Policy, Credit Channel |
| JEL: | E31 E32 E41 E44 E52 |
| Date: | 2019–08 |
| URL: | http://d.repec.org/n?u=RePEc:apc:wpaper:150&r=all |
| By: | Lee, Michael Junho (Federal Reserve Bank of New York); Neuhann, Daniel (University of Texas at Austin) |
| Abstract: | We study a dynamic model of collateralized lending under adverse selection in which the quality of collateral assets is endogenously determined by hidden effort. Complementarities in incentives lead to non-ergodic dynamics: Asset quality and output grow when asset quality is high, but stagnate or deteriorate otherwise. Inefficiencies remain, even in the most efficient competitive equilibrium—investment and output are vulnerable to spells of lending market illiquidity, and these spells may persist because of suboptimal effort. Nevertheless, benevolent regulators without commitment can destroy welfare by prioritizing liquidity over incentives. Optimal interventions with commitment call for large, long-term subsidies in excess of what is required to restore liquidity. |
| Keywords: | liquidity; government intervention; adverse selection; collateral |
| JEL: | E44 E50 G01 G18 |
| Date: | 2019–08–07 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:894&r=all |
| By: | Abdoulaye Millogo (Département d'économique, Université de Sherbrooke); Jean-François Rouillard (Département d'économique, Université de Sherbrooke) |
| Abstract: | In line with New-Keynesian predictions and certain historical trajectories that tracked by inflation during past crises, the context of the Great Recession should have spurred a sharp fall in inflation or even deflation. On the contrary, the sensitivity of inflation to changes in unemployment has diminished, giving rise to the paradox of missing disinflation. By investigating this paradox, this article develops a variant of the New-Keynesian models where mechanisms of depreciation of human capital are implemented. In the model, rising unemployment translates into a relatively large increase in long-term unemployment. Unemployed people with low levels of human capital become dominant and more workers are now likely to suffer from depreciation of human capital. The depreciation weakens the intensity with which the unemployed prospect new jobs and moderates the decline in wages and prices. Calibrated to the United States economy, model simulations show that this model variant compares relatively better the highlights of missing disinflation than a New-Keynesian without depreciation of human capital. In response to shocks of the same size, the response of inflation in the model with depreciation of human capital is 3 to 4-fold less than in standard New-Keynesian models. |
| Keywords: | Missing Disinflation, Deflation, Human Capital Depreciation, Unemployment, Great Recession |
| JEL: | E31 E32 J24 |
| Date: | 2019–08 |
| URL: | http://d.repec.org/n?u=RePEc:shr:wpaper:19-03&r=all |
| By: | Jean-Marc Fournier |
| Abstract: | A fiscal reaction function to debt and the cycle is built on a buffer-stock model for the government. This model inspired by the buffer-stock model of the consumer (Deaton 1991; Carroll 1997) includes a debt limit instead of the Intertemporal Budget Constraint (IBC). The IBC is weak (Bohn, 2007), a debt limit is more realistic as it reflects the risk of losing market access. This risk increases the welfare cost of fiscal stimulus at high debt. As a result, the higher the debt, the less governments should smooth the cycle. A larger reaction of interest rates to debt and higher hysteresis magnify this interaction between the debt level and the appropriate reaction to shocks. With very persistent shocks, the appropriate reaction to negative shocks in highly indebted countries can even be procyclical. |
| Date: | 2019–07–22 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:19/159&r=all |
| By: | Jonathan Benchimol; Lahcen Bounader |
| Abstract: | The form of bounded rationality characterizing the representative agent is key in the choice of the optimal monetary policy regime. While inflation targeting prevails for myopia that distorts agents' inflation expectations, price level targeting emerges as the optimal policy under myopia regarding the output gap, revenue, or interest rate. To the extent that bygones are not bygones under price level targeting, rational inflation expectations is a minimal condition for optimality in a behavioral world. Instrument rules implementation of this optimal policy is shown to be infeasible, questioning the ability of simple rules à la Taylor (1993) to assist the conduct of monetary policy. Bounded rationality is not necessarily associated with welfare losses. |
| Date: | 2019–08–02 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:19/166&r=all |
| By: | Korfhage, T.; |
| Abstract: | In this paper, I estimate a dynamic structural model of labor supply, retirement, and informal care supply, incorporating labor market frictions and the German tax and benefit system. I find that informal elderly care has adverse and persistent effects on labor market outcomes and therefore negatively affects lifetime earnings, future pension benefits, and individuals'well-being. These consequences of caregiving are heterogeneous and depend on age, previous earnings, and institutional regulations. Policy simulations suggest that, even though fiscally costly, public long-term care insurance can offset the personal costs of caregiving to a large extent - in particular for low-income individuals. |
| Keywords: | long-term care; informal care; long-term care insurance; labor supply; retirement; pension benefits; structural model; |
| JEL: | I18 I38 J14 J22 J26 |
| Date: | 2019–08 |
| URL: | http://d.repec.org/n?u=RePEc:yor:hectdg:19/17&r=all |
| By: | Taisuke Nakata; Sebastian Schmidt |
| Abstract: | We study optimal monetary and fiscal policy in a New Keynesian model where occasional declines in agents' confidence give rise to persistent liquidity trap episodes. There is no straightforward recipe for enhancing welfare in this economy. Raising the inflation target or appointing an inflation-conservative central banker mitigates the inflation shortfall away from the lower bound but exacerbates deflationary pressures at the lower bound. Using government spending as an additional policy instrument worsens allocations at and away from the lower bound. However, appointing a policymaker who is sufficiently less concerned with government spending stabilization than society eliminates expectations-driven liquidity traps. |
| Keywords: | Effective Lower Bound ; Sunspot Equilibria ; Monetary Policy ; Fiscal Policy ; Discretion ; Policy Delegation |
| JEL: | E62 E61 E52 |
| Date: | 2019–07–17 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2019-53&r=all |
| By: | Fiorella De Fiore; Oreste Tristani |
| Abstract: | We study the optimal combination of interest rate policy and unconventional monetary policy in a model where agency costs generate a spread between deposit and lending rates. We show that credit policy can be a powerful substitute for interest rate policy. In the face of shocks that negatively affect banks' monitoring efficiency, unconventional measures insulate the real economy from further deterioration in financial conditions and it may be optimal for the central bank not to cut rates to zero. Thus, credit policy lowers the likelihood of hitting the zero bound constraint. Reductions in the policy rates without non-standard measures are suboptimal as they inefficiently force savers to change their intertemporal consumption patterns. |
| Keywords: | optimal monetary policy, unconventional policies, zero-lower bound, asymmetric information |
| JEL: | E44 E52 E61 |
| Date: | 2019–08 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:804&r=all |
| By: | Hanno Förster |
| Abstract: | In many countries divorce law mandates post-marital maintenance payments (child support and alimony) to insure the lower earner in married couples against financial losses upon divorce. This paper studies how maintenance payments affect couples’ intertemporal decisions and welfare. I develop a dynamic model of family labor supply, housework, savings and divorce and estimate it using Danish register data. The model captures the policy trade off between providing insurance to the lower earner and enabling couples to specialize efficiently, on the one hand, and maintaining labor supply incentives for divorcees, on the other hand. I use the estimated model to analyze counterfactual policy scenarios in which child support and alimony payments are changed. The welfare maximizing maintenance policy is to triple child support payments and reduce alimony by 12.5% relative to the Danish status quo. Switching to the welfare maximizing policy makes men worse off, but comparisons to a first best scenario reveal that Pareto improvements are feasible, highlighting the limitations of maintenance policies. |
| Keywords: | marriage and divorce, child support, alimony, household behavior, labor supply, limited commitment |
| JEL: | D10 D91 J18 J12 J22 K36 |
| Date: | 2019–08 |
| URL: | http://d.repec.org/n?u=RePEc:bon:boncrc:crctr224_2019_115&r=all |
| By: | Falter, Alexander |
| Abstract: | This paper builds a macro model with a financial sector and a housing market to understand the transmission and effects of macroprudential instruments addressing mortgage credit. The model compares the introduction of a loan-to-value ratio (LTV), a countercyclical capital buffer (CCyB)-style rule and sectoral constraints similar to sectoral risk weights. The results show that instruments work largely as intended and are to different extents suitable to dampen credit booms. Moreover, there is a trade-off between effectiveness, i.e. the extent to which instruments are able to dampen credit booms, and efficiency, i.e. the extent to which instruments might exhibit unintended consequences for the financial sector or real economy. General shocks, where housing credit increases as a side effect of larger movements, might warrant the use of the CCyB or also sectoral risk weights to correct for sector specific developments. Simple sectoral shocks can be dealt with or responded to first with sectoral risk weights. The LTV is much more effective than sectoral risk weights in confining credit growth, but shows less efficiency due to strong substitution effects. |
| Keywords: | Macroprudential Regulation,Mortgage Markets,Housing Markets,Asset Markets,Waterbed Effects |
| JEL: | E31 G21 |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bubdps:252019&r=all |
| By: | Maria, Ferrara; Patrizio, Tirelli |
| Abstract: | We investigate the redistributive and welfare effects of disinflation in a two-agent New Keynesian (TANK) model characterized by Limited Asset Market Participation (LAMP) and wealth inequality. We highlight two key mechanisms driving our long-run results: i) the cash in advance constraint on firms working capital (CIA); ii) dividends endogeneity. These two channels point in opposite directions. Lower inflation softens the CIA and, by raising labor demand, lowers inequality. But the disinflation also raises dividends and this increases inequality. The disinflation is always welfare-improving for asset holders. We obtain ambiguous results for non-asset holders, who suffer substantial consumption losses during the transition. |
| Keywords: | Firms Pricing, Disinflation, Inequality, Welfare Economics |
| JEL: | E31 E5 D3 D6 |
| Date: | 2019–02 |
| URL: | http://d.repec.org/n?u=RePEc:mib:wpaper:402&r=all |