nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2019‒11‒11
thirty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Going Negative at the Zero Lower Bound: The Effects of Negative Nominal Interest Rates By Ulate, Mauricio
  2. Scarred Consumption By Ulrike Malmendier; Leslie Sheng Shen
  3. Default Recovery Rates and Aggregate Fluctuations By Giacomo Candian; Mikhail Dmitriev
  4. Long-term business relationships, bargaining and monetary policy By Mirko Abbritti; Asier Aguilera-Bravo; TommasoTrani
  5. Dominant-Currency Pricing and the Global Output Spillovers from U.S. Dollar Appreciation By Georgiadis, Georgios; Schumann, Ben
  6. Indeterminacy and Imperfect Information By Lubik, Thomas A.; Matthes, Christian; Mertens, Elmar
  7. Capital Controls and Firm Performance By Eugenia Andreasen; Sofía Bauducco; Evangelina Dardati
  8. Implications of money-back guarantees for individual retirement accounts: Protection then and now By Horneff, Vanya; Liebler, Daniel; Maurer, Raimond; Mitchell, Olivia S.
  9. Consumption in the Great Recession: The Financial Distress Channel By Athreya, Kartik B.; Mather, Ryan; Mustre-del-Rio, Jose; Sanchez, Juan M.
  10. Global v. Local Methods in the Analysis of Open-Economy Models with Incomplete Markets By Oliver de Groot; Ceyhun Bora Durdu; Enrique G. Mendoza
  11. Effects of subsidies on growth and welfare in a quality-ladder model with elastic labor By Hu, Ruiyang; Yang, Yibai; Zheng, Zhijie
  12. On the Heterogeneous Welfare Gains and Losses from Trade By Carroll, Daniel R.; Hur, Sewon
  13. The collateralizability premium By Ai, Hengjie; Li, Jun E.; Li, Kai; Schlag, Christian
  14. Unemployment, Partial Insurance, and the Multiplier Effects of Government Spending By Givens, Gregory
  15. Debt Limits and Credit Bubbles in General Equilibrium By Martins-da-Rocha, V. Filipe; Phan, Toan; Vailakis, Yiannis
  16. Endogenous Leverage and Default in the Laboratory By Cipriani, Marco; Fostel, Ana; Houser, Daniel
  17. Employment Effects of Income Tax Reforms: Lessons from Slovakia By Michal Horváth; Zuzana Siebertová
  18. The Economic Effects of Trade Policy Uncertainty By Dario Caldara; Matteo Iacoviello; Patrick Molligo; Andrea Prestipino; Andrea Raffo
  19. Convergence, productivity and debt: the case of Hungary By Daniel Baksa; Istvan Konya
  20. Synergizing Ventures By Akcigit, Ufuk; Dinlersoz, Emin M.; Greenwood, Jeremy; Penciakova, Veronika
  21. The Distributional Impact of Labour Market Reforms: A Model-Based Assessment By Werner Roeger; Janos Varga; Jan in't Veld; Lukas Vogel
  22. Fiscal Stimulus Under Sovereign Risk By Javier Bianchi; Pablo Ottonello; Ignacio Presno
  23. The Dynamics of the Racial Wealth Gap By Aliprantis, Dionissi; Carroll, Daniel R.; Young, Eric R.
  24. Spatial Wage Gaps and Frictional Labor Markets By Heise, Sebastian; Porzio, Tommaso
  25. The Politics of Flat Taxes By Carroll, Daniel R.; Dolmas, James; Young, Eric R.
  26. On the Special Role of Deposits for Long-Term Lending By Perazzi, Elena
  27. Optimal Policy for Macro-Financial Stability By Benigno, Gianluca; Chen, Huigang; Otrok, Christopher; Rebucci, Alessandro; Young, Eric R.
  28. MoNK: Mortgages in a New-Keynesian Model By Carlos Carriga; Finn E. Kydland; Roman Sustek
  29. What Does Financial Crisis Tell Us About Exporter Behavior and Credit Reallocation? By Jiao, Yang; Wen, Yi
  30. How to Starve the Beast: Fiscal and Monetary Policy Rules By Martin, Fernando M.
  31. Partial Default By Arellano, Cristina; Mateos-Planas, Xavier; Rios-Rull, Jose-Victor

  1. By: Ulate, Mauricio (Federal Reserve Bank of San Francisco)
    Abstract: After the Great Recession several central banks started setting negative nominal interest rates in an expansionary attempt, but the effectiveness of this measure remains unclear. Negative rates can stimulate the economy by lowering the rates that commercial banks charge on loans, but they can also erode bank profitability by squeezing deposit spreads. This paper studies the effects of negative rates in a new DSGE model where banks intermediate the transmission of monetary policy. I use bank-level data to calibrate the model and find that monetary policy in negative territory is between 60% and 90% as effective as in positive territory.
    JEL: E32 E44 E52 E58 G21
    Date: 2019–08–27
  2. By: Ulrike Malmendier; Leslie Sheng Shen
    Abstract: We show that prior lifetime experiences can "scar" consumers. Consumers who have lived through times of high unemployment exhibit persistent pessimism about their future financial situation and spend significantly less, controlling for the standard life-cycle consumption factors, even though their actual future income is uncorrelated with past experiences. Due to their experience-induced frugality, scarred consumers build up more wealth. We use a stochastic lifecycle model to show that the negative relationship between past experiences and consumption cannot be generated by financial constraints, income scarring, and unemployment scarring, but is consistent with experience-based learning.
    Keywords: Household consumption ; Experience effects ; Expectation ; Lifecycle model
    JEL: D12 D83 D91
    Date: 2019–10–09
  3. By: Giacomo Candian (HEC Montreal); Mikhail Dmitriev (Department of Economics, Florida State University)
    Abstract: Default recovery rates in the US are highly volatile and pro-cyclical. We show that stateof-the-art models with a Bernanke-Gertler-Gilchrist financial accelerator mechanism imply that recovery rates are flat over the cycle. We propose a model where financially constrained entrepreneurs face an idiosyncratic cost of redeploying liquidated capital. The resulting endogenous liquidation costs magnify the effect of the financial accelerator. We fit the model to US data and find that it explains a substantial amount of variation in recovery rates. Our mechanism alters the transmission of structural disturbances and leads to novel policy implications about the effectiveness of subsidies for liquidated assets.
    Keywords: Financial accelerator; financial frictions; recovery rates; liquidation costs
    JEL: C68 E44 E61
    Date: 2019–09
  4. By: Mirko Abbritti (University of Navarra); Asier Aguilera-Bravo (Public University of Navarra and INARBE); TommasoTrani (University of Navarra)
    Abstract: A growing empirical literature documents the importance of long-term relationships and bargaining for price rigidity and firms' dynamics. This paper introduces long-term business-to-business (B2B) relationships and price bargaining into a standard monetary DSGE model. The model is based on two assumptions: first, both wholesale and retail producers need to spend resources to form new business relationships. Second, once a B2B relationship is formed, the price is set in a bilateral bargaining between firms. The model provides a rigorous framework to study the effect of long-term business relationships and bargaining on monetary policy and business cycle dynamics. It shows that, for a standard calibration of the product market, these relationships reduce both the allocative role of intermediate prices and the real effects of monetary policy shocks. We also find that the model does a good job in replicating the second moments and cross-correlations of the data, and that it improves over the benchmark New Keynesian model in explaining some of them.
    Keywords: Monetary Policy, PriceBargaining, ProductMarketSearch, B2B
    JEL: E52 E3 D4 L11
    Date: 2019–10–28
  5. By: Georgiadis, Georgios (European Central Bank); Schumann, Ben (European Central Bank)
    Abstract: Different export-pricing currency paradigms have different implications for a host of issues that are critical for policymakers such as business cycle co-movement, optimal monetary policy, optimum currency areas and international monetary policy coordination. Unfortunately, the literature has not reached a consensus on which pricing paradigm best describes the data. Against this background, we test for the empirical relevance of dominant-currency pricing (DCP). Specifically, we first set up a structural three-country New Keynesian dynamic stochastic general equilibrium model which nests DCP, producer-currency pricing (PCP) and local-currency pricing (LCP). In the model, under DCP the output spillovers from shocks that appreciate the U.S. dollar multilaterally decline with an economy's export-import U.S. dollar pricing share differential, i.e., the difference between the share of an economy's exports and imports that are priced in the dominant currency. Underlying this prediction is a change in an economy's net exports in response to multilateral changes in the U.S. dollar exchange rate that arises because of differences in the extent to which exports and imports are priced in the dominant currency. We then confront this prediction of DCP with the data in a sample of up to 46 advanced and emerging-market economies for the time period from 1995 to 2018. Specifically, controlling for other cross-border transmission channels, we document that consistent with the prediction from DCP the output spillovers from U.S. dollar appreciation correlate negatively with recipient economies' export-import U.S. dollar invoicing share differentials. We document that these findings are robust to considering U.S. demand, U.S. monetary policy and exogenous exchange rate shocks as a trigger of U.S. dollar appreciation, as well as to accounting for the role of commodity trade in U.S. dollar invoicing.
    Keywords: Dominant-currency pricing; U.S. shocks; spillovers
    JEL: C50 E52 F42
    Date: 2019–09–04
  6. By: Lubik, Thomas A. (Federal Reserve Bank of Richmond); Matthes, Christian (Federal Reserve Bank of Richmond); Mertens, Elmar (Deutsche Bundesbank)
    Abstract: We study equilibrium determination in an environment where two kinds of agents have different information sets: The fully informed agents know the structure of the model and observe histories of all exogenous and endogenous variables. The less informed agents observe only a strict subset of the full information set. All types of agents form expectations rationally, but agents with limited information need to solve a dynamic signal extraction problem to gather information about the variables they do not observe. We show that for parameter values that imply a unique equilibrium under full information, the limited information rational expectations equilibrium can be indeterminate. We illustrate our framework with a monetary policy problem where an imperfectly informed central bank follows an interest rate rule.
    Keywords: Limited information; rational expectations; Kalman filter; belief shocks
    JEL: C11 C32 E52
    Date: 2019–10–08
  7. By: Eugenia Andreasen; Sofía Bauducco; Evangelina Dardati
    Abstract: This paper studies the effects of capital controls on firms' production, investment and exporting decisions. We empirically characterize the firm's responses to the introduction of a capital control, using the Chilean encaje implemented between 1991 and 1998 as a laboratory. Motivated by our findings, we build a general equilibrium model with heterogeneous firms, financial constraints and international trade and calibrate it to the Chilean economy. We find that capital controls re- duce aggregate production and investment while increasing exports, the share of exporters and TFP. The effects of capital controls are exacerbated for firms in more capital-intensive sectors and for exporters.
    Date: 2019–10
  8. By: Horneff, Vanya; Liebler, Daniel; Maurer, Raimond; Mitchell, Olivia S.
    Abstract: In the wake of the financial crisis and continued volatility in international capital markets, there is growing interest in mechanisms that can protect people against retirement account volatility. This paper explores the consequences for savers' wellbeing of implementing market-based retirement account guarantees, using a life cycle consumption and portfolio choice model where investors have access to stocks, bonds, and tax-qualified retirement accounts. We evaluate the case of German Riester plans adopted in 2002, an individual retirement account produce that includes embedded mandatory money-back guarantees. These guarantees influenced participant consumption, saving, and investment behavior in the higher interest rate environment of that era, and they have even larger impacts in a low-return world such as the present. Importantly, we conclude that abandoning these guarantees could enhance old-age consumption for over 80% of retirees, particularly lower earners, without harming consumption during the accumulation phase. Our results are of general interest for other countries implementing default investment options in individual retirement accounts, such as the U.S. 401(k) defined contribution plans and the Pan European Pension Product (PEPP) recently launched by the European Parliament.
    Keywords: individual retirement account,investment guarantee,longevity risk,retirement income,lifecycle model
    JEL: D14 D91 G11
    Date: 2019
  9. By: Athreya, Kartik B. (Federal Reserve Bank of Richmond); Mather, Ryan (Federal Reserve Bank of St. Louis); Mustre-del-Rio, Jose (Federal Reserve Bank of Kansas City); Sanchez, Juan M. (Federal Reserve Bank of St. Louis)
    Abstract: During the Great Recession, the collapse of consumption across the U.S. varied greatly but systematically with house-price declines. We find that financial distress among U.S. households amplified the sensitivity of consumption to house-price shocks. We uncover two essential facts: (1) the decline in house prices led to an increase in household financial distress prior to the decline in income during the recession, and (2) at the zip-code level, the prevalence of financial distress prior to the recession was positively correlated with house-price declines at the onset of the recession. Using a rich-estimated-dynamic model to measure the financial distress channel, we find that these two facts amplify the aggregate drop in consumption by 7 percent and 45 percent respectively.
    Keywords: Consumption; Credit Card; Mortgage; Bankruptcy; Foreclosure; Delinquency; Financial Distress; Great Recession
    JEL: D31 D58 E21 E44 G11 G12 G21
    Date: 2019–09–17
  10. By: Oliver de Groot; Ceyhun Bora Durdu; Enrique G. Mendoza
    Abstract: Global and local methods are widely used in international macroeconomics to analyze incomplete-markets models. We study solutions for an endowment economy, an RBC model and a Sudden Stops model with an occasionally binding credit constraint. First-order, second-order, risky steady state (RSS), and DynareOBC solutions are compared v. fixed-point-iteration global solutions in the time and frequency domains. The solutions differ in key respects, including measures of precautionary savings, cyclical moments, impulse response functions, financial premia and macro responses to credit constraints, and periodograms of consumption, foreign assets and net exports. The global method is easy to implement and fast albeit slower than local methods, except DynareOBC which is of comparable speed. These findings favor global methods except when prevented by the curse of dimensionality and urge caution when using local methods. Of the latter, first-order solutions are preferable because results are very similar to second-order and RSS methods.
    JEL: E44 E47 F41 F44 F47
    Date: 2019–11
  11. By: Hu, Ruiyang; Yang, Yibai; Zheng, Zhijie
    Abstract: This paper develops a quality-ladder growth model with elastic labor supply and distortionary taxes to analyze the effects of different subsidy instruments: subsidies to the production of final goods, subsidies to the purchase of intermediate goods, and subsidies to research and development (R&D). The model is calibrated to the US data to compare the growth and welfare implications of these subsidies. The main results are as follows. First, a coordination of all instruments attains the social optimum. Second, as for the use of a single instrument, the R&D subsidy is less growth-enhancing and welfare-improving than the other subsidies. Finally, as for the use of a mix of any two instruments, subsidizing the production of final goods and the purchase of intermediate goods is most effective in promoting growth but least effective in raising welfare.
    Keywords: Economic Growth; R&D; Quality Ladder; Subsidies
    JEL: D61 E62 O31 O38
    Date: 2019–11–04
  12. 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 57 percent larger than those in the highest wealth decile.
    Keywords: trade gains; inequality; consumption;
    JEL: E21 F10 F13 F62
    Date: 2019–09–23
  13. By: Ai, Hengjie; Li, Jun E.; Li, Kai; Schlag, Christian
    Abstract: A common prediction of macroeconomic models of credit market frictions is that the tightness of financial constraints is countercyclical. As a result, theory implies a negative collateralizability premium; that is, capital that can be used as collateral to relax financial constraints provides insurance against aggregate shocks and commands a lower risk compensation compared with non-collateralizable assets. We show that a longshort portfolio constructed using a novel measure of asset collateralizability generates an average excess return of around 8% per year. We develop a general equilibrium model with heterogeneous firms and financial constraints to quantitatively account for the collateralizability premium.
    Keywords: Cross-Section of Returns,Financial Frictions,Collateral Constraint
    JEL: E2 E3 G12
    Date: 2019
  14. By: Givens, Gregory
    Abstract: I interpret the empirical evidence on government spending multipliers using an equilibrium model of unemployment in which workers are not fully insured against the risk of job loss. Consumption of resources by the government affects aggregate spending along two margins: (i) an intensive margin owing to a fall in household wealth and (ii) an extensive margin that accounts for growth in the working population. At insurance levels below a certain threshold, the positive effects of (ii) dominate the negative effects of (i), leading to multipliers for private consumption and output that exceed zero and one. Similar results appear in a quantitative version of the model scaled to match estimates from micro data on the consumption cost of unemployment.
    Keywords: Government Spending Multipliers, Unemployment Insurance, Shirking Models
    JEL: E13 E24 E32 E62 H50 J41
    Date: 2019–11
  15. By: Martins-da-Rocha, V. Filipe (Sao Paulo School of Economics-FGV and CNRS); Phan, Toan (Federal Reserve Bank of Richmond); Vailakis, Yiannis (University of Glasgow)
    Abstract: We provide a novel characterization of self-enforcing debt limits in a general equilibrium framework of risk sharing with limited commitment, where defaulters are subject to recourse (a fractional loss of current and future endowments) and exclusion from future credit. We show that debt limits are exactly equal to the present value of recourse plus a credit bubble component. We provide applications to models of sovereign debt, private collateralized debt, and domestic public debt. Implications include an original equivalence mapping among distinct institutional arrangements, thereby clarifying the relationship between different enforcement mechanisms and the connection between asset and credit bubbles.
    Keywords: Limited commitment; general equilibrium; rational credit bubbles
    JEL: E00 E10 F00
    Date: 2019–10–11
  16. By: Cipriani, Marco (Federal Reserve Bank of New York); Fostel, Ana (University of Virginia); Houser, Daniel (George Mason University)
    Abstract: We study default and endogenous leverage in the laboratory. To this purpose, we develop a general equilibrium model of collateralized borrowing amenable to laboratory implementation and gather experimental data. In the model, leverage is endogenous: agents choose how much to borrow using a risky asset as collateral, and there are no ad hoc collateral constraints. When the risky asset is financial—namely, its payoff does not depend on ownership (such as a bond)— collateral requirements are high and there is no default. In contrast, when the risky asset is nonfinancial—namely, its payoff depends on ownership (such as a firm)—collateral requirements are lower and default occurs. The experimental outcomes are in line with the theory's main predictions. The type of collateral, whether financial or not, matters. Default rates and loss from default are higher when the risky asset is nonfinancial, stemming from laxer collateral requirements. Default rates and collateral requirements move closer to the theoretical predictions as the experiment progresses.
    Keywords: collateral; default; double auction; experimental economics; leverage
    JEL: A10 C90 G12
    Date: 2019–11–01
  17. By: Michal Horváth; Zuzana Siebertová
    Abstract: Fundamental income tax reforms are usually justified by or opposed because of large employment implications. The employment gains and losses are supposed to originate from various behavioural and dynamic effects of tax reforms over the medium to long term. To test the limits of such arguments, we study hypothetical radical measures designed to have potentially large employment effects in the context of Slovakia. A close inspection of the different implications of such tax reforms for adjustment on the extensive margin of the labour market reveals that promises or worries of large employment effects have little empirical support. This is because labour supply responses to ‘making work pay’ are small, the requirement of revenue neutrality limits the extent to which (dis)incentivising work is feasible, and because income effects arising from positive assortative mating within families counteract total individual-level effects. Our framework suggests the focus of tax reformers should be on the variation in effective labour supply coming from intensive margin effects.
    Keywords: microsimulation, dynamic general equilibrium, employment, labour supply elasticity, tax reform
    JEL: E24 H24 H31 J22
    Date: 2019–11–07
  18. By: Dario Caldara; Matteo Iacoviello; Patrick Molligo; Andrea Prestipino; Andrea Raffo
    Abstract: We study the effects of unexpected changes in trade policy uncertainty (TPU) on the U.S. economy. We construct three measures of TPU based on newspaper coverage, firms' earnings conference calls, and aggregate data on tari rates. We document that increases in TPU reduce investment and activity using both firm-level and aggregate macroeconomic data. We interpret the empirical results through the lens of a two-country general equilibrium model with nominal rigidities and firms' export participation decisions. In the model as in the data, news and increased uncertainty about higher future tariffs reduce investment and activity.
    Keywords: Trade Policy Uncertainty ; Textual Analysis ; Tariffs ; Investment ; Uncertainty Shocks
    JEL: C1 D22 D80 E12 E32 F13 H32
    Date: 2019–09
  19. By: Daniel Baksa (Institute for Capacity Development, International Monetary Fund and Central European University); Istvan Konya (Institute of Economics, Centre for Economic and Regional Studies, and University of Pécs and Central European University)
    Abstract: We study the role of productivity convergence and financial conditions in the recent growth experience of Hungary. We build a stochastic, small-open economy growth model with productivity convergence, capital accumulation and external borrowing. Using empirically identified processes for productivity and the external interest premium, we simulate the effects of two unexpected, permanent changes on Hungarian growth. The first change is the sharp productivity slowdown starting in 2006, and the second is the tightening of external financial conditions starting in 2009. Simulating our model, we show that the empirically identified productivity and interest premium processes - along with the two unexpected permanent changes and regular i.i.d. productivity and interest premium innovations – capture the main medium-run dynamics of the Hungarian economy both before and after the global financial crisis. Running counterfactuals, we also find that the observed slowdown in GDP per capita growth was mostly driven by productivity, while the tightening of external financing conditions is important to understand investment behavior and the net foreign asset position.
    Keywords: economic growth, convergence, productivity, interest premium, Hungary
    JEL: E13 E22 F43 O47
    Date: 2019
  20. By: Akcigit, Ufuk (University of Chicago); Dinlersoz, Emin M. (U.S. Census Bureau); Greenwood, Jeremy (University of Pennsylvania); Penciakova, Veronika (Federal Reserve Bank of Atlanta)
    Abstract: Venture capital (VC) and growth are examined both empirically and theoretically. Empirically, VC-backed startups have higher early growth rates and initial patent quality than non-VC-backed ones. VC backing increases a startup's likelihood of reaching the right tails of the firm size and innovation distributions. Furthermore, outcomes are better for startups matched with more experienced venture capitalists. An endogenous growth model, where venture capitalists provide both expertise and financing for business startups, is constructed to match these facts. The presence of venture capital, the degree of assortative matching between startups and financiers, and the taxation of VC-backed startups matter significantly for growth.
    Keywords: venture capital; assortative matching; endogenous growth; IPO; management; mergers and acquisitions; research and development; startups; synergies; taxation; patents
    JEL: E13 E22 G24 L26 O16 O31 O40
    Date: 2019–09–01
  21. By: Werner Roeger; Janos Varga; Jan in't Veld; Lukas Vogel
    Abstract: This paper studies the effects of labour market reforms on the functional distribution of income in a DSGE model (Roeger et al., 2008) with skill differentiation, in which households supply three types of labour: low-, medium- and high-skilled. The households receive income from labour, tangible capital, intangible capital, financial wealth and transfers. We trace how structural reforms in the labour market affect these different types of income. The quantification of labour market reforms is based on changes in structural indicators that significantly reduce the gap of the EU average income towards the best-performing EU countries. We find a general trade-off between an increase in employment for a particular group and the income of the average group member relative to income per capita. Reforms that increase employment of low- and medium-skilled workers imply a trade-off between employment and wages in the low- and medium-skilled group, due to the increase in the skill-specific supply of labour. Capital owners generally benefit from labour market reforms, with an increasing share in total income. This can be attributed to limited entry into the final goods production sector, underlining the importance of product market reforms in addition to labour market reforms.
    Keywords: labour market reforms, dynamic general equilibrium modelling, income distribution, inequality
    JEL: C33 D58 E25 J20
    Date: 2019
  22. By: Javier Bianchi; Pablo Ottonello; Ignacio Presno
    Abstract: The excess procyclicality of fiscal policy is commonly viewed as a central malaise in emerging economies. We document that procyclicality is more pervasive in countries with higher sovereign risk and provide a model of optimal fiscal policy with nominal rigidities and endogenous sovereign default that can account for this empirical pattern. Financing a fiscal stimulus is costly for risky countries and can render countercyclical policies undesirable, even in the presence of large Keynesian stabilization gains. We also show that imposing austerity can backfire by exacerbating the exposure to default, but a well-designed "fiscal forward guidance" can help reduce the excess procyclicality.
    Keywords: Fiscal Stabilization Policy ; Sovereign Default ; Procyclicality
    JEL: E62 F34 F41 F44 H50
    Date: 2019–09–20
  23. By: Aliprantis, Dionissi (Federal Reserve Bank of Cleveland); Carroll, Daniel R. (Federal Reserve Bank of Cleveland); Young, Eric R. (Federal Reserve Bank of Cleveland)
    Abstract: We reconcile the large and persistent racial wealth gap with the smaller racial earnings gap, using a general equilibrium heterogeneous-agents model that matches racial differences in earnings, wealth, bequests, and returns to savings. Given initial racial wealth inequality in 1962, our model attributes the slow convergence of the racial wealth gap primarily to earnings, with much smaller roles for bequests or returns to savings. Cross-sectional regressions of wealth on earnings using simulated data produce the same racial gap documented in the literature. One-time wealth transfers have only transitory effects unless they address the racial earnings gap.
    Keywords: Racial Inequality; Wealth Dynamics;
    JEL: D31 D58 E21 E24 J7
    Date: 2019–10–08
  24. By: Heise, Sebastian (Federal Reserve Bank of New York); Porzio, Tommaso (Columbia Business School)
    Abstract: We develop a job-ladder model with labor reallocation across firms and space, which we design to leverage matched employer-employee data to study differences in wages and labor productivity across regions. We apply our framework to data from Germany: twenty-five years after the reunification, real wages in the East are still 26 percent lower than those in the West. We find that 60 percent of the wage gap is due to labor being paid a higher wage per efficiency unit in West Germany, and quantify three distinct barriers that prevent East Germans from migrating west to obtain a higher wage: migration costs, workers' preferences to live in their home region, and more frequent job opportunities received from home. Interpreting the data as a frictional labor market, we estimate that these spatial barriers to mobility are small, which implies that the spatial misallocation of workers between East and West Germany has at most moderate aggregate effects.
    Keywords: employment; aggregate labor productivity; labor mobility; migration
    JEL: E24 J61 O15
    Date: 2019–10–01
  25. By: Carroll, Daniel R. (Federal Reserve Bank of Cleveland); Dolmas, James (Federal Reserve Bank of Dallas); Young, Eric R. (Federal Reserve Bank of Cleveland)
    Abstract: We study the political determination of flat tax systems using a workhorse macroeconomic model of inequality. There is significant variation in preferred tax policy across the wealth and income distribution. The majority voting outcome features (i) zero labor income taxation, (ii) simultaneous use of capital income and consumption taxation, and (iii) essentially zero transfers. This policy is supported by a coalition of low- and middle-wealth households. Zero labor income taxation is supported by households with below average wealth, while the middle-wealth households prefer to keep the transfer (and thus other tax rates) low. We also show that the outcome is sensitive to assumptions about the voting power of household groups, the degree of wealth and income mobility, and the forward-looking nature of votes.
    Keywords: Political Economy; Essential Set; Voting; Inequality; Incomplete Markets;
    JEL: D52 D72 E62
    Date: 2019–09–25
  26. By: Perazzi, Elena
    Abstract: I build a general equilibrium model to show that deposits are a special form of financing, that makes banks more suitable to extend long-term loans when confronted with the risks of monetary policy. In the model, banks borrow short-term and lend long-term, are subject to a minimum equity requirement consistent with Basel III, and face a financial friction: they cannot raise equity on the market. Consistent with the "bank-capital channel" of monetary policy, when the risk-free rate increases, the value of the banks' assets and equity are eroded, and banks deleverage by cutting their lending. I show that, thanks to a combination of banks' market power in the deposit market and of the money-like properties of deposits, the profits on deposits are strongly countercyclical, and reduce the contraction of lending at high interest rates due to the bank capital channel. Amid current proposals for narrow banking, this effect provides a rationale for the coexistence of lending and deposit-taking activities in current commercial banks.
    Keywords: Deposits, Banks, Long-Term Lending, Narrow Banking
    JEL: E5 G21
    Date: 2019–10–25
  27. By: Benigno, Gianluca (Federal Reserve Bank of New York); Chen, Huigang (Uber Technologies Inc.); Otrok, Christopher (University of Missouri, Federal Reserve Bank of St. Louis); Rebucci, Alessandro (John Hopkins University, CEPR); Young, Eric R. (University of Virginia)
    Abstract: There is a new and now large literature analyzing government policies for financial stability based on models with endogenous borrowing constraints. These normative analyses build upon the concept of constrained efficient allocation, where the social planner is constrained by the same borrowing limit that agents face. In this paper, we show that the same set of policy tools that implement the constrained efficient allocation can be used by a Ramsey planner to replicate the unconstrained allocation, thus achieving higher welfare. The constrained social planner approach may lead to inaccurate characterizations of welfare-maximizing policies relative to the Ramsey approach.
    Keywords: constrained efficiency; financial crises; macroprudential policies and capital controls; pecuniary externalities; Ramsey optimal policy; social planner
    JEL: E61 F38 F44 H23
    Date: 2019–10–01
  28. By: Carlos Carriga (Federal Reserve Bank of St. Louis); Finn E. Kydland (University of California – Santa Barbara; NBER); Roman Sustek (Centre for Macroeconomics (CFM))
    Abstract: We propose a tractable framework for monetary policy analysis in which both short - and long-term debt affect equilibrium outcomes. This objective is motivated by observations from two literatures suggesting that monetary policy contains a dimension affecting expected future interest rates and thus the costs of long-term financing. In New-Keynesian models, however, long-term loans are redundant assets. We use the model to address three questions: what are the effects of statement vs. action policy shocks; how important are standard New-Keynesian vs. cash flow effects in their transmission; and what is the interaction between these two effects?
    Keywords: Mortgages, Cash-flow effects, Sticky prices, Monetary policy transmission, Monetary policy communication
    JEL: E52 G21 R21
    Date: 2019–10
  29. By: Jiao, Yang (Fudan University); Wen, Yi (Federal Reserve Bank of St. Louis)
    Abstract: Using Japanese firm data covering the Japanese financial crisis in the early 1990s, we find that exporters' domestic sales declined more significantly than their foreign sales, which in turn declined more significantly than non-exporters' sales. This stylized fact provides a new litmus test for different theories proposed in the literature to explain a trade collapse associated with a financial crisis. In this paper we embed the Melitz's (2003) model into a tractable DSGE framework with incomplete financial markets and endogenous credit allocation to explain both the Japanese firm-level data and the well-documented aggregate trade collapse during a financial crisis in world economic history. The model highlights the role of credit reallocation between non-exporters and exporters as the main mechanism in explaining exporters' behaviors and trade collapse following a financial crisis.
    Keywords: Credit Crunch; Credit Reallocation; Exporter Behavior; Financial Crisis; Heterogeneous Firms; Trade Collapse
    JEL: E22 E32 E44 F00 F10 F11 F41
    Date: 2019–09–24
  30. By: Martin, Fernando M. (Federal Reserve Bank of St. Louis)
    Abstract: Societies often rely on simple rules to restrict the size and behavior of governments. When fiscal and monetary policies are conducted by a discretionary and profligate government, I find that revenue ceilings vastly outperform debt, deficit and monetary rules, both in effectiveness at curbing public spending and welfare for private agents. However, effective revenue ceilings induce an increase in deficit, debt and inflation. Under many scenarios, including recurrent adverse shocks, the optimal ceiling on U.S. federal revenue is about 15% of GDP, which leads to welfare gains for private agents worth about 2% of consumption. Austerity programs should be sudden instead of gradual, and focus on lowering revenue to reduce spending rather than raising revenue to lower debt.
    Keywords: time-consistency; fiscal rules; discretion; government debt; inflation; deficit; institutional design; political frictions; austerity; debt sustainability
    JEL: E52 E58 E61 E62
    Date: 2019–10–11
  31. By: Arellano, Cristina (Federal Reserve Bank of Minneapolis); Mateos-Planas, Xavier (Queen Mary University London); Rios-Rull, Jose-Victor (University of Pennsylvania)
    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.
    Keywords: Sovereign risk; Debt crises; Default episodes; Emerging markets; Debt restructuring
    JEL: F34 G01 H63
    Date: 2019–07–09

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