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on Dynamic General Equilibrium |
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Issue of 2019‒11‒18
nineteen papers chosen by Christian Zimmermann Federal Reserve Bank of St. Louis |
| By: | Patrick Fève; Pablo Garcia Sanchez; Alban Moura; Olivier Pierrard |
| Abstract: | We augment a simple Real Business Cycle model with financial intermediaries that may default on their liabilities and a financial friction generating social costs of default. We provide a closed-form solution for the general equilibrium of the economy under specific assumptions, allowing for analytic results and straightforward simulations. Endogenous default generates asymmetric business cycles and our model replicates both the negative skew of GDP and the positive skew of credit spreads found in US data. Stronger financial frictions cause a rise in asymmetry and amplify the welfare costs of default. A Pigouvian tax on financial intermediation mitigates most of these negative effects at the cost of a steady-state distortion. |
| Keywords: | Real Business Cycle model, default, financial frictions, asymmetry, skewness |
| JEL: | E32 E44 G21 |
| Date: | 2019–11 |
| URL: | http://d.repec.org/n?u=RePEc:bcl:bclwop:bclwp134&r=all |
| By: | Anna Bartocci (Bank of Italy); Alessandro Notarpietro (Bank of Italy); Massimiliano Pisani (Bank of Italy) |
| Abstract: | We evaluate the macroeconomic effects of long-term sovereign bond purchases by the central bank in the ‘New Normal’, i.e. in an economy with a low equilibrium real interest rate and a high probability of hitting the zero lower bound (ZLB) on the short-term policy rate. Our analysis is based on the simulations of a dynamic general equilibrium model for the euro area. The main results are the following. First, long-term sovereign bond purchases reacting to a positive inflation gap help stabilize macroeconomic conditions when the monetary policy rate hits the ZLB. Second, these purchases are an effective stabilization tool following positive shocks to the sovereign term premium (financial shocks) and negative shocks to aggregate demand (real shocks). Third, purchases that also react to the long-term rates are effective in the case of recessionary financial shocks but not in the case of recessionary real shocks and fourth, to stabilize the effects of expansionary shocks, the central bank can increase the short-term monetary policy rate according to an ‘aggressive’ Taylor rule, instead of selling long-term sovereign bonds. |
| Keywords: | euro area, non-standard monetary policy, zero lower bound |
| JEL: | E31 E32 E58 |
| Date: | 2019–11 |
| URL: | http://d.repec.org/n?u=RePEc:bdi:wptemi:td_1251_19&r=all |
| By: | Krolikowski, Pawel (Federal Reserve Bank of Cleveland); McCallum, Andrew H. (Board of Governors, Federal Reserve System) |
| Abstract: | We add goods-market frictions to a general equilibrium dynamic model with heterogeneous exporting producers and identical importing retailers. Our tractable framework leads to endogenously unmatched producers, which attenuate welfare responses to foreign shocks but increase the trade elasticity relative to a model without search costs. Search frictions are quantitatively important in our calibration, attenuating welfare responses to tariffs by 40 percent and increasing the trade elasticity by 50 percent. Eliminating search costs raises welfare by 1 percent and increasing them by only a few dollars has the same effects on welfare and trade flows as a 10 percent tariff. |
| Keywords: | Search; trade; welfare; constrained optimization; |
| JEL: | C61 D83 F12 |
| Date: | 2019–08–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedcwq:163502&r=all |
| By: | Vanya Horneff (Finance Department, Goethe University); Raimond Maurer (Finance Department, Goethe University); Olivia S. Mitchell (Wharton School, University of Pennsylvania) |
| Abstract: | The U.S. has long incentivized retirement saving in 401(k) and similar retirement accounts by permitting workers to defer taxes on contributions, levying them instead when retirees withdraw funds in retirement. This paper develops a dynamic life-cycle model to show how and whether “Rothification†— that is, taxing 401(k) contributions rather than payouts — would alter household saving, investment, and Social Security claiming patterns. We show that these changes differ importantly for low- versus higher-paid workers. We conclude that moving to a system that taxes pension contributions instead of withdrawals will lead to later retirement ages, particularly for the better-educated. It also would reduce work hours and lifetime tax payments and increase wealth and consumption inequality. In addition, we show how these behaviors would differ in a persistently low interest rate environment versus a more “normal†historical return world. |
| Date: | 2019–09 |
| URL: | http://d.repec.org/n?u=RePEc:mrr:papers:wp398&r=all |
| By: | Huber, Florian (University of Salzburg); Rabithsc, Katrin (WU Wien) |
| Abstract: | In this paper, we reconsider the question how monetary policy influences exchange rate dynamics. To this end, a vector autoregressive (VAR) model is combined with a two country dynamic stochastic general equilibrium (DSGE) model. Instead of focusing exclusively on how monetary policy shocks affect the level of exchange rates, we also analyze how they impact exchange rate volatility. Since exchange rate volatility is not observed, we estimate it alongside the remaining quantities in the model. Our findings can be summarized as follows. Contractionary monetary policy shocks lead to an appreciation of the home currency, with exchange rate responses in the short-run typically undershooting their long-run level of appreciation. They also lead to an increase in exchange rate volatility. Historical and forecast error variance decompositions indicate that monetary policy shocks explain an appreciable amount of exchange rate movements and the corresponding volatility. |
| Keywords: | Monetary policy; Exchange rate overshooting; stochastic volatility modeling; DSGE priors |
| JEL: | E43 E52 F31 |
| Date: | 2019–10–22 |
| URL: | http://d.repec.org/n?u=RePEc:ris:sbgwpe:2019_005&r=all |
| By: | Adam Brzezinski (Department of Economics, University of Oxford); Yao Chen (Erasmus School of Economics, Erasmus University Rotterdam); Nuno Palma (Department of Economics, University of Manchester; Instituto de Ciências Sociais, Universidade de Lisboa; CEPR); Felix Ward (Erasmus School of Economics, Erasmus University Rotterdam) |
| Abstract: | We exploit a recurring natural experiment to identify the effects of money supply shocks: maritime disasters in the Spanish Empire (1531-1810) that resulted in the loss of substantial amounts of monetary silver. A one percentage point reduction in the money growth rate caused a 1.3% drop in real output that persisted for several years. The empirical evidence highlights nominal rigidities and credit frictions as the primary monetary transmission channels. Our model of the Spanish economy confirms that each of these two channels explain about half of the initial output response, with the credit channel accounting for much of its persistence. |
| Keywords: | Monetary Shocks, Natural Experiment, Nominal Rigidity, Financial Accelerator, DSGE, Minimum-Distance Estimation, Local Projection |
| JEL: | E43 E44 E52 N10 N13 |
| Date: | 2019–11 |
| URL: | http://d.repec.org/n?u=RePEc:hes:wpaper:0170&r=all |
| By: | Phelan, Tom (Federal Reserve Bank of Cleveland) |
| Abstract: | How should a utilitarian government balance redistributive concerns with the need to provide incentives for business creation and investment? Should they tax business profits, the (risk-free) savings of owners, or some combination of both? To address this question, this paper presents a model in which the desirability of differential asset taxation emerges endogenously from the presence of agency frictions. I consider an environment in which entrepreneurs hire workers and rent capital to produce output subject to privately observed shocks and have the ability to both divert capital to private consumption and abscond with a fraction of assets. To provide incentives to invest, the wealth of an agent must depend on the performance of his/her firm, leading to ex-post inequality in all efficient allocations. I show that the efficient stationary distribution of wealth exhibits a thick right (Pareto) tail, with the degree of inequality monotonically increasing in the number of workers per entrepreneur. The efficient allocation is then implemented in a general equilibrium model using history-independent linear taxes on risk-free savings and (reported) business profits. The tax on entrepreneurs’ savings may be positive or negative, while the tax on business profits depends solely upon the degree of private information and is independent of all technological and preference parameters. |
| Keywords: | Optimal taxation; moral hazard; optimal contracting; entrepreneurship; |
| JEL: | D61 D63 E62 |
| Date: | 2019–08–29 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedcwq:191700&r=all |
| By: | Zhu, Guozhong (University of Alberta); Mikhed, Vyacheslav (Federal Reserve Bank of Philadelphia); Scholnick, Barry (Federal Reserve Bank of Philadelphia) |
| Abstract: | We provide a novel explanation to the longstanding puzzle of the “missing bankruptcy filings.” Even though a household with a negative net worth will receive contemporaneous benefit from bankruptcy, there may be greater insurance value from delaying the filing. Household bankruptcy is thus an American-style put option, which is not necessarily exercised even if the option is "in the money." Based on the value functions in the household’s dynamic programming problem, we formulate the value of the bankruptcy option as well as the exercise price. We estimate a life-cycle model in which households choose the optimal time to exercise their bankruptcy option. |
| Keywords: | personal bankruptcy; option value; life cycle; secured and unsecured debts |
| JEL: | E21 R21 |
| Date: | 2019–11–13 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:19-46&r=all |
| By: | Broadbent, Ben (Bank of England and Centre for Macroeconomics); Di Pace, Federico (Bank of England); Drechsel, Thomas (London School of Economics and Centre for Macroeconomics); Harrison, Richard (Bank of England and Centre for Macroeconomics); Tenreyro, Silvana (Bank of England, Centre for Macroeconomics, CEPR and London School of Economics) |
| Abstract: | The UK economy has experienced significant macroeconomic adjustments following the 2016 referendum on its withdrawal from the European Union. This paper develops and estimates a small open economy model with tradable and non-tradable sectors to characterise these adjustments. We demonstrate that many of the effects of the referendum result can be conceptualised as news about a future slowdown in productivity growth in the tradable sector. Simulations show that the responses of the model economy to such news are consistent with key patterns in UK data. While overall economic growth slows, an immediate permanent fall in the relative price of non-tradable output (the real exchange rate) induces a temporary ‘sweet spot’ for tradable producers before the slowdown in tradable sector productivity associated with Brexit occurs. Resources are reallocated towards the tradable sector, tradable output growth rises and net exports increase. These developments reverse after the productivity decline in the tradable sector materialises. The negative news about tradable sector productivity also leads to a decline in domestic interest rates relative to world interest rates and to a reduction in investment growth, while employment remains relatively stable. As a by-product of our analysis, we provide a quantitative analysis of the UK business cycle. |
| Keywords: | Brexit; small open economy; productivity; tradable sector; UK economy |
| JEL: | E13 E32 F17 F47 O16 |
| Date: | 2019–08–27 |
| URL: | http://d.repec.org/n?u=RePEc:mpc:wpaper:0051&r=all |
| By: | George Economides (Athens University of Economics and Business, and CESifo); Anastasios Xepapadeas (Athens University of Economics and Business and University of Bologna) |
| Abstract: | We investigate the impact of climate change on the macroeconomic performance of a small open economy. The setup is a new Keynesian dynamic stochastic general equilibrium model of a small open economy without monetary policy independence in which a climate module that interacts with the economy has been incorporated. The model is solved numerically using common parameter values, fiscal data and projections about temperature growth from the Greek economy. Our results, suggest that climate change implies a significant output loss and a deterioration of competitiveness. Moreover, it seems that the loss of monetary policy independence is not a big loss, when we investigate the short- and long-term implications of climate change for a small open economy. |
| Keywords: | Climate change; monetary policy; new Keynesian models |
| JEL: | E5 E1 |
| Date: | 2019–09 |
| URL: | http://d.repec.org/n?u=RePEc:bog:wpaper:267&r=all |
| By: | Been-Lon Chen (Institute of Economics, Academia Sinica, Taipei, Taiwan); Chih-Feng Lai (Department of Economics, Soochow University) |
| Abstract: | In infinitely lived, representative-agent models with linear income taxes, the influential studies by Chamley (1986) and Judd (1985) have shown that the optimal capital tax is zero in the long run. Our paper studies otherwise the same model except for progressive taxes and the results are as follow. First, the long-run optimal capital income tax is positive under progressive income taxes. Second, the welfare gain of tax reforms from current tax rates toward positive optimal income taxes under progressive tax rates is larger than that toward a zero capital income tax under linear income taxes. Our findings lend support to positive capital income taxes under a system of progressive income taxes adopted in developed countries since the late 19th century. |
| Keywords: | : infinite horizon model, optimal capital income taxation, progressive taxes |
| JEL: | E1 E6 H2 |
| Date: | 2018–08 |
| URL: | http://d.repec.org/n?u=RePEc:sin:wpaper:19-a004&r=all |
| By: | Cesa-Bianchi, Ambrogio (Bank of England and Centre for Macroeconomics); Kumhof, Michael (Bank of England, CEPR and Centre for Macroeconomics); Sokol, Andrej (European Central Bank, Bank of England and Centre for Macroeconomics); Thwaites, Gregory (Bank of England) |
| Abstract: | We study exchange rate determination in a 2-country model where domestic banks create each economy’s supply of domestic and foreign currency. The model combines the UIP-based and monetary theories of exchange rate determination, but the latter with a focus on private rather than public money creation. The model features an endogenous monetary spread or excess return in the UIP condition. This spread experiences sizeable changes when shocks affect the relative supplies (of bank loans) or demands (for bank deposits) of the two currencies. Under such shocks, monetary effects dominate traditional UIP effects in the determination of exchange rates and allocations, and this becomes stronger as domestic and foreign currencies become more imperfect substitutes. With these shocks, the model successfully addresses the UIP puzzle, and it is also consistent with the Meese-Rogoff and PPP puzzles. |
| Keywords: | Bank lending; money creation; money demand; endogenous money; uncovered interest parity; exchange rate determination; international capital flows; gross capital flows |
| JEL: | E44 E51 F41 F44 |
| Date: | 2019–08–30 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:0817&r=all |
| By: | Adrian Pagan; Michael Wickens |
| Abstract: | Pesaran and Smith (2011) concluded that DSGE models were sometimes a straitjacket which hampered the ability to match certain features of the data. In this paper we look at how one might assess the fit of these models using a variety of measures, rather than what seems to be an increasingly common device - the Marginal Data Density. We apply these in the context of models by Christiano et.al (2014) and Ireland (2004), finding they fail to make a match by a large margin. Against this, there is a strong argument for having a straitjacket as it enforces some desirable behaviour on models and makes researchers think about how to account for any non-stationarity in the data. We illustrate this with examples drawn from the SVAR literature and also more eclectic models such as Holston et al (2017) for extracting an estimate of the real natural rate. |
| Date: | 2019–11 |
| URL: | http://d.repec.org/n?u=RePEc:een:camaaa:2019-81&r=all |
| By: | Gabriele Camera (Economic Science Institute, Chapman University; University of Bologna); Alessandro Gioffré (University of Florence) |
| Abstract: | Experiments that investigate the spontaneous emergence of money in laboratory so cieties rely on inde?nitely repeated helping games with random matching (Camera et al., 2013; Camera and Casari, 2014). An important open issue is the lack of a general proof of existence of an equilibrium capable of supporting the e?cient allocation under private monitoring, without money. Here, we ?ll this gap by o?ering a general proof, as well as by characterizing the e?cient non-monetary equilibrium. This technique can be extended to study games with simultaneous actions. |
| Keywords: | Tacit coordination; Random matching; Social norms |
| JEL: | E4 E5 C7 |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:chu:wpaper:19-28&r=all |
| By: | Juan Carlos Conesa; Matthew J. Delventhal; Pau S. Pujolas; Gajendran Raveendranathan |
| Abstract: | We study the impact of trade on a country catching up to the industrial leader.We calibrate our dynamic, two-country model to Spain and UK from 1850 to 2000, accounting for the inter-war trade collapse (IWTC) and the subsequent catch up by Spain. In our model, the effects of trade disruptions are stronger with more distance tothe leader and more openness. A collapse today (less distance, more openness) similarto the IWTC (more distance, less openness) decreases the capital stock thrice as much(12% instead of 4%). Importantly, traded varieties would fall today but increased dur-ing the IWTC |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:nys:sunysb:19-04&r=all |
| By: | Pablo Garcia Sanchez; Alban Moura |
| Abstract: | We augment the original LU-EAGLE model with disaggregated public expenditure, allowing for (i) a distinction between public consumption and investment expenditures, (ii) complementarity between public and private consumption, (iii) a productive role for public capital, and (iv) separate private and public employment. This extended model embeds a wide range of transmission channels from public expenditures and allows for a detailed analysis of the general-equilibrium effects of public demand in Luxembourg. Model simulations suggest that a rise in public employment induces the strongest GDP response in the short run, while a rise in public investment has the largest effects in the long run. The results also indicate that crowding-out effects through changes in net exports are essential in determining fiscal multipliers for small open economies such as Luxembourg. |
| Keywords: | DSGE models, open economy models, fiscal policy, Luxembourg |
| JEL: | C54 E17 E32 E37 E62 F47 |
| Date: | 2019–11 |
| URL: | http://d.repec.org/n?u=RePEc:bcl:bclwop:bclwp135&r=all |
| By: | Anton Grui (National Bank of Ukraine); Artem Vdovychenko (National Bank of Ukraine) |
| Abstract: | This paper introduces the Quarterly Projection Model utilized by the National Bank of Ukraine to make its regular macroeconomic forecasts and monetary policy recommendations. The model is a semi-structural representation of an open-economy New-Keynesian general equilibrium model. It captures the transmission mechanism of monetary policy in the context of the Ukrainian economy. Among the economy’s key features are the disinflation agenda, heterogeneous prices, imperfect monetary policy credibility, high openness and dollarization. |
| Keywords: | National Bank of Ukraine, inflation targeting, monetary policy, projection model, monetary policy transmission mechanism in Ukraine. |
| JEL: | C52 C53 E37 E52 |
| Date: | 2019–09 |
| URL: | http://d.repec.org/n?u=RePEc:ukb:wpaper:03/2019&r=all |
| By: | Nadav Ben Zeev (BGU) |
| Keywords: | Business Cycles, Business Cycle Shock, General purpose technology, Investment-specific technology news shocks |
| JEL: | E32 |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:bgu:wpaper:1906&r=all |
| By: | Kurozumi, Takushi (Bank of Japan); Van Zandweghe, Willem (Federal Reserve Bank of Cleveland) |
| Abstract: | We propose a novel theory of intrinsic inflation persistence by introducing trend inflation and variable elasticity of demand in a model with staggered price and wage setting. Under nonzero trend inflation, the variable elasticity generates intrinsic persistence in inflation through a measure of price dispersion stemming from staggered price setting. It also introduces intrinsic persistence in wage inflation under staggered wage setting, which affects price inflation. With the theory we show that inflation exhibits a persistent, hump-shaped response to a monetary policy shock. We also show that a credible disinflation leads to a gradual decline in inflation and a fall in output, and lower trend inflation reduces inflation persistence, as observed around the time of the Volcker disinflation. |
| Keywords: | Trend inflation; variable elasticity of demand; price dispersion; intrinsic inflation persistence; credible disinflation; |
| JEL: | E31 E52 |
| Date: | 2019–08–29 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedcwq:191600&r=all |