nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2019‒12‒02
eighteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Consumption Insurance Against Wage Risk: Family Labor Supply and Optimal Progressive Income Taxation By Chunzan Wu; Dirk Krueger
  2. Is Monetary Policy Always Effective? Incomplete Interest Rate Pass-through in a DSGE Model By Hilde C. Bjørnland; Andrew Binning; Junior Maih
  3. Expectations switching in a DSGE model for the UK By Anette Borge; Gunnar Bårdsen; Junior Maih
  4. Credit, Bankruptcy, and Aggregate Fluctuations By Nakajima, Makoto; Rios-Rull, Jose-Victor
  5. Monetary policy regimes and inflation persistence in the United Kingdom By Shayan Zakipour-Saber
  6. Forecasting with instabilities: an application to DSGE models with financial frictions By Roberta Cardani; Alessia Paccagnini; Stefania Villa
  7. Endogenous Leverage and Default in the Laboratory By Marco Cipriani; Ana Fostel; Daniel Houser
  8. Policy Maker's Credibility with Predetermined Instruments for Forward-Looking Targets By Jean-Bernard Chatelain; Kirsten Ralf
  9. Average Inflation Targeting and Interest-Rate Smoothing By Eo, Yunjong; Lie, Denny
  10. Fiscal devaluation and labour market frictions in a monetary union By Lorenzo Burlon; Alessandro Notarpietro; Massimiliano Pisani
  11. Toward Rebuilding of Modern Macroeconomic Theory: Market Failure in a Macro Economy and Keynes's Unemployment Equilibrium By Eizo Kawai
  12. Trade Wars, Technology and Productivity By Ching-mu Chen; Wan-Jung Cheng; Shin-Kun Peng; Raymond Riezman; Ping Wang
  13. Subjective Beliefs, Monetary Policy, and Stock Price Volatility By Katsuhiro Oshima
  14. The Wife's Protector: A Quantitative Theory Linking Contraceptive Technology with the Decline in Marriage By Greenwood, Jeremy; Guner, Nezih; Kopecky, Karen A.
  15. Optimal monetary and macroprudential policies for financial stability in a commodity-exporting economy By Ivan Khotulev; Konstantin Styrin
  16. Labor Market Frictions and Lowest Low Fertility By Guner, Nezih; Kaya, Ezgi; Sánchez Marcos, Virginia
  17. Disinflationary shocks and inflation target uncertainty By Stefano Neri; Tiziano Ropele
  18. Heterogeneous Beliefs, Monetary Policy, and Stock Price Volatility By Katsuhiro Oshima

  1. By: Chunzan Wu; Dirk Krueger
    Abstract: We show that a calibrated life-cycle two-earner household model with endogenous labor supply can rationalize the extent of consumption insurance against shocks to male and female wages, as estimated empirically by Blundell, Pistaferri and Saporta-Eksten (2016) in U.S. data. In the model, 35% of male and 18% of female permanent wage shocks pass through to consumption, compared to the empirical estimates of 32% and 19%. Most of the consumption insurance against permanent male wage shocks is provided through the presence and labor supply response of the female earner. Abstracting from this private intra-household income insurance mechanism strongly biases upward the welfare losses from idiosyncratic wage risk as well as the desired extent of public insurance through progressive income taxation. Relative to the standard one-earner life cycle model, the optimal degree of tax progressivity is significantly lower and the welfare gains from implementing the optimal system are cut roughly in half.
    JEL: E21 H21 H31
    Date: 2019–11
  2. By: Hilde C. Bjørnland; Andrew Binning; Junior Maih
    Abstract: We estimate a regime-switching DSGE model with a banking sector to explain incomplete and asymmetric interest rate pass-through, especially in the presence of a binding zero lower bound (ZLB) constraint. The model is estimated using Bayesian techniques on US data between 1985 and 2016. The framework allows us to explain the time-varying interest rate spreads and pass-through observed in the data. We ?nd that pass-through tends to be delayed in the short run, and incomplete in the long run. All this impacts the dynamics of the other macroeconomic variables in the model. In particular, we ?nd monetary policy to be less e?ective under incomplete pass-through. Furthermore, the behavior of pass-through in the loan rate is di?erent from that of the deposit rate shocks. This creates asymmetric dynamics at the zero lower bound, and incomplete pass-through exacerbates that asymmetry.
    Keywords: banking sector, incomplete or symmetric interest rate pass-through, DSGE
    Date: 2019–11
  3. By: Anette Borge (Department of Economics, Norwegian University of Science and Technology); Gunnar Bårdsen (Department of Economics, Norwegian University of Science and Technology); Junior Maih (Norges Bank and Norwegian Business School BI)
    Abstract: Rational expectations (RE) has been dominant both in the economic literature and in the macromodels routinely used in Central banks. The RE assumption has recently come under attack as one of the drawbacks of the Dynamic Stochastic General Equilibrium (DSGE modeling) paradigm. This study attempts to investigate whether other ways of modeling expectations would necessarily find a better support in the data. We investigate the relevance of the RE assumption by introducing regime switching into the expectations formation of an otherwise standard DSGE model by Justiniano and Preston (2010). In our model, expectations switch between RE and Adaptive expectations (AE). The model is estimated on UK data using Bayesian techniques. By introducing a switching mechanism, the model explains the data better than both the pure RE and the pure AE models. Expectation formation switches to AE during changes in monetary policy and the financial crisis. The dynamics of the economic system is different under the two expectation regimes. Hence, should the UK economy switch to an AE regime after Brexit, the dynamics of the economic system could be substantially more uncertain than under RE, given the model.
    Date: 2019–10–15
  4. By: Nakajima, Makoto (Federal Reserve Bank of Philadelphia); Rios-Rull, Jose-Victor (Federal Reserve Bank of Philadelphia)
    Abstract: We document the cyclical properties of unsecured consumer credit (procyclical and volatile) and of consumer bankruptcies (countercyclical and very volatile). Using a growth model with household heterogeneity in earnings and assets with access to unsecured credit (because of bankruptcy costs) and aggregate shocks, we show that the cyclical behavior of household earnings growth accounts for these properties, albeit not for the large volatility of credit. We find that tilting household consumption towards goods that can be purchased on credit and a slight countercyclicality in the terms of access to credit match the sizes of credit and bankruptcy volatilities. We also find that when the right to file for bankruptcy does not exist unsecured credit is countercyclical.
    Keywords: consumer credit; default; bankruptcy; debt; business cycle; heterogeneous agents; incomplete markets
    JEL: D91 E21 E32 E44 K35
    Date: 2019–11–21
  5. By: Shayan Zakipour-Saber (Central Bank of Ireland)
    Abstract: This paper conducts a structural analysis of inflation persistence in the United Kingdom between 1965-2009. I allow for the possibility of shifts in the UK economy by estimating open-economy dynamic stochastic general equilibrium models in which parameters of a Taylor-type monetary policy rule, New Keynesian Phillips curve, and volatilities of structural economic shocks, follow Markov processes (Markov-switching DSGEs). The best-fitting model allows for changes in monetary policy and stochastic shock volatility. The first policy regime responds passively to movements in inflation, adjusting the nominal interest rate less than one-for-one and is estimated to be in place from the early 1970s until the late 1980s. The other regime responds actively to inflation and places less weight on exchange rate movements. This regime is present for the rest sample and almost coincides with the period after the Bank of England explicitly adopted an inflation target in 1992. I find a small but insignificant decrease in inflation persistence in the policy regime that responds more actively to inflation.
    Keywords: Markov-Switching, DSGE, Inflation persistence, Bayesian estimation
    JEL: C11 E31 E52
    Date: 2019–10–15
  6. By: Roberta Cardani (European Commission); Alessia Paccagnini (University College Dublin); Stefania Villa (Bank of Italy)
    Abstract: We assess the importance of parameter instabilities from a forecasting standpoint in a set of medium-scale DSGE models with and without financial frictions using US real-time data. We find that failing to update DSGE model parameter estimates with new data arrival deteriorates point forecasts due to the estimated parameters variation. We also find that the presence of financial frictions helps to better forecast GDP and inflation.
    Keywords: Bayesian estimation, forecasting, financial frictions, parameter instabilities
    JEL: C11 C13 C32 E37
    Date: 2019–10
  7. By: Marco Cipriani; Ana Fostel; Daniel Houser
    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 bonds), collateral requirements are high and there is no default. In contrast, when the risky asset is non-financial, 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 non-financial, stemming from laxer collateral requirements. Default rates and collateral requirements are closer to the theoretical predictions as the experiment progresses.
    JEL: A10 C90 D52 D53 G10
    Date: 2019–11
  8. By: Jean-Bernard Chatelain (PSE - Paris School of Economics, PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique); Kirsten Ralf (Ecole Supérieure du Commerce Extérieur - ESCE - International business school, INSEEC - INSEEC Business School - Institut des hautes études économiques et commerciales Business School (INSEEC))
    Abstract: The aim of the present paper is to provide criteria for a central bank of how to choose among di¤erent monetary-policy rules when caring about a number of policy targets such as the output gap and expected in ‡ation. Special attention is given to the question if policy instruments are predetermined or only forward looking. Using the new-Keynesian Phillips curve with a cost-push-shock policy-transmission mechanism, the forward-looking case implies an extreme lack of robustness and of credibility of stabilization policy. The backward-looking case is such that the simple-rule parameters can be the solution of Ramsey optimal policy under limited commitment. As a consequence, we suggest to model explicitly the rational behavior of the policy maker with Ramsey optimal policy, rather than to use simple rules with an ambiguous assumption leading to policy advice that is neither robust nor credible.
    Keywords: Determinacy,Proportional Feedback Rules,Dynamic Stochastic General Equilibrium,Ramsey Optimal Policy under Quasi-Commitment Keywords: Determinacy,Ramsey Optimal Policy under Quasi-Commitment
    Date: 2019–11
  9. By: Eo, Yunjong; Lie, Denny
    Abstract: We study the welfare implication of average inflation targeting as a simple interest-rate rule, in which the monetary authority adjusts its short-term policy rate in response to the output gap as well as average inflation deviation from its target instead of reacting to the contemporaneous inflation rate as in a Taylor-type rule. We find that the welfare improvement achieved by switching to average inflation targeting from a standard Taylor rule is modest with a high degree of interest-rate smoothing, whereas it is significant without interest-rate smoothing. We show that average inflation targeting is welfare-improving in the same way as interest-rate smoothing by making the conduct of monetary policy history-dependent. Thus, the high degree of monetary policy inertia in the estimated interest-rate rules in many advanced economies implies that the welfare gain from adopting the average inflation targeting rule would be modest.
    Keywords: New Keynesian model; History-dependent policy; Welfare analysis; Ramsey policy; Interest-rate rule; Monetary policy inertia;
    Date: 2019–11
  10. By: Lorenzo Burlon (European Central Bank); Alessandro Notarpietro (Bank of Italy); Massimiliano Pisani (Bank of Italy)
    Abstract: We assess the effects of a fiscal devaluation on economic and labour market conditions in a Member State of the euro area by simulating a monetary union model featuring labour markets with search and matching frictions. The fiscal authority of the Member State enacts a discretionary reduction in the social contribution rate for employers so that the corresponding revenues decrease by 1per cent of the before-shock (steady-state) nominal GDP. The measure is ex ante revenue neutral, because it is financed by a simultaneous discretionary increase in the consumption tax rate that generates additional ex ante revenues equal to 1 per cent of the before-shock GDP. The main results are as follows. First, GDP increases by 0.5 per cent, sustained by the increase in investment and net exports, while consumption decreases. Second, the unemployment rate decreases by 0.3 percentage points. Third, the trade balance improvement is equal to 0.3 per cent of GDP (the improvement in real net exports is partially offset by the deterioration in term of trade). Fourth, the results are rather robust to changes in key parameters.
    Keywords: fiscal devaluation, labour market, trade deficit, dynamic general equilibrium modelling
    JEL: F32 F47 H20
    Date: 2019–10
  11. By: Eizo Kawai
    Abstract: The present study aims to perceive an unacceptable unreality of a macro price mechanism: that is, the unreality that under any severe recession, deterioration of deflation or a consistent decrease in the rate of inflation will lead an economy to full employment equilibrium. This unreality results from an arbitrary assumption that the micro price mechanism operates even in a macro economy. This study challenges the existing modern macroeconomics theories on price mechanism and unemployment based on the skepticism toward existing theories based on the observations of a real economy. The study reveals two main results. First, market failure in a macro economy, that is, the price mechanism is significantly incomplete and does not function, in particular, under deflation. This differs significantly from "the market failure due to the inflexibility of wages and prices, asymmetry of information, and so on," as stated by new Keynesianism. The key reason for market failure in a short-run macro economy is the unavoidable spillover effects, or derived demand effects between goods and labor markets under disequilibrium due to inflexible wages and prices. Macro price mechanism completely overlooks these effects because of the arbitrary assumption, thus leading to the unrealistic price mechanism stated earlier. Considering the spillover effects, or derived demand effects under disequilibrium, the assumption of full employment equilibrium, along with the assumption of flexible wages and prices, does not hold. Although these effects are the results of the short-run analysis, there would be market failure in a macro economy even in the long run as an inevitable conjecture. To rebuild dynamic stochastic general equilibrium (DSGE) models, it is important to study the aforementioned fundamental and theoretical problem that macro price mechanism does not function. A static model is enough to explain the mechanism and dynamic models appear unnecessary and unfeasible. Second, Keynes's unemployment equilibrium is realized owing to market failure in a macro economy. Market failure in a macro economy shows that involuntary unemployment results from quantitative and not price aspects. In other words, involuntary unemployment is not a result of the rigidity of real wages but of a shortage in labor demand under rigid real wages. This is possible by reinterpreting the Shapiro-Stiglitz efficiency wage model. Finally, demand is a critical factor in both the short run and the long run.
    Date: 2019–10
  12. By: Ching-mu Chen; Wan-Jung Cheng; Shin-Kun Peng; Raymond Riezman; Ping Wang
    Abstract: If international trade is strictly trade in intermediate goods, would the common presumption, that small, less developed economies (the South) lose from trade wars still be true? We address this question by constructing a dynamic general equilibrium model in which the North and the South trade technology-embodied intermediate goods. We show that the detrimental effects of the trade war are mitigated by the fact that producers in the South can adjust their choice of imported intermediate goods and their investment in domestic technologies. We establish sufficient conditions under which the steady-state trade equilibrium length of the production line and the range of domestic production in the South both expand in response to a tariff war. It thereby creates a novel channel of scale-scope trade-off: The South counters the losses from trade protection in the volume and value of trade (scale) with an upward movement along the value chain (scope). As a result, average productivity in the South and aggregate technology used by the South both turn out to be higher.
    JEL: D92 F12 O33
    Date: 2019–11
  13. By: Katsuhiro Oshima (Graduate School of Economics, Kyoto University)
    Abstract: The main purpose of this study is to understand how the stance of monetary policy affects stock price volatility in a New Keynesian model with investors who have subjective beliefs about stock price growth. I assume that investors construct subjective beliefs about expected capital gains from stock prices by Bayesian learning from observed growth rates of stock prices. I design the model so that the effects of the existence of subjective households are minimal, i.e., it affects only stock prices. I find that higher monetary policy persistence increases stock price volatilities under the interest rate shock because the subjective beliefs imply myopic pricing in which near-term pricing kernels (or real interest rates) and near-term dividends matter. This result contrasts with stock pricing under the rational expectation, in which future discounted dividends matter.
    Keywords: stock price, asset pricing, subjective belief, sticky prices, New Keynesian
    JEL: D83 D84 E44 E52 G12 G14
    Date: 2019–11
  14. By: Greenwood, Jeremy (University of Pennsylvania); Guner, Nezih (CEMFI, Madrid); Kopecky, Karen A. (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, history, never-married population, number of partners, out-of-wedlock births, premarital sex, singles
    JEL: J11 J12 N3 O3
    Date: 2019–11
  15. By: Ivan Khotulev (Bank of Russia, Russian Federation); Konstantin Styrin (Bank of Russia, Russian Federation)
    Abstract: We develop a model to analyze the optimal combination of macroprudential and monetary policies in a small open commodity-exporting economy. Unlike a closed economy, where monetary and macroprudential policies tend to be substitutes, in a small open economy the optimal policy mix depends on the specifics of shocks and economic structure. Monetary and macroprudential policies tend to be complements when the degree of pass-through of credit spreads into marginal costs and prices is sufficiently high, or when a credit boom is caused by a commodity boom, a fraction of consumers lacks access to financial markets, and the government follows a fiscal policy rule. The two policies are substitutes when the complementarity between domestic and imported production inputs is sufficiently high.
    Keywords: Monetary policy, macroprudential policy, financial stability, commodity exporter, small open economy.
    JEL: E52 E58 G01 G28
    Date: 2019–11
  16. By: Guner, Nezih (CEMFI, Madrid); Kaya, Ezgi (Cardiff University); Sánchez Marcos, Virginia (Universidad de Cantabria)
    Abstract: The total fertility rate is well below its replacement level of 2.1 children in high- income countries. Why do women choose such low fertility levels? We study how labor market frictions affect the fertility of college-educated women. We focus on two frictions: uncertainty created by dual labor markets (the coexistence of jobs with temporary and open-ended contracts) and inflexibility of work schedules. Using rich administrative data from the Spanish Social Security records, we show that women are less likely to be promoted to permanent jobs than men. Temporary contracts are also associated with a lower probability of first birth. With Time Use data, we also show that women with children are less likely to work in jobs with split-shift schedules, which come with a fixed time cost. We then build a life-cycle model in which married women decide whether to work or not, how many children to have, and when to have them. In the model, women face a trade-off between having children early and waiting and building their careers. We show that reforms that reduce the labor market duality and eliminate split-shift schedules increase the completed fertility of college-educated from 1.52 to 1.88. These reforms enable women to have more children and have them early in their life-cycle. They also increase the labor force participation of women and eliminate the employment gap between mothers and non-mothers.
    Keywords: fertility, labor market frictions, temporary contracts, split-shift schedules
    JEL: E24 J13 J21 J22
    Date: 2019–11
  17. By: Stefano Neri (Bank of Italy); Tiziano Ropele (Bank of Italy)
    Abstract: In New Keynesian models favourable cost-push shocks lower inflation and increase output. Yet, when the central bank�s inflation target is not perfectly observed these shocks turn contractionary as agents erroneously perceive a temporary reduction in the target. This effect is amplified when monetary policy is constrained by the effective lower bound on the policy rate.
    Keywords: inflation target, imperfect information, monetary policy
    JEL: E31 E52 E58
    Date: 2019–07
  18. By: Katsuhiro Oshima (Graduate School of Economics, Kyoto University)
    Abstract: This paper investigates how the stance of monetary policy affects stock price volatilities in an economy where two types of households with subjective and objective beliefs about expected capital gains from stock prices exist. I assume that investors construct subjective beliefs about expected capital gains by Bayesian learning from observed growth rates of stock prices. In a model with only homogenous subjective beliefs, the effect of the interest rate on stock prices tends to be unrealistically strong. In contrast, assuming heterogeneity by including investors with both subjective and objective beliefs improves the fit of theoretical moments to the data and especially helps to explain stock price volatility under interest rate shocks with conventional sizes. This quantitative improvement in stock price reactions to interest rate shocks allows me to conduct realistic analysis about how the stance of monetary policy affects stock price volatilities. Strong inertia of monetary policy rule does not necessarily reduce asset price volatilities. This depends on what kind of shock the economy is experiencing. When the monetary policy is persistent, stock price volatilities magnify under an unexpected monetary policy shock
    Keywords: stock price, asset pricing, heterogeneity, subjective belief, monetary policy, sticky prices, New Keynesian
    JEL: D83 D84 E44 E52 G12 G14
    Date: 2019–11

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