nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2020‒01‒13
fourteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. The Unintended Consequences of Meritocratic Government Hiring By Athanasios Geromichalos; Ioannis Kospentaris
  2. Consumption Insurance Against Wage Risk: Family Labor Supply and Optimal Progressive Income Taxation By Chunzan Wu; Dirk Krueger
  3. Aging, Factor Prices and Capital Flows By Andrea BONFATTI; Selahattin Ä°MROHOROÄžLU; KITAO Sagiri
  4. The Importance of Beliefs in Shaping Macroeconomic Outcomes By Roger Farmer
  5. Labor productivity, labor supply of the old, and economic growth By Chen, Hung-Ju; Miyazaki, Koichi
  6. International trade in intermediate inputs and the welfare gains from monetary policy cooperation By Liutang Gong; Jianjian Liu; Chan Wang; Liyuan Wu; Heng-fu Zou
  7. Fast Value Iteration: An Application of Legendre-Fenchel Duality to a Class of Deterministic Dynamic Programming Problems in Discrete Time By Ronaldo Carpio; Takashi Kamihigashi
  8. Does the Life Cycle Hypothesis Apply in the Case of Japan? By Charles Yuji Horioka
  9. Model Uncertainty and Wealth Distribution By Edouard Djeutem; Shaofeng Xu
  10. Investment tax incentives and their big time-to-build fiscal multiplier By Bermperoglou, Dimitrios; Deli, Yota; Kalyvitis, Sarantis
  11. Government Investment, Its Financing and the Public Capital Stock: A Small Open Economy Perspective By Hickey, Rónán; Lozej, Matija; Smyth, Diarmaid
  12. Firm turnover in the export market and the case for fixed exchange rate regime By Hamano, Masashige; Pappadà, Francesco
  13. Generalised Impulse Response Function as a Perturbation of a Global Solution to DSGE Models By Viktors Ajevskis
  14. Optimal Fiscal and Monetary Policy with Distorting Taxes By Christopher A. Sims

  1. By: Athanasios Geromichalos; Ioannis Kospentaris (Department of Economics, University of California Davis)
    Abstract: In an attempt to mitigate the negative effects of clientelism, many governments around the world have adopted meritocratic hiring of public employees. This paper challenges the effectiveness of this common practice by showing that meritocratic government hiring can have unintended negative consequences on macroeconomic aggregates. In many countries, public employees enjoy considerable job security and generous compensation schemes; as a result, many talented workers choose to work for the public sector, which deprives the private sector of productive potential employees. This, in turn, reduces firms' incentives to create jobs, increases unemployment, and lowers GDP. To quantify the effects of this novel channel, we extend the standard Diamond-Mortensen-Pissarides model to incorporate workers of heterogeneous productivity and a government that fills public sector jobs based on merit. We calibrate the model to aggregate data from Greece and perform a series of counterfactual exercises. We find that the adverse effects of our mechanism on the economy's TFP, GDP, and unemployment are sizable.
    Keywords: search and matching models, public sector, meritocracy, unemployment
    JEL: E24 J30 J45 J64
    Date: 2020–01–02
  2. 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.
    Keywords: household model, male wages, female wages, income insurance
    JEL: E20 H21 D19
    Date: 2019–12
  3. By: Andrea BONFATTI; Selahattin Ä°MROHOROÄžLU; KITAO Sagiri
    Abstract: Although populations are aging in all economies, projections for coming decades describe differential timing and extent of aging. Advanced economies are aging earlier and faster than the developing and emerging economies, with Japan leading the way. In a world with integrated capital markets, these differences in demographic trends, with different social security environments, will have differential implications on national or regional capital accumulation, investment, factor prices and capital flows across borders. This paper develops a general equilibrium model of the world economy under imperfect capital mobility, populated by overlapping generations of individuals in three regions: the High-income (HI) and Middle-income (MI) regions and Japan. We compute equilibrium transitions from the 1990s toward a future balanced growth path and numerically characterize the first few decades. Our findings highlight the quantitative importance of the differential aging mechanism in studying capital flows across regions. In particular, we find that the projected decline in national saving in Japan, not matched with a similar decline in domestic investment, will lead to a reversal of capital flows into Japan, which will become a net borrower before 2050. The reason for Japan's attractiveness for foreign capital from the MI region is the initially rising but soon flattening path of its capital labor ratio while the MI region experiences a monotonically increasing capital labor ratio. This projection, coupled with the slow speed with which the MI region's TFP catches up with that of Japan, necessitates an outflow of capital from the MI region to the HI region and Japan in order for the world capital market to clear.
    Date: 2019–12
  4. By: Roger Farmer
    Abstract: For the past thirty years of the history of macroeconomic thought, the Indeterminacy School of Macroeconomics has used general equilibrium models with indeterminate equilibria to understand the independent role of beliefs in shaping macroeconomic outcomes. In this paper I describe the most recent advances in the indeterminacy agenda, Keynesian Search Theory, in which the steady-state unemployment rate is indeterminate as a consequence of labour-market frictions. In Keynesian Search Theory, the belief of market participants is an independent exogenous variable that selects a steady-state equilibrium. I study two assumptions about beliefs, one where investment is exogenous and one where the belief about the stock market is exogenous and I examine their implications for fiscal policy.
    JEL: D50 E12 E24 E32
    Date: 2019–12
  5. By: Chen, Hung-Ju; Miyazaki, Koichi
    Abstract: This study develops an overlapping generations model with human capital accumulation and endogenous labor supply of the old to examine the effects of an old agent's labor productivity on labor supply, educational investments, and economic growth. We present a unique existence of the balanced-growth-path (BGP) equilibrium and find that a rise in an old agent's labor productivity induces more labor supply of the old. Moreover, the growth rate at the BGP equilibrium is hump-shaped in an old agent's labor productivity. As an old agent's labor productivity grows, this growth rate first increases then decreases, which implies that there is no clear negative relationship between an old agent's labor productivity and economic growth.
    Keywords: Human capital; OLG; Labor productivity; Labor supply of the old
    JEL: J24 J26 O11
    Date: 2019–12–03
  6. By: Liutang Gong (Guanghua School of Management and LMEQF Peking University); Jianjian Liu (Guanghua School of Management and LMEQF Peking University); Chan Wang (School of Finance, Central University of Finance and Ecoonomics); Liyuan Wu (Guanghua School of Management and LMEQF Peking University); Heng-fu Zou (China Economics and Management Academy, Central University of Finance and Ecoonomics)
    Abstract: This paper introduces international trade in intermediate inputs into Clarida et al.(2002) to examine the welfare gains from monetary policy cooperation when the world is hit by cost-push shocks. We find that Clarida et al.(2002)'s prediction is right. Specifically, the introduction of the international trade in intermediate inputs opens a new channel through which the terms of trade at the stage of intermediate-goods production produce the spillover effect. In Clarida et al. (2002), the risk sharing effect and the terms of trade effect cancel out and the welfare gains from monetary policy cooperation disappear when the utility function of consumption is logarithmic. By contrast, in our model, the new channel still works. By internalizing the spillover effect produced through the new channel, the cooperative monetary policymaker achieves the welfare gains which are substantially larger than those found in the literature. In addition, we find that the welfare gains increase with the degree of intermediate-goods trade openness.
    Date: 2020
  7. By: Ronaldo Carpio (School of Business and Finance, University of International Business and Economics); Takashi Kamihigashi (Research Institute for Economics and Business Administration, Kobe University)
    Abstract: We propose an algorithm, which we call "Fast Value Iteration" (FVI), to compute the value function of a deterministic infinite-horizon dynamic programming problem in discrete time. FVI is an ecient algorithm applicable to a class of multidimen- sional dynamic programming problems with concave return (or convex cost) functions and linear constraints. In this algorithm, a sequence of functions is generated starting from the zero function by repeatedly applying a simple algebraic rule involving the Legendre-Fenchel transform of the return function. The resulting sequence is guaran- teed to converge, and the Legendre-Fenchel transform of the limiting function coincides with the value function.
    Keywords: Dynamic programming, Legendre-Fenchel transform, Bellman operator, Convex analysis
    Date: 2019–12
  8. By: Charles Yuji Horioka (Research Institute for Economics and Business Administration, Kobe University, Osaka University, Asian Growth Research Institute, and National Bureau of Economic Research)
    Abstract: In this paper, we first discuss the simplest version of the life cycle model, which is arguably the most widely used theoretical model in economics, and then consider whether or not the life cycle model applies in the case of Japan using a variety of methodologies and data and placing emphasis on the author’s own research. In particular, we survey the literature on the impact of the age structure of the population on the saving rate, on the saving behavior of retired households, on saving motives, on the importance of bequests, on bequest motives, on the prevalence of altruism, and on the importance of borrowing (liquidity) constraints and show that almost all previous research suggests that the life cycle model is more applicable in Japan than it is in other countries. Thus, the answer to the question posed in the title of this paper is an unqualified “yes.” Finally, we discuss the policy implications of our finding that the life cycle model applies in the case of Japan.
    Keywords: Age structure of the population, Altruism, Bequests, Bequest motives, Borrowing constraints, Consumption, Elderly, Households, Household saving, Inheritances, Intergenerational transfers, Life cycle hypothesis, Life cycle model, Liquidity constraints, Old age, Retirees, Saving, Saving motives, Selfishness
    JEL: D12 D14 D64 E21 J14
    Date: 2019–12
  9. By: Edouard Djeutem; Shaofeng Xu
    Abstract: This paper studies the implications of model uncertainty for wealth distribution in a tractable general equilibrium model with a borrowing constraint and robustness à la Hansen and Sargent (2008). Households confront model uncertainty about the process driving the return of the risky asset, and they choose robust policies. We find that in the presence of a borrowing constraint, model distortion varies non-monotonically with wealth. Robustness generates two forces that amplify wealth inequality. On the one hand, it increases the speed at which the wealth of unlucky households hits the borrowing constraint. On the other hand, it leads richer households to invest a disproportionately larger share of wealth in the higher yielding asset. Our study also shows that model uncertainty results in an aggregate welfare loss unevenly distributed across households.
    Keywords: Asset Pricing; Business fluctuations and cycles; Economic models
    JEL: D3 D8 E2
    Date: 2019–12
  10. By: Bermperoglou, Dimitrios; Deli, Yota; Kalyvitis, Sarantis
    Abstract: This paper studies how investment tax incentives stimulate output in a medium-scale DSGE model, which allows for a variety of fiscal financing mechanisms. We find that the horizon following a positive shock in investment tax incentives is crucial. The shock is highly expansionary in the long run, with the relevant fiscal multiplier substantially exceeding 1, but this effect only becomes visible after two to three years. Our analysis indicates that a rise in the marginal product of labor and the demand for labor trigger this expansion, which is an effect that partial equilibrium studies ignore. The results suggest that investment tax incentives are even more effective when nominal wages adjust faster.
    Keywords: private investment incentives,investment tax credit,fiscal multipliers
    JEL: E32 E62 H29
    Date: 2019
  11. By: Hickey, Rónán (Central Bank of Ireland); Lozej, Matija (Central Bank of Ireland); Smyth, Diarmaid (Department of Finance)
    Abstract: Expenditure reductions played a key role in many small open economies during the fiscal consolidation between 2008 to 2013, especially for public investment. This led to lower public capital stock and affected competitiveness of these countries. After the crisis, many governments consider increasing government investment to replenish the public capital stock, but have limited resources to do so. This paper shows that budget-neutral investment spending can generate the long-term benefits of a higher public capital stock while at the same time limiting the risks of overheating and negative consequences for public finances and trade balance. The least harmful way of financing government investment, which preserves both fiscal and external balances, is by reducing other government spending, even if it is valued by households. Financing government investment with debt worsens fiscal and external balances. Financing investment with labour taxes reduces the external balance, while financing with VAT only does so in the very short run.
    Keywords: DSGE models, government investment, public finances, monetary union, open-economy macroeconomics.
    JEL: F16 F41 F42 F45 F47
    Date: 2019–08
  12. By: Hamano, Masashige; Pappadà, Francesco
    Abstract: This paper revisits the case for exible vs. fixed exchange rate regime in a two-country model with firm heterogeneity and nominal wage rigidity under incomplete financial markets. Dampening nominal exchange rate fluctuations simultaneously stabilizes the firm turnover in the export market. When firms are homogeneous and low productive, the fixed exchange rate regime dominates the flexible one because it reduces the fluctuations in labor demand arising from entry and exit of exporters following a demand shock. We also show that an alternative regulation policy in the export market does not rule out the possible adoption of a managed floating regime.
    JEL: F32 F41 E40
    Date: 2020–01–07
  13. By: Viktors Ajevskis (Bank of Latvia)
    Abstract: In the conventional perturbation approach for solving DSGE models, the dynamics of the deviation of solutions from the steady state after a shock hitting an economy represents an impulse response function (IRF). A method to construct the IRF as a deviation from a deterministic global solution is proposed. The approach detects asymmetric reactions of an economy to shocks in different initial conditions. For example, in an economic downturn a negative shock might affect the economy more severely than in normal economic conditions. The method allows for constructing the IRF for highly nonlinear DSGE models.
    Keywords: DSGE, perturbation, global solution, trend inflation
    JEL: C54 E32 E52 E58
    Date: 2019–11–29
  14. By: Christopher A. Sims (Princeton University)
    Abstract: When the interest rate on government debt is low enough, it becomes possible to roll it over indefinitely, never taxing to retire it, without producing a growing debt to GDP ratio. This has been called a situation with zero “fiscal cost†to debt.But when low interest on debt arises from its providing liquidity services, zero fiscal cost is equivalent to finance through seigniorage. Some finance through seigniorage is generally optimal, however, despite results in the literature seeming to show that this is not so.
    JEL: E52 E62
    Date: 2019–08

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