nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2020‒01‒27
twenty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Debt sustainability and fiscal space in a heterogeneous Monetary Union: normal times vs the zero lower bound By Javier Andrés; Pablo Burriel; Wenyi Shen
  2. Capital Income Taxation with Housing By Makoto Nakajima
  3. Welfare Effects of Fiscal Procyclicality: Public Insurance with Heterogeneous Agents By Alvaro Aguirre
  4. Specific Human Capital and Real Wage Cyclicality: An Application to Postgraduate Wage Premium By Gu, Ran
  5. Self-Fulfilling Debt Crises, Revisited By Mark Aguiar; Satyajit Chatterjee; Harold L. Cole; Zachary Stangebye
  6. Human Capital and Financial Development: Firm-Level Interactions and Macroeconomic Implications By Allub, Lian; Gomes, Pedro; Kuehn, Zoë
  7. Health, wealth, and informality over the life cycle By Julien Albertini; Xavier Fairise; Anthony Terriau
  8. Price Rigidity and the Granular Origins of Aggregate Fluctuations By Ernesto Pasten; Raphael Schoenle; Michael Weber
  9. Secular Stagnation, Financial Frictions, and Land Prices By Zhifeng Cai
  10. We compare welfare and macroeconomic effects of monetary policy and macroprudential policy, in particular targeting loan-to-value (LTV) ratios. We develop a DSGE model with collateral constraints and two types of agents. In this setup, we study seven potential policy rules responding to credit growth and fluctuations in prices of collateral. We show that monetary policy responding to deviations of collateral prices from their steady state value results in the highest level of social welfare. It is also useful in stabilizing output and inflation. Macroprudential policy using LTV ratio as the instrument is dominated in terms of output and inflation stability by the interest rate rules. If interest rate rules are not available, the LTV ratio can be used to improve welfare, but gains are small.. By Piotr Zoch
  11. Development, Fertility and Childbearing Age: A Unified Growth Theory By Hippolyte d'Albis; Angela Greulich; Grégory Ponthière
  12. Asset Prices and Unemployment Fluctuations By Patrick J. Kehoe; Pierlauro Lopez; Virgiliu Midrigan; Elena Pastorino
  13. Sticky Prices and Costly Credit By Liang Wang; Randall Wright; Lucy Qian Liu
  14. Optimal fiscal policy without commitment: Beyond Lucas-Stokey By Davide Debortoli; Ricardo Nunes; Pierre Yared
  15. Counting innovations: Schumpeterian growth in discrete time By Cozzi, Guido; Galli, Silvia
  16. Persistent Misallocation and the Productivity Slowdown in EU By Shalini Mitra
  17. Skill mismatch and labour turnover in a developing country: the Colombian case By Luz A. Flórez; Leidy Gómez D.
  18. Deconstructing Job Search Behavior By Stefano Banfi; Sekyu Choi; Benjamín Villena
  19. Should Monetary Policy Target Financial Stability? By William Chen; Gregory Phelan
  20. Who Bears the Welfare Costs of Monopoly? The Case of the Credit Card Industry By Herkenhoff, Kyle; Raveendranathan, Gajendran
  21. Monetary Policy, rational confidence, and Neo- Fisherian depressions By Lucio Gobbi; Ronny Mazzocchi; Roberto Tamborini

  1. By: Javier Andrés (Universidad de Valencia); Pablo Burriel (Banco de España); Wenyi Shen (Oklahoma State University)
    Abstract: In this paper we study fiscal policy effects and fiscal space for countries in a monetary union with different levels of public debt. We develop a dynamic stochastic general equilibrium (DSGE) model of a two-country monetary union, calibrated to match the characteristics of Spain and Germany, in which debt sustainability is endogenously determined a la Bi (2012) to shape the responses of the risk premium on public debt. Policy shocks change the market’s expectation about future primary surplus, producing a direct effect on the sovereign risk premium and macroeconomic responses of the economy. In normal times the costs of a government spending driven fiscal consolidation in the high-debt country are greatly diminished when this consolidation improves endogenously its debt sustainability prospects. Fiscal consolidations in both members of the monetary union decrease real interest rates and amplify the reduction in risk premium in the highly-indebted country, improving union-wide output in the long run, but at the cost of lower output in the low-debt country in the short term. On the contrary, when monetary policy is constrained at the zero lower bound, the risk premium channel arising from the endogenous determination of debt sustainability becomes muted. In the ZLB, a fiscal consolidation generates deflation expectations which increase the real interest rate and may compensate partially or completely, depending on the calibration, the benefits from a lower risk premium. In this context, a fiscal expansion in the low-debt country and a consolidation in the high-debt country delivers the greater positive impact on union-wide output. Finally, the risk premium channel only affects countries with medium or low levels of public debt indirectly through the negative spillovers from other high-debt members of the monetary union.
    Keywords: fiscal sustainability, sovereign debt default risk, monetary union
    JEL: E31 E62 H30
    Date: 2020–01
  2. By: Makoto Nakajima
    Abstract: This paper quantitatively investigates capital income taxation in the general-equilibrium overlap-ping generations model with household heterogeneity and housing. Housing tax policy is found to affect how capital income should be taxed, due to substitution between housing and non-housing capital. Given the existing U.S. preferential tax treatment for owner-occupied housing, the optimal capital income tax rate is close to zero (1%), contrary to the high optimal capital income tax rate found with overlapping generations models without housing. A low capital income tax rate improves welfare by narrowing a tax wedge between housing and non-housing capital; the narrowed tax wedge indirectly nullifies the subsidies (taxes) for homeowners (renters) and corrects over-investment to housing. Naturally, when the preferential tax treatment for owner-occupied housing is eliminated, a high capital income tax rate improves welfare as in the model without housing.
    Keywords: Incomplete Markets; Capital Income Taxation; Heterogeneous Agents; Overlapping Generations; Housing; Life Cycle; Optimal Taxation
    JEL: E21 H21 H24 R21
    Date: 2020–01–07
  3. By: Alvaro Aguirre
    Abstract: This paper pursues a welfare analysis of fiscal policy, specifically public spending, in an economy with heterogenous agents and incomplete markets. The main quantitative exercise consists in measuring the gains of switching from the (procyclical) spending path of the typical developing country to an acyclical or countercyclical path. The model emphasizes the role of transfer payments from the government to households in alleviating the costs of idiosyncratic shocks. Since these correlate with aggregate shocks, the way fiscal policy is conducted along the business cycle has important welfare effects. I find that the costs of procyclicality are relatively large and very heterogeneous. While wealth-rich agents don't suffer from procyclicality, poor agents, being either unemployed or unskilled, lose the most. In terms of life-time consumption equivalents these agents may lose as much as 2% from fiscal procyclicality, considering only the fraction of spending that is allocated as transfer payments.
    Date: 2020–01
  4. By: Gu, Ran
    Abstract: This paper examines how specific human capital affects labour turnover and real wage cyclicality in a frictional labour market. I develop an equilibrium search model with long-term contracts and imperfect monitoring of worker effort. Imperfect monitoring creates a moral hazard problem that requires firms to pay efficiency wages. The optimal contract implies that more specific capital reduces job separation, thereby alleviating the moral hazard and increasing wage stability over the business cycle. I apply this model to explain novel stylised facts about the cyclicality of the postgraduate-undergraduate wage premium. Postgraduate degree holders experience lower cyclical variation in real wages than those with undergraduate degrees. This effect is significant for workers with a long tenure, but not for new hires. Moreover, postgraduates have more specific human capital than undergraduates. Estimates reveal that specific capital can explain the educational gaps both in labour turnover and in real wage cyclicality.
    Keywords: specific human capital, real wage cyclicality, postgraduates, wage premium, contracts, search
    JEL: E24 E32 I24 J31 J64
    Date: 2019–12–02
  5. By: Mark Aguiar (Federal Reserve Bank; Massachusetts Institute of Technology; National Bureau of Economic Research; University of Rochester; Graduate School of Business; Princeton University); Satyajit Chatterjee (National Bureau of Economic Research; Federal Reserve Bank of Philadelphia; Federal Reserve Bank); Harold L. Cole; Zachary Stangebye
    Abstract: We revisit self-fulfilling rollover crises by exploring the potential uncertainty introduced by a gap in time (however small) between an auction of new debt and the payment of maturing liabilities. It is well known (Cole and Kehoe, 2000) that the lack of commitment at the time of auction to repayment of imminently maturing debt can generate a run on debt, leading to a failed auction and immediate default. We show that the same lack of commitment leads to a rich set of possible self-fulfilling crises, including a government that issues more debt because of the crisis, albeit at depressed prices. Another possible outcome is a “sudden stop” (or forced austerity) in which the government sharply curtails debt issuance. Both outcomes stem from the government’s incentive to eliminate uncertainty about imminent payments at the time of auction by altering the level of debt issuance. In an otherwise standard quantitative version of the model, including such crises in-creases the default probabilities by a factor of five and the spread volatility by a factor of twenty-five.
    Keywords: self-fulfilling debt crises; rollover crises
    JEL: F1 G3
    Date: 2020–01–22
  6. By: Allub, Lian; Gomes, Pedro; Kuehn, Zoë
    Abstract: Capital-skill complementarity in production implies non-trivial interactions between availability of human capital and financial constraints. Firms that are constrained in their access to finance hire a lower proportion of skilled workers than unconstrained firms. On the other hand, higher wages of skilled workers reduce firms’ desired capital intensity and thus loosen their effective financial constraints. We build a dynamic occupational choice model to quantify how a lack of human capital and financial frictions, as well as the joint effect of both restrictions interact to explain cross-country differences in aggregate output per capita, productivity, average firm size and college premia. We calibrate our model to US data, and we vary financial frictions and educational attainment as observed across countries. We find that the joint effect of both restrictions is up to 50 percent larger compared to the sum of the individual effects. In countries with a negligible share of tertiary educated workers, financial development has small effects on aggregate output.
    Keywords: Banca de desarrollo, Educación, Evaluación de impacto, Finanzas,
    Date: 2019
  7. By: Julien Albertini (Univ Lyon, Université Lumière Lyon 2, GATE UMR 5824, F-69130 Ecully, France); Xavier Fairise (GAINS, University of Le Mans); Anthony Terriau (GAINS, University of Le Mans)
    Abstract: How do labor market and health outcomes interact over the life cycle in a country characterized by a large informal sector and strong inequalities? To quantify the effects of bad health on labor market trajectories, wealth, and consumption, we develop a life-cycle heterogeneous agents model with a formal and an informal sector. We estimate our model using data from the National Income Dynamics Study, the first nationally representative panel study in South Africa. We run counterfactual experiments and show that health shocks have an important impact on wealth and consumption. The channel through which these shocks propagate strongly depends on the job status of individuals at the time of the shock. For formal workers, bad health reduces labor efficiency, which translates into lower earnings. For informal workers and the non-employed, the shock lowers the job finding rate and in- creases job separation into non-employment, which results in a surge in non-employment spells. As bad health spells persist more for non-employed than for employed individuals, the interaction between labor market risks and health risks generates a vicious circle.
    Keywords: Health, Wealth, Life cycle, Informality
    JEL: I14 I15 E26 O17 J46 J64
    Date: 2019
  8. By: Ernesto Pasten; Raphael Schoenle; Michael Weber
    Abstract: We study the potency of sectoral productivity shocks to drive aggregate fluctuations in the presence of three empirically relevant heterogeneities across sectors: sector size, intermediate input consumption, and pricing frictions in a multi-sector New Keynesian model. We derive conditions under which sectoral shocks matter for aggregate volatility in a simplified model and find the distribution of sector size or input-output linkages are neither necessary nor sufficient to generate aggregate fluctuations. Quantitatively, we calibrate our full model to 341 sectors using U.S. data and find (1) fully heterogeneous price rigidity across sectors doubles the aggregate volatility from sectoral shocks relative to a calibration with homogeneous price rigidity; 2) realistically calibrated sectoral productivity shocks are key to generating sizable aggregate fluctuations of both GDP and prices; 3) heterogeneity of price rigidity matters because it changes the effective distribution of sector size and network centrality. Our quantitative exercise generates large aggregate fluctuations under different empirically plausible monetary policy rules.
    Date: 2020–01
  9. By: Zhifeng Cai (Rutgers University)
    Abstract: This paper explores a model in which large transitory financial shocks can generate persistent slumps in output, land prices, and interest rate. The propagation originates from high sensitivity of land prices with respect to fundamental, which is achieved by a land consumption channel that exploits the high complementarity of land services and consumption in households’ preference. When this complementarity is disciplined by micro-level evidence, the unique recursive equilibrium features an S-shaped law of motion for capital with two locally stable steady states. Small shocks move the economy around the unconstrained steady state whereas large transitory financial shocks push the economy into the constrained steady state at which low interest rate makes firm unwilling to save out of the financial friction, leading to a secular stagnation.
    Keywords: Secular Stagnation, Steady-State Multiplicity, Financial Frictions, House Prices
    JEL: E0
    Date: 2020–01–23
  10. By: Piotr Zoch (Group for Research in Applied Economics (GRAPE); Department of Economics, University of Chicago)
    Keywords: discounted collateral constraint, financial friction, macroprudential policy
    JEL: E30 E32 E44 E52
    Date: 2019
  11. By: Hippolyte d'Albis (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, PSE - Paris School of Economics); Angela Greulich (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, INED - Institut national d'études démographiques); Grégory Ponthière (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, ERUDITE - Equipe de Recherche sur l’Utilisation des Données Individuelles en lien avec la Théorie Economique - UPEM - Université Paris-Est Marne-la-Vallée - UPEC UP12 - Université Paris-Est Créteil Val-de-Marne - Paris 12)
    Abstract: During the last century, fertility has exhibited, in industrialized economies, two distinct trends: the cohort total fertility rate follows a decreasing pattern, while the cohort average age at motherhood exhibits a U-shaped pattern. This paper proposes a Unified Growth Theory aimed at rationalizing those two demographic stylized facts. We develop a three-period OLG model with two periods of fertility, and show how a traditional economy, where individuals do not invest in education, and where income rises push towards advancing births, can progressively converge towards a modern economy, where individuals invest in education, and where income rises encourage postponing births. Our findings are illustrated numerically by replicating the dynamics of the quantum and the tempo of births for cohorts 1906-1975 of the Human Fertility Database.
    Keywords: regime shift,fertility,childbearing age,births postponement,human capital
    Date: 2018–07
  12. By: Patrick J. Kehoe; Pierlauro Lopez; Virgiliu Midrigan; Elena Pastorino
    Abstract: Recent critiques have demonstrated that existing attempts to account for the unemployment volatility puzzle of search models are inconsistent with the procylicality of the opportunity cost of employment, the cyclicality of wages, and the volatility of risk-free rates. We propose a model that is immune to these critiques and solves this puzzle by allowing for preferences that generate time-varying risk over the cycle, and so account for observed asset pricing fluctuations, and for human capital accumulation on the job, consistent with existing estimates of returns to labor market experience. Our model reproduces the observed fluctuations in unemployment because hiring a worker is a risky investment with long-duration surplus flows. Intuitively, since the price of risk in our model sharply increases in recessions as observed in the data, the benefit from creating new matches greatly drops, leading to a large decline in job vacancies and an increase in unemployment of the same magnitude as in the data.
    JEL: E0 E2 E24 E32 J6 J63 J64
    Date: 2019–12
  13. By: Liang Wang (University of Hawaii at Manoa); Randall Wright (University of Wisconsin - Madison, Zhejiang University, and FRB Minneapolis); Lucy Qian Liu (International Monetary Fund)
    Abstract: We develop a theory of money and credit as competing payment instruments, then put it to work in applications. Agents use cash and credit because the former (latter) is subject to the inflation tax (transaction costs). Frictions that make the choice of payment method interesting also imply equilibrium price dispersion. We derive closed- form solutions for money demand, and show how to simultaneously account for the price-change facts, cash-credit shares in micro data, and money-interest correlations in macro data. The effects of inflation on welfare, price dispersion and markups are discussed, as are nonstationary equilibria with dynamics in the price distribution.
    Keywords: Money, Credit, Inflation, Price Dispersion, Sticky Prices
    JEL: E31 E42 E51 E52
    Date: 2020–01
  14. By: Davide Debortoli; Ricardo Nunes; Pierre Yared
    Keywords: Public debt, optimal taxation, fiscal policy
    JEL: H63 H21 E62
    Date: 2019–02
  15. By: Cozzi, Guido; Galli, Silvia
    Abstract: Schumpeterian growth theory based on creative destruction was originally designed for continuous time innovation and growth models. However its recently expanding use in DSGE modelling calls for an easily usable discrete time recast. We here show how to construct a discrete time version of creative destruction fully equivalent to its continuous time counterpart.
    Keywords: R&D and Growth; Creative Destruction; Discrete Time; DSGE.
    JEL: E3 O3
    Date: 2019
  16. By: Shalini Mitra
    Abstract: Why did the productivity slowdown in EU happen at a time of increasing financial market deregulation and generally easing credit conditions? The fact that productivity growth was declining at a time of rising credit is in contrast to the standard prediction of macroeconomic models which find a positive relation between credit and productivity growth. I argue in this paper that if the conventional channel though which such a productivity increase occurs - the reallocation of capital from less to more productive businesses - is impaired, then a decline in credit constraints has the opposite effect in the standard model and aggregate productivity declines. There is in fact ample evidence in the literature to support the impairment of capital reallocation in the EU during this period.
    Keywords: capital misallocation, financial constraints, heterogenous firms, productivity slowdown, aggregate productivity, EU
    JEL: D24 D5 D61
    Date: 2018–04
  17. By: Luz A. Flórez (Banco de la República de Colombia); Leidy Gómez D.
    Abstract: The objective of this paper is to analyze the impact of skill mismatch on labour turnover for the case of Colombia. Our work follows the of the job matching theory of Jovanovic (1979a, 1979b, 1984). In line with this theory we find a positive relationship between skill mismatch and labour turnover (measured as the worker reallocation rate) using a panel of 23 cities for the period 2009-2017. Our results suggest that cities with a higher proportion of mismatched workers present higher worker reallocation rates. In this case one standard deviation of increment in the proportion of mismatch workers increases the WR rate around 0.12 standard deviations. This result is explained mainly by the increase on separations as is suggested by the theory. **** RESUMEN: El objetivo de este documento es analizar el efecto del desajuste en habilidades en la rotación laboral para el caso de Colombia. Nuestro enfoque teórico sigue de cerca el modelo de búsqueda de empleo propuesto por Jovanovic (1979a, 1979b, 1984). Como es sugerido por esta literatura, usando el panel de 23 ciudades para el periodo 2009-2017, encontramos evidencia de una relación positiva entre el nivel del desajuste en las habilidades y la rotación laboral, medida como la reasignación de trabajadores. Un incremento de una desviación estándar en el nivel de desajuste de habilidades produce un incremento de 0.12 desviaciones estándar en la rotación laboral. Estos resultados se explican principalmente por el incremento en las separaciones como es sugerido por el modelo teórico.
    Keywords: Skill mismatch, overqualification, underqualification, worker reallocation, panel data, and cross-sectional dependence, desajuste de habilidades, sobre-calificación, baja calificación, datos panel, reasignación de trabajadores, y dependencia transversal
    JEL: I25 J62 J63 J64
    Date: 2019–12
  18. By: Stefano Banfi; Sekyu Choi; Benjamín Villena
    Abstract: Job search is generally described by an intensive effort margin such as the number of applications sent or of hours devoted. Using rich online job board data and a novel network method to determine relevant sets of ads for each applicant, we also investigate the job search selective margin, i.e. why workers apply to or forgo job offers. We provide a comprehensive catalogue of search behavior. Gender and age affect the intensive search margin: males and older workers search more controlling for observable ad and worker traits. For the selective margin, we find that the alignment between applicant wage expectations and wage offers, as well as the applicant fit into ad requirements such as education, experience, job location, and occupation increase the application likelihood. On-the-job searchers and males seem more ambitious as they apply to jobs offering wages above their expectations and to jobs requiring more education than they possess. In contrast, unemployed seekers seem conservative: they comply to wage offers and apply to jobs for which they are overqualified. As workers age, or as their unemployment duration or elapsed tenure (for the employed) increase, they tend to make seeking behavior less ambitious and more flexible in terms of requirements compliance. Seekers’ effort is procyclical, except for the jobless when the unemployment rate is pretty high. Comparatively, the selective margin varies less over the cycle. Our empirical evidence can help discipline current and future search-theoretical frameworks. JEL Codes: E24, J40, J64. Key words: Applications,Networks.,On-the-job search,Online job search,Search frictions,unemployment
    Date: 2019
  19. By: William Chen (Williams College); Gregory Phelan (Williams College)
    Abstract: We theoretically investigate the state-dependent effects of monetary policy on aggregate stability. In the model, banks borrow using deposits and invest in productive projects, and monetary policy affects risk-premia. Because banks do not actively issue equity, aggregate outcomes depend on the level of equity in the financial sector and equilibrium is inefficient. Monetary policy can improve household welfare by affecting banks’ leverage decisions and the rate of bank equity growth. A Fed Put is ex-ante stabilizing, decreasing volatility and the likelihood of crises; it does not lead to excessive leverage in good times but enables higher leverage in bad times.
    Keywords: Monetary policy, Leaning against the wind, Financial stability, Macroeconomic instability, Banks, Liquidity.
    JEL: E44 E52 E58 G01 G12 G20 G21
    Date: 2020–01–03
  20. By: Herkenhoff, Kyle (University of Minnesota); Raveendranathan, Gajendran (McMaster University)
    Abstract: How are the welfare costs from monopoly distributed across U.S. households? We answer this question for the U.S. credit card industry, which is highly concentrated, charges interest rates that are 3.4 to 8.8 percentage points above perfectly competitive pricing, and has repeatedly lost antitrust lawsuits. We depart from existing competitive models by integrating oligopolistic lenders into a heterogeneous agent, defaultable debt framework. Our model accounts for 20 to 50 percent of the spreads observed in the data. Welfare gains from competitive reforms in the 1970s are equivalent to a one-time transfer worth between 0.24 and 1.66 percent of GDP. Along the transition path, 93 percent of individuals are better off. Poor households benefit from increased consumption smoothing, while rich households benefit from higher general equilibrium interest rates on savings. Transitioning from 1970 to 2016 levels of competition yields welfare gains equivalent to a one-time transfer worth between 1.87 and 3.20 percent of GDP. Lastly, homogeneous interest rate caps in 2016 deliver limited welfare gains.
    Keywords: welfare costs of monopoly, consumer credit, competition, welfare
    JEL: D14 D43 D60 E21 E44 G21
    Date: 2019–12
  21. By: Lucio Gobbi; Ronny Mazzocchi; Roberto Tamborini
    Abstract: We examine the so-called "Neo-Fisherian" claim that, at the zero lower bound (ZLB) of the monetary policy interest rate, and the economy in a depression equilibrium, in order to restore the desired inflation rate the policy rate should be raised consistently with the Fisher equation. This claim has been questioned on the ground that the Fisher equation cannot be used mechanically to peg the long-run inflation expectations. It is necessary to examine how inflation expectations are formed in response to, and interact with, policy actions and the evolution of the economy. Hence we study a New Keynesian economy where agents' inflation expectations are based on their correct understanding of the data generations process, and on their probabilistic confidence in the central bank's ability to keep inflation on target, driven by the observed state of the economy. We find that the Neo-Fisherian claim is a theoretical possibility depending on the interplay of a set of parameters and very low levels of agents' confidence. Yet, on the basis of simulations of the model, we may say that this possibility is remote for most commonly found empirical values of the relevant parameters. Moreover, the Neo-Fisherian policy-rate peg is not sustained by the expectations formation process.
    Keywords: conventional monetary policy, Neo-Fisherian theory, formation of inflation expectations, monetary policy at the zero lower bound
    JEL: D84 E31 E52
    Date: 2019

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