nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2020‒02‒10
twenty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Rational bubbles in non-linear business cycle models: Closed and open economies By Robert Kollmann
  2. How Should Unemployment Insurance Vary over the Business Cycle? By Serdar Birinci; Kurt See
  3. A Toolkit for Solving Models with a Lower Bound on Interest Rates of Stochastic Duration By Gauti Eggertsson; Sergey K. Egiev; Alessandro Lin; Josef Platzer; Luca Riva
  4. Monetary Policy and Sovereign Risk in Emerging Economies (NK-Default) By Cristina Arellano; Yan Bai; Gabriel P. Mihalache
  5. Health, wealth, and informality over the life cycle By Julien Albertini; Xavier Fairise; Anthony Terriau
  6. Anticipated Productivity and the Labor Market By Ryan Chahrour; Sanjay Chugh; Tristan Potter
  7. Housing Booms and the U.S. Productivity Puzzle By Jose Carreno
  8. Public Debt, Sovereign Spreads and the Unpleasant Arithmetic of Fiscal Consolidations By Minetti, Raoul; Di Pietro, Marco; Marattin, Luigi
  10. State-owned enterprises and entrusted lending: A DSGE analysis for growth and business cycles in China By Shuonan Zhang
  11. Optimal Fiscal Policies under Market Failures By YiLi Chien; Yi Wen
  12. A DSGE Perspective on Safety, Liquidity, and Low Interest Rates By Marc Giannoni; Abhi Gupta; Andrea Tambalotti; Domenico Giannone; Marco Del Negro; Pearl Li
  13. Search and Matching in Rental Housing Market By Mei Dong; Toshiaki Shoji; Yuki Teranishi
  14. Confronting DSGE model with data By Alfredo Villca
  15. Taking off into the Wind: Unemployment Risk and State-Dependent Government Spending Multipliers By Julien Albertini; Stéphane Auray; Hafedh Bouakez; Aurélien Eyquem
  16. Tighter Credit and Consumer Bankruptcy Insurance By António R. Antunes; Tiago Cavalcanti; Caterina Mendicino; Marcel Peruffo; Anne Villamil
  17. Monetary Dynamics in a Network Economy By Antoine Mandel; Vipin Veetil
  18. Does my model predict a forward guidance puzzle? By Gibbs, Christopher G.; McClung, Nigel
  19. Stability of a Small Open Economy under Nonlinear Income Taxation By Chen, Been-Lon; Hu, Yunfang; Mino, Kazuo
  20. Forward Guidance Under the Cost Channel By David Finck
  21. The Long-Run Effects of Monetary Policy By Òscar Jordà; Sanjay R. Singh; Alan M. Taylor

  1. By: Robert Kollmann
    Abstract: This paper studies rational bubbles in non-linear dynamic general equilibrium models of the macroeconomy. The term ‘Rational bubble’ refers to multiple equilibria due to the absence of a transversality condition (TVC) for capital. The lack of TVC can be due to an OLG population structure. If a TVC is imposed, the macro models considered here have a unique solution. Bubbles reflect self-fulfilling fluctuations in agents’ expectations about future investment. In contrast to explosive rational bubbles in linearized models (Blanchard (1979)), the rational bubbles in non-linear models here are bounded. Bounded rational bubbles provide a novel perspective on the drivers and mechanisms of business cycles. I construct bubbles (in non-linear models) that feature recurrent boombust cycles characterized by persistent investment and output expansions which are followed by abrupt contractions in real activity. Both closed and open economies are analyzed. In a non-linear two-country model with integrated financial markets, bubbles must be perfectly correlated across countries. Global bubbles may, thus, help to explain the synchronization of international business cycles.
    Keywords: Rational bubbles, boom-bust cycles, business cycles in closed and open economies, non-linear DSGE models, Long-Plosser model, Dellas model
    JEL: E1 E3 F3 F4 C6
    Date: 2020–02
  2. By: Serdar Birinci; Kurt See
    Abstract: We study optimal unemployment insurance (UI) over the business cycle using a heterogeneous agent job search model with aggregate risk and incomplete markets. We validate the model-implied micro and macro labor market elasticities to changes in UI generosity against existing estimates, and provide an explanation for divergent empirical findings. We show that generating the observed demographic differences between UI recipients and non-recipients is critical in determining the magnitudes of these elasticities. We find that the optimal policy features countercyclical replacement rates with average generosity close to current U.S. policy but adopts longer payment durations reminiscent of European policies.
    Keywords: Business Cycles; Job Search; Unemployment Insurance
    JEL: E24 E32 J64 J65
    Date: 2019–01–01
  3. By: Gauti Eggertsson; Sergey K. Egiev; Alessandro Lin; Josef Platzer; Luca Riva
    Abstract: This paper presents a toolkit to solve for equilibrium in economies with the effective lower bound (ELB) on the nominal interest rate in a computationally efficient way under a special assumption about the underlying shock process, a two-state Markov process with an absorbing state. We illustrate the algorithm in the canonical New Keynesian model, replicating the optimal monetary policy in Eggertsson and Woodford (2003), as well as showing how the toolkit can be used to analyze the medium scale DSGE model developed by the Federal Reserve Bank of New York. As an application, we show how well various policy rules perform relative to the optimal commitment equilibrium. A key conclusion is that previously suggested policy rules – such as price level targeting and nominal GDP targeting – do not perform well when there is a small drop in the price level, as observed during the Great Recession, because they do not imply sufficiently strong commitment to low future interest rates (”make-up strategy”). We propose two new policy rules, Cumulative Nominal GDP Targeting Rule and Symmetric Dual-Objective Targeting Rule that are more robust.
    Date: 2020
  4. By: Cristina Arellano; Yan Bai; Gabriel P. Mihalache
    Abstract: This paper develops a New Keynesian model with sovereign default risk (NK-Default). We focus on the interaction between monetary policy, conducted according to an interest rate rule that targets inflation, and external defaultable debt issued by the government. Monetary policy and default risk interact since both affect domestic consumption, production, and inflation. We find that default risk amplifies monetary frictions and generates a tension for monetary policy, which increases the volatility of inflation and nominal rates. These monetary frictions in turn discipline sovereign borrowing, slowing down debt accumulation and lowering sovereign spreads. Our framework replicates the positive comovements of spreads with nominal domestic rates and inflation, a salient feature of emerging markets data, and can rationalize the experience of Brazil during the 2015 downturn, with high inflation, nominal rates, and spreads.
    JEL: E52 F34 F41
    Date: 2020–01
  5. By: Julien Albertini (GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - ENS Lyon - École normale supérieure - Lyon - UL2 - Université Lumière - Lyon 2 - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon - UJM - Université Jean Monnet [Saint-Étienne] - Université de Lyon - CNRS - Centre National de la Recherche Scientifique); Xavier Fairise (GAINS - Groupe d'Analyse des Itinéraires et des Niveaux Salariaux - UM - Le Mans Université); Anthony Terriau (GAINS - Groupe d'Analyse des Itinéraires et des Niveaux Salariaux - UM - Le Mans Université)
    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 increases 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
    Date: 2020
  6. By: Ryan Chahrour (Boston College); Sanjay Chugh (The Ohio State University); Tristan Potter (Drexel University)
    Abstract: We identify the main shock driving the covariance of the labor market and out- put. The shock drives strong business cycle comovement among output, consumption, investment, hours, and stock prices but is essentially orthogonal to business cycle fluc- tuations in TFP. Yet, the shock is associated with future persistent TFP fluctuations, consistent with theories of technology news. A standard labor search model in which wages are determined by a cash flow sharing rule, rather than the net present value of match surplus, matches the observed responses to TFP news. The response of the wage implied by this rule is consistent with the empirical responses of a broad panel of wage series.
    Keywords: News Shocks, Wages, Search and Matching, Business Cycles
    JEL: E32 E24
    Date: 2020–01–31
  7. By: Jose Carreno
    Abstract: The United States has been experiencing a slowdown in productivity growth for more than a decade. I exploit geographic variation across U.S. Metropolitan Statistical Areas (MSAs) to investigate the link between the 2006-2012 decline in house prices (the housing bust) and the productivity slowdown. Instrumental variable estimates support a causal relationship between the housing bust and the productivity slowdown. The results imply that one standard deviation decline in house prices translates into an increment of the productivity gap -- i.e. how much an MSA would have to grow to catch up with the trend -- by 6.9p.p., where the average gap is 14.51%. Using a newly-constructed capital expenditures measure at the MSA level, I find that the long investment slump that came out of the Great Recession explains an important part of this effect. Next, I document that the housing bust led to the investment slump and, ultimately, the productivity slowdown, mostly through the collapse in consumption expenditures that followed the bust. Lastly, I construct a quantitative general equilibrium model that rationalizes these empirical findings, and find that the housing bust is behind roughly 50 percent of the productivity slowdown.
    Date: 2020–01
  8. By: Minetti, Raoul (Michigan State University, Department of Economics); Di Pietro, Marco (Sapienza University of Rome); Marattin, Luigi (University of Bologna)
    Abstract: In response to severe fiscal consolidation policies implemented after the Great Recession and the euro area sovereign debt crisis, many have questioned the effectiveness of fiscal consolidations in reducing the burden of public debt. This paper revisits this fundamental policy debate qualitatively and quantitatively, studying conditions under which primary budget balance changes can successfully reduce government debt-to-GDP ratios. We first illustrate these conditions through a partial equilibrium setting. We then investigate the conditions quantitatively using a medium-scale New Keynesian DSGE model calibrated on periphery countries of the euro area. The analysis highlights the critical role of sovereign spreads in driving the debt-to-GDP dynamics following a restrictive primary balance shock. Fiscal consolidations turn out to successfully reduce the debt-to-GDP even for fairly low elasticities of spreads to fiscal variables. However, their effectiveness is quantitatively moderate and varies crucially with the initial spread level and with the degree of monetary policy accommodation.
    Keywords: debt-to-GDP; debt sustainability; sovereign spreads; fiscal consolidations
    JEL: E60 H63
    Date: 2020–01–29
  9. By: Houda Boubaker (LAREQUAD, FSEGT, University of Tunis El Manar, Tunisia and Amse, Aix-Marseille School of Economics); Eric Girardin (Amse, Aix-Marseille School of Economics); Christophe Muller (Amse, Aix-Marseille School of Economics)
    Abstract: This paper investigates the role of shocks to trend in explaining the business cycle fluctuations in MENA countries. Therefore, We estimate a stochastic growth model with both transitory and permanent shocks. Our results provide the evidence about the shocks to trend productivity as a driver of the macroeconomic movements in the region. We find also that the model succeed to match a key of the empirical regularities as for emerging economies, which is the high relative volatility of consumption to output. The examination of the model performance for oil exporting and importing MENA countries indicate that the role of trend is more pronounced for the former group. The examination of the determinants of MENA countries’ volatility identifies the trade openness, volatility of inflation rate, the quality of institution and the volatility of government consumption as source of shocks to productivity. Length: 83
    Date: 2019–09–20
  10. By: Shuonan Zhang (Portsmouth Business School)
    Abstract: In this paper, we build and estimate a DSGE model to study how state-owned enterprises (SOEs) and entrusted lending affect growth and business cycles in China. Our model is featured SOEs being bank-favoured firms as well as policy tools, and more productive private firms (POEs) who can borrow from SOEs through entrusted lending. Our findings suggest SOEs dampen output volatility at the cost of TFP volatility. As policy tools, SOEs cause the expense larger than the dampening effect while a reverse case is found for SOEs being bank-favoured firms. In contrast, entrusted lending could dampen variations of both output and TFP by reallocating credits between SOEs and POEs, hence mitigating the cost of SOEs. Focusing on the recent growth slowdown in China, we further show that entrusted lending was conducive to both economic growth and TFP growth by mitigating capital misallocation.
    Keywords: State-owned Enterprises, Shadow Lending, Resource Allocation, Financial Friction, Business Cycles
    JEL: C32 E32 E44
    Date: 2020–01–17
  11. By: YiLi Chien; Yi Wen
    Abstract: The aggregate capital stock in a nation can be overaccumulated for many different reasons. This paper studies which policy or policy mix is more effective in achieving the socially optimal (golden rule) level of aggregate capital stock in an infinite-horizon heterogeneous-agents incomplete-markets economy where capital is over-accumulated for two distinct reasons: (i) precautionary savings and (ii) production externalities. By solving the Ramsey problem analytically along the entire transitional path, we show that public debt and capital taxation play very distinct roles in dealing with the overaccumulation problem. The Ramsey planner opts neither to use a capital tax to correct the overaccumulation problem if it is caused solely by precautionary saving---regardless of the feasibility of public debt---nor use debt (financed by consumption tax) to correct the overaccumulation problem if it is caused solely by pollution---regardless of the feasibility of a capital tax. The key is that the modified golden rule has two margins: an intratemporal margin pertaining to the marginal product of capital (MPK) and an intertemporal margin pertaining to the time discount rate. To achieve the MGR, the Ramsey planner needs to equate not only the private MPK with the social MPK but also the interest rate with the time discount rate---neither of which is equalized in a competitive equilibrium. Yet public debt and a capital tax are each effective only in calibrating one of the two margins, respectively, but not both.
    Keywords: Optimal Quantity of Debt; Capital Taxation; Ramsey Problem; Heterogeneous Agents; Incomplete Markets; Pollution; Production Externalities
    JEL: E13 E62 H21 H30 H27
    Date: 2020–01–21
  12. By: Marc Giannoni; Abhi Gupta; Andrea Tambalotti (Federal Reserve Bank of New York; Research and Statistics Group; Princeton University; New York University; National Bureau of Economic Research); Domenico Giannone (Solvay Brussels School of Economics and Management; Federal Reserve Bank of New York; La Trobe University; Université Libre de Bruxelles; Libera Universität Internazionale degli Studi Sociali; European Central Bank; University of Aston in Birmingham; European Centre for Advanced Research in Economics and Statistics; Centre for Economic Policy Research (CEPR)); Marco Del Negro; Pearl Li
    Abstract: The preceding two posts in this series documented that interest rates on safe and liquid assets, such as U.S. Treasury securities, have declined significantly in the past twenty years. Of course, short-term interest rates in the United States are under the control of the Federal Reserve, at least in nominal terms. So it is legitimate to ask, To what extent is this decline driven by the Federal Reserve?s interest rate policy? This post addresses this question by coupling the results presented in the previous post with those obtained from an estimated dynamic stochastic general equilibrium (DSGE) model.
    Keywords: r star; convenience yield; liquidity; safety
    JEL: E2 E5
  13. By: Mei Dong (University of Melbourne); Toshiaki Shoji (Seikei University); Yuki Teranishi (Keio University)
    Abstract: This paper builds up a model for a rental housing market. With a search and matching friction in a rental housing market, a new house entry is endogenized according to a business cycle. A price negotiation happens only when owner and tenant newly match and make a contract for a rental price. After making a contract, a rental price is fixed until the contract ends. Simulations show that variations of a price and a market tightness change according to a search friction in a housing market, a speed of a housing cycle, a bargaining power between owner and tenant for a price setting. An extensive margin effect brought by a housing entry well contributes to a price variation and this effect significantly changes by parameters.
    Keywords: rental housing market; search and matching
    Date: 2020–02
  14. By: Alfredo Villca
    Keywords: Ciclos económicos, simulación de ciclos económicos, modeloSVAR, análisis bayesiano
    Date: 2019–12–01
  15. By: Julien Albertini (Univ Lyon, Université Lumière Lyon 2, GATE UMR 5824, F-69130 Ecully, France); Stéphane Auray (CREST-Ensai and ULCO); Hafedh Bouakez (Department of Applied Economics and CIREQ, HEC Montréal, 3000 chemin de la Côte-Sainte-Catherine, Montréal, Québec, Canada H3T 2A7); Aurélien Eyquem (Univ Lyon, Université Lumière Lyon 2, GATE UMR 5824, F-69130 Ecully, France, and Institut Universitaire de France)
    Abstract: We propose a model with involuntary unemployment, incomplete markets, and nominal rigidity, in which the effects of government spending are state-dependent. An increase in government purchases raises aggregate demand, tightens the labor market and reduces unemployment. This in turn lowers unemployment risk and thus precautionary saving, leading to a larger response of private consumption than in a model with perfect insurance. The output multiplier is further amplified through a composition effect, as the fraction of high-consumption households in total population increases in response to the spending shock. These features, along with the matching frictions in the labor market, generate significantly larger multipliers in recessions than in expansions. As the pool of job seekers is larger during downturns than during expansions, the concavity of the job-finding probability with respect to market tightness implies that an increase in government spending reduces unemployment risk more in the former case than in the latter, giving rise to countercyclical multipliers.
    Keywords: Government spending, Multipliers, Precautionary saving, State dependence, Unemployment risk
    JEL: D52 E21 E62
    Date: 2020
  16. By: António R. Antunes; Tiago Cavalcanti; Caterina Mendicino; Marcel Peruffo; Anne Villamil
    Abstract: How does bankruptcy protection affect household balance sheet adjustments and aggregate consumption when credit tightens? Using a tractable model of unsecured consumer credit we quantify the trade-off between the insurance and the creditworthiness effects of bankruptcy in response to tighter credit. We show that bankruptcy dampens the effect of tighter credit on aggregate consumption on impact. This is because it allows borrowers to sustain consumption against severe financial distress. However, by leading to consumers’ exclusion from the credit market for a certain period, bankruptcy also reduces their ability to smooth consumption over time, implying a slower recovery. The bankruptcy code establishes how costly it is to default, and, thus, plays a crucial role in determining consumers’ bankruptcy decisions and in shaping consumption dynamics. We quantify that the 2005 BAPCPA reform, by making filing for bankruptcy more costly, worsened the negative welfare effects of the subsequent credit tightening.
    JEL: E2 E5 G1
    Date: 2019
  17. By: Antoine Mandel (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, UP1 - Université Panthéon-Sorbonne, PSE - Paris School of Economics); Vipin Veetil (IIT Madras - Indian Institute of Technology Madras)
    Abstract: We develop a tractable model of out-of-equilibrium dynamics in a general equilibrium economy with cash-in-advance constraints. The dynamics emerge from local interactions between firms governed by the production network underlying the economy. We analytically characterise the influence of network structure on the propagation of monetary shocks. In the long run, the model converges to general equilibrium and the quantity theory of money holds. In the short run, monetary shocks propagate upstream via nominal demand changes and downstream via real supply changes. Lags in the evolution of supply and demand at the micro level can give rise to arbitrary dynamics of the distribution of prices. Our model explains the long standing Price Puzzle: a temporary rise in the price level in response to monetary contractions. The Price Puzzle emerges under two assumptions about downstream firms: they are disproportionally affected by monetary contractions and they account for a sufficiently small share of the wage bill. Empirical evidence supports the two assumptions for the US economy. Our model calibrated to the US economy using a data set of more than fifty thousand firms generates the empirically observed magnitude of the price level rise after monetary contractions.
    Abstract: Nous proposons un modèle de la dynamique hors-équilibre dans une économie en réseau où les agents sont soumis à des contraintes financières. Nous étudions la propagation des chocs de politique monétaire dans ce cadre. Nous démontrons notamment que le "price puzzle" émerge dans ce cadre du fait des délais dans la propagation des chocs.
    Keywords: Price Puzzle,Production Network,Money,Monetary Non-Neutrality,Out-Of-Equilibrium dynamics,Réseaux de production,dynamique hors-équilibre
    Date: 2019–10
  18. By: Gibbs, Christopher G.; McClung, Nigel
    Abstract: We provide suffcient conditions for when a rational expectations structural model predicts bounded responses of endogenous variables to forward guidance announcements. The conditions coincide with a special case of the well-known (E)xpectation-stability conditions that govern when agents can learn a Rational Expectations Equilibrium. Importantly, we show that the conditions are distinct from the determinacy conditions. We show how the conditions are useful for diagnosing the features of a model that contribute to the Forward Guidance Puzzle and reveal how to construct well-behaved forward guidance predictions in standard medium-scale DSGE models.
    JEL: E31 E32 E52 D84 D83
    Date: 2019–09–10
  19. By: Chen, Been-Lon; Hu, Yunfang; Mino, Kazuo
    Abstract: The stabilization effect of nonlinear income taxation is addressed in the standard model of small open economy. It is shown that if income taxation schedule is progressive, the small open economy tends hold saddle-point stability. On the other hand, if taxation on the interest income is regressive, then the small open economy may exhibit sunspot-driven fluctuations or it displays a diverging behavior.
    Keywords: Taxation Rule, Stability, Equilibrium Indeterminacy, Small Open Economy
    JEL: E62 F41
    Date: 2019–05–15
  20. By: David Finck (University of Giesssen)
    Abstract: A common finding in the literature is that forward guidance cannot be credible under discretionary policy as long as the zero lower bound is an one-off event. However, this is not the case when recurring episodes of zero interest rates are possible. In this paper, we contribute to this new result and assess the sustainability of forward guidance under the cost channel. We find that forward guidance can be sustainable under the cost channel. However, we show that it is less credible compared to a standard New Keynesian model. Our results show that this finding also depends on the strength of the cost channel. Furthermore, provide evidence that ignoring the presence of a cost channel can be costly in terms of steady-state consumption.
    Keywords: Forward Guidance, Sustainability, Cost Channel, Discretion
    JEL: E12 E43 E52 E58 E61
    Date: 2020
  21. By: Òscar Jordà; Sanjay R. Singh; Alan M. Taylor
    Abstract: Is the effect of monetary policy on the productive capacity of the economy long lived? Yes, in fact we find such impacts are significant and last for over a decade based on: (1) merged data from two new international historical databases; (2) identification of exogenous monetary policy using the macroeconomic trilemma; and (3) improved econometric methods. Notably, the capital stock and total factor productivity (TFP) exhibit hysteresis, but labor does not. Money is non-neutral for a much longer period of time than is customarily assumed. A New Keynesian model with endogenous TFP growth can reconcile all these empirical observations.
    JEL: E01 E30 E32 E44 E47 E51 F33 F42 F44
    Date: 2020–01

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