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on Dynamic General Equilibrium |
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Issue of 2020‒02‒24
nineteen papers chosen by Christian Zimmermann Federal Reserve Bank of St. Louis |
| 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 boom-bust 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 |
| Date: | 2020–01 |
| URL: | http://d.repec.org/n?u=RePEc:eca:wpaper:2013/301557&r=all |
| By: | Cristina Arellano; Yan Bai; Gabriel 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. |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:nys:sunysb:19-02-rev1&r=all |
| By: | Isaac Baley; Ana Figueiredo; Robert Ulbricht |
| Abstract: | This paper studies the dynamics of skill mismatch over the business cycle. We build a tractable directed search model, in which workers differ in skills along multiple dimensions and sort into jobs with heterogeneous skill requirements along those dimensions. Skill mismatch arises due to information and labor market frictions. Estimated to the U.S., the model replicates salient business cyclic properties of mismatch. We show that job transitions in and out of bottom job rungs, combined with career mobility of workers, are important to account for the empirical behavior of mismatch. The predicted career dynamics provide a novel narrative for the scarring effect of unemployment. The model suggests significant welfare costs associated with mismatch due to learning frictions. |
| Keywords: | Business cycles, cleansing, learning about skills, multidimensional sorting, scarring effect of unemployment, search-and-matching, skill mismatch, sullying |
| JEL: | E24 E32 J24 J64 |
| Date: | 2020–02 |
| URL: | http://d.repec.org/n?u=RePEc:bge:wpaper:1151&r=all |
| By: | Mariana García-Schmidt; Javier García-Cicco |
| Abstract: | We present a fully-edged dynamic stochastic general equilibrium (DSGE) model for the Chilean economy to explain the economy's adjustments to external shocks, explicitly separating between tradable and non-tradable sectors (TNT). The model was built to explain Chile's linkages with the external sector, to recognize that the sectors of the economy have particular price dynamics that are affected differently by shocks that move the nominal exchange rate, and to study different measures of exchange rate pass through (ERPT). We show unconditional and conditional ERPT measures. The former measures are comparable with the empirical literature, while the latter are defined after a particular shock hit the economy. We highlight important differences in their magnitudes and in their effect on different prices. While a shock to international prices has a transitory and low ERPT, one that affects the uncovered interest rate parity condition has a very high and persistent ERPT for all price indexes. In addition, the prices that are more rapidly affected are those of tradable sectors, while non-tradable prices are affected with a lag, but for longer. We use the model to show that the conditional ERPT measures could have helped to anticipate a great part of the inflationary effects of the depreciation following the tapering announcements of the US in 2013-2015, which was not possible using unconditional ERPT measures of the empirical literature. |
| Date: | 2020–02 |
| URL: | http://d.repec.org/n?u=RePEc:chb:bcchwp:868&r=all |
| By: | Sebastian Di Tella; Robert E. Hall |
| Abstract: | We develop an equilibrium theory of business cycles driven by spikes in risk premiums that depress business demand for capital and labor. Aggregate shocks increase firms’ uninsurable idiosyncratic risk and raise risk premiums. We show that risk shocks can create quantitatively realistic recessions, with contractions in employment, consumption, and investment. Business cycles are inefficient—output and employment fall too much during recessions, compared to the constrained-efficient allocation, and consumption should rise. Optimal policy involves stimulating employment and consumption during recessions. |
| JEL: | E21 E22 E32 |
| Date: | 2020–01 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:26721&r=all |
| By: | Eisei Ohtaki |
| Abstract: | It is a well-known observation that, in the overlapping generations (OLG) model with the complete market, we can judge optimality of an equilibrium allocation by examining the associated equilibrium price. Motivated by recent remarkable development in decision theory under ambiguity, this study reexamines the above observation in a stochastic OLG model with convex but not necessarily smooth preferences. It is shown that, under such preferences, optimality of an equilibrium allocation depends on the set of possible supporting prices, not necessarily on the associated equilibrium price itself. Therefore, observations of an equilibrium price do not necessarily tell us precise information on optimality of the equilibrium allocation. |
| Date: | 2020–01 |
| URL: | http://d.repec.org/n?u=RePEc:tcr:wpaper:e145&r=all |
| By: | Dmitry Matveev |
| Abstract: | I show that maturity considerations affect the optimal conduct of monetary and fiscal policy during a period of government debt reduction. I consider a New Keynesian model and study a dynamic game of monetary and fiscal policy authorities without commitment, characterizing the incentives that drive the choice of interest rate. The presence of long-term bonds makes government budgets less sensitive to changes in interest rates. As a result, a reduction of government debt induced by a lack of policy commitment is associated with tight monetary policy. Furthermore, the long maturity of bonds slows down the speed of debt reduction up to the rate consistent with existing empirical evidence on the persistence of government debt. Finally, the long maturity of bonds brings down the welfare loss associated with debt reduction. |
| Keywords: | Fiscal Policy; Monetary Policy |
| JEL: | E52 E62 E63 |
| Date: | 2019–12 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:19-52&r=all |
| By: | Aditya Goenka (University of Birmingham); Lin Liu (University of Liverpool); William Pouliot (University of Birmingham) |
| Abstract: | We study dynamically consistent policy in a neoclassical overlapping generations growth model where pollution externalities undermine health but are mitigated via tax-financed abatement. With arbitrarily constant taxation, two steady states arise: an unstable 'poverty trap' and a 'neoclassical' steady state near which the dynamics might either be monotonically convergent or oscillating. When the planner chooses a time consistent abatement path that maximises a weighted intergenerational sum of expected utility, the optimal tax is zero at low levels of capital and then a weakly increasing function of the capital stock. The non-homogeneity of the tax function along with its feedback effect on savings induces additional steady states, stability reversals and oscillations. |
| Keywords: | Time consistency, pollution, mortality, overlapping generations model, poverty traps, endogenous fluctuations, optimal environmental policy. |
| JEL: | O11 O13 O23 O44 E32 H21 H23 |
| Date: | 2019–10 |
| URL: | http://d.repec.org/n?u=RePEc:bir:birmec:19-12&r=all |
| By: | Aditya Goenka (University of Birmingham); Lin Liu (University of Liverpool) |
| Abstract: | Stylized facts show there is a clustering of countries in three balanced growth paths characterized by colorreddiffering income/growth, human capital and incidence of infectious diseases. To explain this, we develop a dynamic general equilibrium model incorporating SIS epidemiology dynamics, where households choose how much to invest in human and physical capital, as well as in controlling the risk of infection. In the decentralized economy households do not internalize the externality of controlling in- fection. There are multiple balanced growth paths where the endogenous prevalence of the disease determines whether human capital is accumulated or not, i.e. whether there is sustained economic growth or a poverty trap. We characterize the optimal public health policy that internalizes the disease externality and the subsidy that decentralizes it. Perversely, for countries in a poverty trap and most afflicted with diseases, the optimal subsidy is lower than for growing economies. We also study the quantitative effects of better control of diseases, and of increasing life expectancy on countries in a poverty trap. |
| Keywords: | Endogenous Growth; Infectious Diseases; Epidemiology; Poverty Trap; Public Health Policy; Human Capital |
| JEL: | E19 I10 D90 O11 |
| Date: | 2019–10 |
| URL: | http://d.repec.org/n?u=RePEc:bir:birmec:19-11&r=all |
| By: | William Barnett (Department of Economics, The University of Kansas; Center for Financial Stability, New York City; IC2 Institute, University of Texas at Austin); Giovanni Bella (Department of Economics and Business, University of Cagliari, Italy); Taniya Ghosh (Indira Gandhi Institute of Development Research, Mumbai, India); Paolo Mattana (Department of Economics and Business, University of Cagliari, Italy); Beatrice Venturi (Department of Economics and Business, University of Cagliari, Italy) |
| Abstract: | The paper shows that in a New Keynesian (NK) model, an active interest rate feedback monetary policy, when combined with a Ricardian passive fiscal policy, à la Leeper-Woodford, may induce the onset of a Shilnikov chaotic attractor in the region of the parameter space where uniqueness of the equilibrium prevails locally. Implications, ranging from long-term unpredictability to global indeterminacy, are discussed in the paper. We find that throughout the attractor, the economy lingers in particular regions, within which the emerging aperiodic dynamics tend to evolve for a long time around lower-than-targeted inflation and nominal interest rates. This can be interpreted as a liquidity trap phenomenon, produced by the existence of a chaotic attractor, and not by the influence of an unintended steady state or the Central Bank's intentional choice of a steady state nominal interest rate at its lower bound. In addition, our finding of Shilnikov chaos can provide an alternative explanation for the controversial “loanable funds” over-saving theory, which seeks to explain why interest rates and, to a lesser extent inflation rates, have declined to current low levels, such that the real rate of interest is below the marginal product of capital. Paradoxically, an active interest rate feedback policy can cause nominal interest rates, inflation rates, and real interest rates unintentionally to drift downwards within a Shilnikov attractor set. Policy options to eliminate or control the chaotic dynamics are developed. |
| Keywords: | Shilnikov chaos criterion, global indeterminacy, long-term un-predictability, liquidity trap |
| JEL: | C61 C62 E12 E52 E63 |
| Date: | 2020–01 |
| URL: | http://d.repec.org/n?u=RePEc:kan:wpaper:202001&r=all |
| By: | Faccini, Renato (Queen Mary, University of London); Yashiv, Eran (Tel Aviv University) |
| Abstract: | Hiring is a costly activity reflecting firms' investment in their workers. Micro-data shows that hiring costs involve production disruption. Thus, cyclical fluctuations in the value of output, induced by price frictions, have consequences for the optimal allocation of hiring activities. We outline a mechanism based on cyclical markup fluctuations, placing emphasis on hiring frictions interacting with price frictions. This mechanism generates strong propagation and amplification of all key macroeconomic variables in response to technology shocks and mutes the traditional transmission of monetary policy shocks. A local projection analysis of aggregate U.S. data shows that the empirical results, including the cyclicality of markups, are consistent with the model's impulse response functions. |
| Keywords: | hiring as investment, intertemporal allocation, business cycles, confluence of hiring and price frictions, propagation and amplification, mark up cyclicality |
| JEL: | E22 E24 E32 E52 |
| Date: | 2020–01 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp12889&r=all |
| By: | Marina Azzimonti; Laura Karpuska; Gabriel Mihalache |
| Abstract: | Do mandatory spending rules improve society's welfare? To answer this, we analyze an infinite horizon dynamic political-economy model with two parties which disagree on how to split a fixed budget between public and private goods. We study the welfare implications of introducing two types of budget rules, mandatory spending on public goods and entitlement programs, the latter imposing constraints on the private goods' allocations that can be implemented. We model budget rules following the literature on legislative bargaining with an endogenous status quo. Under a mandatory spending rule on public goods, expenditures are governed by criteria determined by enacted law. In particular, previous year's spending bill is applied in the current year unless explicitly changed by a majority of policymakers. Entitlement programs, on the other hand, impose restrictions on the provision of private transfers through eligibility rules and generosity formulas that can only be modified with bi-partisan support. We find that entitlement programs induce over-provision of private goods and under-provision of public goods, whereas the opposite is true under a mandatory spending rule on public goods. We show that mandatory spending rules are typically associated with larger welfare gains than entitlement programs. The desirability of the rule, however, depends on the degree of political turnover: (i) with high enough political turnover, both budget rules are better than discretion, but (ii) entitlement programs can generate welfare losses when political persistence is large. This happens because entitlement rules actually increase the volatility of private and public consumption, and reduce public goods' provision significantly. Finally, we describe conditions under which budget rules would arise in a bargaining equilibrium. |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:nys:sunysb:20-02&r=all |
| By: | Christopher S Adam; Edward F Buffie |
| Abstract: | We show that a dynamic general equilibrium model with efficiency wages and endogenous capital accumulation in both the formal and (non-agricultural) informal sectors can explain the full range of confounding stylized facts associated with minimum wage laws in less developed countries. |
| Date: | 2020–01–31 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:20/23&r=all |
| By: | Takuma Kunieda (School of Economics, Kwansei Gakuin University); Kazuo Nishimura (Research Institute for Economics and Business Administration, Kobe University) |
| Abstract: | Does financial development amplify or contract sunspot fluctuations? To address this question, we explore a two-sector dynamic general equilibrium model with financial frictions and sector-specific production externalities. We first derive a condition for indeterminacy of equilibria to occur, and then, a sunspot variable is introduced in the economy with financial frictions. The outcome shows that if labor intensity in the consumption good sector from the social perspective is very large, financial development is more likely to magnify sunspot fluctuations, whereas if labor intensity in the intermediate good sector from the social perspective is very large, financial development is more likely to contract sunspot fluctuations |
| Keywords: | Two production sectors; financial frictions; sector-specific production externalities; sunspots |
| JEL: | E32 E44 O41 |
| Date: | 2020–02 |
| URL: | http://d.repec.org/n?u=RePEc:kgu:wpaper:204&r=all |
| By: | Francesco Furlanetto (BI Norwegian Business School; Norges Bank); Paolo Gelain; Marzie Sanjani (International Monetary Fund) |
| Abstract: | This paper investigates how the presence of pervasive financial frictions and large financial shocks changes the optimal monetary policy prescriptions and the estimated dynamics in a New Keynesian model. We find that financial factors affect the optimal policy only to some extent. A policy of nominal stabilization (with a particular focus on targeting wage inflation) is still the optimal policy, although the central bank is now unable to fully stabilize economic activity around its potential level. In contrast, the presence of financial frictions and financial shocks crucially changes the size and shape of the estimated output gap and the relative importance of different shocks in driving economic fluctuations, with financial shocks absorbing explanatory power from labor supply shocks. |
| Keywords: | Financial frictions; output gap; monetary policy |
| JEL: | E32 C51 C52 |
| Date: | 2020–02–15 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedcwq:87474&r=all |
| By: | Thomas J. Carter; Rhys R. Mendes |
| Abstract: | We analyze money financing of fiscal transfers (helicopter money) in two simple New Keynesian models: a “textbook” model in which all money is non-interest-bearing (e.g., all money is currency), and a more realistic model with interest-bearing reserves. In the textbook model with only non-interest-bearing money, we find the following: * A money-financed fiscal expansion can be more stimulative than a debt-financed fiscal expansion of equal magnitude. However, the extra stimulus requires that the central bank abandon its usual feedback rule for an extended period, allowing interest rates to instead be determined by the rate of money creation. * Moreover, the extra stimulus associated with money financing stems solely from its implications for the path of short-term interest rates and cannot be attributed to an oft-cited Ricardian-equivalence argument that money financing avoids the adverse wealth effects associated with higher taxes under debt financing. * Because the stimulative effects of money financing are driven by its implications for interest rates, a combination of debt financing and sufficiently accommodative forward guidance can replicate all welfare-relevant outcomes while bypassing the potential political-economic complications associated with helicopter money. * Apart from these complications, money financing also has the drawback that it would allow money-demand shocks to generate volatility in output and inflation, much as was the case under the money-targeting regimes of the 1970s and 1980s. In the model with interest-bearing reserves, we find the following: * The rate of money creation determines the interest rate on reserves, but broader interest rates are invariant across debt- and money-financing regimes. * As a result, money financing delivers no extra stimulus relative to debt financing. Overall, results suggest that helicopter money cannot be justified on the grounds that it would allow policy-makers to get more stimulus out of a given fiscal expansion: either money financing has no extra stimulative benefits to offer, or all potential benefits could be pursued more effectively and robustly using alternative policies. |
| Keywords: | Credibility; Economic models; Fiscal Policy; Inflation targets; Interest rates; Monetary Policy; Monetary policy framework; Transmission of monetary policy; Uncertainty and monetary policy |
| JEL: | E12 E41 E43 E51 E52 E58 E61 E63 |
| Date: | 2020–02 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocadp:20-1&r=all |
| By: | Stefanie Stantcheva |
| Abstract: | This paper reviews recent advances in the study of dynamic taxation, considering three main approaches: the dynamic Mirrlees, the parametric Ramsey, and the sufficient statistics approaches. In the first approach, agents' heterogeneous abilities to earn income are private information and evolve stochastically over time. Dynamic taxes are not ex ante restricted and are set for redistribution and insurance considerations. Capital is taxed only in order to improve incentives to work. Human capital is optimally subsidized if it reduces post-tax inequality and risk on balance. The Ramsey approach specifies ex ante restricted tax instruments and adopts quantitative methods, which allows it to consider more complex and realistic economies. Capital taxes are optimal when age-dependent labor income taxes are not possible. The newer and tractable sufficient statistics approach derives robust tax formulas that depend on estimable elasticities and features of the income distributions. It simplifies the transitional dynamics thanks to a newly defined criterion, the “utility-based steady state approach” that prevents the government from exploiting sluggish responses in the short-run. Capital taxes are here based on the standard equity-efficiency trade-off. |
| JEL: | H2 H21 H23 H24 H25 |
| Date: | 2020–01 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:26704&r=all |
| By: | Lawrence J. Christiano; Martin S. Eichenbaum; Mathias Trabandt |
| Abstract: | We argue that wage inertia plays a pivotal role in allowing empirically plausible variants of the standard search and matching model to account for the large countercyclical response of unemployment to shocks. |
| JEL: | E0 |
| Date: | 2020–01 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:26723&r=all |
| By: | Xiaoyong Cui (School of Economics, Peking University); Liutang Gong (Guanghua School of Management, Peking University); Chan Wang (School of Finance, Central University of Finance and Economics); Heng-fu Zou (China Economics and Management Academy, Central University of Finance and Economics) |
| Abstract: | Contrary to the consensus in the literature, we demonstrate that there exist the welfare gains from monetary policy cooperation when the world is hit by a global shock. We reach our conclusion in a two-country New Keynesian model with a global oil price shock and dollar standard. When exporters in both countries and oil producer which is modeled as a third party such as OPEC price goods in the home currency, the U.S. dollar, the status of home and foreign monetary policy is asymmetric. Speciffically, home monetary policy can influence the welfare levels of the households in the world while foreign monetary policy can only affect the welfare level of the domestic household. By internalizing the negative externality of home monetary policy to foreign country, world planner can achieve the welfare gains from monetary policy cooperation. In addition, unlike what is found in the literature, we show that not all countries are willing to take part in monetary policy cooperation, unless the world planner transfers part of the welfare gains from the country which benefits from the monetary policy cooperation to the one which loses. |
| Keywords: | A global shock, Dollar standard, Monetary policy cooperation, Welfare gains |
| JEL: | E5 F3 F4 |
| Date: | 2020 |
| URL: | http://d.repec.org/n?u=RePEc:cuf:wpaper:612&r=all |