nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2020‒06‒22
thirty-six papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Unemployment and Endogenous Reallocation over the Business Cycle By Carrillo-Tudela, Carlos; Visschers, Ludo
  2. Intergenerational wealth inequality: the role of demographics By António R. Antunes; Valerio Ercolani
  3. Corporate Debt Maturity, Repayment Structure and Monetary Policy Transmission By Hatice Gokce Karasoy Can
  4. Debunking the granular origins of aggregate fluctuations : from real business cycles back to Keynes By Giovanni Dosi; Mauro Napoletano; Andrea Roventini; Tania Treibich
  5. Demographics and the natural interest rate in the euro area By Marcin Bielecki; Michał Brzoza-Brzezina; Marcin Kolasa
  6. Financial frictions and the wealth distribution By Jesús Fernández-Villaverde; Samuel Hurtado; Galo Nuño
  7. MAKING CARBON TAXATION A GENERATIONAL WIN WIN By Laurence J. Kotlikoff; Felix Kubler; Andrey Polbin; Jeffrey D. Sachs; Simon Scheidegger
  8. Higher education funding, welfare and inequality in equilibrium By Gustavo Mellior
  9. Job Polarization, Skill Mismatch and the Great Recession By Riccardo Zago
  10. Volatile Hiring: Uncertainty in Search and Matching Models By Den Haan, Wouter; Freund, Lukas; Rendahl, Pontus
  11. Recruitment Policies, Job-Filling Rates and Matching Efficiency By Carrillo-Tudela, Carlos; Hermann, Gartner; Kaas, Leo
  12. The Macroeconomics of Hedging Income Shares By Grasso, Adriana; Passadore, Juan; Piguillem, Facundo
  13. Public debt and crowding-out: the role of housing wealth By Andrea Camilli; Marta Giagheddu
  14. Labor market institutions and homeownership By Andrea Camilli
  15. Fiscal multipliers with financial fragmentation risk and interactions with monetary policy By Darracq Pariès, Matthieu; Papadopoulou, Niki; Müller, Georg
  16. The Rise of US Earnings Inequality: Does the Cycle Drive the Trend? By Jonathan Heathcote; Fabrizio Perri; Giovanni L. Violante
  17. The return on everything and the business cycle in production economies By Daniel Fehrle; Christopher Heiberger
  18. The Hammer and the Scalpel: On the Economics of Indiscriminate versus Targeted Isolation Policies during Pandemics By V. V. Chari; Rishabh Kirpalani; Christopher Phelan
  19. Interest Rate Pegging, Fluctuations, and Fiscal Policy in China By Tong, Bing; Yang, Guang
  20. Monetary and Fiscal Policies in Times of Large Debt: Unity is Strength By Bianchi, Francesco; Faccini, Renato; Melosi, Leonardo
  21. China’s Housing Bubble, Infrastructure Investment, and Economic Growth By Shenzhe Jiang; Jianjun Miao; Yuzhe Zhang
  22. Unexpected Effects: Uncertainty, Unemployment, and Inflation By Freund, Lukas; Rendahl, Pontus
  23. Optimal lockdown in altruistic economies By Stefano Bosi; Carmen Camacho; David Desmarchelier
  24. Monetary policy with judgment By Gelain, Paolo; Manganelli, Simone
  25. Dynamic Competition in Negotiated Price Markets By Jason Allen; Shaoteng Li
  26. Monetary policy, productivity, and market concentration By Andrea Colciago; Riccardo Silvestrini
  27. Uncertainty, Wages, and the Business Cycle By Cacciatore, Matteo; Ravenna, Federico
  28. Savings externalities and wealth inequality By Konstantinos Angelopoulos; Spyridon Lazarakis; James Malley
  29. Corona Policy According to HANK By Hagedorn, Marcus; Mitman, Kurt
  30. Questioning the puzzle: Fiscal policy, exchange rate and inflation By Laurent Ferrara; Luca Metelli; Filippo Natoli; Daniele Siena
  31. The distributional effects of peer and aspirational pressure By Konstantinos Angelopoulos; Spyridon Lazarakis; James Malley
  32. Distributional Effects of the COVID-19 Lockdown By Marius Clemens; Maik Heinemann
  33. Sticky Capital Controls By Miguel Acosta-Henao; Laura Alfaro; Andrés Fernández
  34. Health versus Wealth: On the Distributional Effects of Controlling a Pandemic By Andrew Glover; Jonathan Heathcote; Dirk Krueger; Jose-Victor Rios-Rull
  35. Information Acquisition, Efficiency, and Non-fundamental Volatility By Hebert, Benjamin; La'O, Jennifer
  36. Deadly Debt Crises: COVID-19 in Emerging Markets By Cristina Arellano; Yan Bai; Gabriel Mihalache

  1. By: Carrillo-Tudela, Carlos; Visschers, Ludo
    Abstract: This paper studies the extent to which the cyclicality of gross and net occupational mobility shapes that of aggregate unemployment and its duration distribution. Using the SIPP, we document the relation between workers' (gross and net) occupational mobility and unemployment duration over the long run and business cycle. To interpret this evidence, we develop an analytically and computationally tractable stochastic equilibrium model with heterogenous agents and occupations as well as aggregate uncertainty. The model is quantitatively consistent with several important features of the US labor market: procyclical gross and countercyclical net occupational mobility, the large volatility of unemployment and the cyclical properties of the unemployment duration distribution, among others. Our analysis shows that "excess" occupational mobility due to workers' changing career prospects interacts with aggregate conditions to drive fluctuations of aggregate unemployment and its duration distribution.
    Keywords: Business cycle; Occupational Mobility; Rest; search; unemployment
    JEL: E24 E30 J62 J63 J64
    Date: 2020–05
  2. By: António R. Antunes; Valerio Ercolani
    Abstract: During the last three decades in the US, the older part of the population has become significantly richer, in contrast with the younger part, which has not. We show that demographics account for a significant part of this intergenerational wealth gap rise. In particular, we develop a general equilibrium model with an OLG structure which is able to mimic the wealth distribution of the household sector in the late 1980s, conditional on its age structure. Inputting the observed rise of life expectancy and the fall in population growth rate into the model generates an increase in wealth inequality across age groups which is between one third and one half of that actually observed. Furthermore, the demographic factors help explain the change of the wealth concentration conditional on the age structure; for example, they account for more than one third of the rise of the share of the elderly within the top 5% wealthiest households. Finally, consistent with a stronger life-cycle motive and an increase of the capital-labor ratio, the model produces an interest rate fall of 1 percentage point.
    JEL: E21 J1
    Date: 2020
  3. By: Hatice Gokce Karasoy Can
    Abstract: Taking a theoretical stand, this paper studies the role of corporate debt maturity and its repayment structure in monetary policy transmission mechanism. It builds on a stylized New Keynesian dynamic stochastic general equilibrium (NK-DSGE) model and discusses the transmission under various corporate debt structures. The results show that a given contractionary monetary policy is less effective in terms of stabilizing inflation when debt contracts are written on a floating rate basis. Moreover, increased corporate debt burden amplifies the real effects of the credit channel. Extending the maturity of floating rate debt aggravates these effects and makes firms even more vulnerable to adverse shocks.
    Keywords: Floating rate debt, Debt maturity, Monetary policy transmission, Credit channel
    JEL: E43 E44 E52 E58 G30
    Date: 2020
  4. By: Giovanni Dosi (LEM - Laboratory of Economics and Management - Sant'Anna School of Advanced Studies); Mauro Napoletano (OFCE - Observatoire français des conjonctures économiques - Sciences Po - Sciences Po); Andrea Roventini; Tania Treibich (OFCE - Observatoire français des conjonctures économiques - Sciences Po - Sciences Po)
    Abstract: In this work we study the granular origins of business cycles and their possible underlying drivers. As shown by Gabaix (Econometrica 79:733–772, 2011), the skewed nature of firm size distributions implies that idiosyncratic (and independent) firm-level shocks may account for a significant portion of aggregate volatility. Yet, we question the original view grounded on "supply granularity", as proxied by productivity growth shocks – in line with the Real Business Cycle framework–, and we provide empirical evidence of a "demand granularity", based on investment growth shocks instead. The role of demand in explaining aggregate fluctuations is further corroborated by means of a macroeconomic Agent-Based Model of the "Schumpeter meeting Keynes" family Dosi et al. (J Econ Dyn Control 52:166–189, 2015). Indeed, the investigation of the possible microfoundation of RBC has led us to the identification of a sort of microfounded Keynesian multiplier.
    Keywords: Business cycles,Granular residual,Granularity hypothesis,Agent-based models,Firm dynamics,Productivity growth,Investment growth
    Date: 2019–03
  5. By: Marcin Bielecki; Michał Brzoza-Brzezina; Marcin Kolasa
    Abstract: We investigate the impact of demographics on the natural rate of interest (NRI) in the euro area, with a particular focus on the role played by economic openness, migrations and pension system design. To this end, we construct a life-cycle model and calibrate it to match the life-cycle profiles from HFCS data. We show that population aging contributes significantly to the decline in the NRI, explaining about two-thirds of its secular decline between 1985 and 2030. Openness to international capital flows has not been important in driving the EA real interest rate so far, but will become a significant factor preventing its further decline in the coming decades, when aging in Europe accelerates relative to the rest of the world. Of two possible pension reforms, only an increase in the retirement age can revert the downward trend on the equilibrium interest rate while a fall in the replacement rate would make its fall even deeper. The demographic pressure on the Eurozone NRI can be alleviated by increased immigration, but only to a small extent and with a substantial lag.
    Keywords: population aging, natural interest rate, life-cycle models, pension systems, migrations
    JEL: E31 E52 J11
    Date: 2020–06
  6. By: Jesús Fernández-Villaverde (University of Pennsylvania, NBER and CEPR); Samuel Hurtado (Banco de España); Galo Nuño (Banco de España)
    Abstract: We postulate a nonlinear DSGE model with a financial sector and heterogeneous households. In our model, the interaction between the supply of bonds by the financial sector and the precautionary demand for bonds by households produces significant endogenous aggregate risk. This risk induces an endogenous regime-switching process for output, the risk-free rate, excess returns, debt, and leverage. The regime-switching generates i) multimodal distributions of the variables above; ii) time-varying levels of volatility and skewness for the same variables; and iii) supercycles of borrowing and deleveraging. All of these are important properties of the data. In comparison, the representative household version of the model cannot generate any of these features. Methodologically, we discuss how nonlinear DSGE models with heterogeneous agents can be efficiently computed using machine learning and how they can be estimated with a likelihood function, using inference with diffusions.
    Keywords: heterogeneous agents, wealth distribution, financial frictions, continuoustime, machine learning, neural networks, structural estimation, likelihood function
    JEL: C45 C63 E32 E44 G01 G11
    Date: 2020–06
  7. By: Laurence J. Kotlikoff (Boston University and NBER); Felix Kubler (University of Zurich and Swiss Financial Institute); Andrey Polbin (The Russian Presidential Academy of National Economy and Public Administration, and The Gaidar Institute for Economic Policy); Jeffrey D. Sachs (Columbia University and NBER); Simon Scheidegger (University of Lausanne Department of Finance)
    Abstract: Carbon taxation has been studied primarily in social planner or infinitely lived agent models, which trade off the welfare of future and current generations. Such frameworks obscure the potential for carbon taxation to produce a generational win-win. This paper develops a large-scale, dynamic 55-period, OLG model to calculate the carbon tax policy delivering the highest uniform welfare gain to all generations. The OLG framework, with its selfish generations, seems far more natural for studying climate damage. Our model features coal, oil, and gas, each extracted subject to increasing costs, a clean energy sector, technical and demographic change, and Nordhaus (2017)'s temperature/damage functions. Our model's optimal uniform welfare increasing (UWI) carbon tax starts at $30 tax, rises annually at 1.5 percent and raises the welfare of all current and future generations by 0.73 percent on a consumption-equivalent basis. Sharing efficiency gains evenly requires, however, taxing future generations by as much as 8.1 percent and subsidizing early genrations by as much as 1.2 percent of lifetime consumption. Without such redistribution (the Nordhaus “optimum†), the carbon tax constitutes a win-lose policy with current generations experiencing an up to 0.84 percent welfare loss and future generations experiencing an up to 7.54 percent welfare gain. With a six-times larger damage function, the optimal UWI initial carbon tax is $70, again rising annually at 1.5 percent. This policy raises all generations’ welfare by almost 5 percent. However, doing so requires levying taxes on and giving transfers to future and current generations ranging up to 50.1 percent and 10.3 percent of their lifetime consumption. Delaying carbon policy, for 20 years, reduces efficiency gains roughly in half.
    JEL: F0 F20 H0 H2 H3 J20
    Date: 2019–04
  8. By: Gustavo Mellior
    Abstract: This paper analyses theoretically and quantitatively the effect that different higher education funding policies have on welfare (on aggregate and at the individual level) and wealth inequality. A heterogeneous agent model in continuous time, which has uninsurable income risk and endogenous educational choice is used to evaluate ï¬ ve different higher education ï¬ nancing schemes. Educational investments can be self ï¬ nanced, supported by government guaranteed student loans - that may come with or without income contingent support - or be covered by the public sector. When educational costs are small, differences in outcomes amongst systems are negligible. On the other hand, when these costs rise to realistic levels we see that there can be large gains in welfare and signiï¬ cant drops in inequality by moving to a system with more public sector support. This support can come in the form of tuition subsidies and/or income contingent student loans. However, as the cost of education and the share of debtors in society gets larger, it is preferable to increase public support in the form of tuition subsidies. The reason is that there is a pecuniary externality of debt that gets magniï¬ ed when student loans become excessive. While I identify large steady state welfare gains from more public sector ï¬ nancing, I show that the transition costs can be large enough to justify the status quo.
    Keywords: Incomplete markets, Higher education funding, Human capital
    JEL: D52 D58 E24 I22 I23
    Date: 2020–05–27
  9. By: Riccardo Zago
    Abstract: This paper shows that job polarization has a persistent negative effect on employment opportunities, labor mobility and skill-to-job match quality for mid/low-skilled workers, in particular during downturns. I introduce a model generating an endogenous mapping between skills and jobs, that I estimate to match solely occupational dynamics during the Great Recession, a major episode of polarization in the US economy. Yet, this is sufficient for the model to replicate well the reallocation patterns of all workers on the job ladder and the mismatch dynamics observed in the data. Comparison with the planner solution reveals that 1/4 of mismatches is efficient and attenuates polarization and unemployment over the cycle.
    Keywords: : Job Polarization, Business Cycle, Job Quality, Skill Demand.
    JEL: E24 E32 J21 J24 J62 O33
    Date: 2020
  10. By: Den Haan, Wouter; Freund, Lukas; Rendahl, Pontus
    Abstract: This paper analyzes in detail the role of uncertainty shocks in search and matching models of the labor market, both when uncertainty actually increases and when it is only expected to do so. The non-linear nature of search frictions increases average unemployment rates during periods with higher volatility. However, they are by themselves not sufficient to raise the unemployment rate in response to an increase in perceived uncertainty. We show that key to understanding the result of Leduc and Liu (2016) that perceived uncertainty does affect the unemployment rate is the particular form of wage bargaining chosen, Nash bargaining; option value considerations play no role.
    Keywords: Option value; search frictions; uncertainty; unemployment
    JEL: E24 E32 J64
    Date: 2020–05
  11. By: Carrillo-Tudela, Carlos; Hermann, Gartner; Kaas, Leo
    Abstract: Recruitment behavior is important for the matching process in the labor market. Using unique linked survey-administrative data, we explore the relationships between hiring and recruitment policies. Faster hiring goes along with higher search effort, lower hiring standards and more generous wages. To analyze the mechanisms behind these patterns, we develop a directed search model in which firms use different recruitment margins in response to productivity shocks. The calibrated model points to an important role of hiring standards for matching efficiency and for the impact of labor market policy, whereas search effort and wage policies play only a minor role.
    Keywords: Labor market matching; Recruitment; Vacancies
    JEL: E24 J23 J63
    Date: 2020–05
  12. By: Grasso, Adriana; Passadore, Juan; Piguillem, Facundo
    Abstract: The recent debate about the falling labor share has brought the attention to the income shares' trends, but less attention has been devoted to their variability. In this paper, we analyze how their fluctuations can be insured between workers and capitalists, and the corresponding implications for financial markets. We study a neoclassical growth model with aggregate shocks that affect income shares and financial frictions that prevent firms from fully insuring idiosyncratic risk. We examine theoretically how aggregate risk sharing is distorted by the combination of idiosyncratic risk and moving shares. Accumulation of safe assets by firms and risky assets by households emerges naturally as a tool to insure income shares' risk. We calibrate the model to the U.S. economy and show that low rates, rising capital shares, and accumulation of safe assets by firms and risky assets by households can be rationalized by persistent shocks to the labor share.
    Keywords: Income shares fluctuation. Risk Sharing. Asset prices. Corporate Savings Glut
    JEL: E20 E32 E44 G11
    Date: 2020–05
  13. By: Andrea Camilli; Marta Giagheddu
    Abstract: We investigate the role of housing wealth concentration for the transmission of macroeconomic shocks in high-debt economies. We build a general equilibrium model with housing and heterogeneous agents who differ in their saving and investment opportunities. Banks optimizing their portfolio between mortgages and sovereign securities are characterized by financial frictions operating as a transmission mechanism, as households' collateralized debt links sovereign debt with the real economy, through interest rates and housing prices. We find that the more concentrated wealth is the worse the recession is, however associated with less consumption inequality due to a smaller crowding out of households' lending. We also show that a similar positive effect across agents can be obtained at different levels of inequality through financial repression and that a relevant distributional trade-off between macroprudential policy and households collateral requirements is present.
    Keywords: Sovereign risk, housing, lending crowding-out, regulation, liquidity, heterogeneity.
    JEL: E32 E44 G11 G18 R21
    Date: 2020–05
  14. By: Andrea Camilli
    Abstract: To what extent labor market institutions can explain homeownership rate differences over time and across countries? Using data from 19 countries over fifty years, I find a positive correlation between employment rigidities and homeownership, and a negative correlation with wage rigidities. I rationalize these findings through a DSGE model where heterogeneous households face a housing tenure decision in presence of labor frictions. Labor rigidities affect housing tenure choice through their impact on employment and wage volatility. Labor institutions explain a relevant share of homeownership heterogeneity between countries and over time and labor reforms can interfere with policies targeted to increase homeownership.
    Keywords: Housing markets; Labor market institutions; DSGE; Labor reforms.
    JEL: J08 J30 J50 R20 R21
    Date: 2020–05
  15. By: Darracq Pariès, Matthieu; Papadopoulou, Niki; Müller, Georg
    Abstract: We quantify the size of fiscal multipliers under financial fragmentation risk and demonstrate how non-standard monetary policy can support the macroeconomic transmission of fiscal interventions. We employ a DSGE model with financial frictions whereby the interplay of corporate, banks and sovereign solvency risk affect the transmission of fiscal policy. The output multiplier of fiscal expansion is found to be significantly dampened by tighter financial conditions in case households are less certain about implicit and explicit state-guarantees for the banking system, or banks are weakly capitalized and highly exposed to the government sector. In this context, we show that central bank asset purchases or liquidity operations designed to ensure favourable bank funding conditions can restore fiscal multipliers. JEL Classification: E44, E52, E62
    Keywords: DSGE models, fiscal stabilization, sovereign-bank nexus, sovereign risk
    Date: 2020–06
  16. By: Jonathan Heathcote; Fabrizio Perri; Giovanni L. Violante
    Abstract: We document that declining hours worked are the primary driver of widening inequality in the bottom half of the male labor earnings distribution in the United States over the past 52 years. This decline in hours is heavily concentrated in recessions: hours and earnings at the bottom fall sharply in recessions and do not fully recover in subsequent expansions. Motivated by this evidence, we build a structural model to explore the possibility that recessions cause persistent increases in inequality; that is, that the cycle drives the trend. The model features skill-biased technical change, which implies a trend decline in low-skill wages relative to the value of non-market activities. With this adverse trend in the background, recessions imply a potential double-whammy for low skilled men. This group is disproportionately likely to experience unemployment, which further reduces skills and potential earnings via a scarring effect. As unemployed low skilled men give up job search, recessions generate surges in non-participation. Because non-participation is highly persistent, earnings inequality remains elevated long after the recession ends.
    Keywords: Earnings losses upon displacement; Inequality; Non-participation; Recession; Skill-biased technical change; Zero earnings
    JEL: E24 E32 J24 J64
    Date: 2020–06–04
  17. By: Daniel Fehrle; Christopher Heiberger
    Abstract: The risk premium puzzle is even worse than previously reported if housing is also taken into consideration next to equity. While housing premia are only moderately smaller than equity premia, they are signi?cantly less volatile and the Sharpe ratio of housing is signi?cantly larger. Hence, three question arise: i) are existing approaches to explain the equity premium puzzle also capable of explaining even larger Sharpe ratios than previously required, ii) can return rates and volatilities of various assets be differentiated, and iii) can different Sharpe ratios between the two risky assets be matched. We analyze these questions, next to business cycle statistics, by including housing into seminal approaches to solve the risk premium puzzle in production economies. Non-disaster economies with habit formation, capital adjustment costs and limited factor mobility fail to generate a Sharpe ratio of housing of the empirically observed size and do not explain co-moving economic activity. A basic model with time-varying disaster risk can reproduce the large Sharpe ratio of housing. Moreover, the model can explain different means and volatilities of the risky assets, economic activity comoves and the model explains the volatility ratio of business investments, residential investments and house prices. However, the model does not allow to disentangle the Sharpe ratios of the risky assets and premia on equity remain too involatile
    Keywords: Equity premium puzzle, housing, rare disasters, production CAPM, real business cycle literature
    JEL: C63 E32 E44 G12
    Date: 2020–03
  18. By: V. V. Chari; Rishabh Kirpalani; Christopher Phelan
    Abstract: We develop a simple dynamic economic model of epidemic transmission designed to be consistent with widely used SIR biological models of the transmission of epidemics, while incorporating economic benefits and costs as well. Our main finding is that targeted testing and isolation policies deliver large welfare gains relative to optimal policies when these tools are not used. Specifically, we find that when testing and isolation are not used, optimal policy delivers a welfare gain equivalent to a 0.6% permanent increase in consumption relative to no intervention. The welfare gain arises because under the optimal policy, the planner engineers a sharp recession that reduces aggregate output by about 40% for about 3 months. This sharp contraction in economic activity reduces the rate of transmission and reduces cumulative deaths by about 0.1%. When testing policies are used, optimal policy delivers a welfare gain equivalent to a 3% permanent increase in consumption. The associated recession is milder in that aggregate output declines by about 15% and cumulative deaths are reduced by .3%. Much of this welfare gain comes from isolating infected individuals. When individuals who are suspected to be infected are isolated without any testing, optimal policy delivers a welfare gain equivalent to a 2% increase in permanent consumption.
    Keywords: Social distancing; Epidemiology; SIR model; COVID-19
    JEL: Q59 E69 H41
    Date: 2020–05–15
  19. By: Tong, Bing; Yang, Guang
    Abstract: This paper proves in a New Keynesian model that interest rate pegging can explain the unusual business cycle fluctuations in China. It is traditional wisdom that when the nominal interest rate is inflexible, there is no unique equilibrium in macroeconomic models. We prove that a unique equilibrium exists if the nominal rate is pegged for a limited period, after which it switches to a flexible rate regime. The peg alters the propagation of external shocks, magnifies volatility of endogenous variables, and leads to instability of the economy. Besides, the model becomes more unstable when the peg duration extends, and when the pegged rate deviates from steady state. At the same time, fiscal multiplier increases under the peg, indicating fiscal policy may be more effective in mitigating economic fluctuations when monetary policy is restricted by interest rate pegging.
    Keywords: New Keynesian model; Chinese economy; Interest rate peg; Fiscal policy; Rational expectation
    JEL: E31 E32 E43 E62
    Date: 2020–05–15
  20. By: Bianchi, Francesco; Faccini, Renato; Melosi, Leonardo
    Abstract: The COVID pandemic found policymakers facing constraints on their ability to react to an exceptionally large negative shock. The current low interest rate environment limits the tools the central bank can use to stabilize the economy, while the large public debt curtails the efficacy of fiscal interventions by inducing expectations of costly fiscal adjustments. Against this background, we study the implications of a coordinated fiscal and monetary strategy aiming at creating a controlled rise of inflation to wear away a targeted fraction of debt. Under this coordinated strategy, the fiscal authority introduces an emergency budget with no provisions on how it will be balanced, while the monetary authority tolerates a temporary increase in inflation to accommodate the emergency budget. In our model the coordinated strategy enhances the efficacy of the fiscal stimulus planned in response to the COVID pandemic and allows the Federal Reserve to correct a prolonged period of below-target inflation. The strategy results in only moderate levels of inflation by separating long-run fiscal sustainability from a short-run policy intervention.
    Keywords: COVID; emergency budget; Fiscal policy; monetary policy; shock specific rule
    JEL: E30 E50 E62
    Date: 2020–05
  21. By: Shenzhe Jiang (Peking University); Jianjun Miao (Boston University); Yuzhe Zhang (Texas A&M University)
    Abstract: China’s housing prices have been growing rapidly over the past few decades, despite low growth in rents. We study the impact of housing bubbles on China’s economy, based on the understanding that local governments use land-sale revenue to fuel infrastructure investment. We calibrate our model to the Chinese data over the period 2003-2013 and find that our calibrated model can match the declining capital return and GDP growth, the average housing price growth, and the rising infrastructure to GDP ratio in the data. We conduct two counterfactual experiments to estimate the impact of a bubble collapse and a property tax.
    Keywords: Housing Bubble, Infrastructure, Economic Growth, Chinese Economy, Property Tax
    JEL: O11 O16 O18 P24 R21 R31
    Date: 2019–12
  22. By: Freund, Lukas; Rendahl, Pontus
    Abstract: This paper studies the role of uncertainty in a search-and-matching framework with risk-averse households. A mean-preserving spread to future productivity contracts current economic activity even in the absence of nominal rigidities, although the effect is reinforced by the presence of the latter. That is, uncertainty shocks carry both contractionary demand- and supply effects. The reason is that a more uncertain future increases the precautionary behavior of households, which reduces interest rates and contracts demand. At the same time, as future asset prices becomes more volatile and positively covary with aggregate consumption, households demand a larger risk premium, which puts negative pressure on current asset values and thereby contracts supply. Thus, in comparison to a pure negative demand shock, an uncertainty shock puts less deflationary pressure on the economy and, as a result, renders a flatter Phillips curve.
    Keywords: inflation; search frictions; uncertainty; unemployment
    JEL: E21 E32 J64
    Date: 2020–05
  23. By: Stefano Bosi (EPEE - Centre d'Etudes des Politiques Economiques - UEVE - Université d'Évry-Val-d'Essonne); Carmen Camacho (PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, PSE - Paris School of Economics); David Desmarchelier (BETA - Bureau d'Économie Théorique et Appliquée - UNISTRA - Université de Strasbourg - UL - Université de Lorraine - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement)
    Abstract: The recent COVID-19 crisis has revealed the urgent need to study the impact of an infectious disease on market economies and provide adequate policy recommendations. In this regard, we consider here the SIS hypothesis in dynamic general equilibrium models with and without capital accumulation, and we compute the efficient lockdown of altruistic agents. We find that the zero lockdown is efficient if agents are selfish, while a positive lockdown is recommended beyond a critical level of altruism. Moreover, the lockdown intensity increases in the degree of altruism. Our robust analytical results are illustrated by numerical simulations, which show, in particular, that the optimal lockdown never trespasses 60% and that eradication is not always optimal.
    Keywords: optimal lockdown,SIS model,Ramsey model,Ramsey model Keywords: optimal lockdown
    Date: 2020–05
  24. By: Gelain, Paolo; Manganelli, Simone
    Abstract: Two approaches are considered to incorporate judgment in DSGE models. First, Bayesian estimation indirectly imposes judgment via priors on model parameters, which are then mapped into a judgmental interest rate decision. Standard priors are shown to be associated with highly unrealistic judgmental decisions. Second, judgmental interest rate decisions are directly provided by the decision maker, and incorporated into a formal statistical decision rule using frequentist procedures. When the observed interest rates are interpreted as judgmental decisions, they are found to be consistent with DSGE models for long stretches of time, but excessively tight in the 1980s and late 1990s and excessively loose in the late 1970s and early 2000s. JEL Classification: E50, E58, E47, C12, C13
    Keywords: DSGE, maximum likelihood, monetary policy, statistical decision theory
    Date: 2020–05
  25. By: Jason Allen; Shaoteng Li
    Abstract: This paper develops a framework for investigating dynamic competition in markets where price is negotiated between an individual customer and multiple firms repeatedly. Using contract-level data for the Canadian mortgage market, we provide evidence of an “invest-then-harvest” pricing pattern: lenders offer relatively low interest rates to attract new borrowers and poach rivals' existing customers, and then at renewal charge interest rates which can be higher than what may be available through other lenders in the marketplace. We build a dynamic model of price negotiation with search and switching frictions to capture key market features. We estimate the model and use it to investigate (i) the effects of dynamic competition on borrowers' and banks' payoffs, (ii) the implications of dynamic versus static settings for merger-studies, and (iii) the impacts from recent Canadian macroprudential policies.
    Keywords: Financial institutions; Financial services; Market structure and pricing
    JEL: L2 D4 G21
    Date: 2020–06
  26. By: Andrea Colciago; Riccardo Silvestrini
    Abstract: This paper builds a New Keynesian industry dynamics model for the analysis of macroeconomic fluctuations and monetary policy. A continuum of heterogeneous firms populates the economy, markets are imperfectly competitive and nominal wages are sticky. An expansionary monetary policy shock triggers a response in labor productivity. By reducing borrowing costs, the shock initially attracts low productivity firms in the market. As a result, aggregate productivity decreases on impact. It then overshoots its initial level since, after the initial over-crowding, competition cleanses the market from low productivity firms. The overshooting amplifies the response of the main macroeconomic variables to the shock. A high ex-ante degree of market concentration partially impairs the transmission of monetary policy by disrupting the entry and exit mechanism.
    Keywords: Market Concentration; Monetary Policy; Competition; Productivity
    JEL: D42 E52 E58 L16
    Date: 2020–05
  27. By: Cacciatore, Matteo; Ravenna, Federico
    Abstract: We show that occasional deviations from efficient wage setting generate strong and state-dependent amplification of uncertainty shocks and can explain the cyclical behavior of empirical measures of uncertainty. Central to our analysis is the existence of matching frictions in the labor market and an occasionally binding constraint on downward wage adjustment. The wage constraint enhances the concavity of firms' hiring rule, generating an endogenous profit-risk premium. In turn, uncertainty shocks increase the profit-risk premium when the economy operates close to the wage constraint. This implies that higher uncertainty can severely deepen a recession, although its impact is weaker on average. Additionally, the variance of the unforecastable component of future economic outcomes always increases at times of low economic activity. Thus, measured uncertainty rises in a recession even in the absence of uncertainty shocks.
    Keywords: Business cycle; occasionally binding constraints; uncertainty; unemployment
    JEL: E2 E32 E6
    Date: 2020–05
  28. By: Konstantinos Angelopoulos; Spyridon Lazarakis; James Malley
    Abstract: Incomplete markets models imply heterogeneous household savings behaviour which in turn generates pecuniary externalities via the interest rate. Conditional on differences in the processes determining household earnings for distinct groups in the population, these savings externalities may contribute to inequality. Working with an open economy heterogenous agent model, where the interest rate only partially responds to domestic asset supply, we find that differences in the earnings processes of British households with university and non-university educated heads entail savings externalities that increase wealth inequality between the groups and within the group of the non-university educated households. We further find that while the inefficiency effects of these externalities are quantitatively small, the distributional effects are sizeable.
    Keywords: incomplete markets, productivity di§erences, savings externalities
    JEL: E21 E25 H23
    Date: 2019–04
  29. By: Hagedorn, Marcus; Mitman, Kurt
    Abstract: In this note, we analyze the role of the European Central Bank through the lens of the Heterogenous-agent New Keynesian Model (HANK), a new paradigm of fiscal and monetary policy that abandons the assumption of perfectly functioning financial markets. We emphasize three principles that emerge from this view: 1) the effect of fiscal and monetary financing on inflation; 2) the close interaction between fiscal and monetary policy in the determination of inflation; and 3) an economic perspective on Art.123(1) TFEU, the "prohibition of monetary financing."
    Keywords: Art.123(1) TFEU; Fiscal/monetary policy interaction; HANK; inflation; monetary financing
    JEL: D52 E31 E52 E62 E63
    Date: 2020–05
  30. By: Laurent Ferrara; Luca Metelli; Filippo Natoli; Daniele Siena
    Abstract: The paper re-investigates the effects of government spending shocks on the real exchange rate and inflation. In contrast with some previous puzzling results, we find that an increase in government spending appreciates the real exchange rate and is inflationary; besides, it induces a trade balance deficit and a decrease in consumption. The discrepancy with the existing literature lies in the identification of fiscal shocks: embedding a narrative approach in a proxy-SVAR is what makes the difference. Empirical findings are then well explained by a standard estimated open real business cycle model.
    Keywords: : Fiscal Shocks, Real Exchange Rate, Inflation, Proxy SVAR, Narrative Shocks.
    JEL: E62 F41
    Date: 2020
  31. By: Konstantinos Angelopoulos; Spyridon Lazarakis; James Malley
    Abstract: We develop a theoretical framework where the cross-sectional distributions of hours, earnings, wealth and consumption are determined jointly with a set of expenditure targets defining peer and aspirational pressure for members of different social classes. We show existence of a stationary socio-economic equilibrium, under idiosyncratic stochastic productivity and socio-economic class participation. We calibrate a model belonging to this framework using British data and find that it captures the main patterns of inequality, between and within the social groupings. We find that the effects of peer pressure on within group inequality differ between groups. We also find that wealth and consumption inequality increase within groups who aspire to match social targets from a higher class, despite a reduction in within-group inequality in hours and earnings.
    Keywords: inequality, incomplete markets, peer pressure, aspirations
    JEL: E21 E25 D01 D31
    Date: 2019–09
  32. By: Marius Clemens; Maik Heinemann
    Abstract: A two-sector incomplete markets model with heterogeneous agents can be used to study the distributional effects of the COVID-19 lockdown. While negative aggregate welfare effects of the lockdown are unavoidable, the size of aggregate welfare effects as well as the distribution of the welfare effects across agents turn out to depend on the specific economic environment of the affected economy as well as the response of the government to the shock. We use the model to simulate the lockdown effects based on a calibration to German data. First, we find that without state aid and limited access to international financial markets especially poor household suffer large welfare losses, while wealthy house- hold could even benefit from the lockdown. Second, a state aid program reduces large parts of the welfare losses of workers across all income groups in the affected sectors by forcing loss sharing with agents working in the non-affected sector. However, wealthy households no matter in which sector still benefit more than the average household. Third, access to international financial markets is key to shift relative welfare gains from superrich to poorer households in both sectors. Once the country is able to borrow internationally, the benefit for superrich diminishes. Our results implicate that countries with rather limited access to financial markets and less stable government budget positions will suffer higher welfare losses and increases in inequality.
    Keywords: COVID-19, Income and Wealth Inequality, Heterogeneous Agents, Fiscal Policy
    JEL: D31 E21 E62 I14
    Date: 2020
  33. By: Miguel Acosta-Henao; Laura Alfaro; Andrés Fernández
    Abstract: There is much ongoing debate on the merits of capital controls as effective policy instruments. The differing perspectives are due in part to a lack of empirical studies that look at the intensive margin of controls, which in turn has prevented a quantitative assessment of optimal capital control models against the data. We contribute to this debate by addressing both positive and normative features of capital controls. On the positive side, we build a new dataset using textual analysis, from which we document a set of stylized facts of capital controls along their intensive and extensive margins for 21 emerging markets. We document that capital controls are "sticky"; that is, changes to capital controls do not occur frequently, and when they do, they remain in place for a long time. Overall, they have not been used systematically across countries or time, and there has been considerable heterogeneity across countries in terms of the intensity with which they have been used. Onthe normative side, we extend a model of capital controls relying on pecuniary externalities augmented by including an (S; s) cost of implementing such policies. We illustrate how this friction goes a long way toward bringing the model closer to the data. When the extended model is calibrated for each of the countries in the new dataset, we find that the size of these costs is large, thus substantially reducing the welfare-enhancing effects of capital controls compared with the frictionless Ramsey benchmark. We conclude with a discussion of the structural interpretations of such costs, which calls for a richer set of policy constraints when considering the use of capital controls in models of pecuniary externalities.
    Date: 2020–05
  34. By: Andrew Glover; Jonathan Heathcote; Dirk Krueger; Jose-Victor Rios-Rull
    Abstract: To slow the spread of COVID-19, many countries are shutting down non-essential sectors of the economy. Older individuals have the most to gain from slowing virus diffusion. Younger workers in sectors that are shuttered have the most to lose. In this paper, we build a model in which economic activity and disease progression are jointly determined. Individuals differ by age (young and retired), by sector (basic and luxury), and by health status. Disease transmission occurs in the workplace, in consumption activities, at home, and in hospitals. We study the optimal economic mitigation policy of a utilitarian government that can redistribute across individuals, but where such redistribution is costly. We show that optimal redistribution and mitigation policies interact, and reflect a compromise between the strongly diverging preferred policy paths of different subgroups of the population. We find that the shutdown in place on April 12 is too extensive, but that a partial shutdown should remain in place through July.
    Keywords: Economic policy; COVID-19; Redistribution
    Date: 2020–04–20
  35. By: Hebert, Benjamin (Stanford U); La'O, Jennifer (Columbia U)
    Abstract: This paper analyzes non-fundamental volatility and efficiency in a class of large games (including e.g. linear-quadratic beauty contests) that feature strategic interaction and endogenous information acquisition. We adopt the rational inattention approach to information acquisition but generalize to a large class of information costs. Agents may learn not only about exogenous states, but also about endogenous outcomes. We study how the properties of the agents' information cost relate to the properties of equilibria in these games. We provide the necessary and sufficient conditions information costs must satisfy to guarantee zero non-fundamental volatility in equilibrium, and provide another set of necessary and sufficient conditions to guarantee equilibria are efficient. We show in particular that mutual information, the cost function typically used in the rational inattention literature, both precludes non-fundamental volatility and imposes efficiency, whereas the Fisher information cost introduced by Hebert and Woodford [2020] generates both non-fundamental volatility and inefficiency.
    JEL: C72 D62 D83
    Date: 2020–02
  36. By: Cristina Arellano; Yan Bai; Gabriel Mihalache
    Abstract: The COVID-19 epidemic in emerging markets risks a combined health, economic, and debt crisis. We integrate a standard epidemiology model into a sovereign default model and study how default risk impacts the ability of these countries to respond to the epidemic. Lockdown policies are useful for alleviating the health crisis but they carry large economic costs and can generate costly and prolonged debt crises. The possibility of lockdown induced debt crises in turn results in less aggressive lockdowns and a more severe health crisis. We find that the social value of debt relief can be substantial because it can prevent the debt crisis and can save lives.
    Keywords: Default risk; Pandemic mitigation; Sovereign debt; Partial default; Debt relief; COVID-19
    JEL: E52 F34 F41
    Date: 2020–05–22

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