nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2020‒08‒31
nineteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Macroeconomic Effects of Tariffs Shocks: The Role of the Effective Lower Bound and the Labour Market By Jacquinot, Pascal; Lozej, Matija; Pisani, Massimiliano
  2. Economic consequences of high public debt: evidence from three large scale DSGE models By Pablo Burriel; Cristina Checherita-Westphal; Pascal Jacquinot; Matthias Schön; Nikolai Stähler
  3. Liquidity, the Mundell-Tobin Effect, and the Friedman Rule By Lukas Altermatt; Christian Wipf
  4. Liquidity Traps in a Monetary Union By Kollmann, Robert
  5. Global Liquidity Traps By Kollmann, Robert
  6. Sovereign Default, Taxation, and the Underground Economy By Almuth Scholl; Liang Tong
  7. Macroprudential policy and the role of institutional investors in housing markets By Muñoz, Manuel A.
  8. Unemployment Insurance during a Pandemic By Jun Nie; Zoe Xie
  9. Heterogeneity and the Dynamic Effects of Aggregate Shocks By Andreas Tryphonides
  10. Doubts about the Model and Optimal Policy By Anastasios G. Karantounias
  11. A Quantitative Model for the Integrated Policy Framework By Tobias Adrian; Christopher J. Erceg; Jesper Lindé; Pawel Zabczyk; Jianping Zhou
  12. This Time It’s Different: The Role of Women’s Employment in a Pandemic Recession By Titan Alon; Matthias Doepke; Jane Olmstead-Rumsey
  13. The Liquidity Channel of Fiscal Policy By Christian Bayer; Benjamin Born; Ralph Luetticke
  14. Labor Market Effects of Tax Changes in Times of High and Low Unemployment: Working Paper 2020-05 By U. Devrim Demirel
  15. A note on pollution and infectious disease. By Guillaume MOREL
  16. Financial Shocks to Banks, R&D Investment, and Recessions By Ohdoi, Ryoji
  17. Economic consequences of follow-up disasters: lessons from the 2011 Great East Japan Earthquake By Anastasios Evgenidis; Masashige Hamano; Wessel N. Vermeulen
  18. Do We Really Know that U.S. Monetary Policy was Destabilizing in the 1970s? By Qazi Haque; Nicolas Groshenny; Mark Weder
  19. Rising Wealth Inequality: Intergenerational Links, Entrepreneurship, and the Decline in Interest Rate By Ayşe İmrohoroğlu; Kai Zhao

  1. By: Jacquinot, Pascal (European Central Bank); Lozej, Matija (Central Bank of Ireland); Pisani, Massimiliano (Bank of Italy)
    Abstract: We simulate a version of the EAGLE, a New Keynesian multi-country model of the world economy, to assess the macroeconomic effects of US tariffs imposed on one country member of the euro area (EA), and the rest of the world (RW). The model is augmented with an endogenous effective lower bound (ELB) on the monetary policy rate of the EA and country-specific labour markets with search-and-matching frictions. Our main results are as follows. First, tariffs produce recessionary effects in each country. Second, if the ELB holds, then the tariff has recessionary effects on the whole EA, even if it is imposed on one EA country and the RW. Third, if the ELB holds and the real wage is flexible in the EA country subject to the tariff, or if there are segmented labour markets with directed search within each country, then the recessionary effects on the whole EA are amplified in the short run. Fourth, if the elasticity of substitution among tradables is low, then the tariff has recessionary effects on the whole EA also when the ELB does not hold.
    Keywords: DSGE models, protectionism, unemployment, monetary policy.
    JEL: F16 F41 F42 F45 F47
    Date: 2020–07
  2. By: Pablo Burriel (Banco de España); Cristina Checherita-Westphal (ECB); Pascal Jacquinot (ECB); Matthias Schön (Bundesbank); Nikolai Stähler (Bundesbank)
    Abstract: The paper reviews the economic risks associated with regimes of high public debt through DSGE model simulations. The large public debt build-up following the 2009 global financial and economic crisis acted as a shock absorber for output, while in the recent and more severe COVID19-crisis, an increase in public debt is even more justified given the nature of the crisis. Yet, once the crisis is over and the recovery firmly sets in, keeping debt at high levels over the medium term is a source of vulnerability in itself. Moreover, in the euro area, where monetary policy focuses on the area-wide aggregate, countries with high levels of indebtedness are poorly equipped to withstand future asymmetric shocks. Using three large scale DSGE models, the simulation results suggest that high-debt economies (1) can lose more output in a crisis, (2) may spend more time at the zero-lower bound, (3) are more heavily affected by spillover effects, (4) face a crowding out of private debt in the short and long run, (5) have less scope for counter-cyclical fiscal policy and (6) are adversely affected in terms of potential (long-term) output, with a significant impairment in case of large sovereign risk premia reaction and use of most distortionary type of taxation to finance the additional debt burden in the future. Going forward, reforms at national level, together with currently planned reforms at the EU level, need to be timely implemented to ensure both risk reduction and risk sharing and to enable high debt economies address their vulnerabilities.
    Keywords: government debt, interest rates, economic growth, fiscal sustainability
    JEL: E62 H63 O40 E43
    Date: 2020–08
  3. By: Lukas Altermatt; Christian Wipf
    Abstract: We investigate how the Mundell-Tobin effect, i.e., a positive relation between in flation and capital investment, changes the optimal monetary policy prescription in a framework that combines overlapping generations and new monetarist models. We find that the Friedman rule is optimal if and only if there is no Mundell-Tobin effect. A Mundell-Tobin effect is more likely to occur at the Friedman rule if capital is relatively liquid, and if the agents' risk aversion is relatively low. If the Friedman rule is not optimal, the optimal money growth rate lies between the Friedman rule and a constant money stock. We also show that it is more efficient to implement de flationary monetary policies by raising lump-sum taxes on old agents only.
    Keywords: New monetarism, overlapping generations, optimal monetary policy
    JEL: E4 E5
    Date: 2020–08
  4. By: Kollmann, Robert
    Abstract: The closed economy macro literature has shown that a liquidity trap can result from the self-fulfilling expectation that future inflation and output will be low (Benhabib et al. (2001)). This paper investigates expectations-driven liquidity traps in a two-country New Keynesian model of a monetary union. In the model here, country-specific productivity shocks induce synchronized responses of domestic and foreign output, while country-specific aggregate demand shocks trigger asymmetric domestic and foreign responses. A rise in government purchases in an individual country lowers GDP in the rest of the union. The result here cast doubt on the view that, in the current era of ultra-low interest rates, a rise in fiscal spending by Euro Area (EA) core countries would significantly boost GDP in the EA periphery (e.g. Blanchard et al. (2016)).
    Keywords: Zero lower bound, liquidity trap, monetary union, terms of trade, international fiscal spillovers, Euro Area.
    JEL: E3 E4 F2 F3 F4
    Date: 2020–08–08
  5. By: Kollmann, Robert
    Abstract: This paper studies fluctuations of interest rates, inflation and output in a two-country New Keynesian business cycle model with a zero lower bound (ZLB) constraint for nominal interest rates. The presence of the ZLB generates multiple equilibria driven by self-fulfilling changes in domestic and foreign inflation expectation. Each country randomly switches in and out of a liquidity trap. In a floating exchange rate regime, liquidity traps can either be synchronized or unsynchronized across countries. This is the case even if countries are perfectly financially integrated. By contrast, in a monetary union, self-fulfilling fluctuations in inflation expectations must be perfectly correlated across countries.
    Keywords: Zero lower bound, liquidity trap, global business cycles
    JEL: E3 E4 F2 F3 F4
    Date: 2020–04–15
  6. By: Almuth Scholl (Department of Economics, University of Konstanz); Liang Tong (Department of Economics, University of Konstanz)
    Abstract: This paper studies the dynamic interaction between sovereign default risk, taxation, and the un-derground economy. For a large sample of countries, we find that the size of the underground economy is positively correlated with sovereign debt and interest spreads. We rationalize these empirical regularities within a quantitative model of sovereign default that explicitly accounts for underground activities. We highlight a vicious circle: Higher sovereign risk premia tighten the endogenous borrowing constraint and force the government to raise taxes. Tax hikes, however, induce the private sector to invest less and to evade taxes by producing in the underground sector. Eventually, falling tax revenues force the government to either implement further tax hikes or to default. Our quantitative findings suggest that the underground economy fosters sovereign default risk and deepens debt crises.
    Keywords: sovereign debt, default, fiscal policy, underground economy, tax evasion
    JEL: E62 F34 H26
  7. By: Muñoz, Manuel A.
    Abstract: Since the onset of the Global Financial Crisis, the presence of institutional investors in housing markets has steadily increased over time. Real estate funds (REIFs) and other housing investment firms leverage large-scale buy-to-rent investments in real estate assets that enable them to set prices in rental housing markets. A significant fraction of this funding is being provided in the form of non-bank lending (i.e., lending that is not subject to regulatory LTV limits). I develop a quantitative two-sector DSGE model that incorporates the main features of the real estate fund industry in the current context to study the effectiveness of dynamic LTV ratios as a macroprudential tool. Despite the comparatively low fraction of total property and debt held by REIFs, optimized LTV rules limiting the borrowing capacity of such funds are more effective in smoothing property prices, credit and business cycles than those affecting (indebted) households – borrowing limit. This finding is remarkably robust across alternative calibrations (of key parameters) and specifications of the model. The underlying reason behind such an important and unexpectedly robust finding relates to the strong interconnectedness of REIFs with various sectors of the economy. JEL Classification: E44, G23, G28
    Keywords: leverage, loan-to-value ratios, real estate funds, rental housing
    Date: 2020–08
  8. By: Jun Nie; Zoe Xie
    Abstract: The CARES Act implemented in response to the COVID-19 crisis dramatically increased the generosity of unemployment insurance (UI) benefits, triggering concerns about substantial effects on unemployment. This paper combines a labor market search-matching model with the SIR-type infection dynamics to study the effects of the CARES Act UI on both unemployment and infection. More generous UI policies create work disincentives and lead to higher unemployment but also reduce infection and save lives. Economic shutdown policies further amplify these effects of UI policies. Quantitatively, the CARES UI policies raise unemployment by an average of 3.7 percentage points over April to December 2020, but also reduce cumulative death by 4.7 percent. Eligibility expansion and the extra $600 increase in benefit level account for over 90 percent of the total effects, while the 13-week benefit duration extension plays a much smaller role. Overall, UI policies improve the welfare of workers and reduce the welfare of non-workers, both young and old.
    Keywords: COVID-19; Unemployment insurance; CARES Act; Search and matching models
    JEL: E24 J64 J65
    Date: 2020–08–06
  9. By: Andreas Tryphonides
    Abstract: Using a semi-structural approach, the paper identifies how heterogeneity and financial frictions affect the transmission of aggregate shocks. Approximating a heterogeneous agent model around the representative agent allocation can successfully trace the aggregate and distributional dynamics and can be consistent with alternative mechanisms. Employing Spanish macroeconomic data as well as firm and household survey data, the paper finds that frictions on both consumption and investment have rich interactions with aggregate shocks. The response of heterogeneity amplifies or dampens these effects depending on the type of the shock. Both dispersion in consumption shares and the marginal revenue product of firms, as well as the proportion of investment constrained firms are key determinants of the fiscal multiplier.
    Date: 2020–07
  10. By: Anastasios G. Karantounias
    Abstract: This paper analyzes optimal policy in setups where both the leader and the follower have doubts about the probability model of uncertainty. I illustrate the methodology in two environments: a) an industry populated with a large firm and many small firms in a competitive fringe, where both types of firms doubt the probability model of demand shocks, and b) a general equilibrium economy, where a policymaker taxes linearly the labor income of a representative household in order to finance an exogenous stream of stochastic spending shocks. The policymaker can distrust the probability model of spending shocks more, the same, or less than the household. Whenever there are doubts about the model, cautious agents form endogenous worst-case beliefs by assigning high probability on low profitability or low-utility events. There are two forces that shape optimal policy results: the manipulation of the endogenous beliefs of the follower to the benefit of the leader, and the discrepancy (if any) in the pessimistic beliefs between the leader and the follower. Depending on the application, the leader may amplify or mitigate the worst-case beliefs of the follower.
    Keywords: model uncertainty; ambiguity aversion; multiplier preferences; misspecification; robustness; martingale; monopolist; competitive fringe; demand uncertainty; Ramsey taxation
    JEL: D80 E62 H21 H63
    Date: 2020–07–31
  11. By: Tobias Adrian; Christopher J. Erceg; Jesper Lindé; Pawel Zabczyk; Jianping Zhou
    Abstract: Many central banks have relied on a range of policy tools, including foreign exchange intervention (FXI) and capital flow management tools (CFMs), to mitigate the effects of volatile capital flows on their economies. We develop an empirically-oriented New Keynesian model to evaluate and quantify how using multiple policy tools can potentially improve monetary policy tradeoffs. Our model embeds nonlinear balance sheet channels and includes a range of empirically-relevant frictions. We show that FXI and CFMs may improve policy tradeoffs under certain conditions, especially for economies with less well-anchored inflation expectations, substantial foreign currency mismatch, and that are more vulnerable to shocks likely to induce capital outflows and exchange rate pressures.
    Date: 2020–07–07
  12. By: Titan Alon (University of California San Diego); Matthias Doepke (Northwestern University); Jane Olmstead-Rumsey (Northwestern University)
    Abstract: In recent US recessions, employment losses have been much larger for men than for women. Yet, in the current recession caused by the Covid-19 pandemic, the opposite is true: unemployment is higher among women. In this paper, we analyze the causes and consequences of this phenomenon. We argue that women have experienced sharp employment losses both because their employment is concentrated in heavily affected sectors such as restaurants, and due to increased childcare needs caused by school and daycare closures, preventing many women from working. We analyze the repercussions of this trend using a quantitative macroeconomic model featuring heterogeneity in gender, marital status, childcare needs, and human capital. Our quantitative analysis suggests that a pandemic recession will i) feature a strong transmission from employment to aggregate demand due to diminished within-household insurance; ii) result in a widening of the gender wage gap throughout the recovery; and iii) contribute to a weakening of the gender norms that currently produce a lopsided distribution of the division of labor in home work and childcare.
    Keywords: COVID-19, gender, marital status, human capital
    JEL: I14 J16 E24
    Date: 2020–08
  13. By: Christian Bayer; Benjamin Born; Ralph Luetticke
    Abstract: We provide evidence that expansionary fiscal policy lowers the return difference between more and less liquid assets—the liquidity premium. We rationalize this finding in an estimated heterogeneous-agent New-Keynesian (HANK) model with incomplete markets and portfolio choice, in which public debt affects private liquidity. In this environment, the short-run fiscal multiplier is amplified by the countercyclical liquidity premium. This liquidity channel stabilizes investment and crowds in consumption. We then quantify the long-run effects of higher public debt, and find a sizable decline of the liquidity premium, increasing the fiscal burden of debt, but little crowding out of capital.
    Keywords: fiscal policy, liquidity premium, business cycles, Bayesian estimation, incomplete markets, HANK
    JEL: C11 D31 E32 E63
    Date: 2020
  14. By: U. Devrim Demirel
    Abstract: This paper examines how the effects of legislated tax changes on labor market outcomes vary with the amount of slack in the economy, as measured by the rate of unemployment. I find that effects on hours worked, employment, and the unemployment rate become smaller in times of higher unemployment. I then develop a theoretical model in which changes in taxes on labor income directly affect the demand for labor by changing the costs that firms incur for employing workers. In the model, tax changes have smaller effects in times of higher unemployment because overall employee
    JEL: E20 E60 H20
    Date: 2020–08–27
  15. By: Guillaume MOREL
    Abstract: Within the present paper, we build a model from epidemiology and economics to study the impact of infectious diseases on the steady states and dynamic of an economy. More precisely, we embed a SIS model within a Ramsey growth model in a close framework with a tax where pollution comes from consumption. Firstly, we show that a consumption tax allocated to a depollution policy possesses an ambiguous effect on consumption and welfare, depending on the disease infectivity factor. Secondly, we point out that an increase in the spread of an infectious disease can’t make a limit cycle (Hopf bifurcation) emerge near the endemic steady state.
    Keywords: Hopf bifurcation, Pollution, Ramsey model, SIS model.
    JEL: C62 O44 Q5 I1
    Date: 2020
  16. By: Ohdoi, Ryoji
    Abstract: In some classes of macroeconomic models with financial frictions, an adverse financial shock successfully explains a drop in GDP, but simultaneously induces a stock price boom. The latter theoretical result is not consistent with data from actual financial crises. This study develops a simple macroeconomic model featuring a banking sector, financial frictions, and R&D-led endogenous growth to examine the impacts of an adverse financial shock to banks on firms' R&D investments and equity prices. Both the analytical and numerical investigations show that a shock that hinders the banks' financial intermediary function can be a key to generating both a prolonged recession and a drop in the firms' equity prices.
    Keywords: Banks; Endogenous growth; Financial frictions; Financial shocks; Quality-ladder growth model
    JEL: E32 E44 G01 O31 O41
    Date: 2020–07–22
  17. By: Anastasios Evgenidis; Masashige Hamano; Wessel N. Vermeulen
    Abstract: We apply a Bayesian Panel VAR (BPVAR) and DSGE approach to study the regional effects of the 2011 Great East Japan Earthquake. We disentangle the persistent fall in electricity supply following the Fukushima accident, from the immediate but more temporary production shock attributable to the natural disaster. Specifically, we estimate the contribution of the electricity fall on the regions' economic recovery. First, we estimate a BPVAR with regional-level data on industrial production, prices, and trade, to obtain impulse responses of the natural disaster shock. We find that all regions experienced a strong and persistent decline in trade, and long-lasting disruptions on production. Inflationary pressures were strong but short-lived. Second, we present a DSGE model that can capture key observations from this empirical model, and provide theoretical impulse response functions that distinguish the immediate earthquake shock from the persistent electricity supply shock. Thirdly, in line with the predictions from the theoretical model, counterfactual analysis via conditional forecasts based on our BPVAR reveals that the Japanese regional economies, particularly the hit regions, did experience a loss in production and trade due to the persistent fall in electricity supply.
    Date: 2020–08
  18. By: Qazi Haque (University of Western Australia and CAMA); Nicolas Groshenny (University of Adelaide and CAMA); Mark Weder (Department of Economics and Business Economics, Aarhus University and CAMA)
    Abstract: The paper re-examines whether the Federal Reserve’s monetary policy was a source of instability during the Great Inflation by estimating a sticky-price model with positive trend inflation, commodity price shocks and sluggish real wages. Our estimation provides empirical evidence for substantial wage rigidity and finds that the Federal Reserve responded aggressively to inflation but negligibly to the output gap. In the presence of non-trivial real imperfections and well-identified commodity price-shocks, U.S. data prefers a determinate version of the New Keynesian model: monetary policy-induced indeterminacy and sunspots were not causes of macroeconomic instability during the pre-Volcker era. However, had the Federal Reserve in the Seventies followed the policy rule of the Volcker-Greenspan-Bernanke period, inflation volatility would have been lower by one third.
    Keywords: Monetary policy, Trend inflation, Great Inflation, Cost-push shocks, Indeterminacy
    JEL: E32 E52 E58
    Date: 2020–08–14
  19. By: Ayşe İmrohoroğlu (University of Southern California); Kai Zhao (University of Connecticut)
    Abstract: The share of wealth held by the top one percent of Americans has increased from about 24% in 1980 to 40% in 2010. This paper examines the potential role played by three factors in accounting for this increase – decline in the corporate tax rates, increase in the income risk, and the decline in the world interest rates. Our model consists of altruistic households who either run a business or work for others. Entrepreneurial households enjoy high returns due to high productivity while worker households' savings earn the bank deposit rate that is determined in a competitive banking sector and equals the rate of return on foreign bonds. We find that entrepreneurship and intergenerational links via altruism are important factors generating a wealth distribution that mimics the data in the 2000s. However, it is the decline in the interest rate that plays a major role in accounting for the increase in the U.S. wealth inequality since the 1980s. In our model, the decline in the interest rate increases wealth inequality as it affects the two types of households differently. Entrepreneurial households benefit from lower financing costs and increase their investments while worker households face lower returns to their savings as the interest rate declines. Other changes such as the changes in taxation and income risk play a less significant role.
    Keywords: inequality, intergenerational links, saving, lifecycle models
    Date: 2020–08

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