nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2020‒09‒21
twenty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Optimal Dynamic Capital Requirements and Implementable Capital Buffer Rules By Matthew B. Canzoneri; Behzad T. Diba; Luca Guerrieri; Arsenii Mishin
  2. Long Live the Vacancy By Haefke, Christian; Reiter, Michael
  3. Monetary rules in an open economy with distortionary subsidies and inefficient shocks: A DSGE approach for Bolivia By Jemio Hurtado, Valeria
  4. Redistributive Policy Shocks and Monetary Policy with Heterogeneous Agents By Bahl, Ojasvita; Ghate, Chetan; Mallick, Debdulal
  5. Investment for the Demographic Window in Latin America By Rodriguez Maria Jose
  6. Nonlinear dynamic stochastic general equilibrium models in Stata By David Schenck
  7. Financial Frictions and the Wealth Distribution By Jesús Fernández-Villaverde; Samuel Hurtado; Galo Nuño
  8. The Distributional Effects of COVID-19 and Mitigation Policies By Sewon Hur
  9. Modeling optimal quarantines under infectious disease related mortality By Goenka, Aditya; Liu, Lin; Nguyen, Manh-Hung
  10. Child mortality, child labor, fertility, and demographics* By Kei Takakura
  11. Monetary Policy and Cross-Border Interbank Market Fragmentation: Lessons from the Crisis By Tobias Blattner; Jonathan Swarbrick
  12. Nature versus nurture in social mobility under private and public education systems By FAN Simon,; PANG Yu,; PESTIEAU Pierre,
  13. Active, or passive? Revisiting the role of fiscal policy in the Great Inflation By Ettmeier, Stephanie; Kriwoluzky, Alexander
  14. Bequests or education By DAVILA Julio,
  15. Jacks of All Trades and Masters of One: Declining Search Frictions and Unequal Growth By Paolo Martellini; Guido Menzio
  16. Supply-Side Effects of Pandemic Mortality: Insights from an Overlapping-Generations Model By Etienne Gagnon; Benjamin K. Johannsen; J. David Lopez-Salido
  17. Vacancy Posting Costs in Search and Matching Models and in Data By Mehrab Kiarsi; Samuel Muehlemann
  18. Involuntary unemployment under monopolistic competition and fiscal policy for full-employment By Tanaka, Yasuhito
  19. Prevention and Mitigation of Epidemics: Biodiversity Conservation and Confinement Policies By Emmanuelle Augeraud-Véron; Giorgio Fabbri; Katheline Schubert
  20. Average is Good Enough: Average-inflation Targeting and the ELB By Robert Amano; Stefano Gnocchi; Sylvain Leduc; Joel Wagner
  21. Fiscal multipliers in the most aged country: Empirical evidence and theoretical interpretation By Morita, Hiroshi

  1. By: Matthew B. Canzoneri; Behzad T. Diba; Luca Guerrieri; Arsenii Mishin
    Abstract: We build a quantitatively relevant macroeconomic model with endogenous risk-taking. In our model, deposit insurance and limited liability can lead banks to make risky loans that are socially inefficient. This excessive risk-taking can be triggered by aggregate or sectoral shocks that reduce the return on safer loans. Excessive risk-taking can be avoided by raising bank capital requirements, but unnecessarily tight requirements lower welfare by limiting liquidity producing bank deposits. Consequently, optimal capital requirements are dynamic (or state contingent). We provide examples in which a Ramsey planner would raise capital requirements: (1) during a downturn caused by a TFP shock; (2) during an expansion caused by an investment-specific shock; and (3) during an increase in market volatility that has little effect on the business cycle. In practice, the economy is driven by a constellation of shocks, and the Ramsey policy is probably beyond the policymaker's ken; so, we also consider implementable policy rules. Some rules can mimic the optimal policy rather well but are not robust to all the calibrations we consider. Basel III guidance calls for increasing capital requirements when the credit to GDP ratio rises, and relaxing them when it falls; this rule does not perform well. In fact, slightly elevated static capital requirements generally do about as well as any implementable rule.
    Keywords: Countercylical capital buffer; DSGE models; Bank capital requirements; Ramsey policy
    JEL: C51 E58 G28
    Date: 2020–08–06
  2. By: Haefke, Christian; Reiter, Michael
    Abstract: We reassess the role of vacancies in a Diamond-Mortensen-Pissarides style search and matching model. In the absence of free entry long lived vacancies and endogenous separations give rise to a vacancy depletion channel which we identify via joint unemployment and vacancy dynamics. We show conditions for constrained efficiency and discuss important implications of vacancy longevity for modeling and calibration, in particular regarding match cyclicality and wages. When calibrated to the postwar US economy, the model explains not only standard deviations and autocorrelations of labor market variables, but also their dynamic correlations with only one shock.
    Keywords: Beveridge Curve,Business Cycles,Job Destruction,Random Matching,Separations,Unemployment Volatility,Wage Determination
    JEL: E24 E32 J63 J64
    Date: 2020
  3. By: Jemio Hurtado, Valeria
    Abstract: Through an estimated and calibrated DSGE model with imperfect competition and nominal rigidities, this work aims to assess the dynamic effects of exogenous perturbations in a small open economy to provide a prescription of a simple monetary policy rule associated with the minimal welfare losses in the case of Bolivia. Following Gali and Monacelli (2005) and De Paoli (2009), I display the baseline model in a canonical representation. Yet, unlike them, I consider the presence of efficient and inefficient perturbations, namely government spending, productivity, foreign demand, and cost-push shocks, to analyze its effects in terms of observable variables but also on the relevant output gap. Moreover, considering the significance of raw materials as a proportion of the Bolivian exports, I extend the model by taking into account a distortionary subsidy on consumption financed by the positive profits of the commodity sector, Further, in the style of Gali and Monacelli (2005), I compare the welfare implications under two scenarios: A monetary rule focus on maintain a nominal exchange rate peg (fixed) regime and a Taylor rule. The main results reveal that the latter outperforms the former when the full set of shocks occurs simultaneously, showing the importance of inflation targeting. Yet, by focusing only on inefficient exogenous perturbations, and taking into account a pegged regime and a simple Taylor rule based on consumer and producer price inflation, the ranking of monetary policy aligns in the first place an exchange rate peg. This scenario shows the potential success of alternative simple monetary rules under these circumstances.
    Keywords: Macroeconomics; Monetary Policy; Business Cycles; Bayessian Estimation
    JEL: C11 C13 C15 E0 E12 E32 E52 E58 F41 F44
    Date: 2020–07–14
  4. By: Bahl, Ojasvita; Ghate, Chetan; Mallick, Debdulal
    Abstract: Governments in EMDEs routinely intervene in agriculture markets to stabilize food prices in the wake of adverse domestic or external shocks. Such interventions typically involve a large increase in the procurement and redistribution of food, which we call a redistributive policy shock. What is the impact of a redistributive policy shock on the sectoral and aggregate dynamics of inflation, and the distribution of consumption amongst rich and poor households? To address this, we build a tractable two-sector (agriculture and manufacturing) two-agent (rich and poor) New Keynesian DSGE model with redistributive policy shocks. We calibrate the model to the Indian economy. We show that for an inflation targeting central bank, consumer heterogeneity matters for whether monetary policy responses to a variety of shocks raises aggregate welfare or not. Our paper contributes to a growing literature on understanding the role of consumer heterogeneity in monetary policy.
    Keywords: TANK models, HANK Models, Inflation Targeting, Emerging Market and Developing Economies, Food Security, Procurement and Redistribution, DSGE.
    JEL: E31 E32 E44 E52 E63
    Date: 2020–07–07
  5. By: Rodriguez Maria Jose
    Abstract: This paper studies the behavior of investment during demographic transitions. In particular, I focus on the period where the working age to population ratio reaches its maximum, namely the demographic window. I document that in Europe, Asia, and Oceania investment rates are higher 15 years before and during the window than in other periods, whereas in Latin America they are lower. To understand the relation between investment and a demographic window, I build an overlapping generations model with demographic change and variable degree of financial openness. Within this framework, I conduct several exercises and counterfactuals involving potential drivers of the investment behavior. I find that the demographic behavior in conjunction with the region-specific financial openness can explain the main pattern of investment for the demographic window in Latin America vis-a-vis Europe and Asia.
    Keywords: Investment;Demographic Window;Latin America
    JEL: F21 E22 J10 O54 F41
    Date: 2019–10
  6. By: David Schenck (StataCorp)
    Abstract: Dynamic stochastic general equilibrium (DSGE) models are used in macroeconomics for policy analysis and forecasting. A DSGE model consists of a system of equations—usually a nonlinear system of equations—that is derived from economic theory. I will show you how to easily solve, estimate, and analyze nonlinear DSGEs. We will explore how to obtain policy matrices, transition matrices, and impulse–response functions for nonlinear models.
    Date: 2020–08–20
  7. By: Jesús Fernández-Villaverde; Samuel Hurtado; Galo Nuño
    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, continuous-time, machine learning, neural networks, structural estimation, likelihood function
    JEL: C45 C63 E32 E44 G01 G11
    Date: 2020
  8. By: Sewon Hur
    Abstract: This paper develops a quantitative life cycle model in which economic decisions impact the spread of COVID-19 and, conversely, the virus affects economic decisions. The calibrated model is used to measure the welfare costs of the pandemic across the age, income and wealth distribution and to study the effectiveness of various mitigation policies. In the absence of mitigation, young workers engage in too much economic activity relative to the social optimum, leading to higher rates of infection and death in the aggregate. The paper considers a subsidy-and-tax policy that imposes a tax on consumption and subsidizes reduced work compared to a lockdown policy that caps work hours. Both policies are welfare improving and lead to less infections and deaths. Notably, almost all agents favor the subsidy-and-tax policy, suggesting that there need not be a tradeoff between saving lives and economic welfare.
    Keywords: pandemic; coronavirus; COVID-19
    JEL: D62 E21 E32 E62 I14 I15
    Date: 2020–09–02
  9. By: Goenka, Aditya; Liu, Lin; Nguyen, Manh-Hung
    Abstract: This paper studies optimal quarantines (can also be interpreted as lockdowns or selfisolation) when there is an infectious disease with SIS dynamics and infections can cause disease related mortality in a dynamic general equilibrium neoclassical growth framework. We characterize the optimal decision and the steady states and how these change with changes in effectiveness of quarantine, productivity of working from home, contact rate of disease and rate of mortality from the disease. A standard utilitarian welfare function gives the counter-intuitive result that increasing mortality reduces quarantines but increases mortality and welfare while economic outcomes and infections are largely unaffected. With an extended welfare function incorporating welfare loss due to disease related mortality (or infections generally) however, quarantines increase, and the decreasing infections reduce mortality and increase economic outcomes. Thus, there is no optimal trade-off between health and economic outcomes. We also study sufficiency conditions and provide the first results in economic models with SIS dynamics with disease related mortality - a class of models which are non-convex and have endogenous discounting so that no existing results are applicable.
    Keywords: Infectious diseases; Covid-19; SIS model; mortality; sufficiency conditions;; economic growth; lockdown; quarantine; self-isolation.
    Date: 2020–08
  10. By: Kei Takakura (Graduate School of Economics, Osaka University)
    Abstract: In this study,we analyze how an improvement in child mortality affects fertility, childlabor,and investments in education.We consider an overlapping generations model,in which skilled and unskilled workers coexist.Improvement in child mortality has different effects on skilled workers and unskilled ones.We study three alternative policies for increasing the proportion of skilled workers in the economy:improvement in child mortality,a ban on child labor,and child education.The ban on child labor means that the government enforces a law that prohibits a household from supplying child labor.The model reveals that improvements in child mortality policy and a ban on child labor policy can decrease the proportion of skilled workers and the average income in the economy.On the other hand,the child education policy,which supports both skilled and unskilled workers' investments in the education of their children by building schools,increases the proportion of skilled workers and the average income in the economy.
    Keywords: Child mortality, Child labor, Fertility, Education, Health, Overlapping genera-tions model
    JEL: D1 I1 I2 J1 O1
  11. By: Tobias Blattner; Jonathan Swarbrick
    Abstract: We present a two-country model featuring risky lending and cross-border interbank market frictions. We find that (i) the strength of the financial accelerator, when applied to banks operating under uncertainty in an interbank market, will critically depend on the economic and financial structure of the economy; (ii) adverse shocks to the real economy can be the source of banking crisis, causing an increase in interbank funding costs, aggravating the initial shock; and (iii) asset purchases and central bank long-term refinancing operations can be effective substitutes for, or supplements to, conventional monetary policy.
    Keywords: Business fluctuations and cycles; Credit and credit aggregates; International financial markets; Monetary policy framework; Transmission of monetary policy
    JEL: E52 F36
    Date: 2020–08
  12. By: FAN Simon, (Lingnan University, Hong Kong); PANG Yu, (Macau University of Science and Technology, Macau); PESTIEAU Pierre, (Université de Liège, CORE, Toulouse School of Economics)
    Abstract: This paper analyzes the roles of innate talent versus family background in shaping intergenerational mobility and social welfare under different education systems. We establish an overlapping-generations model in which the allocation of workers between a high-paying skilled labor sector and a low-paying unskilled labor sector depends on talent, parental human capital, and educational resources, and the wage rate of skilled workers is determined by their average talent. Our model suggests that under the private education system, there is a negative relationship between income inequality and social mobility, and the steady-state average talent of skilled workers decreases with educational investments. Under the public education system that provides all children with equal educational resources, the allocation of workforce depends more on talent and less on family background. Consequently, both mobility and inequality increase, and social welfare may improve under reasonable conditions. When private educational investments are allowed on top of public education, the steady-state social welfare increases further. Moreover, if some parents are myopic, public education yields the highest welfare.
    Keywords: innate ability, private education, public education, intergenerational mobility
    JEL: H20 H31 H50
    Date: 2020–02–11
  13. By: Ettmeier, Stephanie; Kriwoluzky, Alexander
    Abstract: We reexamine whether pre-Volcker U.S. fiscal policy was active or passive. To do so, we estimate a DSGE model with monetary and fiscal policy interactions employing a sequential Monte Carlo algorithm (SMC) for posterior evaluation. Unlike existing studies, we do not have to treat each policy regime as distinct, separately estimated, models. Rather, SMC enables us to estimate the DSGE model over its entire parameter space. A differentiated perspective results: pre-Volcker macroeconomic dynamics were similarly driven by a passive monetary/passive fiscal policy regime and fiscal dominance. Fiscal policy actions, especially government spending, were critical in the pre-Volcker inflation build-up.
    Keywords: Bayesian Analysis,DSGE Models,Monetary-Fiscal Policy Interactions,MonteCarlo Methods
    JEL: C11 C15 E63 E65
    Date: 2020
  14. By: DAVILA Julio, (CORE, UCLouvain)
    Abstract: Wether parents choose to endow their offspring with bequests, or with human capital - the effectiveness with which they do so surely depending on their own human capital - or with both, markets cannot deliver, under laissez-faire, the egalitarian planner’s mix of bequests and education that maximises the representative agent’s welfare. Specifically, at the steady state and for a close enough to linear human capital production - out of educational investment and parents human capital - the market wage per efficient unit of labor is too high compared to the marginal productivity of labor resulting from the steady state the planner would choose, so that the market human capital is too low. In other words, the market misses the planner’s allocation by leading households to transfer to their offspring more in bequests and less in education than would be advisable. This is so even if parents internalise in their utility the value of their bequests and educational investment for their children. The problem is not, therefore, one of an externality not internalised, but rather the impossibility of replicating in a decentralised way, under laissez-faire, the kind of intergenerational coordination that a planner constrained only by the feasibility of the allocation of resources can achieve. The planner’s allocation can, nonetheless, be decentralised through the market by means of subsidising labor income at the expense of a lump-sum tax on saving returns.
    Keywords: human capital, bequests, externalities, overlapping generations
    JEL: A14 C70 D20
    Date: 2020–02–11
  15. By: Paolo Martellini; Guido Menzio
    Abstract: Declining search frictions generate productivity growth by allowing workers to find jobs for which they are better suited. The return of declining search frictions on productivity varies across different types of workers. For workers who are “jacks of all trades”—in the sense that their productivity is nearly independent from the distance between their skills and the requirements of their job’ declining search frictions lead to minimal productivity growth. For workers who are “masters of one trade”—in the sense that their productivity is very sensitive to the gap between their individual skills and the requirements of their job—declining search frictions lead to fast productivity growth. As predicted by this view, we find that workers in routine occupations have low wage dispersion and growth, while workers in non-routine occupations have high wage dispersion and growth.
    JEL: E24 J24 J31 J64 O47
    Date: 2020–08
  16. By: Etienne Gagnon; Benjamin K. Johannsen; J. David Lopez-Salido
    Abstract: We use an overlapping generation model to explore the implications of mortality during pandemics for the economy's productive capacity. Under current epidemiological projections for the progression of COVID-19, our model suggests that mortality will have, in itself, at most small effects on output and factor prices. The reason is that projected mortality is small in proportion to the population and skewed toward individuals who are retired from the labor force. That said, we show that if the spread of COVID-19 is not contained, or if the ongoing pandemic were to follow a mortality pattern similar to the 1918-1920 Great Influenza pandemic, then the effects on the productive capacity would be economically significant and persist for decades.
    Keywords: Pandemics; Potential output; Real wage; Equilibrium real interest rate; Demographics; COVID-19
    JEL: E21 E27 E43
    Date: 2020–08–19
  17. By: Mehrab Kiarsi; Samuel Muehlemann
    Abstract: We first show that in any reconfigured matching models of the labor market low vacancy posting costs play a central role in generating large unemployment volatility as observed in the data. Moreover, we show that low vacancy costs play a critical role in inducing wage inertia in these models as well. We show that the seemingly important roles of the replacement ratio and fundamental surplus fraction in inducing high unemployment and market tightness volatility are confounded with the role of vacancy posting costs. They, per se, are not important for labor market volatility. We then use unique data on job vacancies in Germany and show that the ratio of vacancy costs to GDP is extremely low. The estimated low vacancy costs imply that the leading models of the labor market perhaps have not much empirical difficulty in accounting for cyclical behavior of wages and labor market activity observed in the data.
    Keywords: Search and matching model, vacancy posting costs, wage inertia, unemployment volatility
    JEL: E23 E24 E30 E32 E39 J24 J31 J63
    Date: 2020–09
  18. By: Tanaka, Yasuhito
    Abstract: We show the existence of involuntary unemployment based on consumers' utility maximization and firms' profit maximization behavior under monopolistic competition with increasing, decreasing or constant returns to scale technology using a three-period overlapping generations (OLG) model with a childhood period as well as younger and older periods. We also analyze the effects of fiscal policy financed by tax and budget deficit (or seigniorage) to realize full-employment under a situation with involuntary unemployment. We show the following results. 1) In order to maintain the steady state where employment increases at some positive rate, we need a budget deficit (Proposition 1). 2) If the full-employment state is realized, we do not need budget deficit to maintain full-employment (Proposition 2).
    Keywords: Involuntary unemployment, Three-period overlapping generations model, Monopolistic competition
    JEL: E12 E24
    Date: 2020–07–02
  19. By: Emmanuelle Augeraud-Véron; Giorgio Fabbri; Katheline Schubert
    Abstract: This paper presents a first model integrating the relation between biodiversity loss and zoonose pandemic risks in a general equilibrium dynamic economic set-up. The occurrence of pandemics is modeled as Poissonian leaps in economic variables. The planner can intervene in the economic and epidemiological dynamics in two ways: first (prevention), by deciding to preserve a greater quantity of biodiversity, thus decreasing the probability of a pandemic occurring, and second (mitigation), by reducing the death toll through a confinement policy. The class of social welfare functional considered has, as polar cases, a total utilitarian and an average utilitarian specifications. It implicitly considers, at the same time, the effects of policies on mortality and on the productive capacity of the country. Thanks to the Epstein-Zin specification of preferences, we disantangle risk aversion and fluctuation aversion. The model is explicitly solved and the optimal policy completely described. The qualitative dependence of the optimal policy on natural, productivity and preference parameters is discussed. In particular the optimal lockdown is shown to be more severe in societies valuing more human life, and the optimal biodiversity conservation is shown to be more relevant for more “forward looking” societies, with a small discount rate and a high degree of altruism towards individuals of future generations. We also show that societies accepting a large welfare loss to mitigate the pandemics are also societies doing a lot of prevention. After calibrating the model with COVID-19 pandemic data we compare the miti-gation efforts predicted by the model with those of the recent literature and we study the optimal prevention-mitigation policy mix.
    Keywords: biodiversity, COVID-19, prevention, mitigation, epidemics, Poisson processes, recursive preferences
    JEL: Q56 Q57 Q58 O13 C61
    Date: 2020
  20. By: Robert Amano; Stefano Gnocchi; Sylvain Leduc; Joel Wagner
    Abstract: The Great Recession and current pandemic have focused attention on the constraint on nominal interest rates from the effective lower bound. This has renewed interest in monetary policies that embed makeup strategies, such as price-level or average-inflation targeting. This paper examines the properties of average-inflation targeting in a two-agent New Keynesian (TANK) model in which a fraction of firms have adaptive expectations. We examine the optimal degree of history dependence under average-inflation targeting and find it to be relatively short for business cycle shocks of standard magnitude and duration. In this case, we show that the properties of the economy are quantitatively similar to those under a price-level target.
    Keywords: Business fluctuations and cycles; Economic models; Monetary policy framework
    JEL: E52
    Date: 2020–07
  21. By: Morita, Hiroshi
    Abstract: This study investigates how population aging impacts the effectiveness of a government spending shock. We estimate a panel VAR model with prefectural data in Japan, the world’s fastest aging country and reveal that a government spending shock becomes less effective as the aging rate increases. Subsequently, we construct a New Keynesian model with workers and retirees, which can replicate our empirical findings. This highlights the role of the supply-side channel through which workers facing a liquidity constraint can benefit from increased disposable income, in generating the state-dependent effect of the government spending shock. Our theoretical finding may suggest that promoting labor market participation by elderly people could increase the effectiveness of a government spending shock amid a rapidly aging society.
    Keywords: Population aging, Panel VAR model, New Keynesian model, Fiscal policy
    JEL: E62 C11 C23
    Date: 2020–09

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