nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2020‒10‒05
nineteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Long Live the Vacancy By Haefke, Christian; Reiter, Michael
  2. A Macro-Financial Perspective to Analyse Maturity Mismatch and Default By Xuan Wang
  3. Macroeconomic Implications of COVID-19: Can Negative Supply Shocks Cause Demand Shortages? By Veronica Guerrieri; Guido Lorenzoni; Ludwig Straub; Iv‡n Werning
  4. Does Unemployment Risk Affect Business Cycle Dynamics? By Sebastian Graves
  5. Uncertainty and monetary policy during extreme events By Giovanni Pellegrino; Efrem Castelnuovo; Giovanni Caggiano
  6. Exchange Rates and Endogenous Productivity By Nils Gornemann; Pablo Guerron-Quintana; Felipe Saffie
  7. Generational Distribution of Fiscal Burdens: A Positive Analysis By Uchida, Yuki; Ono, Tetsuo
  8. Avoiding Root-Finding in the Krusell-Smith Algorithm Simulation By Ivo Bakota
  9. Firm Leverage and Wealth Inequality By Ivo Bakota
  10. Uncertainty, Long-Run, and Monetary Policy Risks in a Two-Country Macro Model By Kimberly A. Berg; Nelson C. Mark
  11. One Rule Fits All ? Heterogeneous Fiscal Rules for Commodity Exporters When Price Shocks Can Be Persistent: Theory and Evidence By Galego Mendes,Arthur; Pennings,Steven Michael
  12. A Structural Model of the Labor Market to Understand Gender Gaps among Marginalized Roma Communities By Salazar-Saenz,Mauricio; Robayo,Monica
  13. Internal and External Effects of Social Distancing in a Pandemic By Maryam Farboodi; Gregor Jarosch; Robert Shimer
  14. Nontradable Goods and Fiscal Multipliers By Christian Glocker; Jesus Crespo Cuaresma
  15. International Trade and Innovation Dynamics with Endogenous Markups By Laurent Cavenaile; Pau Roldan-Blanco; Tom Schmitz
  16. Capital Income Taxation with Portfolio Choice By Ivo Bakota
  17. Recruiting Intensity and Hiring Practices: Cross-Sectional and Time-Series Evidence By Lochner, Benjamin; Merkl, Christian; Stüber, Heiko; Gürtzgen, Nicole
  18. On the Importance of Household versus Firm Credit Frictions in the Great Recession By Patrick J. Kehoe; Pierlauro Lopez; Virgiliu Midrigan; Elena Pastorino
  19. Population Ageing and the Impact of Later Retirement on the Pension System in China: An Applied Dynamic General Equilibrium Analysis By Xuejin Zuo; Xiujian Peng; Xin Yang; Philip Adams; Meifeng Wang

  1. By: Haefke, Christian (New York University, Abu Dhabi); Reiter, Michael (IHS - Institute for Advanced Studies, Vienna)
    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: 2020–09
  2. By: Xuan Wang (Vrije Universiteit Amsterdam)
    Abstract: The Basel Committee proposed the Net Stable Funding Ratio (NSFR) to curb excessive maturity mismatch of the banking sector. However, it remains to be ascertained as to what are the financial and real effects of the NSFR on banks' credit quality, investment, and the pass-through of monetary policy. This paper develops a nominal dynamic general equilibrium featuring banks' maturity mismatch and the moral hazard due to costly monitoring. First, I show that a tightening of the NSFR to move loan maturity towards the long-run capital investment cycle would only increase real investment if it sufficiently improves banks' credit quality. Then in the numerical example calibrated with the US data, I show that such tightening of the NSFR can indeed increase real investment and also reduce the aggregate fluctuation of the economy. In the steady states, a 10% tightening in the NSFR can decrease net charge-offs of non-performing loans by about 0.06 pp annually, despite squeezing banks' interest margin. Moreover, the moral hazard stemming from banks' unobserved monitoring effort impairs the pass-through of monetary policy. However, a 10% tightening in the NSFR improves the pass-through of a 20-bp policy rate reduction by around 17% annually. Finally, the model simulates the stochastic dynamic equilibrium path to study the propagation of shocks, demonstrating that the NSFR complements monetary policy in reducing financial frictions.
    Keywords: Maturity mismatch, Net Stable Funding Ratio, default, banking, monetary policy, macro-prudential policy
    JEL: E44 E51 G18 G21
    Date: 2020–09–22
  3. By: Veronica Guerrieri (University of Chicago - Booth School of Business); Guido Lorenzoni (Northwestern University and NBER); Ludwig Straub (Harvard University); Iv‡n Werning (Massachusetts Institute of Technology (MIT) and NBER)
    Abstract: We present a theory of Keynesian supply shocks: supply shocks that trigger changes in aggregate demand larger than the shocks themselves. We argue that the economic shocks associated to the COVID-19 epidemicÑshutdowns, layoffs, and firm exitsÑmay have this feature. In one-sector economies supply shocks are never Keynesian. We show that this is a general result that extend to economies with incomplete markets and liquidity constrained consumers. In economies with multiple sectors Keynesian supply shocks are possible, under some conditions. A 50% shock that hits all sectors is not the same as a 100% shock that hits half the economy. Incomplete markets make the conditions for Keynesian supply shocks more likely to be met. Firm exit and job destruction can amplify the initial effect, aggravating the recession. We discuss the effects of various policies. Standard fiscal stimulus can be less effective than usual because the fact that some sectors are shut down mutes the Keynesian multiplier feedback. Monetary policy, as long as it is unimpeded by the zero lower bound, can have magnified effects, by preventing firm exits. Turning to optimal policy, closing down contact-intensive sectors and providing full insurance payments to affected workers can achieve the first-best allocation, despite the lower per-dollar potency of fiscal policy.
    Date: 2020
  4. By: Sebastian Graves
    Abstract: In this paper, I show that the decline in household consumption during unemployment spells depends on both liquid and illiquid asset positions. I also provide evidence that unemployment spells predict the withdrawal of illiquid assets, particularly when households have few liquid assets. Motivated by these findings, I embed endogenous unemployment risk in a two-asset heterogeneous-agent New Keynesian model. The model is consistent with the above evidence and provides a new propagation mechanism for aggregate shocks due to a flight-to-liquidity that occurs when unemployment risk rises. This mechanism implies that unemployment insurance plays an important role as an automatic stabilizer, particularly when monetary policy is constrained.
    Keywords: Heterogeneous-agent model; liquid and illiquid assets; Unemployment insurance; Unemployment risk
    JEL: E10 E24 E32 E62 J64
    Date: 2020–09–18
  5. By: Giovanni Pellegrino; Efrem Castelnuovo; Giovanni Caggiano
    Abstract: How damaging are uncertainty shocks during extreme events such as the great recession and the Covid-19 outbreak? Can monetary policy limit output losses in such situations? We use a nonlinear VAR framework to document the large response of real activity to a financial uncertainty shock during the great recession. We replicate this evidence with an estimated DSGE framework featuring a concept of uncertainty comparable to that in our VAR. We employ the DSGE model to quantify the impact on real activity of an uncertainty shock under different Taylor rules estimated with normal times vs. great recession data (the latter associated with a stronger response to output). We find that the uncertainty shock-induced output loss experienced during the 2007-09 recession could have been twice as large if policymakers had not responded aggressively to the abrupt drop in output in 2008Q3. Finally, we use our estimated DSGE framework to simulate different paths of uncertainty associated to different hypothesis on the evolution of the coronavirus pandemic. We find that: i) Covid-19-induced uncertainty could lead to an output loss twice as large as that of the great recession; ii) aggressive monetary policy moves could reduce such loss by about 50%.
    Keywords: Uncertainty shock, nonlinear IVAR, nonlinear DSGE framework, minimum-distance estimation, great recession, Covid-19
    JEL: C22 E32 E52
    Date: 2020–09
  6. By: Nils Gornemann; Pablo Guerron-Quintana; Felipe Saffie
    Abstract: Real exchange rates (RERs) display sizable uctuations not only over the business cycle, but also at lower frequencies, resulting in large and persistent swings over decades|facts that many business cycle models struggle to match. We propose an international macroeconomics model with endogenous productivity to rationalize these facts. In the model, endogenous growth amplifies stationary uctuations generating persistent productivity differences between countries that trigger low-frequency cycles in the RER. The estimated model effortlessly replicates the empirical spectrum, autocorrelation, and half-life of the RER. In addition, we document that low frequency movements in aggregate trade ows are crucial to discipline the RER cycles. Finally, we validate the model-implied co-movement between relative prices and technology differentials using a panel of cross industry-country data on patent and industry prices.
    Keywords: Real exchange rate; Endogenous growth; RBC
    JEL: F31 F41 F43 F44
    Date: 2020–09–18
  7. By: Uchida, Yuki; Ono, Tetsuo
    Abstract: This study presents a political economy model with overlapping generations to analyze the effects of population aging on fiscal policy formation and the resulting distribution of fiscal burden across generations. The analysis shows that increased political power of the old, arising from population aging, leads to (i) an increase in the ratio of labor income tax revenue to GDP and the ratio of debt to GDP, and (ii) an increase in the ratio of capital income tax revenue to GDP in countries with high degrees of preferences for public goods, but an initial decrease followed by an increase in this ratio in countries with low degrees of preferences for public goods.
    Keywords: Generational burden; Overlapping generations; Political economy; Population aging; Public debt
    JEL: D70 E24 E62 H60
    Date: 2020–09–09
  8. By: Ivo Bakota
    Abstract: This paper proposes a novel method to compute the simulation part of the Krusell-Smith (1997, 1998) algorithm when the agents can trade in more than one asset (for example, capital and bonds). The Krusell-Smith algorithm is used to solve general equilibrium models with both aggregate and uninsurable idiosyncratic risk and can be used to solve bounded rationality equilibria and to approximate rational expectations equilibria. When applied to solve a model with more than one financial asset, in the simulation, the standard algorithm has to impose equilibria for each additional asset (find the market-clearing price), for each period simulated. This procedure entails root-finding for each period, which is computationally very expensive. I show that it is possible to avoid this rootfinding by not imposing the equilibria each period, but instead by simulating the model without market clearing. The method updates the law of motion for asset prices by using Newton-like methods (Broyden’s method) on the simulated excess demand, instead of imposing equilibrium for each period and running regressions on the clearing prices. Since the method avoids the root-finding for each time period simulated, it leads to a significant reduction in computation time. In the example model, the proposed version of the algorithm leads to a 32% decrease in computational time, even when measured conservatively. This method could be especially useful in computing asset pricing models (for example, models with risky and safe assets) with both aggregate and uninsurable idiosyncratic risk since methods which use linearization in the neighborhood of the aggregate steady state are considered to be less accurate than global solution methods for these particular types of models.
    Keywords: portfolio choice; heterogeneous agents; Krusell-Smith;
    JEL: E44 G12 C63
    Date: 2020–09
  9. By: Ivo Bakota
    Abstract: This paper studies the effects of a change in firm leverage on wealth inequality and macroeconomic aggregates. The question is studied in a general equilibrium model with a continuum of heterogeneous agents, life-cycle, incomplete markets, and idiosyncratic and aggregate risk. The analysis focuses on the particular change in firm leverage that occurred in the U.S. during the 1980s, when firm leverage increased significantly, and subsequently has been dropping since the early 1990s. In the benchmark model, an increase in firm leverage of the size that occurred during the 1980s increases capital accumulation by 5.38%, decreases wealth inequality by 1.07 Gini points and decreases government revenues by 0.11% of output. An increase in firm leverage increases average after-tax returns on savings, as firm debt has beneficial tax treatment. This increases the saving rates of all households, and disproportionately increases the saving rates of relatively poorer households. Consequently, the model implies that the increase in firm leverage did not contribute to rising inequality in the U.S. in the 1980s, but rather the opposite; that the reduction in leverage from the early 1990s to 2008 has contributed to rising wealth inequality. Furthermore, I show that if the model abstracts from beneficial tax treatment of corporate debt, the change in leverage has only minor effects on macro aggregates and inequality, despite having significant implications for asset prices. This is consistent with the previous result in the literature showing that the Modigliani-Miller theorem approximately holds in the heterogeneous agents model with imperfect markets.
    Keywords: portfolio choice; heterogeneous agents; life-cycle; leverage;
    JEL: E44 G10 G11 G32
    Date: 2020–09
  10. By: Kimberly A. Berg; Nelson C. Mark
    Abstract: We study international currency risk in a two-country dynamic stochastic general equilibrium model under incomplete markets. The underlying sources of risk are direct shocks to productivity growth, shocks to a long-run risk component of productivity growth, shocks to a stochastic volatility component of productivity growth, and shocks to monetary policy. The long-run risk and stochastic volatility shocks have the interpretation of aggregate demand shocks. Cross-country heterogeneity in the model arises from three sources: differences in the long-run risk and stochastic volatility process parameters that we estimate using United States and Japanese total factor productivity data, differences in monetary policy parameters, and differences in export pricing. The driving force behind currency risk is heterogeneity in precautionary saving. Differences in monetary policy can generate moderate currency risk, but structural differences in productivity growth are more important. Export pricing conventions are not important sources of currency risk. Stochastic volatility shocks are key to generating volatility in the currency risk premium, but they do not help at all in explaining the forward premium bias/anomaly.
    JEL: E21 E43 F31 G12
    Date: 2020–09
  11. By: Galego Mendes,Arthur; Pennings,Steven Michael
    Abstract: Commodity-exporting developing economies are often characterized as having needlessly procyclical fiscal policy: spending when commodity prices are high and cutting back when prices fall. The standard policy advice is instead to save during price windfalls and maintain spending during price busts. This paper questions this characterization and policy advice. Using a New Keynesian model, it finds that optimal fiscal policy is heterogeneous depending on the commodity exported and exchange rate regime. Optimal fiscal policy is often procyclical in countries with floating exchange rates because many commodity price shocks are highly persistent, and so they should be spent according to the permanent income hypothesis. In contrast, in countries with fixed exchange rates, optimal fiscal policy becomes countercyclical to smooth the business cycle. Empirically, the paper introduces a new measure of fiscal cyclicality, the marginal propensity to spend (MPS) an extra dollar of commodity revenues, and shows that it is moderately procyclical overall but highly heterogeneous across countries depending on their characteristics. Consistent with theory, the MPS is more procyclical in countries with floating exchange rates than those with fixed exchange rates. Moreover, in countries with floating exchange rates, the MPS is higher in countries facing more persistent commodity price shocks.
    Date: 2020–09–15
  12. By: Salazar-Saenz,Mauricio; Robayo,Monica
    Abstract: This paper constructs and estimates a household-level search model to analyze Roma spouses'utility maximization for leisure, home production, and work. The paper aims to explain labor market gender gaps in a marginalized Roma population with low labor market participation rates (males 53 percent and females 17 percent). The analysis uses data from the 2017 Regional Roma Survey for six Western Balkan countries. The simulation results show that the main source for gender differentials in the labor market is the unequal opportunities in favor of males -- not gender preferences or differences in home production productivity. Therefore, most of the gender differences in the labor market can be closed by providing wives the same labor market conditions as husbands. Counterfactual policy experiments show that policies that increase the frequency of receiving a job offer, decrease the frequency of laying off workers, and reduce search increase Roma husbands'labor participation. Policies that equalize wages induces more wives to join the labor market and husbands to withdraw from it. This outcome signals that the wage gap is the dimension that deters the greatest number of Roma wives from joining the labor market.
    Keywords: Rural Labor Markets,Gender and Development,Employment and Unemployment,Inequality,Labor Markets
    Date: 2020–09–15
  13. By: Maryam Farboodi (Massachusetts Institute of Technology); Gregor Jarosch (Princeton University); Robert Shimer (University of Chicago)
    Abstract: We use a conventional dynamic economic model to integrate individual optimization, equilibrium interactions, and policy analysis into the canonical epidemiological model. Our tractable framework allows us to represent both equilibrium and optimal allocations as a set of differential equations that can jointly be solved with the epidemiological model in a unified fashion. Quantitatively, the laissez-faire equilibrium accounts for the decline in social activity we measure in US micro-data from Safe Graph. Relative to that, we highlight three key features of the optimal policy: it imposes immediate, discontinuous social distancing; it keeps social distancing in place for a longtime or until treatment is found; and it is never extremely restrictive, keeping the effective reproduction number mildly above the share of the population susceptible to the disease.
    Date: 2020
  14. By: Christian Glocker; Jesus Crespo Cuaresma
    Abstract: We assess the role that nontradable goods play as a determinant of fiscal spending multipliers, making use of a two-sector model. While fiscal multipliers increase with the share of nontradable goods, an inverted U-shaped relationship exists between multiplier size and the import share. Employing an interacted panel VAR model for EU countries, we estimate the effect of the share of nontradable goods on fiscal spending multipliers. Our empirical results provide strong evidence for the predictions of the theoretical model. They imply that the drag of fiscal consolidations is on average smaller in countries with a low share of nontradable goods.
    Keywords: fiscal spending multiplier, nontradable goods, openness, DSGE model, interacted panel VAR model
    JEL: E62 F41 C23
    Date: 2020
  15. By: Laurent Cavenaile; Pau Roldan-Blanco; Tom Schmitz
    Abstract: Lower costs of international trade affect both firms’ innovation incentives and theirmarket power. We develop a dynamic general equilibrium model with endogenous innovation and endogenous markups to study the interaction between these effects. Lower trade costs stimulate innovation by large firms that are technologically close to their rivals. However, as innovators increase their productivity advantage over others, they also increase their markups. Our calibrated model suggests that a fall in trade costs which increases the trade-to-GDP ratio of the US manufacturing sector from 12% (its level in the 1970s) to 24% (its current level) increases productivity growth by 0.12 percentage points and the aggregate markup by 1.70 percentage points. Without the feedback effect of innovation on the productivity distribution, markups would actually have fallen. JEL codes: F43, F60, L13, O31, O32, O33, and O41. Keywords: International Trade, Markups, Innovation, R&D, Productivity.
    Date: 2020
  16. By: Ivo Bakota
    Abstract: This paper analyzes redistributional and macroeconomic effects of differential taxation of financial assets with a different risk levels. The redistributive effect stems from the fact that various households hold portfolios with a starkly different risk levels. In particular, poor households primarily save in safe assets, while rich households often invest a substantially higher share of their wealth in (risky) equity. At the same time, equity and safe assets are often taxed at different rates in many tax codes. This is primarily because investments in equity (which are relatively riskier) are taxed both as corporate and personal income, unlike debt, which is tax deductible for corporations. This paper firstly builds a simple theoretical two-period model which shows that the optimal tax wedge between risky and safe assets is increasing in the underlying wealth inequality. Furthermore, I build a quantitative model with a continuum of heterogeneous agents, parsimonious life-cycle, borrowing constraint, aggregate shocks and uninsurable idiosyncratic shocks, in which the government raises revenue by using linear taxes on risky and safe assets. Simulations of quantitative models shows that elimination of differential asset taxation leads to a welfare loss equivalent to a 0.3% permanent reduction in consumption. I find that the optimal tax wedge between taxes on equity and debt is higher than the one in the U.S. tax code.
    Keywords: portfolio choice; optimal taxation; redistribution;
    JEL: E62 G11 G32 H21 H23
    Date: 2020–09
  17. By: Lochner, Benjamin (Institute for Employment Research (IAB), Nuremberg); Merkl, Christian (University of Erlangen-Nuremberg); Stüber, Heiko (University of Erlangen-Nuremberg); Gürtzgen, Nicole (Institute for Employment Research (IAB), Nuremberg)
    Abstract: Using the German IAB Job Vacancy Survey, we look into the black box of recruiting intensity and hiring practices from the employers' perspective. Our paper evaluates three important channels for hiring —namely vacancy posting, the selectivity of hiring (labor selection), and the number of search channels— through the lens of an undirected search model. Vacancy posting and labor selection show a U-shape over the employment growth distribution. The number of search channels is also upward sloping for growing establishments, but relatively flat for shrinking establishments. We argue that growing establishments react to positive establishment-specific productivity shocks by using all three channels more actively. Furthermore, we connect the fact that shrinking establishments post more vacancies and are less selective than those with a constant workforce to churn triggered by employment-to-employment transitions. In line with our theoretical framework, all three hiring margins are procyclical over the business cycle.
    Keywords: administrative data, survey data, labor selection, vacancies, recruiting intensity
    JEL: E24 J63
    Date: 2020–09
  18. By: Patrick J. Kehoe; Pierlauro Lopez; Virgiliu Midrigan; Elena Pastorino
    Abstract: Although a credit tightening is commonly recognized as a key determinant of the Great Recession, to date, it is unclear whether a worsening of credit conditions faced by households or by firms was most responsible for the downturn. Some studies have suggested that the household-side credit channel is quantitatively the most important one. Many others contend that the firm-side channel played a crucial role. We propose a model in which both channels are present and explicitly formalized. Our analysis indicates that the household-side credit channel is quantitatively more relevant than the firm-side credit channel. We then evaluate the relative benefits of a fixed-sized transfer to households and to firms that improves each group’s access to credit. We find that the effects of such a transfer on employment are substantially larger when the transfer targets households rather than firms. Hence, we provide theoretical and quantitative support to the view that the employment decline during the Great Recession would have been less severe if instead of focusing on easing firms’ access to credit, the government had expended an equal amount of resources to alleviate households’ credit constraints.
    Keywords: credit constraints; collateral constraints; Great Recession; financial recession; government transfers
    JEL: E3 E32 E62 J2 J6
    Date: 2020–09–25
  19. By: Xuejin Zuo; Xiujian Peng; Xin Yang; Philip Adams; Meifeng Wang
    Abstract: China's population is rapidly ageing because of the sustained low fertility and increasing life expectancy. At the end of 2019, the elderly 65 and older accounted for 12.6 percent of the total population, compared to around seven percent in 2000. It will continue to increase to 31 percent in 2050. Rapid ageing imposes a big challenge to sustainable growth. The Chinese government is considering increasing the retirement age as a remedy to the challenge of population ageing. Using a dynamic general equilibrium model of the Chinese economy, this paper explores the implications of raising the retirement age on economic growth and pension sustainability in China over the period of 2020 to 2100. In the baseline scenario, we assume that China maintains its current retirement age. The simulation results reveal that growth in the labour force would turn negative because of population ageing. Thus China has to rely on technology improvement and capital stock increases to support its economic growth. Without reforming the current pension system, China's pension account will accumulate huge debts. The debt plus the interest obligation will put high pressure on the general government budget. By the end of this century, the general government budget deficit will reach to 22 percent of GDP. In the policy scenario, we assume that China will gradually increase the retirement age from 58 to 65 years old starting from 2020. The simulation results show that increasing the retirement age is a powerful policy in the short to medium term. It will boost China's economic growth and reduce the pension fund deficit significantly because it will not only increase the labour force but also reduce the number of pensioners by delaying them access to the pension fund. However, the effectiveness of the policy depends on how much the labour force participation rate for people aged 58 to 65 can be increased.
    Keywords: Population ageing, retirement age, labour force participation, pension, economic growth, CGE model
    JEL: J11 J26 C68
    Date: 2020–04

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