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on Dynamic General Equilibrium |
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Issue of 2020‒10‒19
seventeen papers chosen by Christian Zimmermann Federal Reserve Bank of St. Louis |
| By: | Gauti B. Eggertsson; Sergey K. Egiev; Alessandro Lin; Josef Platzer; Luca Riva |
| Abstract: | This paper presents a toolkit to solve for equilibrium in economies with the effective lower bound (ELB) on the nominal interest rate in a computationally efficient way under a special assumption about the underlying shock process, a two-state Markov process with an absorbing state. We illustrate the algorithm in the canonical New Keynesian model, replicating the optimal monetary policy in Eggertsson and Woodford (2003), as well as showing how the toolkit can be used to analyse the medium-scale DSGE model developed by the Federal Reserve Bank of New York. As an application, we show how various policy rules perform relative to the optimal commitment equilibrium. A key conclusion is that previously suggested policy rules – such as price level targeting and nominal GDP targeting – do not perform well when there is a small drop in the price level, as observed during the Great Recession, because they do not imply sufficiently strong commitment to low future interest rates (“make-up strategy”). We propose two new policy rules, Cumulative Nominal GDP Targeting Rule and Symmetric Dual-Objective Targeting Rule that are more robust. Had these policies been in place in 2008, they would have reduced the output contraction by approximately 80 percent. If the Federal Reserve had followed Average Inflation Targeting – which can arguably approximate the new policy framework announced in August 2020 – the output contraction would have been roughly 25 percent smaller. |
| JEL: | E31 E40 E50 E60 |
| Date: | 2020–10 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:27878&r=all |
| By: | Sergii Kiiashko (National Bank of Ukraine) |
| Abstract: | Author develops a tractable model to study the optimal debt maturity structure and fiscal policy in an environment with incomplete markets, lack of commitment, and opportunity to default by the government. The default on public debt is endogenous and the real interest rate reflects the default risk and the marginal rate of substitution between present and future consumption. I show that the Lucas and Stokey (1983) time-consistency result can be extended to environments with an opportunity of outright default. The maturity is used to resolve the time-consistency problem: The present government can incentivize future governments to stick to an ex ante optimal sequence of fiscal policies and interest rates. I show that if both risk-free interest rates and risk premiums can be manipulated, the optimal maturity structure tends to have a decaying profile: The government issues debt at all maturity dates, but the distribution of payments over time is skewed toward the short end. The model allows for numerical characterization of the optimal maturity structure of debt with arbitrarily large number of maturities. Debt maturity data across countries are consistent with model predictions. |
| Keywords: | time consistency, maturity structure, sovereign debt, fiscal policy, default |
| JEL: | E43 E62 F22 F34 |
| Date: | 2019–12 |
| URL: | http://d.repec.org/n?u=RePEc:ukb:wpaper:04/2019&r=all |
| By: | Pierre-Richard Agénor; Timothy Jackson; Luiz Awazu Pereira da Silva |
| Abstract: | This paper studies the effects of sterilized foreign exchange market intervention in a model with financial frictions and imperfect capital mobility. The central bank operates a managed float regime and issues sterilization bonds that are imperfect substitutes (as a result of economies of scope) to investment loans in bank portfolios. The model is parameterized and used to study the macroeconomic effects of, and policy responses to, capital inflows associated with a transitory shock to world interest rates. The results show that sterilized intervention can be expansionary through a bank portfolio effect and may increase volatility and financial stability risks. Full sterilization is optimal only when the bank portfolio effect is absent. The optimal degree of intervention is more aggressive when the central bank can choose simultaneously the degree of sterilization; in that sense, the instruments are complements. When the central bank's objective function depends on the cost of sterilization, and concerns with that cost are sufficiently high, intervention and sterilization can be substitutes---independently of whether exchange rate and financial stability considerations also matter. |
| JEL: | E32 E58 F41 |
| Date: | 2020–09 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:889&r=all |
| By: | André Marine Charlotte; Dai Meixing |
| Abstract: | We study the impact of adaptive learning for the design of a robust monetary policy using a small open-economy New Keynesian model. We find that slightly departing from rational expectations substantially changes the way the central bank deals with model misspecification. Learning induces an intertemporal trade-off for the central bank, i.e., stabilizing inflation (output gap) today or stabilizing it tomorrow. The central bank should optimally anchoring private agents expectations in the short term in exchange of easier future intratemporal trade-offs. Compared to the rational expectations equilibrium, the possibility to conduct robust monetary policy is limited in a small open economy under learning for any exchange rate pass-through level and any degree of trade openness. The misspecification that can be introduced into all equations of the model is lower in a small open economy, and approaches zero at high speed as the learning gain rises. |
| Keywords: | Robust control;model uncertainty;adaptive learning;small open economy |
| JEL: | C62 D83 D84 E52 E58 |
| Date: | 2020–09 |
| URL: | http://d.repec.org/n?u=RePEc:bdm:wpaper:2020-12&r=all |
| By: | Cantore, C.; Freund, L. B. |
| Abstract: | We propose a novel two-agent New Keynesian model to study the interaction of fiscal policy and household heterogeneity in a tractable environment. Workers can save in bonds subject to portfolio adjustment costs; firm ownership is concentrated among capitalists who do not supply labor. The model is consistent with micro data on empirical intertemporal marginal propensities to consume, and it avoids implausible profit income effects on labor supply. Relative to the traditional two-agent model, these features imply, respectively, a lower sensitivity of consumption to the composition of public financing; and smaller fiscal multipliers alongside pronounced redistributive effects. |
| Keywords: | Fiscal Policy, Heterogeneity, HANK, TANK |
| JEL: | E12 E21 E25 E32 E62 |
| Date: | 2020–10–09 |
| URL: | http://d.repec.org/n?u=RePEc:cam:camdae:2095&r=all |
| By: | William Ginn (Université de Nuremberg); Marc Pourroy |
| Abstract: | Monetary policy is generally viewed in the literature as the only institution responsible for price stability. This approach overlooks the importance of food price stabilization policies, which are particularly important in low-and middle-income economies. We estimate a Bayesian DSGE model that incorporates fiscal and monetary policy tailored to India. Fiscal policy is based on a consumer food price subsidy. The empirical evidence suggests that food subsidies create a policy-induced form of food price-stickiness that operates in parallel with, yet is different to, the classic Calvo monopolistic competition framework. We find that the food price subsidy reduces CPI volatility and monetary policy reaction: following a world food price shock, interest rate volatility would be 10% higher absent food subsidies. Putting this effect aside would lead to overestimate the effectiveness of inflation targeting in EMEs. A main finding is the subsidy policy reduces aggregate welfare, albeit we find heterogeneous distributional effects by households. |
| Keywords: | DSGE Model,Price stabilisation,Food prices,Commodities,Monetary Policy |
| Date: | 2020–09–21 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-02944209&r=all |
| By: | Andrés Rodríguez-Clare; Mauricio Ulate; José P. Vásquez |
| Abstract: | There is a growing empirical consensus that trade shocks can have important effects on unemployment and nonemployment across local-labor markets within an economy. This paper introduces downward nominal wage rigidity to an otherwise standard quantitative trade model and shows how this framework can generate changes in unemployment and nonemployment that match those uncovered by the empirical literature studying the “China shock.” We also compare the associated welfare effects predicted by this model with those in the model without unemployment. We find that the China shock leads to average welfare increases in most U.S. states, including many that experience unemployment during the transition. However, nominal rigidities reduce the overall U.S. gains from the China shock between one and two thirds. In addition, there are ten states that experience welfare losses in the presence of downward nominal wage rigidity but would have experienced welfare gains without it. |
| JEL: | F10 F16 F66 |
| Date: | 2020–10 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:27905&r=all |
| By: | Nicolas Clootens (AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique - AMU - Aix Marseille Université); Francesco Magris (DEAMS - Università degli Studi di Trieste Dipartimento di Scienze Economiche, Aziendali, Matematiche e Statistiche "Bruno de Finetti" (DEAMS), LEO - Laboratoire d'Économie d'Orleans - UO - Université d'Orléans - Université de Tours - CNRS - Centre National de la Recherche Scientifique) |
| Abstract: | This paper introduces a public debt stabilization constraint in an overlapping generation model in which non-renewable resources constitute a necessary input in the production function and belong to agents. It shows that stabilization of public debt at high level (as share of capital) may prevent the existence of a sustainable development path. Public debt thus appears as a threat to sustainable development. It also shows that higher public debt-to-capital ratios (and public expenditures-to-capital ones) are associated with lower growth. Two transmission channels are identified. As usual, public debt crowds out capital accumulation. In addition, public debt tends to increase resource use which reduces the rate of growth. We also show that the economy is characterized by saddle path stability. Finally, we show that the public debt-to-capital ratio may be calibrated to implement the social planner optimal allocation. |
| Keywords: | non-renewable resources,growth,public finances,overlapping generations |
| Date: | 2020–09 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-02952314&r=all |
| By: | Hirschbühl, Dominik; Krustev, Georgi; Stoevsky, Grigor |
| Abstract: | We estimate a modified version of the “Financial Business Cycles” model originally developed by Iacoviello (2015) in order to investigate the role played by financial factors in driving the business cycle in the euro area. In the model, financial shocks such as borrower defaults, collateral shocks and credit supply effects amplify economic downturns by reducing the flow of credit from banks to the real sector. In this novel application to the euro area, we introduce capital reallocation inefficiency, an innovation to the original set-up which allows for more realistic effects of entrepreneur defaults on economic activity. Our results suggest that financial factors, as captured by this model, played a smaller role in the euro area throughout the double-dip recession than in the United States during the 2008-09 global financial crisis. In a scenario on second-round effects implied by potential NFC loan losses due to the COVID-19 pandemic, we find large financial amplification risks to real economic activity. JEL Classification: E32, E44, E47 |
| Keywords: | Bayesian estimation, DSGE, financial frictions, housing |
| Date: | 2020–10 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20202475&r=all |
| By: | Nicolas Clootens (Aix-Marseille Univ., CNRS, EHESS, Centrale Marseille, AMSE); Francesco Magris (DEAMS, University of Trieste, Italy and LEO, University of Orléans, France) |
| Abstract: | This paper introduces a public debt stabilization constraint in an overlapping generation model in which non-renewable resources constitute a necessary input in the production function and belong to agents. It shows that stabilization of public debt at high level (as share of capital) may prevent the existence of a sustainable development path. Public debt thus appears as a threat to sustainable development. It also shows that higher public debt-to-capital ratios (and public expenditures-to-capital ones) are associated with lower growth. Two transmission channels are identified. As usual, public debt crowds out capital accumulation. In addition, public debt tends to increase resource use which reduces the rate of growth. We also show that the economy is characterized by saddle path stability. Finally, we show that the public debt-to-capital ratio may be calibrated to implement the social planner optimal allocation. |
| Keywords: | non-renewable resources; growth; public finances; overlapping generations |
| JEL: | Q32 Q38 H63 |
| Date: | 2020–09 |
| URL: | http://d.repec.org/n?u=RePEc:aim:wpaimx:2032&r=all |
| By: | Aditya Goenka (University of Birmingham); Lin Liu (University of Liverpool); Nguyen, Manh-Hung (Toulouse School of Economics) |
| 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. |
| JEL: | E13 E22 D50 D63 I10 I15 I18 O41 C61 |
| Date: | 2020–10 |
| URL: | http://d.repec.org/n?u=RePEc:bir:birmec:20-24&r=all |
| By: | Cóndor Richard |
| Abstract: | Shared-appreciation mortgage (SAM) contracts, which display payments indexed to a local house price, have been proposed as an alternative to alleviate the costs of recessions. Using a heterogeneous agent model with two types of agents (Borrowers and Savers), uninsurable idiosyncratic income risk, and calibrated to the US, this paper studies the effects, on both macroeconomic variables and welfare, of introducing such contracts. I find that equilibrium default rates, house price volatility, and welfare losses of both Borrowers and Savers following an unexpected negative shock on aggregate income, are smaller. Also, while this policy benefits Savers, only Borrowers with moderate/low mortgage and housing wealth levels are better-off (61% of Borrowers under the main calibration). Finally, if Borrowers are less patient, the fraction that benefits may never be above 50%. |
| Keywords: | Mortgage design;Heterogeneous agents;Housing policy |
| JEL: | G00 C61 E44 |
| Date: | 2020–09 |
| URL: | http://d.repec.org/n?u=RePEc:bdm:wpaper:2020-11&r=all |
| By: | Andersen, Torben M.; Bhattacharya, Joydeep; Liu, Pan |
| Abstract: | Climate change policies create intergenerational winners and losers because the costs come first and the benefits later. In such cases, Kaldor-Hicks cost-benefit analysis seeks potential Pareto-improvements by showing the hypothetical potential for the winners to compensate the losers via lump-sum transfers. In their absence, once a costly climate policy is actually implemented, it unleashes distortions and general-equilibrium effects rendering unclear whether Kaldor-Hicks potential improvements lead to actual improvements. We study policies which, once implemented, would pass the Pareto test that no generation subsequent to policy action be made worse off than before. We develop a stylized climate-economy model in which production by the current generation generates pollution which “damages†production for future generations. Over time, the business-as-usual (BAU) economy gets increasingly polluted, consumption falls, and generational welfare levels decline. A government introduces costly pollution abatement and finances it via distorting taxes and the sale of debt (“green bonds†). Pollution levels start to decline, generating downstream welfare gains which may be taxed – without hurting anyone, in a Pareto sense – to help finance the policy and pay off the debt. Along the transition, every generation faces less pollution, consumes more and is happier than if life had continued in the BAU world. |
| Date: | 2020–03–01 |
| URL: | http://d.repec.org/n?u=RePEc:isu:genstf:202003010800001070&r=all |
| By: | Michael Kumhof; Phurichai Rungcharoenkitkul; Andrej Sokol |
| Abstract: | Understanding gross capital flows is increasingly viewed as crucial for both macroeconomic and financial stability policies, but theory is lagging behind many key policy debates. We fill this gap by developing a two-country DSGE model that tracks domestic and cross-border gross positions between banks and households, with explicit settlement of all transactions through banks. We formalise the conceptual distinction between cross-border saving and financing, which often move in opposite directions in response to shocks. This matters for at least four policy debates. First, current accounts are poor indicators of financial vulnerability, because in a crisis, creditors stop financing debt rather than current accounts, and because following a crisis, current accounts are not the primary channel through which balance sheets adjust. Second, we reinterpret the global saving glut hypothesis by arguing that US households do not finance current account deficits with foreigners' physical saving, but with digital purchasing power, created by banks that are more likely to be domestic than foreign. Third, Triffin's current account dilemma is not in fact a dilemma, because the creation of additional US dollars requires dollar credit creation by US and non-US banks rather than US current account deficits. Finally, we demonstrate that the observed high correlation of gross capital inflows and outflows is overwhelmingly an automatic consequence of double entry bookkeeping, rather than the result of two separate sets of economic decisions. |
| JEL: | E44 E51 F41 F44 |
| Date: | 2020–10 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:890&r=all |
| By: | Bhattacharya, Joydeep; Bishnu, Monisankar; Wang, Min |
| Abstract: | This paper studies the welfare of time-inconsistent, partially sophisticated agents living under two different regimes, one with complete, unfettered credit markets (CM) and the other with endogenous borrowing constraints (EBC) where the borrowing limits are set to make agents indifferent between defaulting and paying back their unsecured loans. The CM regime cannot deliver the first best because partially sophisticated agents would undo plans laid out by previous selves and borrow too much. Somewhat counterintuitively, in some cases, the EBC regime may deliver higher welfare than the CM regime. These results speak to the academic debate surrounding the creation and functioning of the CFPB (Consumer Financial Protection Bureau) in the U.S. and its implementation of the ability-to-repay rule on lenders after the 2007-8 crisis. Such institutions generate commitment publicly and may help time-inconsistent agents economize on the costs of private commitment provision. |
| Date: | 2020–04–03 |
| URL: | http://d.repec.org/n?u=RePEc:isu:genstf:202004030700001100&r=all |
| By: | Johannes Schünemann (University of Fribourg, Department of Economics); Holger Strulik (University of Goettingen, Department of Economics); Timo Trimborn (Department of Economics and Business Economics, Aarhus University) |
| Abstract: | We integrate anticipatory utility and endogenous beliefs about future negative health shocks into a life-cycle model of physiological aging. Individuals care about their future utility derived from their health status and form endogenous beliefs about the probability of a negative health shock. We calibrate the model with data from gerontology and use the model to predict medical testing decisions of individuals. We find that anticipation in combination with endogenous beliefs provides a quantitatively strong motive to avoid medical testing for Huntington's disease which explains the low testing rates found empirically. We also study the case of breast and ovarian cancer and provide an explanation for why testing rates depend on the individual's income when treatment is available. |
| Keywords: | Health, Anticipation, Longevity, Health behavior, Beliefs, Information avoidance |
| JEL: | D11 D91 I12 J17 |
| Date: | 2020–09–30 |
| URL: | http://d.repec.org/n?u=RePEc:aah:aarhec:2020-14&r=all |
| By: | Albrecht, James (Georgetown University); Decreuse, Bruno (Aix-Marseille University); Vroman, Susan (Georgetown University) |
| Abstract: | When vacancies are filled, the ads that were posted are often not withdrawn, creating "phantom" vacancies. The existence of phantoms implies that older job listings are less likely to represent true vacancies than are younger ones. We assume that job seekers direct their search based on the listing age and so equalize the expected benefit of a job application across listing age. Forming a match with a vacancy of age α creates a phantom of age α with probability β and this leads to a negative informational externality that affects all vacancies of age α and older. Thus, the magnitude of this externality decreases with the age of the listing when the match is formed. Relative to the constrained efficient search behavior, the directed search of job seekers leads them to over-apply to younger listings. We illustrate the model using US labor market data. The contribution of phantoms to overall frictions is large, but, conditional on the existence of phantoms, the social planner cannot improve much on the directed search allocation. |
| Keywords: | directed search, phantom vacancies, unemployment |
| JEL: | J60 D83 |
| Date: | 2020–09 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp13704&r=all |