nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2020‒10‒26
twenty-six papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Fiscal Implications of Interest Rate Normalization in the United States By Huixin Bi; Wenyi Shen; Shu-Chun S. Yang
  2. Conventional macroeconomic policies and the pandemic-driven recession By Celso José Costa Jr; Alejandro Garcia-Cintado; Karlo Marques
  3. Charge-offs, Defaults and the Financial Accelerator By Christopher M. Gunn; Alok Johri; Marc-Andre Letendre
  4. DSGE Models Used by Policymakers: A Survey By Takeshi Yagihashi
  5. Unconventional Monetary Policy, Leverage & Default Dynamics By Edoardo Palombo
  6. The Effects of Trend Inflation on Aggregate Dynamics and Monetary Stabilization By Andrey Alexandrov
  7. Macro Uncertainty and Unemployment Risk By Oh, Joonseok; Rogantini Picco, Anna
  8. A Relative Answer to the Growth-Saving Puzzle By Gruber, Noam
  9. Uncertainty, Intangible Capital, and Productivity Dynamics By Edoardo Palombo
  10. Quantitative Easing and Direct Lending in Response to the COVID-19 Crisis By Filippo Occhino
  11. Accounting for the International Quantity-Quality Trade-Off By Cordoba, Juan Carlos; Liu, Xiying; Ripoll, Marla
  12. Pareto-improving transition to fully funded pensions under myopia By Andersen, Torben M.; Bhattacharya, Joydeep; Gestsson, Marias H.
  13. Enduring Relationships in an Economy with Capital and Private Information By Aubhik Khan; Latchezar Popov; B. Ravikumar
  14. Pension Reforms, Population Aging, and Retirement Decision of the Elderly in a Neoclassical Growth Model By Hirono, Makoto; Mino, Kazuo
  15. Modeling optimal quarantines under infectious disease related mortality By Aditya Goenka; Lin Liu; Manh-Hung Nguyen
  16. Household Financial Distress and the Burden of ‘Aggregate’ Shocks By Kartik B. Athreya; Ryan Mather; Jose Mustre-del-Rio; Juan M. Sanchez
  17. On the Magnitude of the Expenditure Multiplier By Jesús Rodríguez-López; Mario Solís-García
  18. Capital Allocation and Wealth Distribution in a Global Economy with Financial Frictions By Been-Lon Chen; Yunfang Hu; Kazuo Mino
  19. Imperfect Substitutability in Real Estate Markets and the Effect of Housing Demand on the Macroeconomy By J. Scott Davis; Kevin X. D. Huang; Ayse Sapci
  20. Intergenerational Debt Dynamics Without Tears By Andersen, Torben M.; Bhattacharya, Joydeep
  21. Cross-Border Regulatory Spillovers and Macroprudential Policy Coordination By Pierre-Richard Agénor; Timothy P. Jackson; Luiz Pereira da Silva
  22. Fixed and Flexible Exchange-rates in Two Matching Models: Non-equivalence Results By Zhu, Tao; Wallace, Neil
  23. Productive government expenditure and economic growth in a heterogeneous-agents model By Ryo Arawatari; Takeo Hori; Kazuo Mino
  24. Perceived Uncertainty Shocks, Excess Optimism-Pessimism, and Learning in the Business Cycle By Pratiti Chatterjee; Fabio Milani
  25. Pandemic Recession Dynamics: The Role of Monetary Policy in Shifting a U-Shaped Recession to a V-Shaped Rebound By Michael T. Kiley
  26. Firm Dynamics and Trade By George A. Alessandria; Costas Arkolakis; Kim J. Ruhl

  1. By: Huixin Bi; Wenyi Shen; Shu-Chun S. Yang
    Abstract: This paper studies the fiscal implications of interest rate normalization from the zero lower bound (ZLB) in the United States. At the ZLB, the decline in tax revenues and the real bond price drives up government debt. During normalization, interest payments continue to rise higher than they would have had rates not reached the ZLB, potentially increasing government debt even as output and tax revenues recover. We find that against the yardstick of ability to pay, interest rate normalization is unlikely to pose an immediate threat to debt sustainability at the current net federal debt level of 90 to 100 percent of GDP. If the net federal debt reaches 150 percent of GDP, however, sovereign default risk can rise more quickly. We also find that a more active monetary policy better anchors inflation expectations and generates a faster recovery than a less active one, helping slow debt accumulation during normalization.
    Keywords: Interest rate normalization; Monetary and fiscal policy interaction; Debt sustainability; Non-linear DSGE model; New Keynesian model
    JEL: E43 E52 E62 E63 H30
    Date: 2020–10–02
  2. By: Celso José Costa Jr (Department of Economics, State University of Ponta Grossa); Alejandro Garcia-Cintado (Department of Economics, Pablo de Olavide University); Karlo Marques (Department of Economics, State University of Ponta Grossa)
    Abstract: We build a three-country DSGE model to address the economic fallout from the COVID-19 shock with and without the economic authorities’ reaction. In the latter case, three different scenarios are drawn: optimistic, baseline, and pessimistic scenarios. We find that the pandemic brings about a prolonged economic depression in the pessimistic scenario, as GDP and hours worked fall by 20% (from trend) and they never recover their pre-crisis levels over the span of time studied. Interestingly, the supply-side effects dominate the demand-side ones, which leads to inflationary pressures on a temporary basis. In the base scenario, output and hours worked decline by 10% and deflation kicks in, but the economy goes back to the initial steady-state faster than in the preceding setting, roughly after two years. As for the optimistic one, the effects of the shock on output and hours worked are relatively mild and short-lived. We then move on to analyze the effectiveness of a collection of fiscal and monetary policy tolos in curbing the recessionary consequences of the pandemic. The most powerful instruments are government purchases and expansionary monetary policy, although these two measures come with some trade-offs. A labor-income tax cut can also play an important role in helping the economy return to its steady-state levels. The remaining tax policies seem to have small effects on the economy.
    Keywords: Pandemic, Taxation, Public spending, Monetary policy, DSGE model.
    JEL: E59 E60 E62 H00 I10
    Date: 2020–04
  3. By: Christopher M. Gunn; Alok Johri; Marc-Andre Letendre
    Abstract: We uncover new facts: U.S. banks countercyclically vary the ratio of charge-offs to defaulted loans (COD). The variance of this ratio is roughly 15 times larger than that of GDP. Canonical financial accelerator models cannot explain this variance. We develop an expression for the wedge between charge-offs and defaults in the model and show that introducing stochastic default costs as in Gunn and Johri (2013a) and stochastic risk as in Christiano et al. (2014) into the canonical theoretical model can potentially resolve the discrepancy since both shocks have the ability to move this wedge. Estimating the augmented model using Bayesian techniques reveals that default cost shocks account for most of the variance of COD, while risk shocks account for most of the credit spread. Both shocks also matter for standard U.S. business cycle variables, with the anticipated components of each being most important.
    Keywords: Charge-offs and defaults; default cost shocks; news shocks; risk shocks; financial accelerator models; business cycles
    JEL: E3 E44
    Date: 2020–10
  4. By: Takeshi Yagihashi (Policy Research Institute, Ministry of Finance, Japan)
    Abstract: The paper conducts a comprehensive survey on the current state of the dynamic stochastic general equilibrium (DSGE) models developed by policy institutions, including central banks, government agencies, and international organizations around the world. Our main sample consists of 84 models developed by 58 institutions, and many of them were developed or updated after the 2008 financial crisis. We first document the evolution of macroeconomic models used for policy purpose, and then provide summary statistics on the models by type of institution, region, and number of authors of the publication. We find that there is a steady increase in the development of DSGE models by policy institutions. While central banks have been the main users of DSGE models, more government agencies in Europe have been actively developing their own DSGE models in the years following the 2008 Global Financial Crisis. We also find that some institutions have multiple DSGE models serving different purposes. Next, we narrow our focus to a subset of 42 models that are owned and actively used by policy institutions, and conduct a model comparison based on five key model features. Although the models share common basic structures, there are large variations in parameter values and modelling strategies, some of which do not necessarily reflect the findings of the empirical literature. Finally, we create a score card for each model depending on whether the model incorporated recent empirical findings on the five model features. Two models have a score of 4 out of 5, and the overall average is 2.21. In conclusion, there is a greater need for future DSGE policy models to adopt more recent findings in the empirical literature.
    Keywords: DSGE model, financial friction, intertemporal elasticity of substitution, non-Ricardian household
    Date: 2020–10
  5. By: Edoardo Palombo (Queen Mary University of London)
    Abstract: The objective of this paper is to investigate the effectiveness of credit easing policy in mitigating the economic fallout from a financial recession using a model that can account for the observed default and leverage dynamics during the financial crisis of 2007. A general equilibrium model is developed with a financial sector and endogenous asset defaults able to account for the observed default and leverage dynamics. Following an adverse aggregate shock, banks deleverage through two channels: (i) higher non-performing loans provisions, and (ii) lower the marginal return of assets. Credit policy is modelled as an expansion of the central bank’s balance sheet countering the disruption in private financial intermediation. Unconventional monetary policy, namely credit easing policy, is shown to be ineffective in mitigating the effects of a financial crisis due to its crowding out effect on the private asset market. Other non-monetary policy tools such as credit subsidies and their efficacy considered.
    Keywords: unconventional monetary policy, credit easing, credit subsidies, financial frictions, default, leverage, financial sector.
    JEL: E20 E32 E44 E52 E58
    Date: 2020–06–25
  6. By: Andrey Alexandrov
    Abstract: I derive a set of new analytic results for the effects of trend inflation on aggregate price and output dynamics in menu cost models. I find that positive trend inflation: (1) induces asymmetry in price and output responses to monetary shocks, (2) leads to price overshooting after large shocks, and (3) destroys the monetary neutrality result for large shocks. Under positive trend inflation, large expansionary monetary interventions lead to output contractions, and smaller expansionary interventions have substantially reduced potency. Using U.S. sectoral data, I provide supporting evidence for these model predictions. Calibrating a general equilibrium model to the U.S. economy, I find sizable effects of trend inflation on monetary stabilization policy. Raising the inflation target from 2% to 4% increases the economy's sensitivity to an adverse markup shock and worsens the stabilization trade-off.
    Keywords: trends, asymmetry, trend inflation, aggregate dynamics
    JEL: E32 E52
    Date: 2020–10
  7. By: Oh, Joonseok (Freie Universitat Berlin); Rogantini Picco, Anna (Research Department, Central Bank of Sweden)
    Abstract: This paper shows how uninsurable unemployment risk is crucial to qualitatively and quantitatively match macro responses to uncertainty shocks. Empirically, uncertainty shocks i) generate deflationary pressure; ii) have considerably negative consequences on economic activity; iii) produce a drop in aggregate consumption, which is mainly driven by the response of the households in the bottom 60% of the income distribution. Standard representative-agent New Keynesian models have difficulty to deliver these effects. A heterogeneous-agent framework with search and matching frictions and Calvo pricing allows us to jointly attain these results. Uncertainty shocks induce households' precautionary saving and firms' precautionary pricing behaviors, triggering a fall in aggregate demand and supply. These precautionary behaviors increase the unemployment risk of the imperfectly insured households, who strengthen precautionary saving. When the feedback loop between unemployment risk and precautionary saving is strong enough, a rise in uncertainty leads to i) a drop in inflation; ii) amplified negative responses of macro variables; iii) heterogeneous consumption responses of households, which are consistent with the empirical evidence.
    Keywords: Uncertainty shock; Inflation; Unemployment risk; Precautionary savings
    JEL: E12 E31 E32 J64
    Date: 2020–10–01
  8. By: Gruber, Noam
    Abstract: Prolonged rapid growth, i.e. a "catching-up" process, is known to be accompanied by high rates of household saving. This phenomenon is central in explaining the direction of international capital flows and trade imbalances in the past several decades, yet it is very much in contradiction to prevailing macroeconomic theory. This paper finds that a standard life-cycle model, even when integrated with uncertainty about future growth and credit constraints, is completely unable to replicate the relations between growth and saving as seen in the data. However, adding utility from relative consumption to the model allows for the full replication of these relations.
    Keywords: Life Cycle, Saving Growth, Open Economy Growth, Household Saving, Life Cycle Models and Saving, Relative Income Hypothesis
    JEL: D91 E21 F43 O11
    Date: 2020–10–06
  9. By: Edoardo Palombo (Queen Mary University of London)
    Abstract: Following an unparalleled rise in uncertainty over the Great Recession, the US economy has been experiencing anaemic productivity growth. This paper offers a quantitative study on the link between uncertainty and low productivity growth. Firstly, using micro level data I show that uncertainty accounts for half of the drop in intangible capital stock during the Great Recession. Secondly, to investigate the effect of uncertainty on productivity growth dynamics, I present a novel general equilibrium endogenous growth model with heterogeneous firms that undertake intangible capital investment subject to non-convex costs and time-varying uncertainty. I show that uncertainty can generate slow recoveries and a persistent slowdown in productivity growth when accounting for the empirical discrepancy between the realised and expected changes to the second-moment of fundamentals.
    Keywords: Uncertainty, R&D, Innovation, Productivity, Great Recession, Intangible Capital, Slow Recoveries
    JEL: O40 O41 O51
    Date: 2020–06–25
  10. By: Filippo Occhino
    Abstract: When the COVID-19 crisis hit the economy in 2020, the Federal Reserve responded with numerous programs designed to prevent a collapse in bank credit and firms’ available funds. I develop a dynamic general equilibrium model to study how these programs work and to evaluate their effectiveness. In the model, quantitative easing works through three channels: the expansion of bank reserves lowers a liquidity premium, the purchase of assets lowers a volatility risk premium, and the economic stimulus lowers a credit risk premium. Since bank reserves are currently larger than in the past, the liquidity premium channel is weaker, and quantitative easing is less effective. Direct lending to firms at a market rate is also less effective. Direct lending to firms at a subsidized rate can be more stimulative than quantitative easing, provided that it lowers firms’ marginal borrowing rate and user cost of capital.
    Keywords: Quantitative easing; credit easing; liquidity premium; risk premium; COVID-19
    JEL: E32 E43 E51 E52 E58
    Date: 2020–10–05
  11. By: Cordoba, Juan Carlos; Liu, Xiying; Ripoll, Marla
    Abstract: We investigate what accounts for the observed international differences in schooling and fertil- ity, and draw lessons for the underlying sources of cross-country income differences. For this purpose, we extend a life-cycle dynastic model to include features relevant for schooling and fertility choices. Our approach allows for country-specific human capital technologies in addi- tion to differences in TFP, public education policies, and demographic factors. We find that differences in human capital production functions, specifically in the degree of complementarity of educational investments, are key to match schooling data, and result in novel estimates of human capital stocks and TFP levels. According to the model, differences in TFP, public edu- cation spending per pupil and retiree survival rates are the most important factors explaining the international dispersion of fertility. Differences in the number of years of public education provision and working-age survival rates are key determinants of the schooling dispersion. Our model suggests that human capital policies are key for development.
    Date: 2019–01–31
  12. By: Andersen, Torben M.; Bhattacharya, Joydeep; Gestsson, Marias H.
    Abstract: Under dynamic efficiency, a pay-as-you-go (PAYG) pension scheme is often described as an “original sin†: It helps the current generation of retirees but hurts future generations because they are forced to save via a return-dominated scheme. Abandoning it is deemed welfare-improving but typically not for all generations. But what if agents are present-biased (hence, undersave for retirement) and the “paternalistically motivated forced savings†component of a PAYG scheme motivated its existence in the first place? This paper shows it is possible to transition from such a PAYG scheme on to a higher return, mandated fully-funded scheme; yet, no generation is hurt in the process. The results informthe debate on policy design of pension systems as more and more policy makers push for the transition to take place but are forced to recognize that current retirees may get hurt along the way.
    Date: 2018–11–01
  13. By: Aubhik Khan; Latchezar Popov; B. Ravikumar
    Abstract: We study efficient risk sharing in a model where agents operate linear production technologies with private information about idiosyncratic productivity. Capital is the sole factor of production, and accumulable. We establish a time-invariant, one-to-one mapping between the capital allocated to an agent and his lifetime utility entitlement. The mapping implies properties that are distinct from those in models with private information about endowments. In contrast to the latter, the value of the risk-sharing arrangement in our model always remains above the autarky value. There is no need for long-term commitment. Further, in our model, there are no net expected transfers each period across individuals. This allows us to decentralize the efficient allocation into one-period insurance contracts that do not require long-term commitment on the part of the principal or agent. Furthermore, while the efficient allocation implies an increasing dispersion of lifetime utility entitlements and consumption, this need not lead to declines in individual consumption as in the endowment model. When technology is sufficiently productive, all individuals experience consumption growth.
    Keywords: Efficiency; Private information; Capital accumulation; Commitment; Immiseration; One-period contract
    JEL: D30 D52 D82
    Date: 2020–09
  14. By: Hirono, Makoto; Mino, Kazuo
    Abstract: This study explores the linkage between the labor force participation of the elderly and the long-run performance of the economy in the context of a two-period-lived over- lapping generations model. We assume that the old agents are heterogeneous in their labor efficiency and they continue working if their income exceeds the pension that can be received in the case of full retirement. We first inspect the key factors that the retirement decision of the elderly. We then examine analytically as well as numeri-cally the long-run impact of labor participation of the elderly on capital accumulation.
    Keywords: retirement decision, labor force participation, population aging, pension system, capital accumulation
    JEL: E62
    Date: 2020–07–10
  15. By: Aditya Goenka; Lin Liu; Manh-Hung Nguyen
    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: 2020–09
  16. By: Kartik B. Athreya; Ryan Mather; Jose Mustre-del-Rio; Juan M. Sanchez
    Abstract: In this paper we show that household-level financial distress (FD) varies greatly and can increase vulnerability to economic shocks. To do this, we establish three facts: (i) regions in the United States vary significantly in their “FD-intensity,” measured either by how much additional credit households can access or how delinquent they are on debts, (ii) shocks that are typically viewed as “aggregate” in nature hit geographic areas quite differently, and (iii) FD is an economic “pre-existing condition”: the share of an aggregate shock borne by a region is positively correlated with the level of FD present at the time of the shock. Using an empirically disciplined and institutionally rich model of consumer debt and default, we show that in the shocks dealt by the Great Recession and the initial months of the COVID-19 pandemic, FD had quantitative significance for consumption. Our model suggests that the uneven distribution of FD creates widely varying consumption responses to shocks. This is true even when subjecting regions with differing levels of FD to the same shocks.
    Keywords: Consumption; Credit card debt; Bankruptcy; Recession; Foreclosure; Mortgages; Delinquency; Financial distress; Geography
    JEL: D31 D58 E21 E44 G11 G12 G21
    Date: 2020–10–05
  17. By: Jesús Rodríguez-López (U. Pablo de Olavide); Mario Solís-García (Macalester College)
    Abstract: We investigate the causes underlying the decline in the government expenditure multiplier after the Korean War. While this phenomenon has been documented before, we look at the decrease in relative multiplier values through the lens of a structural DSGE model, which we estimate using Bayesian methods and annual-frequency data from 1939 to 2017. The model replicates the observed fall in the expenditure multiplier; moreover, using a counterfactual exercise we show that the decline is accounted, for the most part, by changes in two of the model’s structural parameters, namely, a decline in consumption habit persistence and a higher autocorrelation of the public expenditure processes. Taken together, these changes imply a stronger negative wealth effect (over consumption), a lower discretion of U.S. fiscal policy and, consequently, a multiplier of smaller magnitude.
    Keywords: business cycles, military expenditure, government multipliers.
    JEL: E32 E62 H56
    Date: 2020–10
  18. By: Been-Lon Chen (Institute of Economics, Academia Sinica); Yunfang Hu (Graduate School of Economics, Kobe University); Kazuo Mino (Institute of Economic Research, Kyoto University)
    Abstract: This paper constructs a two-country model in which fi rms with heterogeneous production efficiency are subject to fi nancial constraints. In our setting, the total factor productivity of the aggregate production function in each county depends on the cutoff level of production efficiency of firms. We fi rst show that in the presence of international capital mobility, the cutoff condition is affected by the wealth distribution between the two countries. We then examine the existence and stability of the steady-state equilibrium of the world economy as well as the long-run impacts of real and fi nancial shocks. It is shown that, compared to global fi nancial shocks, global real shocks have larger impact on income and wealth in each country, especially if heterogeneity of production efficiency among firms is sufficiently low. The tractability of the model made it possible to analytically derive the main results.
    Keywords: two-country model, fi nancial frictions, firm heterogeneity, wealth distribution, capital mobility
    JEL: F21 F32 F41
    Date: 2020–10
  19. By: J. Scott Davis; Kevin X. D. Huang; Ayse Sapci
    Abstract: Changes in housing demand can have a macroeconomic effect through the collateral channel, where the change in residential real estate prices is associated with a change in commercial real estate prices, affecting firm collateral and thus firm investment. We argue that this channel is weaker when residential and commercial real estate are poor substitutes. Using cross-state heterogeneity in the strength of zoning regulations as a proxy for heterogeneity in the substitutability of residential and commercial real estate, we first show with firm level data that the strength of local zoning regulations has a negative effect on the estimated increase in firm investment following an increase in local residential real estate prices. We then construct a DSGE model where land has both residential and commercial uses and estimate it using Bayesian techniques and U.S. macroeconomic data. We find the average elasticity of substitution between commercial and residential real estate in the U.S. to be around 0.35, but in states with strong zoning restrictions it can be as low as 0.16 and in states with weak zoning restrictions it can be as high as 0.66. Simulations of the model show how these differences in zoning restrictions can affect the transmission of a housing demand shock to the macroeconomy.
    Keywords: Commercial real estate; residential real estate; housing demand shock; zoning
    JEL: R10 R30 E30
    Date: 2020–09–28
  20. By: Andersen, Torben M.; Bhattacharya, Joydeep
    Abstract: Governments, motivated by a desire to improve upon long-run laissez faire, routinely undertake enduring, productive expenditures, say, in public education, that generate positive externalities across cohorts but require investments be made up front. If everyone after the policy is initiated is at least as happy as before and there are some outstanding resources, the Hicks-Kaldor efficiency rule suggests that the present value of these resources could, hypothetically, be distributed to future generations creating the potential for generational Pareto improvement. The literature recognizes the challenge in constructing a policy that is actually Pareto-improving since the policy itself may generate general-equilibrium gains and losses spread across generations. The paper takes on this task. In a dynamically-efficient economy with an intergenerational human capital externality, it constructs an equilibrium path with public education financed by non-explosive debt and taxes that truly improves upon laissez faire, yet no generation is harmed along the transition, not even the current ones.
    Date: 2018–12–03
  21. By: Pierre-Richard Agénor; Timothy P. Jackson; Luiz Pereira da Silva
    Abstract: A two-region, core-periphery model with financial frictions, imperfect financial integration, and cross-border banking is used to assess the gains from international macroprudential policy coordination. A core global bank lends to its affiliates in the periphery and banks are subject to a risk-sensitive capital regulatory regime. An expansionary monetary policy in the core is used to illustrate how lending costs, countercyclical capital buffers (which respond to real credit growth), and regulatory arbitrage affect cross-border bank capital flows, under both economies and diseconomies of scope in domestic and foreign lending by the global bank. Welfare gains are calculated for three policy regimes: independent policies (Nash), coordination, and reciprocity–where capital ratios set in the core region are also imposed in the periphery. Coordination generates significant gains at the level of the world economy, and these gains increase with the degree of international financial integration. However, their distribution tends to be highly asymmetric. Under certain circumstances, reciprocity may generate higher gains than independent policies for the world economy, despite the reciprocating jurisdiction (the periphery) being invariably worse off.
    JEL: E58 F42 F62
    Date: 2020–09
  22. By: Zhu, Tao; Wallace, Neil
    Abstract: There is a presumption that fixed and flexible (floating or market-determined) exchange-rate systems are equivalent if prices are flexible. We show that the presumption does not hold in two matching models of money. In both models, (i) currencies are the only assets and all trade is spot trade; (ii) the trades that directly determine welfare occur in pairwise meetings between buyers and sellers; and (iii) imperfect substitutability (including, as a special case, no substitutability) among currencies is a consequence of the trading protocol in those meetings. The two models are variants of the Lagos-Wright (2005) model and differ regarding the timing of the shock realizations relative to the centralized trade opportunities. One version has a speculative fringe. In it, the unique stationary (monetary) equilibrium under the fixed exchange-rate regime is one of a continuum of equilibria under a flexible exchange-rate regime. The other version has no speculative fringe. In it, there is a unique (monetary) stationary equilibrium under each exchange-rate regime and they differ.
    Keywords: Matching models of money; exchange-rate regimes
    JEL: E4 F3 F31
    Date: 2020–09–13
  23. By: Ryo Arawatari (Graduate School of Economics, Doshisha University); Takeo Hori (Department of Industrial Engineering and Economics, School of Engineering Tokyo Institute of Technology); Kazuo Mino (Institute of Economic Research, Kyoto University)
    Abstract: This paper examines the relationship between productive government expenditure and economic growth. An R&D-based model of endogenous growth is used in which agents have heterogeneous entrepreneurial abilities. We show that if the entrepreneurial ability follows a long- and fat-tailed distribution, then the relationship between government ex-penditure/ GDP and economic growth rate is depicted by an inverted U-shaped curve with a flat top. The flat top indicates that government size change has a limited impact on growth. We calibrate the model to U.S. data and empirically confirm the above theoretical prediction.
    Keywords: endogenous growth, government expenditure, heterogeneous agents, nonlinear relationship
    JEL: E62 O40
    Date: 2020–10
  24. By: Pratiti Chatterjee; Fabio Milani
    Abstract: What are the effects of beliefs, sentiment, and uncertainty, over the business cycle? To answer this question, we develop a behavioral New Keynesian macroeconomic model, in which we relax the assumption of rational expectations. Agents are, instead, boundedly rational: they have a finite-planning horizon, and they learn about the economy over time. Moreover, we allow agents to have a potentially asymmetric loss function in forecasting, which creates a direct channel for expected variances to affect the economy. In forming expectations, agents may be subject to shifts in optimism and pessimism (sentiment) and their beliefs may be influenced by their perceptions about future uncertainty. We estimate the behavioral model using Bayesian methods and exploit a large number of subjective expectation series (both point and density forecasts) at different horizons from the Survey of Professional Forecasters. We find that sentiment shocks are the key source of business cycle fluctuations. Shifts in perceived uncertainty can also affect real activity and inflation through a confidence channel, as they play an important role in belief formation. Overall, the results shed light on the importance of behavioral forces over the business cycles, and on the contribution and interaction of first-moment - sentiment - shocks versus second-moment - perceived uncertainty - shocks.
    Keywords: uncertainty shocks, sentiment, animal spirits, learning, behavioural New Keynesian model, sources of business cycle fluctuations, observed survey expectations, optimism and pessimism in business cycles, probability density forecasts
    JEL: C32 E32 E50 E52
    Date: 2020
  25. By: Michael T. Kiley
    Abstract: COVID-19 has depressed economic activity around the world. The initial contraction may be amplified by the limited space for conventional monetary policy actions to support recovery implied by the low level of nominal interest rates recently. Model simulations assuming an initial contraction in output of 10 percent suggest several policy lessons. Adverse effects of constrained monetary policy space are large, changing a V-shaped rebound into a deep U-shaped recession absent large-scale Quantitative Easing (QE). Additionally, the medium-term scarring on economic potential can be large, and mitigation of such effects involves persistently accommodative monetary policy to support investment and long-run productive capacity. The simulations also illustrate the importance of coordinating QE and interest rate policy. Finally, the simulations, conducted within a model developed prior to the pandemic, illustrate limitations in economists’ understanding of QE and the channels through which shocks like a pandemic affect medium-term economic performance.
    Keywords: Quantitative easing; Effective lower bound; Unconventional monetary policy;
    JEL: E52 E58 E44 E37
    Date: 2020–10–07
  26. By: George A. Alessandria; Costas Arkolakis; Kim J. Ruhl
    Abstract: We review the literature that studies the dynamics of firms in foreign markets, both at the intensive and extensive margins, and their aggregate implications. We first summarize a set of micro facts on exporter entry, expansion, contraction, and exit and macro facts about the response of aggregate trade flows to trade-policy and business-cycle shocks. We then present the canonical model developed in the literature to account for these facts and discuss its connection to the empirical evidence. We show how three model features — future uncertain profits, an investment in market access, and high depreciation of that access upon exit — generate transition dynamics and long-run aggregate outcomes from a cut in tariffs. The model and its extensions contribute to our understanding of the dynamics of trade integration and the evolution of future trade barriers. We discuss the key challenges faced by the canonical model, possible extensions, and applications of the framework to recent global events.
    JEL: F1 F11 F12 F14 F15 F41 F61 F62
    Date: 2020–10

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