nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2020‒11‒02
fifteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. The Effect of Wealth on Worker Productivity By Jan Eeckhout; Alireza Sepahsalari
  2. Foreign Exchange Intervention and Financial Stability By Pierre-Richard Agénor; Timothy P. Jackson; Luiz Pereira da Silva
  3. Age-dependent risk aversion: Re-evaluating fiscal policy impacts of population ageing By Phitawat Poonpolkul
  4. The Life-Cycle Effects of Pension Reforms: A Structural Approach By Claudio Daminato; Mario Padula
  5. Redistributive Capital Taxation Revisited By Ozlem Kina; Ctirad Slavik; Hakki Yazici
  6. Trade Secret Protection in a Developing Economy By Klein, Michael A
  7. Microeconomic foundation for Phillips curve with three-periods overlapping generations model and negative real balance effect By Tanaka, Yasuhito
  8. Recapitalization, bailout, and long-run welfare in a dynamic model of banking By Modena, Andrea
  9. Risky Mortgages and Bank Runs By Nurlan Turdaliev; Yahong Zhang
  10. Macroeconomics, firm dynamics and IPOs By Beatriz González
  11. Aggregating Heterogeneous-Agent Models with Permanent Income Shocks By Harmenberg, Karl
  12. The Role of Information in Explaining the Lack of Welfare-Induced Migration By Jeremy McCauley
  13. A Macroeconomic Theory of Banking Oligopoly By Dong, Mei; Huangfu, Stella; Sun, Hongfei
  14. Inflation, Output and Monetary Policy in South Africa By Harold Ngalawa; Coretha Komba
  15. Bottom-up Markup Fluctuations By Burstein, A.; Carvalho, V. M.; Grassi, B.

  1. By: Jan Eeckhout; Alireza Sepahsalari
    Abstract: We propose a theory that analyzes how a workers’ asset holdings a↵ect their job productivity. In a labor market with uninsurable risk, workers choose to direct their search to jobs that trade o↵ productivity and wages against unemployment risk. Workers with low asset holdings have a precautionary job search motive, they direct their search to low productivity jobs because those o↵er a low risk at the cost of low productivity and a low wage. We show that such sorting occurs under a condition closely related to Decreasing Relative Risk Aversion and that the presence of consumption smoothing can reconcile the directed search model with negative duration dependence on wages, a robust empirical regularity that the canonical directed search model cannot rationalize. We calibrate the infinite horizon economy and find that this mechanism is quantitatively important. We evaluate a tax financed unemployment insurance (UI) scheme and how it a↵ects welfare. Aggregate welfare is inverted U-shaped in benefits: the insurance e↵ect UI dominates the incentive e↵ects for low levels of benefits and vice versa for high benefits. Also, when UI increases, total production falls in the economy while worker productivity increases. Finally, we compare a one-o↵ severance payment with per period benefits and find that per period benefits generate superior welfare.
    Date: 2020–10–26
  2. By: Pierre-Richard Agénor; Timothy P. Jackson; Luiz Pereira da Silva
    Abstract: This paper studies the effects of sterilized foreign exchange market intervention in an open-economy 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. Sterilized intervention can be expansionary through a bank portfolio effect and may therefore raise financial stability risks. 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 the optimal degree of exchange market intervention is more aggressive when the central bank can choose simultaneously the degree of sterilization; in that sense, the instruments are complements. At the same time, the presence of the bank portfolio effect implies that full sterilization is not optimal. By contrast, when the central bank’s objective function depends on the cost of sterilization, in addition to household welfare, intervention and sterilization are (partial) substitutes–independently of whether exchange rate and financial stability considerations also matter.
    JEL: E32 E58 F41
    Date: 2020–09
  3. By: Phitawat Poonpolkul
    Abstract: This study revisits optimal fiscal policies in response to population ageing by introducing an age-dependent increasing risk aversion assumption into an OLG model with risk-sensitive preferences. Under this specification, the policy evaluation factors in the welfare cost of policy-induced uncertainties and suggests that, based on future generations’ welfare, financing population ageing by either reducing social security benefits or extending the retirement age may not be as strongly preferred over raising the payroll tax rate as prior studies have suggested. Varying risk aversion also emphasizes the role of precautionary savings that causes individuals to respond slightly differently to changes in demographic structures and price variables. This, in turn, influences the redistribution of life-cycle variables and transition dynamics of aggregate variables.
    Keywords: Overlapping generations model, Increasing risk aversion, Non-expected utility
    JEL: D81 E62 J11
    Date: 2020–10
  4. By: Claudio Daminato (Department of Management, Technology and Economics, ETH Zurich); Mario Padula (Università "Ca' Foscari" Venezia and CSEF)
    Abstract: To assess the life-cycle welfare effects of pension reforms, we provide a dynamic stochastic model of saving, portfolio choice and retirement with a pension system that operates according to the notional defined contribution principle. Relying on the exogenous variation from a sequence of Italian pension reforms, we identify and estimate the model, which is then used to draw implications of alternative pension policies. Our results also shed further light on the mechanisms behind the offset between social security and private wealth and show the importance of labor supply at retirement as an insurance mechanism against shocks to pension wealth.
    Keywords: Pension reforms, Life-Cycle, Savings, Portfolio Choice, Retirement.
    JEL: E21 H31 H55 J26
    Date: 2020–10–23
  5. By: Ozlem Kina; Ctirad Slavik; Hakki Yazici
    Abstract: This paper shows that capital-skill complementarity provides a quantitatively significant rationale to tax capital for redistributive governments. The optimal capital income tax rate is 60%, which is significantly higher than the optimal rate of 48% in an identically calibrated model without capital-skill complementarity. The skill premium falls from 1.9 to 1.67 along the transition following the optimal reform in the capital-skill complementarity model, implying substantial indirect redistribution from skilled to unskilled workers. These results show that a government that cares about redistribution should take into account capital-skill complementarity in production when setting the tax rate on capital income.
    Keywords: capital taxation; capital-skill complementarity; inequality; redistribution;
    JEL: E25 J31
    Date: 2020–10
  6. By: Klein, Michael A
    Abstract: Surveys of U.S. based multinational enterprises reveal that trade secret misappropriation by current and former employees remains a substantial impediment to conducting business in emerging markets. In this paper, I examine the consequences of strengthening legal protection against this employment related trade secret misappropriation in an open economy context. I develop a general equilibrium model featuring heterogenous firms that differ in both standard productivity and the degree to which they must expose employees to their trade secrets. To pre- vent employees from leaking trade secrets, firms offer an incentive compatible wage based on their individual exposure, and the common level of legal protection. Entry selection generates an endogenous distribution of firm specific wages and positive unemployment in equilibrium. Simulations of the calibrated model show that stronger legal protection stimulates multinational investment and increases aggregate productivity. However, these gains are distributed unevenly across workers, and many are worse-off following this reform.
    Keywords: Trade secrets; intellectual property rights, multinational firms, development
    JEL: F16 F23 O34
    Date: 2020–10–06
  7. By: Tanaka, Yasuhito
    Abstract: We show a negative relation between the inflation rate and the unemployment rate , that is, the Phillips curve using a three-periods overlapping generations (OLG) model with childhood period and pay-as-you-go pension for older generation under monopolistic competition. We consider the effects of a change in nominal wage rate with negative real balance effect and the effects of an exogeneous change in labor productivity. In a three periods OLG model there may exist a negative real balance effect. A fall (or rise) in nominal wage rate induces a fall (or rise) in the price, then by negative real balance effect the unemployment rate rises (or falls), and we get a negative relation between the inflation rate and the unemployment rate. This conclusion is based on the premise of utility maximization of consumers and profit maximization of firms. Therefore, we presented a microeconomic foundation of the Phillips curve. About the effects of a change in labor productivity we obtain similar results. We also examine the effects of fiscal policy financed by seigniorage.
    Keywords: Phillips Curve, Microeconomic foundation, Three-periods overlapping generations model, Monopolistic competition, Negative real balance effect.
    JEL: E12 E24 E31
    Date: 2020–10–16
  8. By: Modena, Andrea
    Abstract: This paper studies the link between bank recapitalization and welfare in a dynamic production economy. The model features financial frictions because banks benefit of a cost advantage at monitoring firms and face costly equity issuance. The competitive equilibrium outcome is inecient because agents do not internalize the e↵ects banks' capitalization over the allocation of capital, its price and, in turn, firms investments. It follows, individual recapitalizations are sub-optimal and bailout policies may benefit social welfare in the long-run. Bailouts improve capital allocation in states where aggregate banks are poorly capitalized, therefore enhancing their market valuation, fostering investments, and stabilizing the economy recovery path.
    Keywords: banks,bailout,general equilibrium,financial frictions,recapitalization,welfare
    JEL: D51 G21
    Date: 2020
  9. By: Nurlan Turdaliev (Department of Economics, University of Windsor); Yahong Zhang (Department of Economics, University of Windsor)
    Abstract: The collapse of housing prices in the aftermath of the U.S. subprime mortgage crisis of 2008 not only worsened the balance sheet positions of the banking sector but also led to a “bank run” in some cases such as the collapse of Lehman Brothers in September 2008. We develop a theoretical model featuring household debt (mortgages) and banking sector frictions. We show that mortgage risks can potentially lead to a bank run equilibrium. Such an equilibrium exists since mortgage risks reduce the liquidation prices of bank assets. We further show that mortgage market regulations such as loan-to-value requirements reduce the likelihood of bank runs.
    Keywords: bank run, mortgage risk, loan-to-value ratio
    JEL: E32 E44 G01 G21 G33
    Date: 2020–10
  10. By: Beatriz González (Banco de España)
    Abstract: This paper extends a model of firm dynamics to incorporate heterogeneous privately held and publicly traded firms facing different financial frictions, and the decision to become publicly traded (Initial Public Offering, or IPO) is endogenous. This allows changes in the economic environment to affect these firms differently, impacting the selection into becoming publicly traded, and its macroeconomic outcomes. Firms are born privately held and small due to financial frictions. They finance investment with internal resources and debt and have the choice to go public (IPO). The main trade-off is access to external equity financing, at a one-off cost of IPO and an increased cost of operation. The calibrated model is successful in capturing the size distribution of firms, the share of publicly traded firms, and the dynamics around the IPO date. The decrease in corporate and dividend taxes experienced from the 1970s to the 1990s benefited more publicly traded firms financing with equity at the margin. This helps explaining the stock market boom, and the observed changes in the characteristics of firms going public, their investment and payout behavior. I perform some counterfactual exercises to understand what could be the reasons behind the decrease in publicly traded firms since the 2000s: increased cost of being public, increased access to debt, or changes in the idiosyncratic shock process. I find these changes are consistent with part (though not all) of the changes in IPO choice, payout and investment behavior of publicly traded firms in this period.
    Keywords: firm life cycle, macroeconomics, fiscal policy, corporate finance, IPO
    JEL: E23 G32 G35 H25 H32
    Date: 2020–10
  11. By: Harmenberg, Karl (Department of Economics, Copenhagen Business School)
    Abstract: I introduce a method for simulating aggregate dynamics of heterogeneous-agent models where log permanent income follows a random walk. The idea is to simulate the model using a counterfactual permanent-income-neutral measure which incorporates the effect that permanent income shocks have on macroeconomic aggregates. With the permanent-income-neutral measure, one does not need to keep track of the permanent-income distribution. The permanent-income-neutral measure is both useful for the analytical characterization of aggregate consumption-savings behavior and for simulating numerical models. Furthermore, it is trivial to implement with a few lines of code.
    Keywords: Permanent income; Consumption; Simulation
    JEL: C63 E21 E27
    Date: 2020–09–21
  12. By: Jeremy McCauley
    Abstract: This paper examines the role of information as a driver of domestic welfare-induced migration decisions. I exploit a policy reform in England where the government began publicly releasing quality star ratings for each area’s social services (social care). I study the effects of this “information shock†on the main service users, the elderly, and find a one star increase in publicly-released rating is associated with a 1.3% increase in the elderly population of that area. Based on empirical evidence, I estimate a search model with learning, where the elderly search for areas with better social services and gradually learn their true quality. Mimicking the information shock, the model reveals that individuals are more influenced by the rating of their own area than by ratings for other areas. Those induced to move by the information shock experience welfare increases valued at £600 per year.
    Date: 2020–10–22
  13. By: Dong, Mei; Huangfu, Stella; Sun, Hongfei
    Abstract: We study the behavior and macroeconomic impact of oligopolistic banks in a tractable environment with micro-foundations for money and banking. Our model features oligopolistic banks, which resembles the structure of the banking sector observed in most advanced economies. Banks interact strategically where they compete against each other in terms of the volume of loans to make. We find that it is welfare-maximizing to have the banking sector as oligopolistic, i.e., to have a small number of large banks. In addition, moderate inflation improves welfare because it helps to ease congestion in the banking sector.
    Keywords: banking; oligopoly; liquidity; market frictions
    Date: 2020–10
  14. By: Harold Ngalawa; Coretha Komba (University of KwaZulu Natal)
    Abstract: South Africa adopted inflation targeting as its monetary policy framework in February 2000. The country’s monetary authorities, however, have struggled to keep inflation within the targeted 3%-6% band. A review of the literature reveals that an understanding of the inflation-output trade-off is essential for the achievement of price stability. The effects of policy may be different depending on whether the inflation-output trade-off is symmetric or asymmetric; and when it is asymmetric, the outcome may vary contingent on whether the asymmetry is convex or concave. In South Africa, the nature of this relationship is not known. Estimation of the inflation-expectations augmented Phillips curve using the difference Generalized Method of Moments on quarterly time series data for the period 2000:3 to 2015:1 reveals that South Africa’s Phillips curve is concave asymmetric. These estimation results, however, may not be policy-invariant because they are obtained from “highly” aggregated historical data and the model parameters are not structural. Consistent with the Lucas Critique, we formulate a New Keynesian dynamic stochastic general equilibrium model calibrated on South African data. Simulation results of the model show that a negative demand shock reduces inflation and output while a positive demand shock of the same magnitude leads to a smaller increase in inflation and a larger increase in output, confirming the concave asymmetric inflation-output relationship found earlier. Concavity of the Phillip’s curve implies declining sensitivity of inflation to the strength of the economy, suggesting that any given change in inflation requires an increasingly larger adjustment in output.
    Date: 2020
  15. By: Burstein, A.; Carvalho, V. M.; Grassi, B.
    Abstract: We study markup cyclicality in a granular macroeconomic model with oligopolistic competition. We characterize the comovement of firm, sectoral, and economy-wide markups with sectoral and aggregate output following firm-level shocks. We then quantify the model’s ability to reproduce salient features of the cyclical properties of markups in French administrative firm-level data, from the bottom (firm) level to the aggregate level. Our model helps rationalize various, seemingly conflicting, measures of markup cyclicality in the French data.
    Keywords: Markup Cyclicality, Oligopolistic Competition, Firm Dynamics, Granularity, Aggregate Fluctuations
    Date: 2020–10–14

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