nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2020‒11‒23
seventeen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Productivity Shocks, Long-Term Contracts and Earnings Dynamics By Neele Balke; Thibaut Lamadon
  2. Sudden Stops and Reserve Accumulation in the Presence of International Liquidity Risk By Lutz, Flora; Zessner-Spitzenberg, Leopold
  3. Monetary Policy and Firm Dynamics By Matthew Read
  4. Negative Interest Rates on Central Bank Digital Currency By Jia, Pengfei
  5. The macroeconomics of hedging income shares By Adriana Grasso; Juan Passadore; Facundo Piguillem
  6. Optimal Monetary Policy with Heterogeneous Agents By Galo Nuño; Carlos Thomas
  7. Demographics and the Decline in Firm Entry: Lessons from a Life-Cycle Model By Röhe, Oke; Stähler, Nikolai
  8. Involuntary unemployment under ongoing nominal wage rate decline in overlapping generations model By Tanaka, Yasuhito
  9. Are incentivized old-age savings schemes effective under incomplete rationality? By Tyrowicz, Joanna
  10. Redistribution Through Tax Relief By Quitz\'e Valenzuela-Stookey
  11. Female Employment and Childcare By Hassani Nezhad, Lena
  12. Partisanship and Fiscal Policy in Federal Unions: Evidence from US States By Carlino, Gerald; Drautzburg, Thorsten; Inman, Robert; Zarra, Nicholas
  13. Pollution, children’s health and the evolution of human capital inequality By Karine Constant; Marion Davin
  14. How Loose, how tight? A measure of monetary and fiscal stance for the euro area. By Nicoletta Batini; Alessandro Cantelmo; Giovanni Melina; Stefania Villa
  15. Banking Crises under a Central Bank Digital Currency (CBDC) By Bitter, Lea
  16. Social Optimum in a Model with Hierarchical Firms and Endogenous Promotion Time By Mitkova, Mariya
  17. Static and Dynamic Inefficiencies in an Optimizing Model of Epidemics By Garibaldi, Pietro; Moen, Espen R.; Pissarides, Christopher A.

  1. By: Neele Balke; Thibaut Lamadon
    Abstract: This paper examines how employer- and worker-specific productivity shocks transmit to earnings and employment in an economy with search frictions and firm commitment. We develop an equilibrium search model with worker and firm shocks and characterize the optimal contract offered by competing firms to attract and retain workers. In equilibrium, risk-neutral firms provide only partial insurance against shocks to risk-averse workers and offer contingent contracts, where payments are backloaded in good times and frontloaded in bad times. We prove that there exists a unique spot target wage, which serves as an attraction point for smooth wage adjustments. The structural model is estimated on matched employer-employee data from Sweden. The estimates indicate that firms absorb persistent worker and firm shocks, with respective passthrough values of 27 and 11%, but price permanent worker differences, a large contributor (32%) to variations in wages. A large share of the earnings growth variance can be attributed to job mobility, which interacts with productivity shocks. We evaluate the effects of redistributive policies and find that almost 40% of government-provided insurance is undone by crowding out firm-provided insurance.
    JEL: E24 J31 J41 J64
    Date: 2020–11
  2. By: Lutz, Flora; Zessner-Spitzenberg, Leopold
    Abstract: We propose a small open economy model where agents borrow internationally and invest in liquid foreign assets to insure against liquidity shocks, which temporarily shut out the economy of short-term credit markets. Due to the presence of a pecuniary externality individual agents borrow too much and hold too little liquid assets relative to a social planner. This inefficiency rationalizes macroprudential policy interventions in the form of reserve accumulation at the central bank coupled with a tax on foreign borrowing. Unless combined with other measures, a tax on foreign borrowing is detrimental to welfare; it reduces agents' incentives to invest in liquid assets and thereby increases financial instability. Our model can quantitatively match the simultaneous depreciation of the exchange rate and contractions in output, gross trade ows, foreign liabilities and foreign reserves during sudden stop episodes.
    Keywords: international reserves,sudden stops,liquidity,macroprudential policy,pecuniary externalities
    JEL: D62 E44 F32 F34 F41
    Date: 2020
  3. By: Matthew Read
    Abstract: Do firm dynamics matter for the transmission of monetary policy? Empirically, the startup rate declines following a monetary contraction, while the exit rate increases, both of which reduce aggregate employment. I present a model that combines firm dynamics in the spirit of Hopenhayn (1992) with New-Keynesian frictions and calibrate it to match cross-sectional evidence. The model can qualitatively account for the responses of entry and exit rates to a monetary policy shock. However, the responses of macroeconomic variables closely resemble those in a representative-firm model. I discuss the equilibrium forces underlying this approximate equivalence, and what may overturn this result.
    Date: 2020–11
  4. By: Jia, Pengfei
    Abstract: Paying negative interest rates on central bank digital currency (CBDC) becomes increasingly relevant to monetary operations, since several major central banks have been actively exploring both negative interest rate policy and CBDC after the Great Recession. This paper provides a formal analysis to evaluate the macroeconomic impact of negative interest rates on CBDC through the lens of a neoclassical general equilibrium model with monetary aggregates. In the benchmark model, agents have access to two types of assets: CBDC and productive capital. The demand for digital currency is motivated by a liquidity constraint. I show that paying negative interest on CBDC induces agents to save less and consume more via a substitution effect. A drop in savings in turn causes a fall in capital investment, subsequent output, and real money balances. To clear the money market, the price level increases. I then extend the model to include government bonds which deliver a positive return. This allows me to study a non-trivial portfolio effect: when the government pays a negative interest rate on CBDC, the tax on agents' capital spending increases, inducing a decrease in capital investment and an increase in government bonds in agents' portfolio. Such a policy causes a drop in investment and output. However, there is a transitory decline in the price level due to a "flight to quality".
    Keywords: CBDC, Negative interest rates, Monetary policy, Public money.
    JEL: E21 E22 E31 E42 E52 E63
    Date: 2020–10–26
  5. By: Adriana Grasso (Bank of Italy); Juan Passadore (Einaudi Institute for Economics and Finance (EIEF)); Facundo Piguillem (Einaudi Institute for Economics and Finance (EIEF) and CEPR)
    Abstract: The recent debate about the falling share of labor income has brought attention to the trends in income shares, but less attention has been devoted to their variability. In this paper, we analyze how their fluctuations can be insured against between workers and capitalists, and the corresponding implications for financial markets. We study a neoclassical growth model with aggregate shocks that affect income shares and financial frictions that prevent firms from fully insuring idiosyncratic risk. We examine theoretically how aggregate risk sharing is distorted by the combination of idiosyncratic risk and moving shares. Accumulation of safe assets by firms and risky assets by households emerges naturally as a tool to insure income shares’ risk. We calibrate the model to the U.S. economy and show that low interest rates, rising capital shares, and accumulation of safe assets by firms and risky assets by households can be rationalized by persistent shocks to the labor share.
    Keywords: income shares fluctuation, risk sharing, asset prices, corporate savings glut
    JEL: E20 E32 E44 G11
    Date: 2020–06
  6. By: Galo Nuño; Carlos Thomas
    Abstract: We analyze optimal monetary policy under commitment in an economy with uninsurable idiosyncratic risk, long-term nominal bonds and costly inflation. Our model features two transmission channels of monetary policy: a Fisher channel, arising from the impact of inflation on the initial price of long-term bonds, and a liquidity channel. The Fisher channel gives the central bank a reason to inflate for redistributive purposes, because debtors have a higher marginal utility than creditors. This inflationary motive fades over time as bonds mature and the central bank pursues a deflationary path to raise bond prices and thus relax borrowing limits. The result is optimal inflation front-loading. Numerically, we find that optimal policy achieves first-order consumption and welfare redistribution vis-à-vis a zero inflation policy.
    Keywords: optimal monetary policy, incomplete markets, Gâteau derivative, nominal debt, inflation, redistributive effects, continuous time
    JEL: E50 E62 F34
    Date: 2020
  7. By: Röhe, Oke; Stähler, Nikolai
    Abstract: Since the mid-1970s, firm entry rates in the United States have declined significantly. This also holds for other OECD countries over the past years. At the same time, these economies experienced a gradual process of population aging. Applying a tractable life-cycle model with endogenous firm dynamics, we show that falling US firm entry rates can be explained by demographic transition. Specifically, our model simulations suggest that aging can account for up to one third of the observed decrease in US firm entry rates. In addition to the negative effects of a slowdown in working-age population growth on firm entry, our analysis points out that an increase in longevity may also be an important factor contributing to the decline in business dynamism, weighing on both firm entry and exit rates.
    Keywords: Life expectancy,Demographic transition,Endogenous firm dynamics
    JEL: H25 L52 E20 E62 L10 O30
    Date: 2020
  8. By: Tanaka, Yasuhito
    Abstract: We analyze involuntary unemployment based on consumers’ utility maximization and firms’ profit maximization behavior with ongoing nominal wage rate decline. We consider a three-periods overlapping generations (OLG) model with a childhood period as well as younger and older periods under monopolistic competition with increasing, decreasing or constant returns to scale technology. We examine the existenbce of involuntary unemployment in that model with ongoing mominal wage rate decline (or deflation). Even if the nominal wage rate declines, we have a steady state with involuntary unemployment and constant output and employment. We need budget deficit or budget surplus to maintain the steady state depending on whether real balance effect is positive or negative. Also we examine the possibility to achieve full-employment by fiscal policy
    Keywords: Involuntary unemployment, Three-periods overlapping generations model, Monopolistic competition, Ongoing nominal wage rate decline, Real balance effect.
    JEL: E12 E24
    Date: 2020–10–28
  9. By: Tyrowicz, Joanna
    Abstract: Financing consumption of the elderly in the face of the projected increase in life expectancy is a key challenge for economic policy. Moreover, standard structural models with fully rational agents suggest that about 50-60 percent of old-age consumption is financed with voluntary savings, even in the presence of a fairly generous public pension system. This is clearly inconsistent with either the data, or the alarming simulations of old-age poverty in the years to come. Oldage saving (OAS) schemes are widely used policy instruments to address this challenge, but structural evaluations of such instruments remain rare. We develop a framework with incompletely rational agents: lacking financial literacy and experiencing commitment difficulties. We study a broad selection of OAS schemes and find that they raise welfare of financially illiterate agents and to a lesser extent improve welfare of agents with a high degree of time inconsistency. They also reduce the incidence of poverty at old age. Unfortunately, these instruments are fiscally costly, induce considerable crowd-out and direct fiscal transfers mostly to those agents, who need it the least.
    Keywords: old-age savings,incomplete rationality,welfare effects
    JEL: H31 H55 I38
    Date: 2020
  10. By: Quitz\'e Valenzuela-Stookey
    Abstract: This paper studies politically feasible policy solutions to inequities in local public goods provision. I focus in particular on the entwined issues of high property taxes, geographic income disparities, and inequalities in public education prevalent in the United States. It has long been recognized that with a mobile population, local administration and funding of schools leads to competition between districts. By accounting for heterogeneity in incomes and home qualities, I am able to shed new light on this phenomenon, and make novel policy recommendations. I characterize the equilibrium in a dynamic general equilibrium model of location choice and education investment with a competitive housing market, heterogeneous wealth levels and home qualities, and strategic district governments. When all homes are owner-occupied, I show that competition between strategic districts leads to over-taxation in an attempt to attract wealthier residents. A simple class of policies that cap and/or tax the expenditure of richer districts are Pareto improving, and thus politically feasible. These policies reduce inequality in access to education while increasing expenditure for under-funded schools. Gains are driven by mitigation of the negative externalities generated by excessive spending among wealthier districts. I also discuss the policy implications of the degree of homeownership. The model sheds new light on observed patterns of homeownership, location choice, and income. Finally, I test the assumptions and implications empirically using a regression discontinuity design and data on property tax referenda in Massachusetts.
    Date: 2020–11
  11. By: Hassani Nezhad, Lena (affiliation not available)
    Abstract: Childcare and women's employment decisions are intimately linked. I develop a dynamic model designed to analyse the effects of childcare subsidies on labour supply, fertility, marriage, and childcare decisions in a collective setting. In the model, children are a household good, produced by both parental time and time in childcare. Couples cannot commit to insure one another against the lower wages and lower consumption associated with spending time with a child. I estimate the model using the Panel Study of Income Dynamics in the United States to evaluate the impact of childcare subsidy programmes on various life-cycle outcomes of women and men. Offering a 10 percent childcare subsidy expands the labour supply of single women from lower-education backgrounds by 5.4 percent while married women, and higher-educated single women, respond much less. Finally, I show that there are large increases in childcare take-up associated with childcare subsidies, which improves the quality of children as a household good. This increases gains from marriage and results in an increase in the married fraction of the sample.
    Keywords: female labour supply, childcare, collective household models
    JEL: J24 J22 J12 J13 D13
    Date: 2020–11
  12. By: Carlino, Gerald; Drautzburg, Thorsten; Inman, Robert; Zarra, Nicholas
    Abstract: In federal countries, such as the U.S., the fiscal authority consists not of one, but many governments, with state governments accounting for a sizable share of expenditures. We analyze how state partisanship of politicians affects state fiscal policy and quantify the possible macroeconomic consequences for federal fiscal policy. First, using data from close elections, we find strong partisanship effects in the marginal propensity to spend federal transfers, the so-called y-paper effect: Republican governors spend less. Second, this partisan difference has increased over time and is correlated with the political polarization of federal policymakers. Third, we calibrate a two-agent New Keynesian model of Republican and Democratic states in an open economy monetary union, calibrated to deliver defense spending multipliers as in the literature. Lowering back partisan differences to the less-polarized pre-Reagan era would increase the transfer multiplier by about 30 cents per dollar, and variation in governor's partisan composition similarly lead to variation in the multiplier of around to 20 cents. Fourth, we provide direct support for the structural model's partisan predictions using local-projection methods.
    Keywords: partisanship,flypaper effect,intergovernmental transfers,fiscal multiplier,monetary union,regression discontinuity
    JEL: C24 E62 F45 H72 H77
    Date: 2020
  13. By: Karine Constant (ERUDITE - Equipe de Recherche sur l’Utilisation des Données Individuelles en lien avec la Théorie Economique - UPEC UP12 - Université Paris-Est Créteil Val-de-Marne - Paris 12 - UNIV GUSTAVE EIFFEL - Université Gustave Eiffel); Marion Davin (CEE-M - Centre d'Economie de l'Environnement - Montpellier - FRE2010 - UM - Université de Montpellier - CNRS - Centre National de la Recherche Scientifique - Montpellier SupAgro - Institut national d’études supérieures agronomiques de Montpellier - Institut Agro - Institut national d'enseignement supérieur pour l'agriculture, l'alimentation et l'environnement - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement)
    Abstract: This article examines how pollution and its health effects during childhood can affect the dynamics of inequalities among households. In a model in which children's health is endogenously determined by pollution and the health investments of parents, we show that the economy may exhibit inequality in the long run and be stuck in an inequality trap with steadily increasing disparities, because of pollution. We investigate if an environmental policy, consisting in taxing the polluting production to fund pollution abatement, can address this issue. We find that it can decrease inequality in the long run and enable to escape from the trap if the emission intensity is not too high and if initial disparities are not too wide. Otherwise, we reveal that a policy mix with an additional subsidy to health expenditure may be a better option, at least if parental investment on children's health is sufficiently efficient.
    Keywords: Pollution,Health,Human capital,Childhood,Overlapping generations,Inequality.
    Date: 2020–11–05
  14. By: Nicoletta Batini (International Monetary Fund); Alessandro Cantelmo (Bank of Italy); Giovanni Melina (International Monetary Fund); Stefania Villa (Bank of Italy)
    Abstract: This paper builds a model-based dynamic monetary and fiscal conditions index (DMFCI) and uses it to examine the evolution of the joint monetary and fiscal policy stance in the euro area (EA) and its three largest member countries over the period 2007-2018. The index is based on the relative impacts of monetary and fiscal policy on demand using actual and simulated data from rich estimated models also featuring financial intermediaries and long-term government debt. The analysis highlights the short-lived fiscal expansion in the aftermath of the Global Financial Crisis, followed by a quick tightening, with monetary policy left as the 'only game in town' after 2013. Individual countries' DMFCIs show that national policy stances did not always mirror the evolution of the aggregate stance at EA level, due to the different fiscal stances.
    Keywords: policy stance, euro area, monetary policy, fiscal policy.
    JEL: E4 E5 E6
    Date: 2020–09
  15. By: Bitter, Lea
    Abstract: One of the main concerns when considering Central Bank Digital Currency (CBDC) is the disintermediating effect on the banking sector in normal times, and even more the risk of a bank run in times of crisis. This paper extends the bank run model of Gertler and Kiyotaki (2015) by analyzing the impact of a CBDC. A CBDC is an additional type of liability to the central bank which, by accounting identity, must be accompanied by respective accommodations on the asset side. The model compares the effects of two different asset side policies with each other and to the economy without a CBDC. I find that a CBDC reduces net worth in the banking sector in normal times but mitigates the risk of a bank run in times of crisis. The prevailing concerns about the risk of a bank run turn out to be partial equilibrium considerations disregarding the asset side effects of a CBDC.
    Keywords: Central Bank Digital Currency (CBDC),Digital Currency,Central Banking,Financial Intermediation,Bank Runs,Lender of Last Resort
    JEL: E42 E58 G01 G21
    Date: 2020
  16. By: Mitkova, Mariya
    Abstract: This paper develops a search and matching model with hierarchical firms, human capital accumulation, internal promotions and on-the-job search. At the time of their market entry firms maximize present value of profits with respect to their promotion rule. Workers who are eligible for promotion but cannot be promoted because the senior position in the firm is taken start searching on-the-job. The decentralized equilibrium is then compared to the socially optimal one. The welfare analysis is conducted in two steps: in the first one fixed firm entry is assumed, while in the second firm entry is determined by a free-entry condition. Under fixed firm entry, the social planner can induce aprrox. 5% welfare gain by imposing earlier promotion timing compared to the one firms choose in the decentralized equilibrium. The inefficiency of the decentralized equilibrium is caused by strategic complementarity in firms' promotion choices. If a firm delays internal promotions it creates a negative externality on all other firms by reducing the pool of potential candidates to the high productivity senior jobs. However, due to strategic complementarity the competitors respond by also increasing their promotion requirement. Imposing a free-entry condition further reveals that in the decentralized equilibrium firm entry is biased downwards which exacerbates the allocative inefficiency in the economy.
    Keywords: promotions,on-the-job search,human capital,efficiency
    JEL: D21 D61 D63 J63 J64
    Date: 2020
  17. By: Garibaldi, Pietro (University of Turin); Moen, Espen R. (Norwegian Business School (BI)); Pissarides, Christopher A. (London School of Economics)
    Abstract: In an optimizing model of epidemics several externalities arise when agents shield to avoid infection. Optimizing behaviour delays herd immunity but also reduces overall infections to approximately the minimum consistent with herd immunity. For reasonable parameter values, and with no vaccine, we find that agents delay too much because of a "rat race to shield": they shield too much in the hope that others catch the disease and reach herd immunity. This and other externalities drive large wedges between private and social outcomes. The expectation of a vaccine reverses the effects, and agents shield too little.
    Keywords: SIR models, matching model, COVID-19, social distancing, rat race, herd immunity
    JEL: A12 I10 J18 D61 D62
    Date: 2020–11

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