nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2020‒12‒07
seventeen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Optimal quantitative easing in a monetary union By Serdar Kabaca; Renske Maas; Kostas Mavromatis; Romanos Priftis
  2. Sovereign default risk, macroeconomic fluctuations and monetary-fiscal stabilisation By Kirchner, Markus; Rieth, Malte
  3. Redistributive Policy Shocks and Monetary Policy with Heterogeneous Agents By Ojasvita Bahl; Chetan Ghate; Debdulal Mallick
  4. Optimal simple objectives for monetary policy when banks matter By Laureys, Lien; Meeks, Roland; Wanengkirtyo, Boromeus
  5. Equilibrium Unemployment: The Role Of Discrimination By Cordoba, Juan C.; Isojärvi, Anni; Li, Haoran
  6. Fiscal policy shocks and international spillovers By Ayobami E. Ilori; Juan Paez-Farrell; Christoph Thoenissen
  7. Inflation expectation uncertainty in a New Keynesian framework By Fuest, Angela; Schmidt, Torsten
  8. Demographic change and the rate of return in PAYG pension systems By Schön, Matthias
  9. The effects of structural reforms: Evidence from Italy By Emanuela Ciapanna; Sauro Mocetti; Alessandro Notarpietro
  10. Do details matter? An analysis of Italian personal income tax By Martino Tasso
  11. Monetary Policy with Reserves and CBDC: Optimality, Equivalence, and Politics By Dirk Niepelt
  12. Falling Behind: Has Rising Inequality Fueled the American Debt Boom? By Moritz Drechsel-Grau; Fabian Greimel
  13. Endogenous fertility, externality and phase out of pensions By Amol; Monisankar Bishnu; Harsh Kumar; Tridip Ray
  14. The (Ir)Relevance of Rule-of-Thumb Consumers for U.S. Business Cycle Fluctuations By Alice, Albonico; Guido, Ascari; Qazi Haque
  15. Banks, low interest rates, and monetary policy transmission By Wang, Olivier
  16. Falling Natural Rates, Rising Housing Volatility and the Optimal Inflation Target By Klaus Adam; Oliver Pfäuti; Timo Reinelt
  17. Monetary Policy Challenges From Falling Natural Interest Rates By Klaus Adam

  1. By: Serdar Kabaca; Renske Maas; Kostas Mavromatis; Romanos Priftis
    Abstract: This paper explores the optimal allocation of government bond purchases within a monetary union, using a two-region DSGE model, where regions are asymmetric with respect to economic size and portfolio characteristics: the extent of substitutability between assets of different maturity and origin, asset home bias, and steady-state levels of government debt. An optimal quantitative easing (QE) policy under commitment does not only reflect different region sizes, but is also a function of these dimensions of portfolio heterogeneity. By calibrating the model to the euro area, we show that optimal QE favors purchases from the smaller region (Periphery instead of Core), given that the former faces stronger portfolio frictions. A fully optimal policy consisting of both the short-term interest rate and QE lifts the monetary union away from the zero lower bound faster than an optimal interest rate policy alone, which entails forward guidance.
    Keywords: Optimal monetary policy; quantitative easing; monetary union; DSGE model; portfolio rebalancing; zero lower bound
    JEL: E43 E52 E58 F45
    Date: 2020–11
  2. By: Kirchner, Markus; Rieth, Malte
    Abstract: This paper examines the role of sovereign default beliefs for macroeconomic fluctuations and stabilisation policy in a small open economy where fiscal solvency is a critical problem. We set up and estimate a DSGE model on Turkish data and show that accounting for sovereign risk significantly improves the fit of the model through an endogenous amplication between default beliefs, exchange rate and inflation movements. We then use the estimated model to study the implications of sovereign risk for stability, fiscal and monetary policy, and their interaction. We find that a relatively strong fiscal feedback from deficits to taxes, some exchange rate targeting, or a monetary response to default premia are more effective and efficient stabilisation tools than hawkish inflation targeting.
    Keywords: small open economies,sovereign risk,monetary policy,exchange rates,business cycles,DSGE models
    JEL: E58 E63 F41
    Date: 2020
  3. By: Ojasvita Bahl (Indian Statistical Institute, Delhi); Chetan Ghate (Indian Statistical Institute, Delhi); Debdulal Mallick (Deakin University)
    Abstract: Governments in EMDEs routinely intervene in agriculture markets to stabilize food prices in the wake of adverse domestic or external shocks. Such interventions typically involve a large increase in the procurement and redistribution of food, which we call a redistributive policy shock. What is the impact of a redistributive policy shock on the sectoral and aggregate dynamics of ináation, and the distribution of consumption amongst rich and poor households? To address this, we build a tractable two-sector (agriculture and manufacturing) two-agent (rich and poor) New Keynesian DSGE model with redistributive policy shocks. We calibrate the model to the Indian economy. We show that for an ináation targeting central bank, consumer heterogeneity matters for whether monetary policy responses to a variety of shocks raises aggregate welfare or not. Our paper contributes to a growing literature on understanding the role of consumer heterogeneity in monetary policy
    Keywords: TANK models, HANK Models, Ináation Targeting, Emerging Market and Developing Economies, Food Security, Procurement and Redistribution, DSGE
    JEL: E31 E32 E44 E52 E63
    Date: 2020–07
  4. By: Laureys, Lien (Bank of England); Meeks, Roland (International Monetary Fund); Wanengkirtyo, Boromeus (Bank of England)
    Abstract: We reconsider the design of welfare-optimal monetary policy when financing frictions impair the supply of bank credit, and when the objectives set for monetary policy must be simple enough to be implementable and allow for effective accountability. We show that a flexible inflation targeting approach that places weight on stabilising inflation, a measure of resource utilisation, and a financial variable produces welfare benefits that are almost indistinguishable from fully-optimal Ramsey policy. The macro-financial trade-off in our estimated model of the euro area turns out to be modest, implying that the effects of financial frictions can be ameliorated at little cost in terms of inflation. A range of different financial objectives and policy preferences lead to similar conclusions.
    Keywords: Monetary policy; simple loss function; banks; medium-scale DSGE models; euro area economy
    JEL: E17 E52 E58 G21
    Date: 2020–11–20
  5. By: Cordoba, Juan C.; Isojärvi, Anni; Li, Haoran
    Abstract: U.S. labor markets are increasingly diverse and persistently unequal between genders, races/ethnicities, educational groups and age. In the spirit of Chari, Kehoe, and McGrattan (2007), we use a structural model approach to decompose the observed differences in labor market outcomes across demographic groups in terms of underlying wedges, or frictions. Of particular interest is the potential role of discrimination, either taste- based or statistical. Our prototype model is a version of the Diamond- Mortensen-Pissarides model extended to include a life cycle, learning by doing, a non-participation state, and informational frictions. The prototype exhibits group-specific wedges in initial human capital, returns to experience, matching efficiencies, and hazard rates. We use the model to reverse engineer group-specific wedges which we then feed back into the model to assess the fraction of various disparities they account for. Applying this methodology to 1998-2018 U.S. data reveals that differences in initial human capital, returns to experience, and in hazard rates, account for most of the demographic disparities; wedges in matching efficiencies play a secondary role. Our results suggest a minor aggregate impact of taste-based discrimination in hiring and an important role for statistical discrimination affecting particularly female groups and Black males. Our approach is macro, structural, unified, and comprehensive.
    Date: 2020–11–14
  6. By: Ayobami E. Ilori; Juan Paez-Farrell; Christoph Thoenissen
    Abstract: The domestic and international transmission mechanism of fiscal policy shocks are analysed in large developed economies. Using a Bayesian VAR approach, we find that fiscal expansions are associated with increases in output, private consumption and, in many cases, with an increase in private investment. The terms of trade, which affect the international transmission of fiscal policy shocks, are found to depreciate in response to a fiscal expansion, thus transferring some of the increased domestic purchasing power abroad. A US government spending shock is expansionary for all non-US G7 members. A German government spending shock is expansionary for most, but not all European economies, both within and outside the Euro Area. The dynamics of the BVAR are rationalise using a dynamics stochastic general equilibrium model where heterogeneous households and firms face borrowing constraints.
    Keywords: Fiscal policy, Bayesian VAR, DSGE modelling, International business cycles, spillovers
    JEL: E62 F41 F42
    Date: 2020–11
  7. By: Fuest, Angela; Schmidt, Torsten
    Abstract: For monetary policy guiding inflation expectations provides an instrument to achieve price stability. However, expectation uncertainty may undermine monetary policy's ability to stabilise the economy. This study examines the effects of inflation expectation uncertainty on inflation, inflation expectations and the output gap by means of a structural VAR with stochastic volatility in mean. Inflation expectation uncertainty negatively affects the inflation rate and the output gap, without having a distinct effect on the level of expectations. This result is replicable with a model in which uncertainty is approximated by a cross-sectional survey measure. Furthermore, simulating an uncertainty shock in a DSGE model shows that the demand channel dominates the supply channel of an inflation expectation uncertainty shock.
    Keywords: uncertainty,inflation expectations,Phillips curve,New Keynesian model
    JEL: E31 E52 C32 C63
    Date: 2020
  8. By: Schön, Matthias
    Abstract: The currently observed demographic change consists of two independent develop-ments that differ in structure and persistence: (1) A slow, monotonic and (presum-ably) permanent ageing effect caused by an increasing life expectancy; (2) a morerapidly changing, non-monotonic and less permanent cohort effect caused by fluc-tuations in the size of cohorts. This paper shows the ageing effect has a positiveimpact on the rates of return households generate within pay-as-you-go (PAYG) pension system. The cohort effect, by contrast, results in winners and losers in PAYG systems. Taking Germany as an example and using a quantitative OLG model the paper shows that the two effects cause rate of return differentials withinthe pension system of almost 1.3 percentage points between generations.
    Keywords: Demographic Change,Pension System,OLG Models
    JEL: E27 E62 H55 J11 J26
    Date: 2020
  9. By: Emanuela Ciapanna (Bank of Italy); Sauro Mocetti (Bank of Italy); Alessandro Notarpietro (Bank of Italy)
    Abstract: This paper quantifies the macroeconomic effects of three major structural reforms (i.e., service sector liberalizations, incentives to innovation and civil justice reforms) undertaken in Italy in the last decade. We employ a novel approach that estimates the impact of each reform on total factor productivity and markups in an empirical micro setting and that uses these estimates in a structural general equilibrium model to simulate the macroeconomic impact of the reforms. Our results indicate that, accounting for estimation uncertainty, the increase in the level of GDP as of 2019 due to the sole effect of these reforms (ignoring all the other shocks that the Italian economy suffered in the same period) would be between 3% and 6%. The long-run increase in Italy's potential output would lie between 4% and 8%, with non-negligible effects on the labor market.
    Keywords: structural reforms, DSGE models, liberalization, innovation, civil justice
    JEL: E10 E20 J60 K40 L50 O30
    Date: 2020–11
  10. By: Martino Tasso (Bank of Italy)
    Abstract: Do the details of the structure of the tax code matter? Which of the elementary components of a modern and complex tax code is most important for households? This paper explores these issues within the framework of an overlapping generation model with heterogeneous agents and with specific reference to the case of Italy. Risk averse agents in the model are exposed to lifespan uncertainty, borrowing constraints, and uninsurable wage shocks. In this framework, the tax code plays an important role as a source of publicly-provided insurance against unlucky realizations of incomes. In particular, while many features of the tax code are instrumental in shaping its ability to redistribute income across agents, this paper finds that a new-born agent would attach a significant welfare value to the existing tax credit for employees’ earned income. This provision of Italian personal income tax significantly lowers the tax burdens on agents hit by negative productivity shocks and thus plays a crucial role in limiting the dispersion of realized net incomes and consumption.
    Keywords: personal income tax, overlapping generations
    JEL: H21 H24 H31
    Date: 2020–11
  11. By: Dirk Niepelt
    Abstract: We analyze policy in a two-tiered monetary system. Noncompetitive banks issue deposits while the central bank issues reserves and a retail CBDC. Monies di er with respect to operating costs and liquidity. We map the framework into a baseline business cycle model with "pseudo wedges" and derive optimal policy rules: Spreads satisfy modified Friedman rules and deposits must be taxed or subsidized. We generalize the Brunnermeier and Niepelt (2019) result on the macro irrelevance of CBDC but show that a deposit based payment system requires higher taxes. The model implies annual implicit subsidies to U.S. banks of up to 0.8 percent of GDP during the period 1999-2017.
    Keywords: Reserves, deposits, central bank digital currency, monetary policy, Friedman rule, equivalence, Ramsey policy, bank pro ts, money creation
    JEL: E42 E43 E51 E52
    Date: 2020–11
  12. By: Moritz Drechsel-Grau; Fabian Greimel
    Abstract: We evaluate the hypothesis that rising inequality was a causal source of the US household debt boom since 1980. The mechanism builds on the observation that households care about their social status. To keep up with the ever richer Joneses, the middle class substitutes status-enhancing houses for status-neutral consumption. These houses are mortgage-financed, creating a debt boom across the income distri- bution. Using a stylized model we show analytically that aggregate debt increases as top incomes rise. In a quantitative general equilibrium model we show that Keeping up with the Joneses and rising income inequality generate 60% of the observed boom in mortgage debt and 50% of the house price boom. We compare this channel to two competing mechanisms. The Global Saving Glut hypothesis gives rise to a similar debt boom, but does not generate a house prices boom. Loosening collateral constraints does not generate booms in either debt or house prices.
    Keywords: mortgages, housing boom, social comparisons, consumption networks, keeping up with the Joneses
    JEL: D14 D31 E21 E44 E70 R21
    Date: 2020–03
  13. By: Amol; Monisankar Bishnu; Harsh Kumar; Tridip Ray
    Abstract: This paper exploits a well accepted inefficiency that arises out of Pay-As-You-Go (PAYG) pensions itself to phase it out in a Pareto way. The positive externality of having children in a PAYG pension system is carefully utilized to phase the pensions out. In a model with endogenous fertility the paper first confirms the sub-optimality of parent’s choices and recommends an intergenerationally balanced childcare subsidy to correct for the externalities in a PAYG system. However, if PAYG pension program needs to be dismantled for various reasons, it can be phased out from there infinite time and, more importantly, just by exploiting the above mentioned externalities keeping the Pareto conditions intact. This phase out plan under Pareto satisfies all the standard efficiency criteria suggested in the literature when fertility is endogenous.
    Keywords: Endogenous fertility, Fertility externality under PAYG pensions, Phase out of PAYG pensions, Pareto efficiency
    Date: 2020–11
  14. By: Alice, Albonico; Guido, Ascari; Qazi Haque
    Abstract: We estimate a medium-scale model with and without rule-of-thumb consumers over the pre-Volcker and the Great Moderation periods, allowing for indeterminacy. Passive monetary policy and sunspot fluctuations characterize the pre-Volcker period for both models. The estimated fraction of rule-of-thumb consumers is low, such that the models are empirically almost equivalent. In both subsamples, the two models yield very similar impulse response functions, variance and historical decompositions. We conclude that rule-of-thumb consumers are irrelevant to explain aggregate U.S. business cycle fluctuations.
    Keywords: rule-of-thumb consumers, indeterminacy, business cycle fluctuations
    JEL: E32 E52 C11 C13
    Date: 2020–11
  15. By: Wang, Olivier
    Abstract: This paper studies how low interest rates weaken the short-run transmission of monetary policy and contract the long-run supply of bank credit. As U.S. bond rates have fallen, the pass-through of monetary shocks to loan and deposit rates has weakened while the spread on U.S. bank loans has risen. I build a model in which banks earn deposit and loan spreads, deposits compete with money, and banks’ lending capacity depends on their equity. The short-run transmission of monetary policy is dampened at low rates, because deposit spreads act as a better hedge for bank equity against unexpected monetary shocks. In the long run, persistent low rates decrease banks’ “seigniorage” revenue from deposit spreads, hence bank equity and loan supply contract, and loan spreads increase. JEL Classification: E4, E5, G21
    Keywords: deposit spread, financial intermediation, interest rate pass-through, loan spread, low interest rates
    Date: 2020–11
  16. By: Klaus Adam; Oliver Pfäuti; Timo Reinelt
    Abstract: The decline in natural interest rates in advanced economies over the past decades has been accompanied by a signi cant increase in the volatility of housing prices. We show that the monetary policy implications of these macroeconomic trends depend|in the presence of a lower-bound constraint on nominal rates|on the source of increased housing price volatility. If housing price expectations are rational, increased housing price volatility re ects more volatile housing demand shocks. Under optimal monetary policy, average in ation then increases only minimally, as average natural rates fall and housing shocks become more volatile. Instead, if housing price volatility is partly due to speculative housing price beliefs, as suggested by survey data, then lower natural rates endogenously trigger larger uctuations in subjective housing price beliefs and housing prices. A belief-driven increase in housing price volatility causes also the natural rate of interest to become more volatile. This exacerbates the lower-bound problem, especially when average natural rates are low. Under optimal monetary policy, average in ation then rises much more strongly following a fall in natural rates, rationalizing larger increases in the in ation target.
    Keywords: inflation target, real estate booms, natural rate
    JEL: E31 E44
    Date: 2020–11
  17. By: Klaus Adam
    Abstract: The real interest rates consistent with stable inflation (the natural rates of interest) has displayed a sustained downward trend in advanced economies over past decades. This has considerably complicated the conduct of monetary policy, which is increasingly constrained by the inability to lower nominal rates further. Over the same time period, the volatility of housing prices and stock prices has increased considerably, generating additional challenges for monetary policy. This paper summarizes recent academic research that analyses the monetary policy implications of lower natural rates and rising asset price volatility in a setting where policy is constrained by a lower bound on nominal rates. It focuses on the implications for (1) the optimal inflation target and (2) the question how monetary policy should respond to asset price movements.
    Date: 2020–11

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