nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2020‒12‒21
23 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. The extensive margin and US aggregate fluctuations: A quantitative assessment By M. Casares; H. Khan; Jean-Christophe Poutineau
  2. Global oil prices and the macroeconomy: The role of tradeable manufacturing versus nontradeable services By Khalil, Makram
  3. Sudden Stops and Optimal Foreign Exchange Intervention By J. Scott Davis; Michael B. Devereux; Changhua Yu
  4. Optimally Controlling an Epidemic By Martin Gonzalez-Eiras; Dirk Niepelt
  5. Public Debt as Private Liquidity: Optimal Policy By Angeletos, Georges Marios; Collard, Fabrice; Dellas, Harris
  6. The Interaction between Credit and Labor Market Frictions By Yulia Moiseeva
  7. Consumer Credit With Over-Optimistic Borrowers By Florian Exler; Igor Livshits; James MacGee; Michèle Tertilt
  8. Monetary policy, firm exit and productivity By Hartwig, Benny; Lieberknecht, Philipp
  9. Dynamic Expectations Formation and U.S. Monetary Policy Regime Change By Xin Wei
  10. Fiscal Stress and Monetary Policy Stance in Oil-Exporting Countries By Hao Jin; Chen Xiong
  11. Credit cycles revisited By Urban, Jörg
  12. Ramsey Optimal Policy versus Multiple Equilibria with Fiscal and Monetary Interactions By Jean-Bernard Chatelain; Kirsten Ralf
  13. A neoclassical perspective on Switzerland's 1990s stagnation By Yannic Stucki; Jacqueline Thomet
  14. Discrete time multi-period mean-variance model: Bellman type strategy and Empirical analysis By Shuzhen Yang
  15. Education Choice and Human Capital Accumulation with Endogenous Fertility Model By Hiroki Tanaka; Masaya Yasuoka
  16. Bury the Gold Standard? A Quantitative Exploration By Anthony M. Diercks; Jonathan Rawls; Eric Sims
  17. On the Degree and Consequences of Talent Misallocation for the United States By Almarina Gramozi; Theodore Palivos; Marios Zachariadis
  18. Effectiveness of Bailout Policies for Asset Bubbles in a Small Open Economy By Atsushi Motohashi
  19. Trade Integration, Global Value Chains, and Capital Accumulation By Michael Sposi; Kei-Mu Yi; Jing Zhang
  20. Safe Payments By Jonathan Chiu; Mohammad Davoodalhosseini; Janet Hua Jiang; Yu Zhu
  21. The Value of a Cure: An Asset Pricing Perspective By Viral V. Acharya; Timothy Johnson; Suresh Sundaresan; Steven Zheng
  22. Optimal Search and Awareness Expansion By Greminger, Rafael
  23. The Role of Heterogeneous Expectations in Life Cycle Models : Evaluating the Accuracy of Counterfactuals By de Bresser, Jochem

  1. By: M. Casares (UPNA - Universidad Pública de Navarra [Espagne]); H. Khan (Carleton University); Jean-Christophe Poutineau (CREM - Centre de recherche en économie et management - UNICAEN - Université de Caen Normandie - NU - Normandie Université - UR1 - Université de Rennes 1 - UNIV-RENNES - Université de Rennes - CNRS - Centre National de la Recherche Scientifique)
    Abstract: We report empirical evidence indicating that US net business formation has recently turned more volatile, procyclical and persistent. To study these stylized facts, we estimate a DSGE model with endogenous entry and exit. Business units feature heterogeneous productivity and they shut down if the present value of expected future dividends falls below the current liquidation value. The model provides a better fit than a constant exit rate model with the fluctuations of US business formation. The introduction of the extensive margin amplifies the effects of technology and risk-premium shocks, and reduces the procyclicality of firm-level production. The main sources of variability of the US aggregate fluctuations during the Great Recession are countercyclical technology shocks, persistent adverse risk-premium shocks, and expansionary monetary policy shocks.
    Keywords: DSGE Models,Entry and exit,Extensive margin,US Business cycles,entry and exit,DSGE models,US business cycles
    Date: 2020
  2. By: Khalil, Makram
    Abstract: This paper studies the ability of manufacturing-specific shocks to explain global oil prices. In an estimated three-region DSGE model (UnitedStates, OPEC, rest-of-world) in corporating two sectors (manufacturing and services) in the oil-importing economies and featuring cross-border manufacturing supply chains, oil inventories as well as endogenous oil supply, such shocks rationalize the observed empirical pattern of a positive comovement between global oil prices and the global cyclical gap between manufacturing output and services provision. Given positive manufacturing technology shocks, oil demand and demand for intermediate manufactured goods as well as global trade decline in tandem. Of similar importance are shocks to final manufactured goods demand that are amplified by input-output linkages and international trade. From the perspective of the US, all foreign shocks that cause higher oil prices - including adverse oil supply shocks - have a positive impact on manufacturing relative to service s as well as a positive impact on aggregate core inflation and policy rates. These dynamics rationalize, to a large extent, the observed pattern during major oil price hikes, and, correspondingly (with opposite signs), during important episodes of low oil prices.
    Keywords: endogenous global oil price,trade channel,manufacturing and services,oil and the business cycle,oil intensity,intermediate inputs
    JEL: E32 F41 Q43
    Date: 2020
  3. By: J. Scott Davis; Michael B. Devereux; Changhua Yu
    Abstract: This paper shows that foreign exchange intervention can be used to avoid a sudden stop in capital flows in a small open emerging market economy. The model is based around the concept of an under-borrowing equilibrium defined by Schmitt-Grohe and Uribe (2020). With a low elasticity of substitution between traded and non-traded goods, real exchange rate depreciation may generate a precipitous drop in aggregate demand and a tightening of borrowing constraints, leading to an equilibrium with an inefficiently low level of borrowing. The central bank can preempt this deleveraging cycle through foreign exchange intervention. Intervention is effective due to frictions in private international financial intermediation. Reserve accumulation has ex ante benefits by reducing the risk of a sudden stop, while intervention has ex-post benefits by limiting inefficient deleveraging. But intervention itself faces constraints. When the central bank’s stock of reserves is low, even foreign exchange intervention cannot prevent a sudden stop.
    JEL: E30 E50 F40
    Date: 2020–11
  4. By: Martin Gonzalez-Eiras (University of Copenhagen); Dirk Niepelt (Study Center Gerzensee, University of Bern, CEPR, CESifo)
    Abstract: We propose a flexible model of infectious dynamics with a single endogenous state variable and economic choices. We characterize equilibrium, optimal outcomes, static and dynamic externalities, and prove the following: (i) A lockdown generically is followed by policies to stimulate activity. (ii) Re-infection risk lowers the activity level chosen by the government early on and, for small static externalities, implies too cautious equilibrium steady-state activity. (iii) When a cure arrives deterministically, optimal policy is dis-continous, featuring a light/strict lockdown when the arrival date exceeds/falls short of a specific value. Calibrated to the ongoing COVID-19 pandemic the baseline model and a battery of robustness checks and extensions imply (iv) lockdowns for 3-4 months, with activity reductions by 25-40 percent, and (v) substantial welfare gains from optimal policy unless the government lacks instruments to stimulate activity after a lockdown.
    Date: 2020–12
  5. By: Angeletos, Georges Marios; Collard, Fabrice; Dellas, Harris
    Abstract: We study optimal policy in an economy in which public debt is used as collateral or liquidity buffer. Issuing more public debt raises welfare by easing the underlying financial friction; but this easing lowers the liquidity premium and increases the government’s cost of borrowing. These considerations, which are absent in the basic Ramsey paradigm, help pin down a unique, long-run level of public debt. They require a front-loaded tax response to government-spending shocks, instead of tax smoothing. And they explain why a financial recession, more than a traditional one, makes government borrowing cheaper, optimally supporting larger fiscal stimuli.
    Date: 2020–12–02
  6. By: Yulia Moiseeva (University of St Andrews)
    Abstract: I study a novel two-way feedback between credit and labor market frictions. Running from credit to labor markets, amplitude in capital demand induced by collateral constraints spills over onto labor demand due to the complementarity of capital and labor; and, furthermore, credit frictions raise effective financial hiring costs, inducing firms to delay hiring in recessions. Running back from labor to credit markets, search frictions admit a degree of inflexibility in wages which induces greater volatility of net worth, via the wage bill, which then spills over onto capital demand. Together, these considerably amplify and propagate labor and capital market dynamics.
    Keywords: credit frictions, collateral constraints, search frictions, unemployment, wages
    JEL: E22 E24 E32 J64
    Date: 2020–12–07
  7. By: Florian Exler; Igor Livshits; James MacGee; Michèle Tertilt
    Abstract: There is active debate over whether borrowers’ cognitive biases create a need for regulation to limit the misuse of credit. To tackle this question, we incorporate overoptimistic borrowers into an incomplete markets model with consumer bankruptcy. Lenders price loans, forming beliefs—type scores—about borrowers’ types. Since over-optimistic borrowers face worse income risk but incorrectly believe they are rational, both types behave identically. This gives rise to a tractable theory of type scoring as lenders cannot screen borrower types. Since rationals default less often, the partial pooling of borrowers generates cross-subsidization whereby overoptimists face lower than actuarially fair interest rates. Over-optimists make financial mistakes: they borrow too much and default too late. We calibrate the model to the US and quantitatively evaluate several policies to address these frictions: reducing the cost of default, increasing borrowing costs, imposing debt limits, and providing financial literacy education. While some policies lower debt and filings, they do not reduce overborrowing. Financial literacy education can eliminate financial mistakes, but it also reduces behavioral borrowers’ welfare by ending crosssubsidization. Score-dependent borrowing limits can reduce financial mistakes but lower welfare.
    Keywords: Consumer Credit, Over-Optimism, Financial Mistakes, Bankruptcy, Financial Literacy, Financial Regulation, Type Score, Cross-Subsidization
    JEL: E21 E49 G18 K35
    Date: 2020–11
  8. By: Hartwig, Benny; Lieberknecht, Philipp
    Abstract: We analyze the influence of monetary policy on firms' extensive margin and productivity. Our empirical evidence for the U.S. based on a macro-financial SVAR suggests that expansionary monetary policy shocks stimulate corporate profits, reduce firm exit and increase firm entry. In the medium run, exit overshoots the baseline. We rationalize these findings in a general equilibrium model featuring endogenous entry and exit. In the model, expansionary monetary policy shocks increase firm profits by stimulating aggregate demand and thereby allow less productive firms to remain in the market. As the monetary stimulus fades, these lessproductive firms become unprofitable such that exit overshoots. This exit channel of monetary policy implies a flatter aggregate supply curve and therefore amplifies output responses, but dampens inflationary effects.
    Keywords: firm exit,firm entry,extensive margin,corporate profits,monetarypolicy
    JEL: E24 E32 E52 E58 L11
    Date: 2020
  9. By: Xin Wei (Indiana University)
    Abstract: This essay studies the fundamental causes of the monetary policy regime switches within rational expectations models. I introduce a threshold-switching monetary policy process into the model that links the policy stance to the fundamental shocks by an autoregressive regime strength index. It creates an expectations feedback mechanism between private agents’ policy forecasts and future policy regime outcomes. As demonstrated in a novel threshold-switching Fisherian model, well management of the private sector’s expectations of policy regime change can have the same effect as actually switching the regime. Contrastingly, failure to do so leads to unfavorable outcomes of policy intention. Then, I embed the new mechanism into a New Keynesian model. Along the way, I also develop an efficient non-simulation based threshold-switching Kalman filter, in conjunction with a solution method that accounts for the endogeneity of switching regimes, to estimate the nonlinear New Keynesian model. My key empirical findings are threefold. First, non-policy shocks have been instrumental in driving U.S. monetary policy regime changes during the post-World War II period. Most notably, markup shock explains 65.6% of variations in the policy regimes. Second, absent from markup shocks, eight of the eleven less aggressive regimes would not have happened during this history. Finally, I conclude that linking the private sector’s dynamic expectations formation and the Fed’s dilemma of the dual mandate in the presence of adverse supply shocks is a promising path towards providing micro-foundations for monetary policy regime shifts.
    Keywords: expectations formation effects, monetary policy, regime switching, Bayesian analysis
    Date: 2020–08
  10. By: Hao Jin (Wang Yanan Institute for Studies in Economics (WISE) and School of Economics, Xiamen University); Chen Xiong (Wang Yanan Institute for Studies in Economics (WISE) and School of Economics, Xiamen University)
    Abstract: We documented that for some oil-exporting countries, the correlation between exchange rates and oil prices is strongly negative during periods of significant oil price drop but is much weaker during other periods. To interpret this time-varying asymmetric correlation, we develop and estimate a Markov-switching small open economy New Keynesian model with oil income as a source of government revenue. In particular, we allow monetary and fiscal policy coefficients to switch across "active" and "passive" regimes. Using data on Russia, our result shows that the policy combinations fluctuate. We find that active monetary policy isolates the exchange rate from oil price variations but changes to passively tolerate depreciation and inflation to support government debt when oil price drops place fiscal policy in a state of stress. Counterfactual policy experiments suggest policy regime switching is crucial to account for the observed asymmetric impact of oil prices on the exchange rate and that the trans-mission channels of oil price shocks differ significantly across policy regimes.
    Keywords: Fiscal Policy; Monetary Policy; Exchange Rate; Oil Price
    JEL: E63 F41 Q43
    Date: 2020–06
  11. By: Urban, Jörg
    Abstract: Credit and business cycles play an important role in economic research, especially for central banks and supervisors. We reexamine a very useful dynamic model proposed by Kiyotaki and Moore (1997) of an economy with an endogenous credit limit. They claim that a small temporary shock generates large and persistent deviations from the steady state due to a positive feedback loop and the endogenous credit constraint. We mathematically show that contrary to common belief the model does not show amplification and persistence is visible only for a few parameter settings. Kiyotaki and Moore have linearized the model despite higher order terms being more important, rendering the Taylor expansion invalid. Further, we show that spillover effects in an economy with two distinct sectors are small. The strong amplification present in the original results, which supposedly is due to the large inter-temporal or dynamic multiplier effect, is spurious. The dynamic multiplier effect is of similar size than the static effect and in all cases numerically small.
    Keywords: amplification,credit constraints,credit cycles,dynamic economies,Taylor expansion
    JEL: E32 E37 E51 E52
    Date: 2020
  12. By: Jean-Bernard Chatelain (PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique); Kirsten Ralf (Ecole Supérieure du Commerce Extérieur - ESCE - International business school)
    Abstract: We consider a frictionless constant endowment economy based on Leeper (1991). In this economy, it is shown that, under an ad-hoc monetary rule and an ad-hoc fiscal rule, there are two equilibria. One has active monetary policy and passive fiscal policy, while the other has passive monetary policy and active fiscal policy. We consider an extended setup in which the policy maker minimizes a loss function under quasi-commitment, as in Schaumburg and Tambalotti (2007). Under this formulation there exists a unique Ramsey equilibrium, with an interest rate peg and a passive fiscal policy. We thank John P. Conley, Luis de Araujo and one referree for their very helpful comments.
    Keywords: Ramsey optimal policy,Fiscal theory of the Price Level,Frictionless endowment economy,Interest Rate Rule,Fiscal Rule
    Date: 2020–02–05
  13. By: Yannic Stucki; Jacqueline Thomet
    Abstract: We study Switzerland's weak growth during the 1990s through the lens of the business cycle accounting framework of Chari, Kehoe, and McGrattan (2007). Our main result is that weak productivity growth cannot account for the stagnation experienced during that time. Rather, the stagnation is explained by factors that made labour and investment expensive. We show that increased labour income taxes and financial frictions are plausible causes. Holding these factors constant, the counterfactual annualized real output growth over the 1992Q2-1996Q4 period is 1.93% compared to realized growth of 0.35%.
    Keywords: Business cycle accounting, housing crises, stagnation, Switzerland
    JEL: E13 E20 E32 E65
    Date: 2020
  14. By: Shuzhen Yang
    Abstract: In this paper, we attempt to introduce the Bellman principle for a discrete time multi-period mean-variance model. Based on this new take on the Bellman principle, we obtain a dynamic time-consistent optimal strategy and related efficient frontier. Furthermore, we develop a varying investment period discrete time multi-period mean-variance model and obtain a related dynamic optimal strategy and an optimal investment period. This paper compares the highlighted dynamic optimal strategies of this study with the 1/n equality strategy, and shows that we can secure a higher return with a smaller risk based on the dynamic optimal strategies.
    Date: 2020–11
  15. By: Hiroki Tanaka (Doshisha University); Masaya Yasuoka (Kwansei Gakuin University)
    Abstract: This paper sets an endogenous fertility model with endogenous education investment and examines determination of the share of households which select public education, income growth, income inequality, and fertility. Our paper presents consideration of policies of several types such as child allowances and education subsidies for private education and then examines how these policies affect education choice and other outcomes. Results show that a child allowance raises the share of households which select public education. Because of the tax burden, the subsidy for private education can not always raise the share of households which select private education. Furthermore, an increase in the subsidy for private education investment can not always raise the aggregate human capital accumulation even if the share of households selecting private education. The latter half of this paper presents derivation of policy allocations as a result of voting system and describes checking of the robustness of the obtained results.
    Keywords: ;Education choice, Endogenous fertility, Income growth, Income inequality, Subsidy
    JEL: J13 I22 H52
    Date: 2020–12
  16. By: Anthony M. Diercks; Jonathan Rawls; Eric Sims
    Abstract: This paper is one of the first to study the present-day properties of the gold standard in a quantitative model commonly used in central banks. We incorporate gold into an otherwise standard estimated New Keynesian model and compare the positive and normative implications of adopting a gold standard to other more commonly advocated policies. We show that under certain conditions, the gold standard is akin to a nominal GDP targeting framework and can at times be considered an improvement. However, unlike more conventional policies, the gold standard must react to shocks to the supply and demand for gold. We estimate the model for the post-2000 period using a novel dataset on the supply of gold and find that following a gold standard would result in dramatic increases in the volatilities of macroeconomic aggregates and a significant deterioration in household welfare. This is because the estimated shocks to gold supply and demand are significantly larger than for other more conventional aggregate shocks. In the end, what buries the gold standard turns out to be instability in the dynamics of gold itself.
    JEL: E31 E32 E42
    Date: 2020–10
  17. By: Almarina Gramozi; Theodore Palivos; Marios Zachariadis
    Abstract: We develop a search and matching model linking unequal access to employment with wage gaps, labor misallocation, and income losses. We then use microeconomic data for millions of individuals across the United States over the period from 1960 to 2017, to explore the misallocation effects arising due to frictions related to race and gender and to quantify their impact on aggregate economic outcomes. We systematically find that women and non-whites receive lower wages compared to their counterparts with similar individual characteristics. Within our theoretical model, such wage gaps coexist with talent misallocation due to the presence of workers that are underprivileged as a result of their gender or race. State-level misallocation implied by our estimated wage gaps is negatively related to productivity and output at the state level over the period under study. Furthermore, calibrating the theoretical model to match the US economy, we find that a fall in white privilege has a sizeable positive effect on aggregate income.
    Keywords: Economic growth; inefficiencies; wage gaps; race; gender.
    JEL: O4 O51 E0 J31
    Date: 2020–12
  18. By: Atsushi Motohashi (Kyoto University)
    Abstract: This study analyzes the effects of bailout policies on the growth rate and asset prices in a small open economy with asset bubbles. In our model, bubbles stimulate investment and economic activities (so-called “crowd-in effect” of bubbles). Thus, after bubble crushing occurs, recessions follow. Under this condition, we show that as long as bubbles persist, generous bailout policies raise the economic growth rate by enhancing the crowd-in effect. When bubbles burst, the bailout policy mitigates capital losses caused by the burst and accelerates economic growth and workers’ wages compared to the no-bailout case. Since the bailout policy has growth and recovery enhancing effects, a generous bailout policy is a desirable one for governments from the perspective of taxpayers’ welfare. It should be noted, however, that a U.S. monetary policy to reduce the interest rate enlarges the size of asset bubbles in a small open economy, and further reduction of the U.S. interest rate makes the size of asset bubbles too large to be sustainable without adequate policy intervention of the small open economy; the government needs to reduce the scale of bailouts to an appropriate level in response to the U.S. interest rate reduction.
    Keywords: Asset Bubbles; U.S. Interest Rate Policy; Economic Growth; Collapse of Asset Bubbles; Asset Prices; Bailout Policy
    JEL: E32 E44 E61 F43
    Date: 2020–12
  19. By: Michael Sposi; Kei-Mu Yi; Jing Zhang
    Abstract: Motivated by increasing trade and fragmentation of production across countries since World War II, we build a dynamic two-country model featuring sequential, multi-stage production and capital accumulation. As trade costs decline over time, global-value-chain (GVC) trade expands across countries, particularly more in the faster growing country, consistent with the empirical pattern. The presence of GVC trade boosts capital accumulation and economic growth and magnifies dynamic gains from trade. At the same time, endogenous capital accumulation shapes comparative advantage across countries, impacting the dynamics of GVC trade: a country becoming more capital abundant concentrates more on the capital-intensive stage of the production.
    JEL: E22 F10 F43 O4
    Date: 2020–11
  20. By: Jonathan Chiu; Mohammad Davoodalhosseini; Janet Hua Jiang; Yu Zhu
    Abstract: We use a simple model to study whether private payment systems based on bank deposits can provide the optimal level of safety. In the model, bank deposits backed by projects are subject to default risk that can be mitigated by a depositor's ex ante and ex post monitoring. Safe payment instruments issued by a narrow bank can also be used as a back-up payment system when the risky bank fails. Private adoption of safe payment instruments is generally not socially optimal when buyers do not fully internalize the externalities of their adoption decision on sellers, or when the provision of deposit insurance distorts their adoption incentives. Using this framework, we discuss the optimal subsidy policy conditional on the level of deposit insurance.
    Keywords: Central bank research; Digital currencies and fintech; Financial institutions; Payment clearing and settlement systems
    JEL: E42 E50 G21
    Date: 2020–12
  21. By: Viral V. Acharya; Timothy Johnson; Suresh Sundaresan; Steven Zheng
    Abstract: We provide an estimate of the value of a cure using the joint behavior of stock prices and a vaccine progress indicator during the ongoing COVID-19 pandemic. Our indicator is based on the chronology of stage-by-stage progress of individual vaccines and related news. We construct a general equilibrium regime-switching model of repeated pandemics and stages of vaccine progress wherein the representative agent withdraws labor and alters consumption endogenously to mitigate health risk. The value of a cure in the resulting asset-pricing framework is intimately linked to the relative labor supply across states. The observed stock market response to vaccine progress serves to identify this quantity, allowing us to use the model to estimate the economy-wide welfare gain that would be attributable to a cure. In our estimation, and with standard preference parameters, the value of the ability to end the pandemic is worth 5-15% of total wealth. This value rises substantially when there is uncertainty about the frequency and duration of pandemics. Agents place almost as much value on the ability to resolve the uncertainty as they do on the value of the cure itself. This effect is stronger – not weaker – when agents have a preference for later resolution of uncertainty. The policy implication is that understanding the fundamental biological and social determinants of future pandemics may be as important as resolving the immediate crisis.
    JEL: D5 G12 I1 Q54
    Date: 2020–11
  22. By: Greminger, Rafael (Tilburg University, School of Economics and Management)
    Date: 2019
  23. By: de Bresser, Jochem (Tilburg University, School of Economics and Management)
    Date: 2019

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