nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2021‒01‒04
28 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. How Important Is Health Inequality for Lifetime Earnings Inequality? By Roozbeh Hosseini; Karen A. Kopecky; Kai Zhao
  2. A Ramsey Theory of Financial Distortions By Marco Bassetto; Wei Cui
  3. Adding a fiscal rule into a DSGE model: How much does it change the forecasts? By Mikhail Andreyev
  4. News Shocks under Financial Frictions By Christoph Görtz; John D. Tsoukalas; Francesco Zanetti
  5. Losers amongst the losers: the welfare effects of the Great Recession across cohorts By Ferrari, Alessandro
  6. Estimating a Nonlinear New Keynesian Model with the Zero Lower Bound for Japan By Hirokuni Iiboshi; Mototsugu Shintani; Kozo Ueda
  7. DSGE Models under Imperfect Information: A Dynare-based Toolkit By Paul Levine; Joseph Pearlman; Bo Yang
  8. A General and Efficient Method for Solving Regime-Switching DSGE Models By Julien Albertini; Stéphane Moyen
  9. Labor Market Policies During an Epidemic By Serdar Birinci; Fatih Karahan; Yusuf Mercan; Kurt See
  10. Optimal Sustainable Intergenerational Insurance By Francesco Lancia; Alessia Russo; Tim Worrall
  11. The impact of EITC on education, labor market trajectories, and inequalities By Julien Albertini; Arthur Poirier; Anthony Terriau
  12. Block-Recursive Equilibria in Heterogenous-Agent Models By Leo Kaas
  13. Mandates and Monetary Rules a New Keynesian Framework By Szabolcs Deak; Paul Levine; Son T. Pham
  14. Precautionary Liquidity Shocks, Excess Reserves and Business Cycles By Bratsiotis, George; Theodoridis, Konstantinos
  15. A Model of the Euro Area, China and the United States: Trade Links and Trade Wars By Volha Audzei; Jan Bruha
  16. Demographic Structure, Knowledge Diffusion, and Endogenous Productivity Growth By Colin Davis; Ken-ichi Hashimoto; Ken Tabata
  17. Monetary Policy with Reserves and CBDC: Optimality, Equivalence, and Politics By Dirk Niepelt
  18. On the negatives of negative interest rates and the positives of exemption thresholds By Aleksander Berentsen; Hugo van Buggenum; Romina Ruprecht
  19. The COVID epidemic and the economic activity with acquired immunity By Juan Esteban Carranza; Juan David Martin; Álvaro José Riascos
  20. A convenient truth: The convenience yield, low interest rates and implications for fiscal policy By Dennis Bonam
  21. A Congestion Theory of Unemployment Fluctuations By Yusuf Mercan; Benjamin Schoefer; Petr Sedláček
  22. Monetary policy strategies in the New Normal: a model-based analysis for the euro area By Fabio Busetti; Stefano Neri; Alessandro Notarpietro; Massimiliano Pisani
  23. Optimal Carbon Pricing in General Equilibrium Revisited: Damages, Depreciation, and Discounting By Rick van der Ploeg; Armon Rezai
  24. The COVID-19 shock and a fiscal-monetary policy mix in a monetary union By Anna Bartocci; Alessandro Notarpietro; Massimiliano Pisani
  25. Whatever it takes to save the planet? Central banks and unconventional green policy By Ferrari, Alessandro; Landi, Valerio Nispi
  26. Credit Frictions in the Great Recession By Patrick J. Kehoe; Pierlauro Lopez; Virgiliu Midrigan; Elena Pastorino
  27. The Allocation OF Talent: Finance versus Entrepreneurship By Kirill Shakhnov
  28. Precautionary Money Demand in a Cash-in-Advance Model By Sergio Salas

  1. By: Roozbeh Hosseini (University of Georgia); Karen A. Kopecky (Emory University); Kai Zhao (University of Connecticut)
    Abstract: Using a dynamic panel approach, we provide empirical evidence that negative health shocks reduce earnings. The effect is primarily driven by the participation margin and is concentrated in less educated and poor health individuals. We build a dynamic, gen-eral equilibrium, lifecycle model that is consistent with these findings. In the model, individuals, whose health is risky and heterogeneous, choose to either work, or not work and apply for social security disability insurance (SSDI). Health impacts individuals’ productivity, SSDI access, disutility from work, mortality, and medical expenses. Cali-brating the model to the United States, we find that health inequality is an important source of lifetime earnings inequality: nearly 29 percent of the variation in lifetime earnings at age 65 is due to the fact that Americans face risky and heterogeneous life-cycle health profiles. A decomposition exercise reveals that the primary reason why individuals in the United States in poor health have low lifetime earnings is because they have a high probability of obtaining SSDI benefits. In other words, the SSDI program is an important contributor to lifetime earnings inequality. Despite this, we show that it is ex ante welfare improving and, if anything, should be expanded.
    Keywords: earnings, health, frailty, inequality, disability, dynamic panel estimation, life-cycle models
    JEL: D52 D91 E21 H53 I13 I18
    Date: 2020–12
  2. By: Marco Bassetto; Wei Cui
    Abstract: The interest rate on government debt is significantly lower than the rates of return on other assets. From the perspective of standard models of optimal taxation, this empirical fact is puzzling: typically, the government should finance expenditures either through contingent taxes, or by previously-issued state-contingent debt, or by labor taxes, with only minor effects arising from intertemporal distortions on interest rates. We study how this answer changes in an economy with financial frictions, where the government cannot directly redistribute towards the agents in need of liquidity, but has otherwise access to a complete set of linear tax instruments. We establish a stark result. Provided this is feasible, optimal policy calls for the government to increase its debt, up to the point at which it provides sufficient liquidity to avoid financial constraints. In this case, capital-income taxes are zero in the long run, and the returns on government debt and capital are equalized. However, if the fiscal space is insufficient, a wedge opens between the rate of return on government debt and capital. In this case, optimal long-run tax policy is driven by a trade-off between the desire to mitigate financial frictions by subsidizing capital and the incentive to exploit the quasi-rents accruing to producers of capital by taxing capital instead. This latter incentive magnifies the wedge between rates of return on publicly and privately-issued assets.
    Keywords: Low interest rates; Asset directed search; Capital tax; Financial constraints; Optimal level of government debt
    JEL: E44 E62 E22
    Date: 2020–12–23
  3. By: Mikhail Andreyev (Bank of Russia, Russian Federation)
    Abstract: This article analyses an expansion of the dynamic stochastic general equilibrium model presented in Kreptsev, Seleznev (2017) and used by the Bank of Russia to forecast macroeconomic variables. The model was supplemented with an extended description of the fiscal sector, which formalises the fiscal rule in effect in Russia and which is similar to the one used in Medina, Soto (2007). The model was estimated on the basis of Russian data. Based on impulse response functions, we analyse the stabilising effect of the fiscal rule on macroeconomic variables. It was found that the fiscal rule leads to a decrease in output volatility, a slight decrease in exchange rate volatility and a stronger disinflationary effect in response to a positive oil price shock. The forecast errors were used to analyse whether it is possible to apply the formalisation of the fiscal rule in order to improve the forecast of macroeconomic variables within the DSGE model. We found that the fiscal rule does not improve the quality of the forecasts.
    Keywords: DSGE model, fiscal rule, reserve fund, credit cycle, commodity prices, financial frictions, monetary policy
    JEL: D58 E47 E62 E63
    Date: 2020–11
  4. By: Christoph Görtz; John D. Tsoukalas; Francesco Zanetti
    Abstract: We examine the dynamic effects and empirical role of TFP news shocks in the context of frictions in financial markets. We document two new facts using VAR methods. First, a (positive) shock to future TFP generates a significant decline in various credit spread indicators considered in the macro-finance literature. The decline in the credit spread indicators is associated with a robust improvement in credit supply indicators, along with a broad based expansion in economic activity. Second, VAR methods also establish a tight link between TFP news shocks and shocks that explain the majority of un-forecastable movements in credit spread indicators. These two facts provide robust evidence on the importance of movements in credit spreads for the propagation of news shocks. A DSGE model enriched with a financial sector generates very similar quantitative dynamics and shows that strong linkages between leveraged equity and excess premiums, which vary inversely with balance sheet conditions, are critical for the amplification of TFP news shocks. The consistent assessment from both methodologies provides support for the traditional ‘news view’ of aggregate fluctuations.
    Keywords: news shocks, business cycles, DSGE, VAR, Bayesian estimation
    JEL: E20 E30
    Date: 2020
  5. By: Ferrari, Alessandro
    Abstract: This paper studies the effect of deep recessions on intergenerational inequality by quantifying the welfare effects on households at different phases of the life cycle. Deep recessionary episodes are characterized by large declines in the prices of real and financial assets and in employment. The former levies high welfare costs on older households who own financial wealth, the latter determines labour income losses and destroys the human capital of younger cohorts, lowering their productivity. The paper extends previous analyses in the literature by including permanent labour income losses in an OLG model calibrated to match the Great Recession. The analysis shows that younger households lose more than double of all other living cohorts, as younger household become unemployed and experience a decline in their future income. The dynamics of households’ consumption and portfolio composition between 2007 and 2013 in the US are consistent with the predictions of the model. JEL Classification: E21, D31, D58, D63, D91
    Keywords: aggregate risk, inequality, overlapping generations, portfolio choice, youth unemployment
    Date: 2020–12
  6. By: Hirokuni Iiboshi; Mototsugu Shintani; Kozo Ueda
    Abstract: Which type of monetary policy rule best describes the policy conducted by the Bank of Japan during the period when the nominal interest rate is constrained at the zero lower bound (ZLB)? What are the economic fundamentals that explain Japan's prolonged stagnation? How important is incorporating nonlinearities in the analysis? We answer these questions by estimating a small-scale nonlinear DSGE model. We find that: the Bank of Japan conducted a threshold-based forward guidance policy; adverse demand shocks explain Japan's experience; and nonlinear models are very useful in the analysis of the Japanese economy during the ZLB period.
    Date: 2020–12
  7. By: Paul Levine (University of Surrey and CIMS); Joseph Pearlman (City University); Bo Yang (Swansea University)
    Abstract: This paper describes a Dynare-based toolbox which solves, simulates and estimates DSGE rational expectations (RE) models under perfect or imperfect information on the part of agents. The toolbox also delivers tests and conditions for exact and approximate invertibility providing information as to how well VAR residuals map the structural shocks in the RE solution to the DSGE model. Seven working examples come with the package including a version of the Smets and Wouters (2007) model and a standard small-scale New Keyesian (NK) DSGE model. The estimation exercise is conducted on both the NK and Smets-Wouters models. The paper provides alternative estimation results and an assessment for fundamentalness of structural shocks assuming that RE agents do not observe all current state variables (including shock processes) and only have an imperfect information set. Sections of the paper also examine the impulse response functions and unconditional second moments of the estimated model and discuss endogenous persistence.
    Date: 2020–12
  8. By: Julien Albertini (Univ Lyon, Université Lumière Lyon 2, GATE UMR 5824, F-69130 Ecully, France); Stéphane Moyen (Deutsche Bundesbank)
    Abstract: This paper provides a general representation of endogenous and threshold-based regime switching models and develops an efficient numerical solution method. The regime-switching is triggered endogenously when some variables cross threshold conditions that can themselves be regime-dependent. We illustrate our approach using a RBC model with state-dependent government spending policies. It is shown that regime-switching models involve strong non linearities and discontinuities in the dynamics of the model. However, our numerical solution based on simulation and projection methods with regime-dependent policy rules is accurate, and fast enough, to efficiently take into all these challenging aspects. Several alternative specifications to the model and the method are studied.
    Keywords: Regime-switching, RBC model, simulation, accuracy
    JEL: E3 J6
    Date: 2020
  9. By: Serdar Birinci; Fatih Karahan; Yusuf Mercan; Kurt See
    Abstract: We study the positive and normative implications of labor market policies that counteract the economic fallout from containment measures during an epidemic. We incorporate a standard epidemiological model into an equilibrium search model of the labor market to compare unemployment insurance (UI) expansions and payroll subsidies. In isolation, payroll subsidies that preserve match capital and enable a swift economic recovery are preferred over a cost-equivalent UI expansion. When considered jointly, however, a cost-equivalent optimal mix allocates 20 percent of the budget to payroll subsidies and 80 percent to UI. The two policies are complementary, catering to different rungs of the productivity ladder. The relatively small proportion allocated to payroll subsidies is sufficient to preserve high-productivity jobs but this also leaves room for social assistance to workers who face inevitable job losses.
    Keywords: Coronavirus disease (COVID-19); Business fluctuations and cycles; Fiscal policy; Labour markets
    JEL: E24 E62 J64
    Date: 2020–12
  10. By: Francesco Lancia; Alessia Russo; Tim Worrall
    Abstract: Optimal intergenerational insurance is examined in a stochastic overlapping generations endowment economy with limited enforcement of risk-sharing transfers. Transfers are chosen by a benevolent planner who maximizes the expected discounted utility of all generations while respecting the participation constraint of each generation. We show that the optimal sustainable intergenerational insurance is history dependent. The risk from a shock is unevenly spread into the future, generating heteroscedasticity and autocorrelation of consumption even in the long run. The optimum can be interpreted as a social security scheme characterized by a minimum welfare entitlement for the old and state-contingent entitlement thresholds.
    Keywords: Intergenerational insurance, Limited commitment, Risk sharing, Stochastic overlapping generations
    JEL: D64 E21 H55
    Date: 2020–12
  11. By: Julien Albertini (Univ Lyon, Université Lumière Lyon 2, GATE UMR 5824, F-69130 Ecully, France); Arthur Poirier (GAINS, University of Le Mans); Anthony Terriau (GAINS, University of Le Mans)
    Abstract: As a complement to the federal EITC, some states offer their own EITC, typically calculated as a percentage of the federal EITC. In this paper, we analyze the effect of state EITC on education using policy discontinuities at U.S. state borders. Our estimates reveal that an increase in state EITC leads to a statistically significant drop in high school completion. We then use a life-cycle matching model with directed search and endogenous educational choices, search intensities, hirings, hours worked, and separations to investigate the effects of EITC on the labor market in the long run and along the transitional dynamics. We show that a tax credit targeted at low-wage (and low-skilled) workers reduces the relative return to schooling, thereby generating a powerful disincentive to pursue long-term studies. In the long run, this results in an increase in the proportion of low-skilled workers in the economy, which may have important implications in terms of employment, productivity, and income inequalities.
    Keywords: EITC, Education, Human capital, Search and matching, Life cycle
    JEL: D15 E24 H24 I24 J24 J6
    Date: 2020
  12. By: Leo Kaas
    Abstract: Equilibrium models with heterogeneous agents and aggregate uncertainty are difficult to analyze since policy functions and market prices depend on the cross-sectional distribution over agents’ state variables which is generally a high-dimensional object. This paper develops and applies a general model framework in which this problem does not arise. If sufficiently many agents enter the economy in every aggregate state of the world, policy functions and prices depend only on the exogenous aggregate state but are independent of the distribution over idiosyncratic states. The first part of this paper proves existence results for such block-recursive equilibria and derives an ergodic property which is useful for their computation. The second part applies this equilibrium concept to models of firm dynamics with competitive or frictional input markets and to incomplete-market economies with endogenous asset market participation.
    Keywords: block-recursive equilibrium, dynamic general equilibrium, heterogeneous agents
    JEL: C62 D50 E32
    Date: 2020
  13. By: Szabolcs Deak (University of Exeter and CIMS); Paul Levine (University of Surrey and CIMS); Son T. Pham (University of Surrey)
    Abstract: We develop a general mandate framework for delegating monetary policy to an instrument-independent, but goal-dependent central bank. The goal of the mandate consists of: (i) a simple quadratic loss function that penalizes deviations from target macroeconomic variables; (ii) a form of a Taylor-type nominal interest-rate rule that responds to the same target variables; (iii) a zero-lower-bound (ZLB) constraint on the nominal interest rate in the form of an unconditional probability of ZLB episodes and (iv) a long-run (steady-state) inflation target. The central bank remains free to choose the strength of its response to the targets specified by the mandate. An estimated standard New Keynesian model is used to compute household-welfare-optimal mandates with these features. We find two main results that are robust across a number of different mandates: first, the optimized rule takes the form of a Taylor simple rule close to a price-level rule. Second, the optimal level of inflation target, conditional on a quarterly frequency of the nominal interest hitting the ZLB of 0.025, is close to the typical target annual inflation of 2% and to achieve a lower probability of 0.01 requires an inflation target of 3.5%.
    JEL: E52 E58 E61
    Date: 2020–08
  14. By: Bratsiotis, George (Department of Economics, University of Manchester); Theodoridis, Konstantinos (Cardiff Business School)
    Abstract: This paper identifies a precautionary banking liquidity shock via a set of sign, zero and forecast variance restrictions imposed. The shock proxies the reluctance of the banking sector to "lend" to the real economy induced by an exogenous change in financial intermediaries' preference for "high" liquid assets. The identified shock has sizeable and state (volatility) dependent effects on the real economy. To understand the transmission of the shock, we develop a DSGE model of financial intermediation with credit and liquidity frictions. The precautionary liquidity shock is shown to work through two channels: it increases the level of reserves and the deposit rate. The former is a balance sheet effect, which reduces the loan-to-deposit ratio. The higher deposit rate affects the intertemporal decisions of households and the cost of borrowing to firms. The overall effect is a downward co-movement in output, consumption, investment and prices, which is amplified the higher are the long-run risks in the economy and the responsiveness of banks to potential risk.
    Keywords: House Prices, SVAR; Sign and Zero Restrictions; DSGE; Precautionary Liquidity Shock; Excess Reserves; Deposit Rate; Risk, Financial Intermediation.
    JEL: C10 C32 E30 E43 E51 G21
    Date: 2020–12
  15. By: Volha Audzei; Jan Bruha
    Abstract: In this paper we develop a dynamic stochastic general equilibrium model featuring the euro area, the United States and China, with an exogenous rest of the world. The countries in the model are linked through trade and international bond purchases. Having estimated the model, we study several scenarios of trade wars between the countries. Our findings suggest that no country benefits from imposing tariffs in the long run. The degree to which a particular country is hurt depends on the strength of its import and export links.
    Keywords: Bayesian estimation, China, multi-country DSGE, trade wars
    JEL: C11 E37 F13 F41
    Date: 2020–12
  16. By: Colin Davis; Ken-ichi Hashimoto; Ken Tabata
    Abstract: This paper considers how increasing longevity and declining birth rates affect market entry and endogenous productivity growth in a two-country model of trade. In each country, the demographic transition to an older population induces a contraction in the labor force through a decline in the working-age population. Firm-level investment in process innovation generates productivity growth, and with imperfect knowledge diffusion the country with the larger labor force has a greater share of firms with higher productivity levels. In this framework, population aging reduces a country’s labor supply, share of industry, and relative productivity. If the country with the smaller labor force experiences population aging, knowledge spillovers improve and the rate of productivity growth rises, as the level of market entry falls. Alternatively, population aging in the country with the larger labor force weakens knowledge spillovers and lowers the rate of productivity growth, but has an ambiguous affect on market entry. We show that the effects of population aging may be reversed by extending retirement age, and consider the welfare implications for demographic transition and retirement age extension arising in our framework through a quantitative analysis based on population data for the United States and Western Europe.
    Date: 2020–12
  17. 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 differ 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 profits, money creation
    JEL: E42 E43 E51 E52
    Date: 2020
  18. By: Aleksander Berentsen; Hugo van Buggenum; Romina Ruprecht
    Abstract: Major central banks remunerate reserves at negative interest rates and it is increasingly likely that they will keep rates negative for many more years. To study the long run implications of negative rates, we construct a dynamic general equilibrium model with commercial banks funding investment projects and a central bank issuing reserves. Negative rates distort investment decisions resulting in lower output and welfare. These findings sharply contrast the short-run expansionary effects ascribed to negative rate policies by most of the existing literature. Negative rates also reduce commercial bank profitability. Exempting a fraction of reserves from negative rates can resolve profitability concerns without affecting the central bank's ability to control the money market rate. However, exemption thresholds do no mitigate the investment distortions created by negative rates.
    Keywords: Negative interest rate, money market, monetary policy, interest rates
    JEL: E40 E42 E43 E50 E58
    Date: 2020–12
  19. By: Juan Esteban Carranza; Juan David Martin; Álvaro José Riascos
    Abstract: We calibrate a macroeconomic model with epidemiological restrictions using Colombian data. The key feature of our model is that a portion of the population is immune and cannot transmit the virus, which improves substantially the fit of the model to the observed contagion and economic activity data. The model implies that government restrictions and the endogenous changes in individual behavior saved around 15,000 lives and decreased consumption in 2020 by about 4.7%. The results suggest that most of this effect was the result of the government policies. **** Calibramos un modelo macroeconómico con restricciones epidemiológicas utilizando datos colombianos. La característica clave de nuestro modelo es que una parte de la población es inmune y no puede transmitir el virus, lo cual mejora sustancialmente el ajuste del modelo a los datos de contagio y actividad económica observados. El modelo implica que las restricciones gubernamentales y los cambios endógenos en el comportamiento individual salvaron alrededor de 15,000 vidas y redujeron el consumo en 2020 en aproximadamente un 4.7 %. Los resultados sugieren que la mayor parte de este efecto fue el resultado de las políticas gubernamentales.
    Keywords: Colombia, Epidemic, COVID-19, recessions, containment policies, SIR macro model, Colombia, epidemia, COVID-19, recesiones, políticas de confinamiento, Modelo macro SIR.
    JEL: E1 I1 H0
    Date: 2020–12
  20. By: Dennis Bonam
    Abstract: Some countries currently face historically low interest rates on government debt due to a positive 'convenience yield' arising from an excess demand for safe and liquid assets. This low interest rate environment has raised interest in the role of fiscal stabilization policy. We study the convenience yield and its implications for fiscal policy in a New Keynesian model where households derive utility from government bonds. We find that the convenience yield expands the set of sustainable fiscal policies and renders countercyclical fiscal policy successful in stabilizing business cycle fluctuations. Conveniently, fiscal policies that stabilize output rather than debt are feasible, welfare enhancing and can even reduce the risk of exploding debt dynamics if the convenience yield is positive.
    Keywords: convenience yield; low interest rate; fiscal policy; debt sustainability
    JEL: E32 E62 E63
    Date: 2020–12
  21. By: Yusuf Mercan; Benjamin Schoefer; Petr Sedláček
    Abstract: In recessions, unemployment increases despite the—perhaps counterintuitive—fact that the number of unemployed workers finding jobs expands. On net, unemployment rises only because even more workers lose their jobs. We propose a theory of unemployment fluctuations resting on this countercyclicality of gross flows from unemployment into employment. In recessions, the abundance of new hires “congests” the jobs the unemployed fill, diminishes their marginal product and discourages further job creation. Countercyclical congestion alone explains about 30–40 percent of U.S. unemployment fluctuations. Besides generating realistic labor market volatility, it also provides a unified explanation for the cyclical labor wedge, the excess earnings losses from job displacement and from graduating during recessions, and the insensitivity of unemployment to labor market policies, such as unemployment insurance.
    Keywords: unemployment, business cycles, recessions
    JEL: E24 J63 J64
    Date: 2020
  22. By: Fabio Busetti; Stefano Neri (Bank of Italy); Alessandro Notarpietro (Bank of Italy); Massimiliano Pisani (Bank of Italy)
    Abstract: A New Keynesian model calibrated to the euro area is used to evaluate the stabilization properties of alternative monetary policy strategies when the natural interest rate is low (‘new normal’) and the probability of reaching the effective lower bound (ELB) is non-negligible. Price level targeting is the most effective strategy in terms of stabilizing inflation and output and of reducing the duration and frequency of ELB episodes. Temporary price level targeting is also effective in mitigating the ELB constraint, although its stabilization properties are inferior to those of price level targeting. Backward-looking average inflation targeting performs well and is preferable to inflation targeting. The effectiveness of these alternative strategies hinges upon the commitment of a central bank to keeping the policy rate ‘lower for longer’ and is influenced by the agents’ expectation formation mechanism.
    Keywords: monetary policy, natural interest rate, effective lower bound.
    JEL: E31 E32 E58
    Date: 2020–12
  23. By: Rick van der Ploeg; Armon Rezai
    Abstract: The tractable general equilibrium model developed by Golosov et al. (2014), GHKT for short, is modified to allow for additional negative impacts of global warming on utility and productivity growth, mean reversion in the ratio of climate damages to production, labour-augmenting technical progress, and population growth. We also replace the GHKT assumption of full depreciation of capital each decade by annual logarithmic depreciation. Furthermore, we allow the government to use a lower discount rate than the private sector. We derive a tractable rule for the optimal carbon price for each of these extensions which contain the GHKT model as a special case. Finally, the GHKT model is simplified by modelling temperature as cumulative emissions and calibrated to Burke et al. (2015) damages. We illustrate our analytical rules with a range of optimal policy simulations.
    Keywords: carbon price, tractable rule, general equilibrium, utility and growth damages, technical progress, population growth, logarithmic depreciation, differential discount rules
    JEL: H21 Q51 Q54
    Date: 2020
  24. By: Anna Bartocci (Bank of Italy); Alessandro Notarpietro (Bank of Italy); Massimiliano Pisani (Bank of Italy)
    Abstract: This paper evaluates the macroeconomic effects of a monetary and fiscal policy mix implemented in a two-region monetary union in response to the COVID-19 shock. The pandemic is modelled as a mix of recessionary demand and supply shocks affecting both regions simultaneously and symmetrically, under two assumptions: the effective lower bound (ELB) constrains the monetary policy rate; and a fraction of households, labelled ‘hand-to-mouth’ (HTM), consume all their available income in every period. The main results are the following: first, higher lump-sum targeted fiscal transfers to HTM households and public consumption spending in one region, financed by issuing public debt, reduce the recessionary effects both domestically and abroad (via the trade channel). Second, the monetary union-wide recession is mitigated more effectively if both regions implement a fiscal expansion and the central bank limits the increase in long-term rates by purchasing sovereign bonds. Third, fiscal measures are less effective if sovereign bond yields increase relatively more in one region because investors perceive its bonds as risky. Effectiveness can be regained if a supranational fiscal authority issues a safe bond.
    Keywords: monetary policy, fiscal policy, effective lower bound
    JEL: E31 E32 E58
    Date: 2020–12
  25. By: Ferrari, Alessandro; Landi, Valerio Nispi
    Abstract: We study the effects of a temporary Green QE, defined as a policy that temporarily tilts the central bank’s balance sheet toward green bonds, i.e. bonds issued by firms in non-polluting sectors. To this purpose, we merge a standard DSGE framework with an environmental model. In our model, detrimental emissions produced by the brown sector increase the stock of pollution. We find that the imperfect substitutability between green and brown bonds is a necessary condition for the effectiveness of Green QE. Under the assumption of imperfect substitutability, we point out the following results. A temporary Green QE is an effective tool in mitigating detrimental emissions. However, Green QE has limited effects in reducing the stock of pollution, if pollutants are slow-moving variables such as atmospheric carbon. The welfare gains of Green QE are positive but small. Welfare gains increase if the flow of emissions negatively affects also the utility of households. JEL Classification: E52, E58, Q54
    Keywords: central bank, climate change, monetary policy, quantitative easing
    Date: 2020–12
  26. By: Patrick J. Kehoe; Pierlauro Lopez; Virgiliu Midrigan; Elena Pastorino
    Abstract: Although a credit tightening is commonly recognized as a key determinant of the Great Recession, to date, it is unclear whether a worsening of credit conditions faced by households or by firms was most responsible for the downturn. Some studies have suggested that the household-side credit channel is quantitatively the most important one. Many others contend that the firm-side channel played a crucial role. We propose a model in which both channels are present and explicitly formalized. Our analysis indicates that the household-side credit channel is quantitatively more relevant than the firm-side credit channel. We then evaluate the relative benefits of a fixed-sized transfer to households and to firms that improves each group's access to credit. We find that the effects of such a transfer on employment are substantially larger when the transfer targets households rather than firms. Hence, we provide theoretical and quantitative support to the view that the employment decline during the Great Recession would have been less severe if instead of focusing on easing firms' access to credit, the government had expended an equal amount of resources to alleviate households' credit constraints.
    Keywords: Credit constraints; Collateral constraints; Great Recession; Financial recession; Government transfers
    JEL: E30 E32 E62 H51 J20 J60
    Date: 2020–12–15
  27. By: Kirill Shakhnov (University of Surrey)
    Abstract: The rapid growth of US financial services coupled with rapid increases in wealth inequality have been focusing policy debate as to the function of the financial sector and on its social desirability as a whole. I propose a heterogeneous agent model with asymmetric information and matching frictions that produces a tradeoff between finance and entrepreneurship. By becoming bankers, talented agents efficiently match investors with entrepreneurs, but extract excessive informational rents due to contract incompleteness. Thus the financial sector is inefficiently large in equilibrium, and this inefficiency increases with wealth inequality. The estimated model accounts for the simultaneous growth of wealth inequality and the financial sector in the US. The endogenous feedback between inequality and the size of the financial sector is quantitatively important.
    JEL: E44 E24 G14 L26
    Date: 2020–12
  28. By: Sergio Salas
    Abstract: Despite a plethora of studies in monetary economics regarding the study of inflation, interest rates, stock returns, and velocity of money, a model that helps to jointly characterize these interactions is still scarce in the literature. A key missing piece in most of the literature attempting such a characterization is idiosyncratic precautionary money demand, which is prevalent in the data. This paper presents a simple model where precautionary money demand arises due to heterogeneity in households' liquidity needs. In spite of its heterogeneous complexity, aggregation in the model is straightforward, this is one of the main contributions of the paper, and therefore an analysis of the models' implications can be undertaken when households' portfolio is composed of cash, government bonds, and equity. The empirical analysis is conducted separately for the time spans 1984.I-2007.IV and 2008.I-2019.IV. The model can capture important time-series properties that a model without the idiosyncratic feature is unable to achieve. However, the model falls short of providing an adequate match of some moments, especially in the second sub-sample of the analysis.
    Keywords: Precautionary money demand, Portfolio allocation, Heterogeneity, Government bonds, Stock Market, Open market operations
    JEL: E41 E51
    Date: 2020–12

This nep-dge issue is ©2021 by Christian Zimmermann. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.