nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2021‒01‒18
34 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Fiscal DSGE Model for Latvia By Patrick Grüning; Ginters Buss
  2. Labor Market Informality and the Business Cycle By Frederic Lambert; Andrea Pescatori; Frederik G Toscani
  3. Sovereign Default Risk, Macroeconomic Fluctuations and Monetary-Fiscal Stabilization By Markus Kirchner; Malte Rieth
  4. A General and Efficient Method for Solving Regime-Switching DSGE Models By Julien Albertini; Stéphane Moyen
  5. Estimation of a Small Open Economy DSGE Model for Kazakhstan By Erlan Konebayev
  6. Incomplete Financial Markets and the Booming Housing Sector in China By Tamim Bayoumi; Yunhui Zhao
  7. Ramsey Optimal Policy in the New-Keynesian Model with Public Debt By Chatelain, Jean-Bernard; Ralf, Kirsten
  8. Job rotation or specialization? A dynamic matching model analysis By Morimitsu Kurino; Yoshinori Kurokawa
  9. Positive or negative real balance effects, involuntary unemployment, three-generations overlapping generations model By Tanaka, Yasuhito
  10. The Role of Nonlinearity in Indeterminate Models: An Application to Expectations-Driven Liquidity Traps By Yoichiro Tamanyu
  11. Liquidity Traps in a World Economy By Robert Kollmann
  12. Financial Frictions and Firm Informality: A General Equilibrium Perspective By Luis Franjo; Nathalie Pouokam; Francesco Turino
  13. On the long-run fluctuations of inheritance in two-sector OLG models By Florian Pelgrin; Alain Venditti
  14. Lending Relationships and Optimal Monetary Policy By Zachary Bethune; Guillaume Rocheteau; Russell Wong; Cathy Zhang
  15. Evaluating effectiveness of price level targeting in the presence of increasing uncertainty By Engin Kara; Ahmed Pirzada
  16. Idea Diffusion and Property Rights By Boyan Jovanovic; Zhu Wang
  17. Social Security Reform with Heterogeneous Mortality By John Bailey Jones; Yue Li
  18. Postponing Retirement and Social Security in a Two Sector Model By Partha Sen
  19. Output Distortions and the Choice of Legal Form of Organization By Katarzyna Anna Bilicka; Sepideh Raei
  20. Capital Gaps, Risk Dynamics, and the Macroeconomy By Fabian Lipinsky; Mirela S. Miescu
  21. Household Financial Distress and the Burden of 'Aggregate' Shocks By Kartik B. Athreya; Ryan Mather; Jose Mustre-del-Rio; Juan M. Sanchez
  22. Redistribution and the Monetary-Fiscal Policy Mix By Saroj Bhattarai; Jae Won Lee; Choongryul Yang
  23. Government Bonds, Bank Liquidity and Non-Neutrality of Monetary Policy in the Steady By Wang, Tianxi
  24. Should developed economies manage international capital flows? By Dennis Bonam; Gavin Goy; Emmanuel de Veirman
  25. Stabilisation et relance macroéconomiques post COVID-19 dans la CEMAC : Quels instruments pour quels effets dans un modèle DSGE ? By Mvondo, Thierry
  26. Efficient Solution and Computation of Models With Occasionally Binding Constraints By Gregor Boehl
  27. The Spirit of Capitalism and Consumption Inequality By Yulei Luo; Jun Nie; Heng-fu Zou
  28. Social Security and Endogenous Demographic Change: Child Support and Retirement Policies By Cipriani, Giam Pietro; Fioroni, Tamara
  29. Global Robust Bayesian Analysis in Large Models By Paul Ho
  30. Constrained Efficient Borrowing with Sovereign Default Risk By Juan Carlos Hatchondo; Leonardo Martinez; Francisco Roch
  31. The New Keynesian Model and Bond Yields By Martin M. Andreasen
  32. The Bribe Rate and Long Run Differences in Sovereign Borrowing Costs By Alok Johri; Johnny Cotoc
  33. Wage Risk and Government and Spousal Insurance By Mariacristina De Nardi; Giulio Fella; Gonzalo Paz-Pardo
  34. Bank liquidity, bank lending, and "bad bank" policies By Morrison, Alan D; Wang, Tianxi

  1. By: Patrick Grüning (Bank of Lithuania & Vilnius University); Ginters Buss (Latvijas Banka)
    Abstract: We develop a fiscal dynamic stochastic general equilibrium (DSGE) model for policy simulation and scenario analysis purposes tailored to Latvia, a small open economy in a monetary union. The fiscal sector elements comprise government investment, government consumption, government transfers that are asymmetrically directed to both optimizing and hand-to-mouth households, cyclical unemployment benefits, foreign ownership of government debt, import content in public consumption and investment, and fiscal rules for each fiscal instrument. The model features a search-and-matching labour market friction with pro-cyclical labour costs, a financial accelerator mechanism, and import content in final goods. We estimate the model using Latvian data, study the new channels in the model, and provide a comprehensive analysis on the macroeconomic effects of the fiscal elements. A particular finding is that having foreign ownership of government debt generally breaks the Ricardian equivalence paradigm.
    Keywords: Small open economy, Fiscal policy, Fiscal rules, Bayesian estimation
    JEL: E0 E2 E3 F4 H2 H3 H6
    Date: 2020–12–14
  2. By: Frederic Lambert; Andrea Pescatori; Frederik G Toscani
    Abstract: Labor market informality is a pervasive feature of most developing economies. Motivated by the empirical regularity that the labor informality rate falls with GDP per capita, both at business cycle frequency and in a cross-section of countries, and that the Okun's coefficient falls with the level of labor informality, we build a small open-economy dynamic stochastic general equilibrium model with two sectors, formal and informal, which can replicate these key stylized facts. The model is calibrated to Colombia. The results show that labor market and tax reforms play an important role in changing the informality rate but also caution against over-optimism - with low GDP per capita, informality will always be relatively high as there is insufficient demand for formal goods. Quantitatively we find that higher productivity in the formal sector is key in explaining the difference between Colombia and countries with significantly lower informality. We use the model to study how labor informality and labor market frictions mediate the cyclical response of the economy to shocks, including commodity price shocks which are particularly relevant in Latin America. Informality is shown to play an important role as a shock absorber with the informal-formal margin limiting movements in the employed-unemployed margin.
    Keywords: Total factor productivity;Labor;Labor markets;Business cycles;Unemployment;labor market,informality,business cycle,WP,commodity price shock,frictions affect labor market dynamics,GDP growth,sector TFP,labor market informality
    Date: 2020–11–20
  3. By: Markus Kirchner; Malte Rieth
    Abstract: This paper examines the role of sovereign default beliefs for macroeconomic fluctuations and stabilization 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 amplification 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 stabilization tools than hawkish inflation targeting.
    Date: 2020–12
  4. By: Julien Albertini (GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - CNRS - Centre National de la Recherche Scientifique - Université de Lyon - UJM - Université Jean Monnet [Saint-Étienne] - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon - UL2 - Université Lumière - Lyon 2 - ENS Lyon - École normale supérieure - Lyon); Stéphane Moyen (Deutsche Bundesbank - 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
    Date: 2020
  5. By: Erlan Konebayev (NAC Analytica, Nazarbayev University)
    Abstract: This paper adapts the DSGE (dynamic stochastic general equilibrium) model of Medina and Soto (2007) in the context of Kazakhstani economy, and fully estimates it using Bayesian methods. The main goal of the paper is to contribute to the scarce macroeconomic modeling literature on Kazakhstan. Overall, we find that the oil price shock is key in explaining the variance of virtually all the variables of interest - in particular, it accounts for more than 40% of variance in real exchange rate over the long-term horizon. Furthermore, while the oil price and commodity (oil) production shocks contributed positively to the country's GDP growth in real terms before the Great Recession, their effects have been primarily negative during the two major economic crises of 2007 and 2015, and the fiscal policy has had mixed success in counteracting them.
    Keywords: DSGE; Bayesian analysis; small open economy
    JEL: C11 E30 E32 E37
    Date: 2020–09
  6. By: Tamim Bayoumi; Yunhui Zhao
    Abstract: Housing is by far the most important asset in Chinese households’ balance sheets. However, despite forceful and frequent government interventions, the rise in Chinese housing prices has not been contained as much as intended, a trend that has not been reversed by the COVID-19 shock. In this paper, we first provide some stylized facts and then a DSGE model (encompassing both demand and supply channels) to highlight the impact of a “slow-moving” structural vulnerability—financial market incompleteness—on China’s housing prices. The model implies that to eradicate the root causes of the rising housing price, policymakers need to go beyond the housing market itself; instead, it would be desirable to deepen financial markets because these markets would help channel financial resources to productive sectors rather than to housing speculation. This is particularly important in the COVID era because without addressing this structural vulnerability, the higher household savings and the government stimulus may fuel the housing bubble and sow seeds for a future crisis. The paper can also shed light on the housing markets in other economies that face similar vulnerabilities.
    Date: 2020–12–04
  7. By: Chatelain, Jean-Bernard; Ralf, Kirsten
    Abstract: In the discrete-time new-Keynesian model with public debt, Ramsey optimal policy eliminates the indeterminacy of simple-rules multiple equilibria between the fiscal theory of the price level versus new-Keynesian versus an unpleasant equilibrium. If public debt volatility is taken into account into the loss function, the interest rate responds to public debt besides inflation and output gap. Else, the Taylor rule is identical to Ramsey optimal policy when there is zero public debt. The optimal fiscal-rule parameter implies the local stability of public-debt dynamics ("passive" fiscal policy).
    Keywords: Fiscal theory of the Price Level, Ramsey Optimal Policy, New-Keynesian model, Fiscal Rule, Taylor Rule, Multiple Equilibria.
    JEL: C61 C62 E43 E52 E61 E62 E63
    Date: 2020–12–12
  8. By: Morimitsu Kurino (Faculty of Economics, Keio University); Yoshinori Kurokawa (Faculty of Humanities and Social Sciences, University of Tsukuba)
    Abstract: Which works better when making a job assignment in firms, rotation or specialization? To answer this question, we develop a dynamic firm model of matching workers with indivisible jobs as in an overlapping generations (OLG) matching model a la Kurino (2014). First, we build a simple benchmark model without OLG in which all workers are either under-training or fully trained in each period, and then we show that either the rotation or the specialization of jobs for a worker emerges from the firms' profit maximization. We extend the benchmark model to the OLG model in which workers under- and posttraining coexist in each period. We show that the profit-maximizing allocation is either a rotation or a specialization in this extended model as well. Hence, in both the benchmark and the extended models, the rotation and specialization schemes are the only variations that can be optimal in terms of profits. Moreover, the rotation scheme is better when the training cost is smaller, the uncertainty about job continuation in the future is larger, or the slope of seniority wages is larger.Length: 36 pages
    Keywords: Job assignment, Overlapping generations, Rotation, Specialization
    JEL: C78 P51
    Date: 2020–12–17
  9. By: Tanaka, Yasuhito
    Abstract: We examine positive or negative real balance effect (or so-called Pigou effect) by falls in the nominal wage rate and the prices of the goods in situations where there is involuntary unemployment using a three-generations overlapping generations model with childhood period and pay-as-you go pension system for the older generation consumers. We will show that if the net savings of the younger generation consumers are larger than their debts due to consumption in their childhood period, there exists positive real balance effect and the employment increases by a fall in the nominal wage rate; on the other hand, if the net savings of the younger generation consumers are smaller than their debts, there exists negative real balance effect and the employment decreases by a fall in the nominal wage rate.
    Keywords: Positive or negative real balance effects, involuntary unemployment, three-generations overlapping generations model.
    JEL: E12 E24
    Date: 2020–11–24
  10. By: Yoichiro Tamanyu (Graduate School of Economics, Keio University)
    Abstract: This paper proposes a novel methodology to derive nonlinear solutions of an indeterminate DSGE model in which the decision rules are affected by sunspot shocks. We apply the method to an expectations-driven liquidity trap---a liquidity trap that arises because of the zero lower bound constraint on the nominal interest rate and the de-anchoring of economic agents' expectations---and find that the model dynamics exhibit significant nonlinearity. Such nonlinearity arises because the zero lower bound ceases to bind once the inflation rate rises because of a temporary increase in inflation expectations.
    Keywords: Indeterminacy, Nonlinearity, Sunspot, Expectations-Driven Liquidity Traps, Zero Lower Bound
    JEL: C62 C63 E31
    Date: 2020–11–28
  11. By: Robert Kollmann
    Abstract: This paper studies a New Keynesian model of a two-country world with a zero lower bound (ZLB) constraint for nominal interest rates. A floating exchange rate regime is assumed. The presence of the ZLB generates multiple equilibria. The two countries can experience recurrent liquidity traps induced by the self-fulfilling expectation that future inflation will be low. These "expectations-driven" liquidity traps can be synchronized or unsynchronized across countries. In an expectations-driven liquidity trap, the domestic and international transmission of persistent shocks to productivity and government purchases differs markedly from shock transmission in a "fundamentals-driven" liquidity trap.
    Keywords: Zero lower bound, expectations-driven and fundamentals-driven liquidity traps, domestic and international shock transmission, terms of trade, exchange rate, net exports
    Date: 2021–01
  12. By: Luis Franjo; Nathalie Pouokam; Francesco Turino
    Abstract: In this paper we build a model of occupational choice with informal production and progressive income taxation. We calibrate the model to the Brazilian economy to evaluate the impact of removing financial frictions on informality. We find that financial deepening leads to a drop in the size of the informal sector (from 37 percent to 22 percent of official GDP), to an increase in measured TFP (by 4 percent), to an increase in official GDP (by 27 percent), to a decrease in tax evasion (by 17 percent) and to an increase in fiscal revenues (by 15 percent). When assessing the response of this policy at different levels of financial development, we find a non-linear relationship between the credit-to-GDP ratio on the one hand, and either the size of the informal economy, or GDP per capita on the other hand. We test these features with cross-country data and find evidence in favor of both types of non-linearity. We also investigate changes in the income tax progressitivity as an alternative policy and find it to be more effective in countries with a medium to high level of financial markets development.
    Keywords: Self-employment;Tax evasion;Financial frictions;Credit;Informal economy;WP,informal firm,firms informality,survival firm,ghost firm,parasite firm
    Date: 2020–09–25
  13. By: Florian Pelgrin (École des hautes études commerciales du Nord (EDHEC)); Alain Venditti (AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique, École des hautes études commerciales du Nord (EDHEC))
    Abstract: This paper provides a long-run cycle perspective to explain the behavior of the annual flow of inheritance as identified by Piketty [51] for France and Atkinson [3] for the UK. Using a two-sector Barro-type [9] OLG model with non-separable preferences and bequests, we show that endogenous fluctuations are likely to occur through period-2 cycles or Hopf bifurcations. Two key mechanisms, which can generate independently or together quasi-periodic cycles, can be identified as long as agents are sufficiently impatient. The first mechanism relies on the elasticity of intertemporal substitution or equivalently the sign of the cross-derivative of the utility function whereas the second rests on sectoral technologies through the sign of the capital intensity difference across two sectors. Furthermore, building on the quasi-palindromic nature of the degree-4 characteristic equation, we derive some meaningful sufficient conditions associated to the occurrence of complex roots in a two-sector OLG model. Finally, we show that our theoretical results are consistent with some empirical evidence for medium- and long-run swings in the inheritance flows as a fraction of national income in France over the period 1896-2008.
    Keywords: two-sector overlapping generations model,optimal growth,endogenous fluctuations,quasi-palindromic polynomial,periodic and quasi-periodic cycles,altruism,bequest
    Date: 2020–12–17
  14. By: Zachary Bethune; Guillaume Rocheteau; Russell Wong; Cathy Zhang
    Abstract: We construct and calibrate a monetary model of corporate finance with endogenous formation of lending relationships. The equilibrium features money demands by firms that depend on their access to credit and a pecking order of financing means. We describe the mechanism through which monetary policy affects the creation of relationships and firms' incentives to use internal or external finance. We study optimal monetary policy following an unanticipated destruction of relationships under different commitment assumptions. The Ramsey solution uses forward guidance to expedite creation of new relationships by committing to raise the user cost of cash gradually above its long-run value. Absent commitment, the user cost is kept low, delaying recovery.
    Keywords: Credit relationships; banks; corporate finance; optimal monetary policy
    JEL: D83 E32 E51
    Date: 2020–09–25
  15. By: Engin Kara; Ahmed Pirzada
    Abstract: We argue that understanding the macroeconomic effects of increasing economic uncertainty requires understanding nominal rigidities. In the standard new Keynesian model where all firms face the same degree of nominal rigidity, heightened uncertainty leads to higher inflation and lower output. Introducing heterogeneity in price stickiness, suggested by micro-evidence on prices, changes this prediction of the model. In the new model, increased uncertainty leads to decrease in both inflation and output. These effects are more pronounced with higher trend inflation. We find that price-level targeting is more effective in dealing with the consequences of increasing uncertainty than inflation targeting.
    Date: 2021–01–07
  16. By: Boyan Jovanovic; Zhu Wang
    Abstract: We study the innovation and diffusion of technology at the industry level. We derive the full dynamic paths of an industry’s evolution, from birth to its maturity, and we characterize the impact of diffusion on the incentive to innovate. The model implies that protection of innovators should be only partial due to the congestion externality in meetings in which idea transfers take place. We fit the model to the early experiences of the automobile and personal computer industries both of which show an S-shaped growth of the number of firms.
    Keywords: Technology; Innovation
    Date: 2020–08–29
  17. By: John Bailey Jones; Yue Li
    Abstract: Using a heterogeneous-agent, life-cycle model of Social Security claiming, labor supply and saving, we consider the implications of lifespan inequality for Social Security reform. Quantitative experiments show that welfare is maximized when baseline benefits are independent of lifetime earnings, the payroll tax cap is kept roughly unchanged, and claiming adjustments are reduced. Eliminating the earnings test and the income taxation of Social Security benefits provides additional gains. The Social Security system that would maximize welfare in a "2050 demographics" scenario, characterized by longer lifespans and an increased education-mortality gradient, is similar to the one that would maximize welfare today.
    Keywords: Social security; Mortality; Labor Supply; Welfare
    JEL: E21 H24 H55 I38 J11
    Date: 2020–07–17
  18. By: Partha Sen
    Abstract: Pay-as-you-go (PAYG) social security schemes in the OECD countries are facing solvency problems, as people are living longer and birth rates have declined. Postponing the full retirement age (FRA), when retirees are entitled to full pension, has been proposed as a solution. This effectively lowers the payroll tax rate since pension is paid only in the post-FRA period. In a two-period two-sector overlapping generations model, I show that this shift lowers savings (because a part of the expected old age income is consumed in the first period), as employment increases. In the transition to the new steady state, capital is decumulated and the wage rate falls. Contrast this with a reduction of the payroll tax rate where the initial old suffer reduced consumption, but the young have higher post-tax income and this spurs capital accumulation.
    Keywords: overlapping generations, social security reform, postponing retirement
    JEL: H55
    Date: 2020
  19. By: Katarzyna Anna Bilicka; Sepideh Raei
    Abstract: We study the distortions to aggregate output created by the differential tax treatment of corporations and pass through entities. We develop an industry equilibrium model in which the legal form of organization is an endogenous choice for firms facing trade off between tax treatment of business income, access to external capital, and the evolution of productivity over time. We match this model to features of the US economy. We find that, relative to the benchmark economy, revenue-neutral tax reform in which legal forms receive the same tax treatments leads to 1.25% increase in the aggregate output.
    Keywords: output distortions, legal form of organization, pass through
    JEL: E62 H32 H25
    Date: 2020
  20. By: Fabian Lipinsky; Mirela S. Miescu
    Abstract: Motivated by the increasing interest in analyzing the links between the financial sector and the real economy, we develop a macro-financial structural model with two novel features. First, we include idiosyncratic and aggregate risk in a tractable general equilibrium model. This allows us to capture sectoral dynamics and the probabilities of default of both firms and financial intermediaries, and the feedback between them. Second, we introduce the concept of sticky (observed) versus flexible (agents’ target) capital. The identified differences between realized and optimal values — the capital gaps of firms and banks — lead financial and business cycles, and cause gaps in credit spreads and asset prices. The model can be used as a signaling device for macroprudential intervention, and to gauge whether macroprudential action was successful ex-post (e.g., whether gaps were closed). For illustration, we show how the analysis of gaps can be applied to the U.S. economy using Bayesian estimation techniques.
    Keywords: Nonbank financial institutions;Mutual funds;Financial statements;Credit;Financial crises;WP,capital gap,FIs capital,adjustment cost,cash flow,capital level,risk shock
    Date: 2020–09–25
  21. By: Kartik B. Athreya; Ryan Mather; Jose Mustre-del-Rio; Juan M. Sanchez
    Abstract: The goal of this paper is to show that household-level financial distress (FD) varies greatly, meaning there is unequal exposure to macroeconomic risk, and that FD can increase macroeconomic vulnerability. To do this, we first establish three facts: (i) regions in the U.S. vary significantly in their "FD-intensity," measured either by how much additional credit households therein can access, or in how delinquent they typically are on debts, (ii) shocks that are typically viewed as "aggregate" in nature hit geographic areas quite differently, and (iii) FD is an economic "pre-existing condition": the share of an aggregate shock borne by a region is positively correlated with the level of FD present at the time of the shock. Using an empirically disciplined and institutionally rich model of consumer debt and default, we show that in the shocks dealt by the Great Recession and in the initial months in the COVID-19 pandemic, FD mattered. Our model implies that the uneven distribution of FD creates widely varying consumption responses to shocks. This is true even when subjecting regions (with differing levels of FD) to the same shocks, which highlights the importance of FD independently of its correlation with shocks.
    Keywords: Geography; Consumption; Credit Card Debt; Reccession; Bankruptcy; Foreclosure; Mortgage; Delinquency; Financial Distress
    JEL: D31 D58 E21 E44 G11 G21
    Date: 2020–09–15
  22. By: Saroj Bhattarai; Jae Won Lee; Choongryul Yang
    Abstract: We show that the effectiveness of redistribution policy in stimulating the economy and improving welfare is directly tied to how much inflation it generates, which in turn hinges on monetary-fiscal adjustments that ultimately finance the transfers. We compare two distinct types of monetary-fiscal adjustments: In the monetary regime, the government eventually raises taxes to finance transfers while in the fiscal regime, inflation rises, effectively imposing inflation taxes on public debt holders. We show analytically in a simple model how the fiscal regime generates larger and more persistent inflation than the monetary regime. In a quantitative application, we use a two-sector, two-agent New Keynesian model, situate the model economy in a Covid-19 recession, and quantify the effects of the transfer components of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. We find that the transfer multipliers are significantly larger under the fiscal regime—which results in a milder contraction—than under the monetary regime, primarily because inflationary pressures of this regime counteract the deflationary forces during the recession. Moreover, redistribution produces a Pareto improvement under the fiscal regime.
    Keywords: household heterogeneity, redistribution, monetary-fiscal policy mix, transfer multiplier, welfare evaluation, Covid-19, CARES Act
    JEL: E53 E62 E63
    Date: 2020
  23. By: Wang, Tianxi
    Abstract: This paper studies non-neutrality of monetary policy in a model where fiat money is used by banks to meet liquidity demand and a government bond to collateralize reserve borrowing. It finds that if some banks are liquidity constrained, any monetary policy that alters the bond-to-fiat money ratio moves the interbank rate and is non-neutral in the steady state. Moreover, the effect for liquidity un-constrained banks is the opposite of that for the maximally constrained. Lastly, if the expansion of digital ways of payment eliminates depositor withdrawals, fiat money will stop circulation and a bullion standard will probably return.
    Date: 2021–01–12
  24. By: Dennis Bonam; Gavin Goy; Emmanuel de Veirman
    Abstract: At least since the euro area sovereign debt crisis, it is evident that country risk premium shocks have adverse economic effects, not only in emerging economies, but advanced economies as well. Using a Bayesian Panel Vector Autoregression model, we find that increases in the risk premium lower output under monetary union, yet not in countries with flexible exchange rates and independent monetary policies. We study the transmission mechanism in a two-country New Keynesian model and show that capital controls substantially attenuate the effects of risk premium shocks. However, the welfare gain of imposing capital controls hinges on the nature of the shock and the prevailing exchange rate regime.
    Keywords: Bayesian panel VAR; capital controls; exchange rate regime; welfare
    JEL: F32 F38 F41 F45
    Date: 2020–12
  25. By: Mvondo, Thierry
    Abstract: Ce papier s’intéresse à l’efficacité des mesures de stabilisation puis de relance macroéconomique post COVID-19 dans la CEMAC. A cet effet, un modèle DSGE est construit, prenant en compte les spécificités de la zone dont particulièrement une banque centrale appelée à assouplir ses conditions monétaires et, l’Etat creusant son déficit à travers l’émission de titres domestiques et étrangers ainsi que des allègements/exonérations fiscaux. Dans ce cadre, la COVID-19 est modélisée comme un processus autorégressif impactant directement certaines variables et, indirectement d’autres à travers le principe de chocs corrélés. Les simulations menées montrent que : (i) la modélisation retenue de la COVID-19 permet de répliquer les effets postulés de cette dernière dans la CEMAC ; (ii) les mesures budgétaires, quoique plus efficaces par rapport aux mesures monétaires et macroprudentielles pourraient avoir des effets distorsifs sur certaines variables financières et ; (iii) les effets obtenus prendraient 30 trimestres environ pour se réaliser complètement.
    Keywords: Choc COVID-19; Stabilisation; Relance macroéconomique; DSGE; CEMAC
    Date: 2021–01
  26. By: Gregor Boehl
    Abstract: Structural macroeconometric analysis and new HANK-type models with extremely high dimensionality require fast and robust methods to efficiently deal with occasionally binding constraints, especially since major developed economies have again hit the zero lower bound on nominal interest rates. This paper shows that a dynamic economic system with OBCs, depending on the expected duration of the constraint, can be represented in closed form. Combined with a set of simple equilibrium conditions, this can be exploited to avoid matrix inversions and simulations at runtime for significant gains in computational speed. An efficient implementation is provided in Python programming language. Benchmarking results show that for medium-scale models with an OBC more than 150,000 state space evaluations can be done per second. Even large HANK-type models with almost 1000 variables require only 0.1 ms per evaluation.
    Keywords: Occasionally Binding Constraints, Effective Lower Bound, Computational Methods
    Date: 2021–01
  27. By: Yulei Luo (Faculty of Business and Economics, University of Hong Kong); Jun Nie (Research Department, Federal Reserve Bank of Kansas City); Heng-fu Zou (China Economics and Management Academy, Central University of Finance and Economics)
    Abstract: In this paper we argue that Max Weber's (1904-05, German; 1958) theory on "spirit of capitalism" can be modeled via a direct preference for wealth. We incorporate the spirit of capitalism into a general equilibrium consumption-portfolio choice model to examine the effects on consumption inequality, equilibrium interest rate, and equity premium—an unexplored area in the literature. We provide closed-form solutions to help disentangle the effects of the spirit of capitalism in driving the key results. Quantitatively, we show that a small degree of the spirit of capitalism can improve the model’s predictions in all three dimensions (consumption inequality, equilibrium interest rate, and equity premium) simultaneously. We show our results are robust to more general specifications on the income process and to incorporating macroeconomic rare disasters. Finally, we compare the spirit of capitalism with a closely related hypothesis, habit formation, and find that they have opposite effects on equilibrium asset returns and consumption inequality.
    Date: 2021–01–02
  28. By: Cipriani, Giam Pietro (University of Verona); Fioroni, Tamara (University of Verona)
    Abstract: This paper studies retirement and child support policies in a small, open, overlapping-generations economy with PAYG social security and endogenous retirement and fertility decisions. It demonstrates that neither fertility nor retirement choices necessarily coincide with socially optimal allocation, because agents do not take into account the externalities of fertility and the elderly labor supply in the economy as a whole. It shows that governments can realize the first-best allocation by introducing a child allowance scheme and a subsidy to incentivize the labor supply of older workers. As an alternative to subsidizing the elderly labor supply, we show that the first-best allocation can also be achieved by controlling the retirement age. Finally, the model is simulated in order to study whether the policies devoted to realizing the social optimum in a market economy could be a Pareto improvement.
    Keywords: PAYG pensions, social security, endogenous fertility, endogenous retirement
    JEL: D10 H2 H55 J13 J18 J26
    Date: 2021–01
  29. By: Paul Ho
    Abstract: This paper develops a tool for global prior sensitivity analysis in large Bayesian models. Without imposing parametric restrictions, the methodology provides bounds for posterior means or quantiles given any prior close to the original in relative entropy, and reveals features of the prior that are important for the posterior statistics of interest. The author develops a sequential Monte Carlo algorithm and uses approximations to the likelihood and statistic of interest to implement the calculations. Applying the methodology to the error bands for the impulse response of output to a monetary policy shock in the New Keynesian model of Smets and Wouters (2007), the author shows that the upper bound of the error bands is very sensitive to the prior but the lower bound is not, with the prior on wage rigidity playing a particularly important role.
    Keywords: Bayesian models; Monte Carlo algorithm; New Keynesian model
    Date: 2020–06–30
  30. By: Juan Carlos Hatchondo; Leonardo Martinez; Francisco Roch
    Abstract: Using a quantitative sovereign default model, we characterize constrained efficient borrowing by a Ramsey government that commits to income-history-contingent borrowing paths taking as given ex-post optimal future default decisions. The Ramsey government improves upon the Markov government because it internalizes the effects of borrowing decisions in period t on borrowing opportunities prior to t. We show the effect of borrowing decisions in t on utility flows prior to t can be encapsulated by two single dimensional variables. Relative to a Markov government, the Ramsey government distorts borrowing decisions more when bond prices are more sensitive to borrowing, and changes in bond prices have a larger effect on past utility. In a quantitative exercise, more than 80% of the default risk is eliminated by a Ramsey government, without decreasing borrowing. The Ramsey government also has a higher probability of completing a successful deleveraging (without defaulting), while smoothing out the fiscal consolidation.
    Date: 2020–11–08
  31. By: Martin M. Andreasen (Aarhus University and CREATES and The Danish Finance Institute)
    Abstract: This paper presents a New Keynesian model to capture the linkages between macro fundamentals and the nominal yield curve. The model explains bond yields with a low level of news in expected inflation and plausible term premia. This implies that the slope of the yield curve predicts future bond returns, and that risk-adjusted historical bond returns satisfy the expectations hypothesis. A key implication of the model is that U.S. bond yields are consistent with demand shocks that are three times less inflationary than implied by a standard log-linearized New Keynesian model estimated without bond yields.
    Keywords: Inflation variance ratios, Robust structural estimation, Term premia, The expectations hypothesis, Unspanned macro variation
    JEL: E44 G12
    Date: 2021–01–09
  32. By: Alok Johri; Johnny Cotoc
    Abstract: The average cost of borrowing on international financial markets varies widely from nation to nation even after controlling for the varying levels of indebtedness of their governments. This suggests that markets assign country specific default risk assessments. In this paper we focus on one natural source of this difference – the quality of their institutions. We begin by showing that the average sovereign spread is positively related to the average percentage of a government contract that must be given as a “gift” in order to secure the contract. We then build a sovereign default model where the government is constrained to use corrupt bureaucrats to deliver public goods and services and manage its accounts. Using the gift data as a measure of the public resources diverted by bureaucrats, and the Rule of Law index as a measure of institutional quality, we estimate the diversion policy of bureaucrats and use it to calibrate our model to international data. We use the model to generate an artificial international data set where countries vary only in the institutional quality parameter. Running the same regressions on our artificial data, we find that average spreads are positively associated with the bribe (gift) rate and with average debt levels. The model implies that when revenue streams are low, a benefit of default is that public services net of bureaucratic diversion actually increase. Since the net gain in public services obtained by defaulting is decreasing in the level of institutional quality, international lenders assign lower default risk to those countries.
    Keywords: Sovereign default; country spreads; bureaucratic corruption; bribes; provision of public goods
    JEL: D73 F34 F41 G15 H63
    Date: 2021–01
  33. By: Mariacristina De Nardi; Giulio Fella; Gonzalo Paz-Pardo
    Abstract: The extent to which households can self-insure and the government can help them to do so depends on the wage risk that they face and their family structure. We study wage risk in the UK and show that the persistence and riskiness of wages depends on one's age and position in the wage distribution. We also calibrate a model of couples and singles with two alternative processes for wages: a canonical one and a flexible one that allows for the much richer dynamics that we document in the data. We use our model to show that allowing for rich wage dynamics is important to properly evaluate the effects of benefit reform: relative to the richer process, the canonical process underestimates wage persistence for women and generates a more important role for in-work benefits relative to income support. The optimal benefit configuration under the richer wage process, instead, is similar to that in place in the benchmark UK economy before the Universal Credit reform. The Universal Credit reform generates additional welfare gains by introducing an income disregard for families with children. While families with children are better off, households without children, and particularly single women, are worse off.
    JEL: D1 D12 D14 D15 H11 H2
    Date: 2020–12
  34. By: Morrison, Alan D; Wang, Tianxi
    Abstract: Why are bank deposits demandable when they are also negotiable? We present a General Equilibrium model in which demandable debt exposes banks to liquidity risk so that they can signal their types and ensure that their liabilities can circulate as a means of payment. Banks can manage their liquidity risk by altering their deposit rate and their lending scale. When banks are transparent, so that depositors have homogenous information about their assets, they use only the former tool: their lending scale is effcient, and they do not experience liquidity crisis. When banks are opaque, so that depositors receive private signals of their quality, they ineffciently shrink the scale of their lending. A bank's stock of liquid assets affects its capacity for risk taking. A "bad bank" policy can resolve liquidity crises by reducing the opacity of the bank's assets.
    Keywords: Liquidity crises, demandable deposits, negotiable deposits, bad bank policies
    Date: 2021–01–12

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