nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2021‒01‒25
thirty-two 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. Managing Macrofinancial Risk By Tobias Adrian; Francis Vitek
  3. Shocks and Frictions in US Business Cycle: A Bayesian DSGE Approach By Mansur, Alfan
  4. Oil Price Shocks and Macroeconomic Dynamics in an Oil-Exporting Emerging Economy: A New Keynesian DSGE Approach By Oladunni, Sunday
  5. The macroprudential toolkit: effectiveness and interactions By Millard, Stephen; Rubio, Margarita; Varadi, Alexandra
  6. Financial Amplification of Labor Supply Shocks By Nina Biljanovska; Alexandros Vardoulakis
  7. Will Germany's Temporary VAT Tax Rates Cut as Part of the Covid-19 Fiscal Stimulus Package Boost Consumption and Growth? By Michael Funke; Raphael Terasa
  8. Technology, demand, and productivity: what an industry model tells us about business cycles By Molnarova, Zuzana; Reiter, Michael
  9. Endogenous growth, skill obsolescence and output hysteresis in a New Keynesian model with unemployment By Lechthaler, Wolfgang; Tesfaselassie, Mewael F.
  10. Investment housing tax concessions and welfare: Evidence from Australia By Yunho Cho; Shuyun May Li; Lawrence Uren
  11. Part and Full-Time Employment over the Business Cycle By Griffy, Benjamin; Gomis-Porqueras, Pedro
  12. Demographic Transition and Pension Reforms: Adding Demographics to GIMF By Benjamin Carton; Emilio Fernández Corugedo; Benjamin L Hunt; Simon Voigts
  13. The g3+ Model: An Upgrade of the Czech National Bank’s Core Forecasting Framework By Frantisek Brazdik; Tibor Hledik; Zuzana Humplova; Iva Martonosi; Karel Musil; Jakub Rysanek; Tomas Sestorad; Jaromir Tonner; Stanislav Tvrz; Jan Zacek
  14. Earnings and Labor Market Dynamics: Indirect Inference Based on Swedish Register Data By Holmberg, Johan
  15. What drives fluctuations of labor wedge and business cycles? Evidence from Japan By Masaru Inaba; Kengo Nutahara; Daichi Shirai
  16. Stamping out stamp duty: Property or consumption taxes? By Yunho Cho; Shuyun May Li; Lawrence Uren
  17. Unemployment Duration and the Take-up of Unemployment Insurance By Blasco, Sylvie; Fontaine, Francois
  18. Liquidity Traps in a World Economy By Kollmann, Robert
  19. Aggregate-Demand Amplification of Supply Disruptions: The Entry-Exit Multiplier By Florin O. Bilbiie; Marc J. Melitz
  20. Government Spending Effects in a Policy Constrained Environment By Ruoyun Mao; Shu-Chun Susan Yang
  21. Recursive Preferences, the Value of Life, and Household Finance By Antoine Bommier; Daniel Harenberg; François Le Grand; Cormac O'Dea
  22. Political Constraints and Sovereign Default Premia By Nirvana Mitra
  23. A Quantitative Model for the Integrated Policy Framework By Tobias Adrian; Christopher J. Erceg; Jesper Lindé; Pawel Zabczyk; Jianping Zhou
  24. Optimally Controlling an Epidemic By Martín Gonzalez-Eiras; Dirk Niepelt
  25. Redistribution and the monetary–fiscal policy mix By Saroj Bhattarai; Jae Won Lee; Choongryul Yang
  26. Policy Maker's Credibility with Predetermined Instruments for Forward-Looking Targets By Chatelain, Jean-Bernard; Ralf, Kirsten
  27. Efficient solution and computation of models with occasionally binding constraints By Böhl, Gregor
  28. On Government Spending and Income Inequality under Monopolistic Competition By Juin-Jen Chang; Jang-Ting Guo; Wei-Neng Wang
  29. Macroeconomic effects of EU Competition Policy By Merino Troncoso, Carlos
  30. Wage Risk and Government and Spousal Insurance By Mariacristina De Nardi; Giulio Fella
  31. Income Volatility and Portfolio Choices By Yongsung Chang; Jay H. Hong; Marios Karabarbounis; Yicheng Wang
  32. Central Bank Digital Currency: When Price and Bank Stability Collide By Linda Schilling; Jesús Fernández-Villaverde; Harald Uhlig

  1. By: Roozbeh Hosseini; Karen A. Kopecky; Kai Zhao
    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 individuals and those with poor health. We build a dynamic, general equilibrium, life cycle 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 affects individuals’ productivity, SSDI access, disutility from work, mortality, and medical expenses. Calibrating 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: 2021–01–04
  2. By: Tobias Adrian; Francis Vitek
    Abstract: We augment a linearized dynamic stochastic general equilibrium (DSGE) model with a tractable endogenous risk mechanism, to support the joint analysis of monetary and macroprudential policy. This state dependent conditional heteroskedasticity mechanism specifies the conditional variances of structural shocks as functions of the business or financial cycle. The resultant heteroskedastic linearized DSGE model preserves the satisfactory simulation and forecasting performance of its nested homoskedastic counterpart for the conditional means of endogenous variables, while substantially improving its goodness of fit to their conditional distributions. In particular, the model matches the key stylized facts of growth at risk. Accounting for state dependent conditional heteroskedasticity makes it optimal for monetary policy to respond more aggressively to the business cycle, and for macroprudential policy to manage the resilience of the banking sector more actively over the financial cycle.
    Keywords: Mortgages;Production growth;Macroprudential policy;Short term interest rates;Banking;WP,math display
    Date: 2020–08–07
  3. By: Mansur, Alfan
    Abstract: This paper aims to replicate and extend Smets and Wouters (2007) who study the shocks and frictions in the US business cycle using a Bayesian DSGE methodology. The novelty of this research is by applying the extended Taylor rule for monetary policy in which the monetary policy also targets full employment. The SW model seems able to fit the US macroeconomic data very well. When the output gap in the Monetary policy Taylor rule is replaced with the unemployment rate, wage mark up shock becomes more persistent in determining inflation and interest rate. Productivity shock also becomes stronger in driving output. However, some unexpected results also come up, e.g. the negative responses of hours worked to a risk premium shock and inflation to the demand shocks
    Keywords: shocks, frictions, monetary policy
    JEL: C11 E32 E52
    Date: 2020–10–24
  4. By: Oladunni, Sunday
    Abstract: The global oil dynamics has significant implications for both oil exporting and importing small open economies. However, much of the literature on oil shocks is oriented towards advanced oil-importing economies. Micro-founded studies that explore the effects of oil shocks from the standpoint of oil-endowed emerging economies are rather sparse, compared to the preponderance of studies on developed oil importers and exporters. Thus, resulting to a consequential knowledge gap on oil price transmission mechanism and a limited appreciation of the growing policy dilemmas in these economies. In addition, we consider a positive oil price shock to uncover the extent to which oil price increase is positive for the economy. The paper, therefore, sets up a new Keynesian dynamic stochastic general equilibrium (DSGE) model to study how an oil price shock impact macroeconomic aggregates in an oil-rich emerging economy. The typical small open economy model is enriched with an export-oriented oil firm, a multi-sector foreign production and a non-oil domestic firm. The model is closed with exchange rate-augmented interest rate rule, and it is calibrated for Nigeria, an important oil producer. Macroeconomic responses, sequel to a simulated positive oil price shock, reveal evidence of Dutch disease and the operation of the Harrod-Balassa-Samuelson effect. We find a compelling need for oil-endowed emerging economies to address these phenomena by ensuring a robust non-oil sector with limited exposure to the vagaries of oil price oscillation.
    Keywords: Oil Price, DSGE Model, Macroeconomic Dynamics, Emerging Oil Exporter
    JEL: E32 E37 E39
    Date: 2020–03–13
  5. By: Millard, Stephen (Bank of England); Rubio, Margarita (Nottingham University); Varadi, Alexandra (Bank of England)
    Abstract: We use a DSGE model with financial frictions, leverage limits on banks, loan to value (LTV) limits and debt‑service ratio (DSR) limits on mortgage borrowing to examine: i) the effects of different macroprudential policies on key macro aggregates; ii) their interaction with each other and with monetary policy; and iii) their effects on the volatility of key macroeconomic variables and on welfare. We find that capital requirements can nullify the effects of financial frictions and reduce the effects of shocks emanating from the financial sector on the real economy. LTV limits, on their own, are not sufficient to constrain household indebtedness in booms, though can be used with capital requirements to keep DSRs under control. Finally, DSR limits lead to a significant decrease in the volatility of lending, consumption and inflation, since they disconnect the housing market from the real economy. Overall, DSR limits are welfare improving relative to any other macroprudential tool.
    Keywords: Macroprudential policy; monetary policy; leverage ratio; affordability constraint; collateral constraint
    JEL: E44 E58 G21 G28
    Date: 2021–01–15
  6. By: Nina Biljanovska; Alexandros Vardoulakis
    Abstract: We study how financial frictions amplify labor supply shocks in a macroeconomic model with occasionally binding financing constraints. Workers supply labor to entrepreneurs who borrow to purchase factors of production. Borrowing capacity is restricted by the value of capital, generating a pecuniary externality when financing constraints bind. Additionally, there is a distributive externality operating through wages. The planner’s allocation can be decentralized with two instruments: a credit tax/subsidy and a labor tax/subsidy. Labor shocks, such as the COVID-19 shock, amplify the policy responses, which critically depend on whether financing constraints bind or not.
    Keywords: Labor supply;Collateral;Labor taxes;Supply shocks;Labor;WP,utility function,quantitative analysis
    Date: 2020–09–18
  7. By: Michael Funke; Raphael Terasa
    Abstract: On 3 June 2020, the German government announced a EUR 130 billion fiscal stimulus package to stimulate market demand and jumpstart the economy in the wake of the COVID-19 pandemic lockdown in the spring of 2020. The most prominent measure of this package is an unconventional fiscal policy in the form of a temporary VAT rates cut for six months, from 1 July to 31 December 2020. Employing a dynamic stochastic general equilibrium (DSGE) framework, we study the efficiency of the VAT tax rates cut for ameliorating the consequences of the pandemic recession. The simulation of the calibrated DSGE model yields a tax policy-induced real GDP increase of about 0.3 percentage points for 2020.
    Keywords: fiscal policy, value-added tax, DSGE model, Covid-19, Germany
    JEL: E30 E60 H25 I15
    Date: 2020
  8. By: Molnarova, Zuzana (Institute for Advanced Studies, Vienna, Austria); Reiter, Michael (Institute for Advanced Studies, Vienna, Austria)
    Abstract: In this paper, we study the relative importance of demand and technology shocks in generating business cycle fluctuations, both at the aggregate level and at the level of individual industries. We construct a New Keynesian DSGE model that is highly disaggregated at the industry level with an input-output network structure. Measured productivity in the model fluctuates in response to both technology and demand shocks due to endogenous factor utilization. We estimate the model by the simulated method of moments using U.S. industry data from 1960 to 2005. We find that the aggregate technology shock has zero variance. Exogenous shocks to technology are necessary for our model to fit the data, but these shocks are exclusively industry-specific, uncorrelated across industries. The bulk of the aggregate fluctuations, including those in aggregate measured productivity, are explained through shocks to aggregate demand. This shock structure is supported by a host of information from the disaggregate data. Our second finding is that about half of the decrease in the cyclicality of measured productivity in the U.S. after the mid-1980s can be explained by the reduction in the size of demand shocks, in line with the narrative of the great moderation.
    Keywords: Business cycles, productivity, industries, factor utilization, input-output linkages, networks
    JEL: E32 E24 E37
    Date: 2021–01
  9. By: Lechthaler, Wolfgang; Tesfaselassie, Mewael F.
    Abstract: We embed human capital-based endogenous growth into a New-Keynesian model with search and matching frictions in the labor market and skill obsolescence from long-term unemployment. The model can account for key features of the Great Recession: a decline in productivity growth, the relative stability of inflation despite a pronounced fall in output (the "missing disinflation puzzle"), and a permanent gap between output and the pre-crisis trend output. In the model, lower aggregate demand raises unemployment and the training costs associated with skill obsolescence. Lower employment hinders learning-by-doing, which slows down human capital accumulation, feeding back into even fewer vacancies than justified by the demand shock alone. These feedback channels mitigate the disinflationary effect of the demand shock while amplifying its contractionary effect on output. The temporary growth slowdown translates into output hysteresis (permanently lower output and labor productivity).
    Keywords: endogenous growth,search and matching,unemployment,nominal rigidity,output hysteresis,monetary policy
    Date: 2021
  10. By: Yunho Cho; Shuyun May Li; Lawrence Uren
    Abstract: We build a general equilibrium overlapping generations model with heterogeneous agents to study the welfare implications of housing investment tax concessions in the Australian housing market . Comparing stationary equilibria, we find that removing these concessions significantly reduces housing investment. This lowers house prices and raises rents and the home ownership rate. The steady state welfare analysis suggests that eliminating concessions leads to a welfare gain of 1.7 per cent, for which increased redistribution is a key mechanism. Along the transition, a majority of households are better off, but younger landlords and landlords with higher incomes benefit the least.
    Keywords: Housing investment, Home ownership, Taxation, OLG model, Heterogeneous Agents, Welfare
    JEL: D15 E21 R21 R38
    Date: 2021–01
  11. By: Griffy, Benjamin; Gomis-Porqueras, Pedro
    Abstract: We develop a model that allows us to understand the cyclicality of part and full-time employment. In the model, labor market frictions generate a surplus between workers and firms, who jointly decide whether their employment relationship is best suited for part or full-time work based on match quality shocks and the broader economic environment. Lower acyclical costs cause the surplus of part-time matches to vary less with the business cycle than the surplus of full-time matches. As a consequence, the model is able to generate procyclical full-time employment and countercyclical part-time employment as observed in the data. We also show that ignoring part-time employment understates the impact on employment and inequality of a recession and that subsidizing part-time work is far more effective than increasing unemployment insurance at preventing a labor market downturn.
    Keywords: part-time employment, search, matching, bargaining
    JEL: E24 E30 J31 J6
    Date: 2020–12–21
  12. By: Benjamin Carton; Emilio Fernández Corugedo; Benjamin L Hunt; Simon Voigts
    Abstract: The Global Integrated Monetary and Fiscal model (GIMF) is a multi-region, forward-looking, DSGE model developed at the International Monetary Fund for policy analysis and international economic research. This paper documents the incorporation of demographic features into the model. The analysis presented illustrates how these new features enable the model to estimate some of the macroeconomic consequences of changing demographics.
    Keywords: Aging;Population growth;Population and demographics;Labor;Demographic change;WP
    Date: 2020–08–07
  13. By: Frantisek Brazdik; Tibor Hledik; Zuzana Humplova; Iva Martonosi; Karel Musil; Jakub Rysanek; Tomas Sestorad; Jaromir Tonner; Stanislav Tvrz; Jan Zacek
    Abstract: This paper introduces g3+, the new core forecasting model of the Czech National Bank (CNB), which replaced the previous g3 model in July 2019. We present the features of the new core forecasting model together with our motivation for adopting them. The new structural features and extensions were motivated by our experience with using the g3 model for more than a decade as the core forecasting tool at the CNB. The new g3+ model features a novel structural foreign economy block, oil as a production factor, heterogeneous households, and other adjustments. Also, we present a new simulation approach that allows us to emulate limited information for the simulation of conditional forecasts. Furthermore, the introduction of the g3+ model on average preserves the forecasting performance of the CNBs DSGE modeling framework.
    Keywords: Conditional forecast, DSGE, g3 model, oil, small open economy, two country model
    JEL: C51 C53 E27 E37 F41
    Date: 2020–12
  14. By: Holmberg, Johan (Department of Economics, Umeå University)
    Abstract: In this paper, we present a life-cycle earnings dynamics model including endogenous employment and job change. The model is estimated with the method of indirect inference using Swedish register data. By simulating data from this microeconomic model, we study the macroeconomic consequences of transitory shocks to unemployment risk. The results show that transitory aggregate shocks to unemployment risk have long-lasting negative effects on employment, income, and increases earnings volatility. By studying how unemployment at different ages affects the accumulation and distribution of pension entitlements, we find that becoming unemployed at 40 has the largest effect on pension accumulations. Furthermore, unobserved individual heterogeneity contributes substantially to the observed life-cycle earnings inequality for both men and women in Sweden.
    Keywords: Earnings dynamics; unemployment; inequality; social insurance; pensions
    JEL: D63 E27 H55 J24 J64
    Date: 2021–01–19
  15. By: Masaru Inaba; Kengo Nutahara; Daichi Shirai
    Abstract: It is well known that the labor wedge worsens in the recessions. The main research of this study are as follows. (i) What is the main driving force of the labor wedge? (ii) Is the main driver of the labor wedge the same as that of business cycles? In this study, we analyze which structural shocks drive the fluctuation of the labor wedge and business cycles using a canonical medium-scale dynamic stochastic general equilibrium model with nominal and real frictions. The model is estimated using Japanese data. One of the novel features of this study is our estimation strategy. In standard Bayesian estimation, the prior distribution of the parameters for the standard deviations of the structural shocks is inverse gamma, which does not support zero value and assumes the existence of structural shocks. On the contrary, we employ a more flexible prior distribution of the parameters for the standard deviations of structural shocks to allow the non-existence of structural shocks. Under the standard prior distribution, the estimation results imply that the labor wedge is mainly driven by preference and transitory technology shocks, whereas the investment adjustment cost shock is the most important for the business cycle fluctuations. However, under our relaxed prior distribution, which allows the non-existence of structural shocks, the estimation results imply that both the labor wedge and the business cycles are mainly driven by permanent technology and investment adjustment cost shocks.
    Date: 2020–08
  16. By: Yunho Cho; Shuyun May Li; Lawrence Uren
    Abstract: Property transaction taxes - also known as stamp duty - are widely viewed as an inefficient form of taxation. In this paper, we examine the welfare implications of removing stamp duty in a general equilibrium overlapping generation model with heterogeneous agents. Our model features an idiosyncratic shock to housing preferences which may create mismatch or induce household to move. When examining steady states we find that newborn households prefer entering an economy with a recurring property tax rather than one with stamp duty. In contrast, when examining transition dynamics we find that existing households prefer replacing stamp duty with a consumption tax.
    Keywords: Property transaction taxes, OLG model, Heterogeneous agents, Welfare
    JEL: E21 H24 R13 R2
    Date: 2021–01
  17. By: Blasco, Sylvie (GAINS, Université du Maine); Fontaine, Francois (Paris School of Economics)
    Abstract: A large fraction of the eligible unemployed workers does not claim for unemployment insurance (UI) and, among claimants, many do not register immediately upon layoff. This paper argues that, to understand this intriguing phenomenon, one needs to model jointly job search and take-up efforts and to allow for heterogeneity in both dimensions. Estimating such a model using French administrative data, we find substantial heterogeneity in both search and claiming frictions. If half of the sample faces high claiming frictions, many have good employment prospects and exit unemployment quickly. The burden of the claiming difficulties is concentrated on 10% of the sample that suffers both from claiming and job search difficulties. For that reason, the alleviation of the complexity of the claiming process is likely to have very heterogenous effects but little effect on aggregate unemployment duration. Additionally we show that the link between claiming and job search efforts has important implications when measuring how UI parameters impact unemployment duration.
    Keywords: unemployment insurance, take-up, job search
    JEL: J64 J65 C41
    Date: 2021–01
  18. By: Kollmann, Robert
    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
    JEL: E3 E4 F2 F3 F4
    Date: 2021–01–03
  19. By: Florin O. Bilbiie; Marc J. Melitz
    Abstract: The response of entry and exit to adverse supply shocks, such as COVID-19, is amplified by nominal rigidities. This leads to further amplification in the response of aggregate demand. Firms’ inability to adjust their prices induces further changes in profitability that engender additional entry-exit dynamics. These changes in net entry, in turn, amplify the initial response to the shock by generating additional curvature in the relationship between the shock and aggregate demand. Even in our baseline model with efficient equilibrium entry, this entry-exit multiplier triggers a substantial magnification of the welfare losses due to a negative shock through these second-order effects. Nominal rigidities may also induce a first-order effect when entry is no longer efficient. Our model highlights how the addition of endogenous entry to a benchmark New Keynesian model radically changes the consequences of nominal rigidities. We focus on the amplification of aggregate demand to supply shocks, but also highlight other key divergences that can potentially resolve some empirical discrepancies associated with the workhorse New-Keynesian model.
    JEL: E31 E32 E40 E60
    Date: 2020–12
  20. By: Ruoyun Mao; Shu-Chun Susan Yang
    Abstract: The theoretical literature generally finds that government spending multipliers are bigger than unity in a low interest rate environment. Using a fully nonlinear New Keynesian model, we show that such big multipliers can decrease when 1) an initial debt-to-GDP ratio is higher, 2) tax burden is higher, 3) debt maturity is longer, and 4) monetary policy is more responsive to inflation. When monetary and fiscal policy regimes can switch, policy uncertainty also reduces spending multipliers. In particular, when higher inflation induces a rising probability to switch to a regime in which monetary policy actively controls inflation and fiscal policy raises future taxes to stabilize government debt, the multipliers can fall much below unity, especially with an initial high debt ratio. Our findings help reconcile the mixed empirical evidence on government spending effects with low interest rates.
    Keywords: Expenditure;Inflation;Real interest rates;Public debt;Zero lower bound;WP,nominal interest rate,regime F
    Date: 2020–06–12
  21. By: Antoine Bommier (ETH Zurich); Daniel Harenberg (ETH Zurich); François Le Grand (EMLyon Business School); Cormac O'Dea (Cowles Foundation, Yale University)
    Abstract: We analyze lifecycle saving strategies using a recursive utility model calibrated to match empirical estimates of the value of a statistical life. The novelty of our approach is that we require preferences to be monotone with respect to ï¬ rst order stochastic dominance. The framework we use can disentangle risk aversion and the intertemporal elasticity and can feature a positive value of life without placing constraints on the value of the risk aversion parameter or the intertemporal elasticity of substitution. We show that, with a positive value of life, risk aversion reduces savings, decreases stock market participation and decreases annuity purchase. Risk averse agents are willing to make an early death a not-so-adverse outcome by enjoying greater consumption when young and bequeathing wealth in case of death. The model can rationalize low annuity demand while also matching empirically documented levels of wealth and private investments in stocks.
    Keywords: Lifecycle model, Value of life, Risk aversion, Saving choices, Portfolio choices, Annuity puzzle, Recursive utility
    JEL: D91 G11 J14 J17
    Date: 2020–05
  22. By: Nirvana Mitra (Department Of Economics, Shiv Nadar University)
    Abstract: I study the relationship between political constraints and the probability of sovereign default using a dynamic model of fiscal policy augmented with legislative bargaining and default. I find that the tightness of political constraints and default probability are inversely related if the output cost of default is not too high. The model government consists of legislators who bargain over multidimensional fiscal policy, including over a local public good that benefits only the regions they represent. Tighter political constraints are equivalent to more legislators with veto power over fiscal policies. In this case, a default implies that the released resources need to be distributed among more regions as local public goods. Thus, a smaller benefit accrues to each region, decreasing the incentive to default. However, if default is too costly, even relatively unconstrained governments default less frequently because the individual share of cost is too high. Empirical evidence from South American countries is consistent with this result. I calibrate the infinite horizon model to Argentina. It confirms the inverse relationship. A counterfactual exercise with even higher political constraints shows that the default by Argentina in 2001 could not be avoided.
    Keywords: Sovereign debt, Default risk, Interest rates, Political economy, Minimum winning coalition, Endogenous borrowing constraints.
    JEL: D72 E43 F34 E62 F41
    Date: 2021–01–15
  23. By: Tobias Adrian; Christopher J. Erceg; Jesper Lindé; Pawel Zabczyk; Jianping Zhou
    Abstract: Many central banks have relied on a range of policy tools, including foreign exchange intervention (FXI) and capital flow management tools (CFMs), to mitigate the effects of volatile capital flows on their economies. We develop an empirically-oriented New Keynesian model to evaluate and quantify how using multiple policy tools can potentially improve monetary policy tradeoffs. Our model embeds nonlinear balance sheet channels and includes a range of empirically-relevant frictions. We show that FXI and CFMs may improve policy tradeoffs under certain conditions, especially for economies with less well-anchored inflation expectations, substantial foreign currency mismatch, and that are more vulnerable to shocks likely to induce capital outflows and exchange rate pressures.
    Keywords: Return on investment;Inflation;Interest rate parity;Exchange rates;Real exchange rates;WP
    Date: 2020–07–07
  24. By: Martín Gonzalez-Eiras; Dirk Niepelt
    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-continuous, 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.
    Keywords: epidemic, lockdown, forced opening, SIR model, SIS model, SI model, logistic model, Covid-19
    JEL: I18
    Date: 2020
  25. 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: 2020–12
  26. By: Chatelain, Jean-Bernard; Ralf, Kirsten
    Abstract: The aim of the present paper is to provide criteria for a central bank of how to choose among different monetary-policy rules when caring about a number of policy targets such as the output gap and expected inflation. Special attention is given to the question if policy instruments are predetermined or only forward looking. Using the new-Keynesian Phillips curve with a cost-push-shock policy-transmission mechanism, the forward-looking case implies an extreme lack of robustness and of credibility of stabilization policy. The backward-looking case is such that the simple-rule parameters can be the solution of Ramsey optimal policy under limited commitment. As a consequence, we suggest to model explicitly the rational behavior of the policy maker with Ramsey optimal policy, rather than to use simple rules with an ambiguous assumption leading to policy advice that is neither robust nor credible.
    Keywords: Determinacy, Proportional Feedback Rules, Dynamic Stochastic General Equilibrium, Ramsey Optimal Policy under Quasi-Commitment.
    JEL: B22 B23 B41 C61 C62 E52
    Date: 2020–10–31
  27. By: Böhl, Gregor
    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 (OBCs), especially since major developed economies have again hit the zero lower bound on nominal interest rates. This paper shows that a linear dynamic rational expectations 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 vectors can be evaluated per second. This is an improvement of more than three orders of magnitude over existing alternatives. Even state evaluations of large HANK-type models with almost 1000 endogenous variables require only 0.1 ms.
    Keywords: Occasionally Binding Constraints,Effective Lower Bound,Computational Methods
    Date: 2021
  28. By: Juin-Jen Chang (Academia Sinica); Jang-Ting Guo (Department of Economics, University of California Riverside); Wei-Neng Wang (National Taichung University of Science and Technology)
    Abstract: This paper systematically examines the theoretical as well as quantitative interrelations between government spending and disposable-income inequality in a tractable monopolistically competitive Ramsey macroeconomy. Upon a higher government size, we analytically show that whether the long-run after-tax Gini coefficient rises or falls depends on the sign and magnitude of the wealth inequality effect versus those of the adjusted-labor effect. Under (i) a mild level of productive public expenditures and (ii) a sufficiently high intertemporal elasticity of consumption substitution, our calibrated model is able to generate qualitatively as well as quantitatively consistent income-inequality effects of government spending vis-Ã -vis recent estimation results.
    Keywords: Government Spending; Income Inequality; Monopolistic Competition.
    JEL: D31 E30 H50
    Date: 2021–01
  29. By: Merino Troncoso, Carlos
    Abstract: I estimate the macroeconomic impact of competition policy to deter collusion and merger control in the EU using a dynamic macroeconomic model . The impact was estimated using a traditional Dynamic Stochastic General Equilibrium Model and an upgraded version that includes Central Bank quantitative easing policies. When these are included in the model the macroeconomic effects are higher than previously estimated.
    Keywords: competition policy, macroeconomic impact, DSGE
    JEL: L40 L44
    Date: 2021–01–07
  30. By: Mariacristina De Nardi; Giulio Fella
    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.
    Keywords: Government; Government benefits; Self-insurance; Wage risk; Family
    JEL: D15 H24
    Date: 2020–12–23
  31. By: Yongsung Chang; Jay H. Hong; Marios Karabarbounis; Yicheng Wang
    Abstract: Based on administrative data from Statistics Norway, we find economically significant shifts in households' financial portfolios around structural breaks in income volatility. When the standard deviation of labor-income growth doubles, the share of risky assets decreases by 4 percentage points. We ask whether this estimated marginal effect is consistent with a standard model of portfolio choice with idiosyncratic volatility shocks. The standard model generates a much more aggressive portfolio response than we see in the data. We show that Bayesian learning about the underlying volatility regime can reconcile the gap between the model and the data.
    Keywords: Income Volatility; Portfolio Choice; Risky Share; Bayesian Learning
    JEL: E2 G1 J3
    Date: 2020–03–14
  32. By: Linda Schilling; Jesús Fernández-Villaverde; Harald Uhlig
    Abstract: A central bank digital currency, or CBDC, may provide an attractive alternative to traditional demand deposits held in private banks. When offering CBDC accounts, the central bank needs to confront classic issues of banking: conducting maturity transformation while providing liquidity to private customers who suffer “spending” shocks. We analyze these issues in a nominal version of a Diamond and Dybvig (1983) model, with an additional and exogenous price stability objective for the central bank. While the central bank can always deliver on its nominal obligations, runs can nonetheless occur, manifesting themselves either as excessive real asset liquidation or as a failure to maintain price stability. We demonstrate an impossibility result that we call the CBDC trilemma: of the three goals of efficiency, financial stability (i.e., absence of runs), and price stability, the central bank can achieve at most two.
    Keywords: central bank digital currency, monetary policy, bank runs, financial intermediation, inflation targeting, CBDC trilemma
    JEL: E58 G21
    Date: 2020

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