nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2021‒02‒15
eighteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Imperfect Contract Enforcement and Nominal Liabilities By Hajime Tomura
  2. Oil price shocks, fuel subsidies and macroeconomic (in)stability in Nigeria By Omotosho, Babatunde S.
  3. On the heterogeneous impacts of the COVID-19 lockdown on US unemployment By Malak Kandoussi; François Langot
  4. Modeling Trade Tensions: Different Mechanisms in General Equilibrium By Benjamin L Hunt; Susanna Mursula; Rafael A Portillo; Marika Santoro
  5. Elderly Care and Multiple Monies By Hajime Tomura
  6. Bank Balance Sheets and External Shocks in Asia: The Role of FXI, MPMs and CFMs By Zefeng Chen; Sanaa Nadeem; Shanaka J Peiris
  7. Market Regulation, Cycles and Growth in a Monetary Union By Mirko Abbritti; Sebastian Weber
  8. More Gray, More Volatile? Aging and (Optimal) Monetary Policy By Daniel Baksa; Zsuzsa Munkacsi
  9. Constrained-Efficient Capital Reallocation By Andrea Lanteri; Adriano A. Rampini
  10. Monetary and Macroprudential Policy with Endogenous Risk By Tobias Adrian; Fernando Duarte; Nellie Liang; Pawel Zabczyk
  11. Searching for the Equity Premium By Bai, Hang; Zhang, Lu
  12. Dissecting Mechanisms of Financial Crises: Intermediation and Sentiment By Krishnamurthy, Arvind; Li, Wenhao
  13. A Buffer-Stock Model for the Government: Balancing Stability and Sustainability By Jean-Marc Fournier
  14. Quality of life in a dynamic spatial model By Ahlfeldt, Gabriel M.; Bald, Fabian; Roth, Duncan; Seidel, Tobias
  15. Trade and Informality in the Presence of Labor Market Frictions and Regulations By Rafael Dix-Carneiro; Pinelopi K. Goldberg; Costas Meghir; Gabriel Ulyssea
  16. Fiscal Multipliers: A Heterogenous-Agent Perspective By Tobias Broer; Per Krusell; Erik Öberg
  17. Fiscal Consolidation and Public Wages By Juin-Jen Chang; Hsieh-Yu Lin; Nora Traum; Shu-Chun Susan Yang
  18. New Formulations of Ambiguous Volatility with an Application to Optimal Dynamic Contracting By Peter G. Hansen

  1. By: Hajime Tomura (Faculty of Political Science and Economics, Waseda University)
    Abstract: This paper introduces the court's inability to discern different qualities of goods of the same kind into an overlapping generations model. This friction makes fiat money circulate not only as a means of payments for goods, but also as a means of liability repayments in an equilibrium. This result holds with or without dynamic inefficiency. In this equilibrium, a shortage of real money balances for liability repayments can cause underinvestment by borrowers, even if the money supply follows a Friedman rule. This problem can be resolved by an elastic money supply through an intraday discount window at a zero discount fee. In this case, supplying no fiat money overnight maximizes aggregate consumption in a monetary steady state in a dynamically efficient economy. This policy, however, can also lead to a self-fulfilling crunch of discount window lending if commercial banks intermediate the lending from the central bank with a collateral constraint, and if the discount window market is segregated. This equilibrium can be eliminated if the central bank is the monopolistic public issuer of fiat money that also acts as the lender of last resort.
    Keywords: Nominal contract; Discount window; Credit crunch; Lender of last resort; Payment system
    Date: 2019–05
  2. By: Omotosho, Babatunde S.
    Abstract: This paper studies the macroeconomic implications of oil price shocks and the extant fuel subsidy regime for Nigeria. To do this, we develop and estimate a New-Keynesian DSGE model that accounts for pass-through effect of international oil price into the retail price of fuel. Our results show that oil price shocks generate significant and persistent impacts on output, accounting for about 22 percent of its variations up to the fourth year. Under our benchmark model (i.e. with fuel subsidies), we show that a negative oil price shock contracts aggregate GDP, boosts non-oil GDP, increases headline inflation, and depreciates the exchange rate. However, results generated under the model without fuel subsidies indicate that the contractionary effect of a negative oil price shock on aggregate GDP is moderated, headline inflation decreases, while the exchange rate depreciates more in the short-run. Counterfactual simulations also reveal that fuel subsidy removal leads to higher macroeconomic instabilities and generates non-trivial implications for the response of monetary policy to an oil price shock. Thus, this study cautions that a successful fuel subsidy reform must necessarily encompass the deployment of well-targeted safety nets as well as the evolution of sustainable adjustment mechanisms.
    Keywords: Fuel subsidies, oil price shocks, business cycle
    JEL: E31 E32 E52 E62
    Date: 2020
  3. By: Malak Kandoussi (Université Paris-Saclay, UEVE - Université d'Évry-Val-d'Essonne); François Langot (GAINS - Groupe d'Analyse des Itinéraires et des Niveaux Salariaux - UM - Le Mans Université, UM - Le Mans Université, IUF - Institut Universitaire de France - M.E.N.E.S.R. - Ministère de l'Education nationale, de l’Enseignement supérieur et de la Recherche, PSE - Paris School of Economics - ENPC - École des Ponts ParisTech - ENS Paris - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique - EHESS - École des hautes études en sciences sociales - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement)
    Abstract: We develop a matching model that predicts the impact of the COVID-19 lockdown on US unemployment, while accounting for the contrasted impacts across various job types. The model is calibrated on the subprime experience and is then used to identify the job-specific lockdown shocks, using observed worker flows by diploma. The model persistence-which is significantly larger than in the Diamond-Mortensen-Pissarides model-is dampened by CARES act that facilitates the use of temporary separations. Counterfactual experiments show that time-varying risk, hiring cost externalities, and wage rigidity are needed to account for these crises.
    Keywords: COVID-19,Unemployment,search and matching,Worker heterogeneity
    Date: 2021–01–12
  4. By: Benjamin L Hunt; Susanna Mursula; Rafael A Portillo; Marika Santoro
    Abstract: In this paper, we investigate the mechanisms through which import tariffs impact the macroeconomy in two large scale workhorse models used for quantitative policy analysis: a computational general equilibrium (CGE) model (Purdue University GTAP model) and a multi-country dynamic stochastic general equilibrium (DSGE) model (IMF GIMF model). The quantitative effects of an increase in tariffs reflect different mechanisms at work. Like other models in the trade literature, in GTAP higher tariffs generate a loss in terms of output arising from an inefficient reallocation of resources between sectors. In GIMF instead, as in other DSGE models, tariffs act as a disincentive to factor utilization. We show that the two models/channels can be broadly interpreted as capturing the impact of tariffs on different components of a country’s aggregate production function: aggregate productivity (GTAP) and factor supply/utilization (GIMF). We discuss ways to combine the estimates from these two models to provide a more complete assessment of the macro effects of tariffs.
    Keywords: Tariffs;Imports;Exports;Trade balance;Exchange rates;Trade policy,trade elasticity,Nominal and real rigidities,general equilibrium,WP,import tariff,trade diversion,terms of trade,GTAP estimate,price distortion
    Date: 2020–12–11
  5. By: Hajime Tomura (Faculty of Political Science and Economics, Waseda University)
    Abstract: This paper presents an overlapping generations model in which old generations require specific services from young generations due to idiosyncratic shocks. An example of such services is elderly care. The model shows that a two-money system in which fiat money for such services is separated from that for the other types of goods and services can replicate the resource allocation in a one-money system with a fair insurance. For this result, it is necessary to prohibit old generations from exchanging different types of fiat monies in the two-money system. The model implies that the introduction of fiat money for elderly care reduces the real value of government bonds outstanding in the country.
    Date: 2019–06
  6. By: Zefeng Chen; Sanaa Nadeem; Shanaka J Peiris
    Abstract: In emerging Asia, banks constitute the dominant source of financing consumption and investment, and bank balance sheets comprise large gross FX assets and liabilities. This paper extends the DSGE model of Gertler and Karadi (2011) to incorporate these key features and estimates a panel vector autoregression on ten Asian economies to understand the role of the banking sector in transmitting spillovers from the global financial cycle to small open economies. It also evaluates the effectiveness of foreign exchange intervention (FXI) and other macroeconomic policies in responding to external financing shocks. External financial shocks affect net external liabilities of banks and the exchange rate, leading to changes in credit supply by banks and investment. For example, a capital outflow shock leads to a deprecation that reduces the net worth and intermediation capacity of banks exposed to foreign currency liabilities. In such cases, the exchange rate acts as shock amplifier and sterilized FXI, often deployed by Asian economies, can help cushion the economy. By contrast, with real shocks, the exchange rate serves as a shock absorber, and any FXI that weakens that function can be costly. We also explore the effectiveness of the monetary policy interest rate, macroprudential policies (MPMs) and capital flow management measures (CFMs).
    Date: 2021–01–15
  7. By: Mirko Abbritti; Sebastian Weber
    Abstract: We build a two-country currency union DSGE model with endogenous growth to assess the role of cross-country differences in product and labor market regulations for long-term growth and for the adjustment to shocks. We show that with endogenous growth, there is no reason to expect real income convergence. Large shocks, through endogenous TFP movements, can lead to permanent changes of output and real exchange rates. Differences are exacerbated when member countries have different product and labor market regulations. Less regulated economies are likely to have higher trend growth and recover faster from negative shocks. Results are consistent with higher inflation, lower employment and disappointing TFP growth rates experienced in the less reform-friendly euro area members.
    Keywords: Total factor productivity;Return on investment;Labor markets;Commodity markets;Inflation;WP,labor market
    Date: 2019–06–03
  8. By: Daniel Baksa; Zsuzsa Munkacsi
    Abstract: The evidence on the inflation impact of aging is mixed, and there is no evidence regarding the volatility of inflation. Based on advanced economies’ data and a DSGE-OLG model, we find that aging leads to downward pressure on inflation and higher inflation volatility. Our paper is also the first, using this framework, to discuss how aging affects the transmission channels of monetary policy. We are also the first to examine aging and optimal central bank policies. As aging redistributes wealth among generations and the labor force becomes more scarce, our model suggests that aging makes monetary policy less effective and in more gray societies central banks should react more strongly to nominal variables.
    Keywords: Aging;Inflation;Consumption;Real interest rates;Labor supply;WP,monetary policy,transmission mechanism
    Date: 2019–09–20
  9. By: Andrea Lanteri; Adriano A. Rampini
    Abstract: We analyze the constrained-efficient allocation in an equilibrium model of investment and capital reallocation with heterogeneous firms facing collateral constraints. The model features two types of pecuniary externalities: collateral externalities, because the resale price of capital affects firms’ ability to borrow, and distributive externalities, because buyers of old capital are more financially constrained than sellers, consistent with empirical evidence. We show analytically and quantitatively that the equilibrium price of old capital is inefficiently high in general, because the distributive pecuniary externality exceeds the collateral externality, by a factor of two in the calibrated model. New investment generates a positive aggregate externality by reducing the future price of old capital, fostering reallocation toward more constrained firms. The constrained-efficient allocation induces a consumption-equivalent welfare gain of 5% compared to the competitive equilibrium, and can be implemented with subsidies on new capital and taxes on old capital.
    JEL: D51 E22 E44 G31 H21
    Date: 2021–01
  10. By: Tobias Adrian; Fernando Duarte; Nellie Liang; Pawel Zabczyk
    Abstract: We extend the New Keynesian (NK) model to include endogenous risk. Lower interest rates not only shift consumption intertemporally but also conditional output risk via their impact on risk-taking, giving rise to a vulnerability channel of monetary policy. The model fits the conditional output gap distribution and can account for medium-term increases in downside risks when financial conditions are loose. The policy prescriptions are very different from those in the standard NK model: monetary policy that focuses purely on inflation and output-gap stabilization can lead to instability. Macroprudential measures can mitigate the intertemporal risk-return tradeoff created by the vulnerability channel.
    Date: 2020–11–13
  11. By: Bai, Hang (U of Connecticut); Zhang, Lu (Ohio State U)
    Abstract: Labor market frictions are crucial for the equity premium in production economies. A dynamic stochastic general equilibrium model with recursive utility, search frictions, and capital accumulation yields a high equity premium of 4.26% per annum, a stock market volatility of 11.8%, and a low average interest rate of 1.59%, while simultaneously retaining plausible business cycle dynamics. The equity premium and stock market volatility are strongly countercyclical, while the interest rate and consumption growth are largely unpredictable. Because of wage inertia, dividends are procyclical despite consumption smoothing via capital investment. The welfare cost of business cycles is huge, 29%.
    JEL: E32 E44 G12 J23
    Date: 2020–10
  12. By: Krishnamurthy, Arvind (Stanford U); Li, Wenhao (U of Southern California)
    Abstract: We develop a model of financial crises with both a financial amplification mecha- nism, via frictional intermediation, and a role for sentiment, via time-varying beliefs about an illiquidity state. We confront the model with data on credit spreads, equity prices, credit, and output across the financial crisis cycle. In particular, we ask the model to match data on the frothy pre-crisis behavior of asset markets and credit, the sharp transition to a crisis where asset values fall, disintermediation occurs and output falls, and the post-crisis period characterized by a slow recovery in output. A pure amplification mechanism quantitatively matches the crisis and aftermath period but fails to match the pre-crisis evidence. Mixing sentiment and amplification allows the model to additionally match the pre-crisis evidence. We consider two versions of sentiment, a Bayesian belief updating process and one that overweighs recent observations. Both models match the crisis patterns qualitatively, while the non-Bayesian model better matches the pre-crisis froth quantitatively. Finally, we show that a lean-against-the-wind policy has a quantitatively similar impact in both versions of the belief model, indicating that policy need not condition on true beliefs.
    Date: 2020–09
  13. By: Jean-Marc Fournier
    Abstract: A fiscal reaction function to debt and the cycle is built on a buffer-stock model for the government. This model inspired by the buffer-stock model of the consumer (Deaton 1991; Carroll 1997) includes a debt limit instead of the Intertemporal Budget Constraint (IBC). The IBC is weak (Bohn, 2007), a debt limit is more realistic as it reflects the risk of losing market access. This risk increases the welfare cost of fiscal stimulus at high debt. As a result, the higher the debt, the less governments should smooth the cycle. A larger reaction of interest rates to debt and higher hysteresis magnify this interaction between the debt level and the appropriate reaction to shocks. With very persistent shocks, the appropriate reaction to negative shocks in highly indebted countries can even be procyclical.
    Keywords: Fiscal stance;Debt limits;Fiscal policy;Output gap;Fiscal multipliers;WP,buffer stock,interest rate
    Date: 2019–07–22
  14. By: Ahlfeldt, Gabriel M.; Bald, Fabian; Roth, Duncan; Seidel, Tobias
    Abstract: We develop a dynamic spatial model in which heterogeneous workers are imperfectly mobile and forward-looking and yet all structural fundamentals can be inverted without assuming that the economy is in a stationary spatial equilibrium. Exploiting this novel feature of the model, we show that the canonical spatial equilibrium framework understates spatial quality of-life differentials, the urban quality-of-life premium and the value of local non-marketed goods. Unlike the canonical spatial equilibrium framework, the model quantitatively accounts for local welfare effects that motivate many place-based policies seeking to improve quality of life.
    Keywords: Covid-19; dynamic; housing; migration; rents; pollution; productivity; quality of life; wages; welfare; economic geography; well-being
    JEL: J20 J30 R20 R30 R50
    Date: 2020–12
  15. By: Rafael Dix-Carneiro; Pinelopi K. Goldberg; Costas Meghir; Gabriel Ulyssea
    Abstract: We build an equilibrium model of a small open economy with labor market frictions and imperfectly enforced regulations. Heterogeneous firms sort into the formal or informal sector. We estimate the model using data from Brazil, and use counterfactual simulations to understand how trade affects economic outcomes in the presence of informality. We show that: (1) Trade openness unambiguously decreases informality in the tradable sector, but has ambiguous effects on aggregate informality. (2) The productivity gains from trade are understated when the informal sector is omitted. (3) Trade openness results in large welfare gains even when informality is repressed. (4) Repressing informality increases productivity, but at the expense of employment and welfare. (5) The effects of trade on wage inequality are reversed when the informal sector is incorporated in the analysis. (6) The informal sector works as an "unemployment," but not a "welfare buffer" in the event of negative economic shocks.
    JEL: F14 F16 J46 O17
    Date: 2021–01
  16. By: Tobias Broer; Per Krusell; Erik Öberg
    Abstract: We use an analytically tractable heterogeneous-agent (HANK) version of the standard New Keynesian model to show how the size of fiscal multipliers depends on i) the distribution of factor incomes, and ii) the source of nominal rigidities. With sticky prices but flexible wages, the standard representative-agent (RANK) model predicts large multipliers because profits fall after a fiscal stimulus and the resulting negative income effect makes the representative worker work harder. Our HANK model, where workers do not own stock and thus do not receive profit income, predicts smaller fiscal multipliers. In fact, they are smaller with sticky prices than with flexible prices. When wages are the source of nominal rigidity, in contrast, fiscal multipliers are close to one, independently of income heterogeneity and price stickiness.
    JEL: E0
    Date: 2021–01
  17. By: Juin-Jen Chang; Hsieh-Yu Lin; Nora Traum; Shu-Chun Susan Yang
    Abstract: A New Keynesian model with government production, public compensation, and unemployment is fit to U.S. data to study the macroeconomic and fiscal effects of public wage reductions. We find that accounting for the type of government spending is crucial for its macroeconomic implications. Although reductions in public wages and government purchases of goods have similar effects on total output and the fiscal balance, the former can raise private output slightly, in contrast to the substantial contractionary effects of the latter. In addition, the baseline estimation finds that exogenous public wage reductions decrease private wages. Model counterfactuals show that sufficiently rigid nominal private wages can reverse the response of private wages, as the rigidity dampens the labor reallocation effect from the public to private sector that exerts downward pressure on private wages.
    Keywords: Wages;Labor;Public employment;Real wages;Wage adjustments;WP,nominal wage,real wage
    Date: 2019–06–10
  18. By: Peter G. Hansen
    Abstract: I introduce novel preference formulations which capture aversion to ambiguity about unknown and potentially time-varying volatility. I compare these preferences with Gilboa and Schmeidler's maxmin expected utility as well as variational formulations of ambiguity aversion. The impact of ambiguity aversion is illustrated in a simple static model of portfolio choice, as well as a dynamic model of optimal contracting under repeated moral hazard. Implications for investor beliefs, optimal design of corporate securities, and asset pricing are explored.
    Date: 2021–01

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