nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2021‒03‒01
thirty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Productivity Shocks, Long-Term Contracts and Earnings Dynamics By Neele Balke; Thibaut Lamadon
  2. Should the ECB adjust its strategy in the face of a lower r*? By Philippe Andrade; Jordi Galí; Hervé Le Bihan; Julien Matheron
  3. The Poverty of Macroeconomics --- What the Chemical Revolution Tells Us about Neoclassical Production Function By Yi Wen
  4. Globalization, Trade Imbalances and Labor Market Adjustment By ; ; Ricardo M. Reyes-Heroles; Sharon Traiberman
  5. Incomplete Markets and Parental Investments in Children By Brant Abbott
  6. Understanding the gains from wage flexibility in a currency union: the fiscal policy connection By Eiji Okano
  7. Optimal Bailouts in Banking and Sovereign Crises By Sewon Hur; César Sosa-Padilla; Zeynep Yom
  8. Revisiting the New Keynesian policy paradoxes under QE By Bonciani, Dario; Oh, Joonseok
  9. World interest rates and macroeconomic adjustments in developing commodity producing countries By Vincent Bodart; François Courtoy; Erica Perego
  10. Financial Destabilization By Ken-ichi Hashimoto; Ryonghun Im; Takuma Kunieda; Akihisa Shibata
  11. The Great Lockdown and the Big Stimulus: Tracing the Pandemic Possibility Frontier for the U.S. By Greg Kaplan; Benjamin Moll; Giovanni Violante
  12. Default Costs and Self-fulfilling Fiscal Limits in a Small Open Economy By Sergey Pekarski; Anna Sokolova
  13. Inflation Gap Persistence, Indeterminacy, and Monetary Policy By Yasuo Hirose; Takushi Kurozumi; Willem Van Zandweghe
  14. Involuntary unemployment in overlapping generations model due to instability of the economy and fiscal policy for full-employment By Tanaka, Yasuhito
  15. Can shocks to risk aversion explain business cycle fluctuations in Bulgaria (1999-2018)? By Aleksandar Vasilev
  16. Automatic adjustment mechanisms in public pension reforms: Effects over fiscal sustainability, adequacy, and fairness By Diego Wachs; Jorge Onrubia
  17. The Great Transition: Kuznets Facts for Family-Economists By Jeremy Greenwood; Nezih Guner; Ricardo Marto
  18. Nursing Homes in Equilibrium: Implications for Long-term Care Policies By Tatyana Koreshkova; Minjoon Lee
  19. Whatever it takes to save the planet? Central banks and unconventional green policy By Alessandro Ferrari; Valerio Nispi Landi
  20. Temporary Unemployment and Labor Market Dynamics During the COVID-19 Recession By Jessica Gallant; Kory Kroft; Fabian Lange; Matthew J. Notowidigdo
  21. FInance, Endogenous TFP, and Misallocation By Chaoran Chen; Ashique Habib; Xiaodong Zhu
  22. Outsourcing, Inequality and Aggregate Output By Adrien Bilal; Hugo Lhuillier
  23. Universal Basic Income in Developing Countries: Pitfalls and Alternatives By Ferreira, Pedro Cavalcanti; Peruffo, Marcel Cortes; Cordeiro Valério, André
  24. Reconciling Empirics and Theory: The Behavioral Hybrid New Keynesian Model By Atahan Afsar; José Elías Gallegos; Richard Jaimes; Edgar Silgado Gómez; José Elías Gallegos; Richard Jaimes; Edgar Silgado Gómez
  25. The Effectiveness of Asset Purchases in Small Open Economies By Eliezer Borenstein; Alex Ilek
  26. Epidemic Responses Under Uncertainty By Michael Barnett; Greg Buchak; Constantine Yannelis
  27. Dynamic Trade-offs and Labor Supply under the CARES Act By Corina Boar; Simon Mongey
  28. Choice of Social Security System By Larsen, Birthe; Waisman, Gisela
  29. Trade and Informality in the Presence of Labor Market Frictions and Regulations By Rafael Dix-Carneiro; Pinelopi K. Goldberg; Costas Meghir; Gabriel Ulyssea
  30. Why Does the Fed Move Markets so Much? A Model of Monetary Policy and Time-Varying Risk Aversion By Carolin E. Pflueger; Gianluca Rinaldi
  31. Age-targeted Income Taxation, Labor Supply and Retirement By Gustafsson, Johan

  1. By: Neele Balke (University of Chicago - Department of Economics); Thibaut Lamadon (University of Chicago - Department of Economics; NBER)
    Abstract: This paper examines how employer- and worker-specific productivity shocks transmit to earnings and employment in an economy with search frictions and firm commitment. We develop an equilibrium search model with worker and firm shocks and characterize the optimal contract offered by competing firms to attract and retain workers. In equilibrium, risk-neutral firms provide only partial insurance against shocks to risk-averse workers and offer contingent contracts, where payments are backloaded in good times and frontloaded in bad times. We prove that there exists a unique spot target wage, which serves as an attraction point for smooth wage adjustments. The structural model is estimated on matched employer-employee data from Sweden. The estimates indicate that firms absorb persistent worker and firm shocks, with respective passthrough values of 27 and 11%, but price permanent worker differences, a large contributor (32%) to variations in wages. A large share of the earnings growth variance can be attributed to job mobility, which interacts with productivity shocks. We evaluate the effects of redistributive policies and find that almost 40% of government-provided insurance is undone by crowding out firm-provided insurance.
    JEL: E24 J31 J41 J64
    Date: 2020
  2. By: Philippe Andrade; Jordi Galí; Hervé Le Bihan; Julien Matheron
    Abstract: We address this question using an estimated New Keynesian DSGE model of the Euro Area with trend inflation, imperfect indexation, and a lower bound on the nominal interest rate. In this setup, a decrease in the steady-state real interest rate, r*, increases the probability of hitting the lower bound constraint, which entails signiï¬ cant welfare costs and warrants an adjustment of the monetary policy strategy. Under an unchanged monetary policy rule, an increase in the inflation target of eight tenth the size of the drop in the real natural rate of interest is warranted. Absent an increase in the inflation target, and assuming the effective lower bound prevents the ECB from implementing more aggressive negative interest rate policies, adjusting the monetary strategy requires considering alternative instruments or policy rules, such as committing to make-up for recent, below-target inflation realizations.
    Keywords: inflation target, effective lower bound, monetary policy strategy, euro-area.
    JEL: E31 E52 E58
    Date: 2021–01
  3. By: Yi Wen
    Abstract: Quantitative macroeconomics is often portrayed as a science—because of its intensive use of high-powered mathematics—with the possible limitation of being unable to conduct controlled experiments. To qualify as a science, however, theories in that discipline must meet a minimum number of criteria: (i) It has explanatory power to explain phenomena; (ii) it has predictive power to yield quantifiable and falsifiable statements about new phenomenon; and (iii) it has operational power to change the world. A scientific theory consists of axioms and working hypotheses that facilitate the derivation of contestable statements from the axioms.2 Hence, simply laying out a list of contradictions between a theory’s implications and the data is often insufficient to disqualify a theory as science; it may have just challenged its working hypotheses, not its axioms. But, challenging a theory’s working hypotheses is a crucial step to improve or falsify a theory. This is why Isaac Newton spent so much effort in his Principia Mathematica to deal with the law of motion under air friction. This article discusses one of the working hypotheses of the Arrow-Debreu paradigm and its dynamic stochastic general equilibrium reincarnation in quantitative macroeconomics—the supply curve and its embodiment in the neoclassical production function. The supply curve is a much stronger pillar than the demand curve in holding up the Arrow-Debreu paradigm, but we argue in this article that the neoclassical production function embodying the supply curve is full of cracks. More specifically, we show that the neoclassical production function is not quantifiable as a working hypothesis to support the Arrow-Debreu DSGE model, unlike the chemical reaction equations based on Lavoisier’s oxygen theory of combustion. The neoclassical production function relies on the unobservable and unmeasurable Solow residual to explain the quantity of output produced at the firm, industry, or national level, and the hypothetical factors of production (capital and labor) are much like “fire, air, water, and earth” in the ancient Greek theory of the universe. Because the working hypotheses of quantitative macroeconomics are not themselves quantifiable, the neoclassical theory is not yet a science. And this explains the lack of power for DSGE models to predict the 2008 Financial Crisis and the inability of economic theory to change the world by engineering or recreating economic prosperity in developing countries.
    Keywords: Production Function; DSGE Models; Methodology
    JEL: A1 B0 B4 E1
    Date: 2021–02
  4. By: ; ; Ricardo M. Reyes-Heroles; Sharon Traiberman
    Abstract: We study the role of global trade imbalances in shaping the adjustment dynamics in response to trade shocks. We build and estimate a general equilibrium, multi-country, multi-sector model of trade with two key ingredients: (a) Consumption-saving decisions in each country commanded by representative households, leading to endogenous trade imbalances; (b) labor market frictions across and within sectors, leading to unemployment dynamics and sluggish transitions to shocks. We use the estimated model to study the behavior of labor markets in response to globalization shocks, including shocks to technology, trade costs, and inter-temporal preferences (savings gluts). We find that modeling trade imbalances changes both qualitatively and quantitatively the short- and long-run implications of globalization shocks for labor reallocation and unemployment dynamics. In a series of empirical applications, we study the labor market effects of shocks accrued to the global economy, their implications for the gains from trade, and we revisit the "China Shock" through the lens of our model. We show that the US enjoys a 2.2 percent gain in response to globalization shocks. These gains would have been 73 percent larger in the absence of the global savings glut, but they would have been 40 percent smaller in a balanced-trade world.
    Keywords: Globalization; Labor markets; Trade imbalances
    JEL: F10 F16
    Date: 2021–02–10
  5. By: Brant Abbott
    Abstract: The effect of incomplete markets on parental investments is investigated. Uninsured risk and credit constraints can distort the timing of parental investments, causing them to be delayed relative to what would occur under full-insurance. Age-dependent subsidies, taxes or transfers can all possibly correct this. Analytical results are provided, and a numerical life-cycle model provides quantitative results. Data on ability and parental investment dynamics are used to calibrate the model. A sequence of optimal policy experiments is conducted beginning with a simple reform of the tax and transfer schedule and ending with more complex parent-specific tax parameters and investment subsidies, all of which vary with child age. The final experiment generates substantial improvements in the ability distribution and a consumption equivalent welfare gain that is 2.5 times as large as simply reforming the tax schedule. About 1/4 of this incremental gain results from including child-age dependent policies that alleviate distortions of parental investment timing.
    Keywords: Incomplete Markets, Human Capital, Skill Formation
    JEL: E2 E24 J24
    Date: 2021–02
  6. By: Eiji Okano (Birkbeck, University of London)
    Abstract: I investigate two findings in Gali and Monacelli (2016, American Economic Review) which are (i) the effectiveness of labor cost adjustments on employment is much smaller in a currency union and (ii) an increase in wage flexibility often reduces welfare, more likely so in an economy that is part of a currency union. First, I introduce a distorted steady state in the small open economy model of GM, in which employment subsidies to make the steady state efficient are not available, and replicate their two findings. Second, I introduce an endogenous fiscal policy rule similar to the Bohn rule with a government budget constraint into the model. The results suggest that while the first finding of Gali and Monacelli is still applicable, their second finding is not necessarily applicable. It is, therefore, possible that an increase in wage flexibility reduces welfare loss in an economy that is part of a currency union as long as wage rigidity is high enough. Thus, there is still scope to discuss how wage flexibility is beneficial in a currency union.
    Keywords: Sticky Wages, Nominal Rigidities, New Keynesian Models, Monetary and Fiscal Policy, Exchange Rate Policy, Currency Union, Fiscal Theory of the Price Level, Bohn Rule
    JEL: E32 E52 E60 F41 F47
    Date: 2020–11
  7. By: Sewon Hur; César Sosa-Padilla; Zeynep Yom
    Abstract: We study optimal bailout policies in the presence of banking and sovereign crises. First, we use European data to document that asset guarantees are the most prevalent way in which sovereigns intervene during banking crises. Then, we build a model of sovereign borrowing with limited commitment, where domestic banks hold government debt and also provide credit to the private sector. Shocks to bank capital can trigger banking crises, with government sometimes finding it optimal to extend guarantees over bank assets. This leads to a trade-off: Larger bailouts relax domestic financial frictions and increase output, but also imply increasing government fiscal needs and possible heightened default risk (i.e., they create a ‘diabolic loop’). We find that the optimal bailouts exhibit clear properties. Other things equal, the fraction of banking losses that the bailouts would cover is: (i) decreasing in the level of government debt; (ii) increasing in aggregate productivity; and (iii) increasing in the severity of the banking crisis. Even though bailouts mitigate the adverse effects of banking crises, we find that the economy is ex ante better off without bailouts: the ‘diabolic loop’ they create is too costly.
    Keywords: Bailouts; Sovereign Defaults; Banking Crises; Conditional Transfers; Sovereign-bank diabolic loop
    JEL: E32 E62 F34 F41 G01 G15 H63
    Date: 2021–01–29
  8. By: Bonciani, Dario (Bank of England); Oh, Joonseok (Freie Universität Berlin)
    Abstract: Standard New Keynesian models deliver puzzling results at the effective lower bound of short-term interest rates: greater price flexibility amplifies the fall in output in response to adverse demand shocks; labour tax cuts are contractionary; the multipliers of wasteful government spending are large. These outcomes stem from a failure to characterise monetary policy correctly. Both analytically and numerically, we show that allowing the central bank to respond to inflation with quantitative easing (QE) can resolve all these paradoxes. In quantitative terms, mild adjustments to the central bank’s balance sheet are sufficient to obtain results more in line with conventional wisdom.
    Keywords: Policy paradoxes; unconventional monetary policy; quantitative easing; liquidity trap; effective lower bound
    JEL: E52 E58 E62 E63
    Date: 2021–02–22
  9. By: Vincent Bodart (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES)); François Courtoy (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES)); Erica Perego (CEPII, Paris, France)
    Abstract: With commodities becoming international financial securities, commodity prices are affected by the international financial cycle. With this evidence in mind, this paper reconsiders the macroeconomic adjustment of developing commodity-exporting countries to changes in world interest rates. We proceed by building a model of a small open economy that produces a non-tradable good and a storable tradable commodity. The difference with standard models of small open economies lies in the endogenous response of commodity prices which -due to commodity storage- adjust to variations in international interest rates. We find that the endogenous response of commodity prices amplifies the reaction of commodity exporting countries to international monetary shocks. This suggests that commodity exporting countries are more vulnerable to unfavourable international monetary disturbances than other small open economies. In particular, through the commodity price channel, even those small open commodity-exporting economies that are disconnected from international financial markets can be affected by the international financial cycle.
    Keywords: Storable commodity, International financial shock, Developing economies
    JEL: E32 F41 G15 Q02
    Date: 2021–01–23
  10. By: Ken-ichi Hashimoto (Kobe University); Ryonghun Im (Kyoto University); Takuma Kunieda (Kwansei Gakuin University); Akihisa Shibata (Kyoto University)
    Abstract: This paper uses a dynamic general equilibrium model to examine whether financial innovations destabilize an economy. Applying a neoclassical production function, we demonstrate that as financial frictions are mitigated, the economy loses stability and a flip bifurcation occurs at a certain level of financial frictions under an empirically plausible elasticity of substitution between capital and labor. Furthermore, the amplitude of fluctuations increases as financial frictions are mitigated and is maximized when the financial market approaches perfection. These outcomes imply that financial innovations are likely to destabilize an economy.
    Keywords: Financial innovations, endogenous business cycles, financial destabilization, heterogeneous agents.
    JEL: E13 E32 E44
    Date: 2021–02
  11. By: Greg Kaplan (University of Chicago - Department of Economics; NBER); Benjamin Moll (London School of Economics; CEPR; NBER); Giovanni Violante (Princeton University - Department of Economics; CEPR; IFS; IZA; NBER)
    Abstract: We provide a quantitative analysis of the trade-offs between health outcomes and the distribution of economic outcomes associated with alternative policy responses to the COVID-19 pandemic. We integrate an expanded SIR model of virus spread into a macroeconomic model with realistic income and wealth inequality, as well as occupational and sectoral heterogeneity. In the model, as in the data, economic exposure to the pandemic is strongly correlated with financial vulnerability, leading to very uneven economic losses across the population. We summarize our findings through a distributional pandemic possibility frontier, which shows the distribution of economic welfare costs associated with the different aggregate mortality rates arising under alternative containment and fiscal strategies. For all combinations of health and economic policies we consider, the economic welfare costs of the pandemic are large and heterogeneous. Thus, the choice governments face when designing policy is not just between lives and livelihoods, as is often emphasized, but also over who should bear the burden of the economic costs. We offer a quantitative framework to evaluate both trade-offs.
    Date: 2020
  12. By: Sergey Pekarski (National Research University Higher School of Economics); Anna Sokolova (National Research University Higher School of Economics)
    Abstract: We revisit the link between the risk of sovereign default and default costs. Contrary to prior literature, we show that higher costs of default may result in higher default probabilities, lower bond prices, and fiscal limits that are not pinned down by economic fundamentals. Government debt sustainability depends on private investment behavior, which is affected by expectations about defaults and capital returns. We argue that this feedback loop gives rise to multiple equilibria. In `bad' equilibria, investors expect default and low capital returns; their low capital investment tightens the governments' fiscal constraints and reduces the probability of debt repayment, validating investor pessimism. In `good' equilibria, optimistic investors choose higher capital investment; this results in higher future fiscal surpluses, raises the probability of debt repayment and validates investor optimism.
    Keywords: sovereign default, default costs, fiscal limit, multiple equilibria
    JEL: E62 H30 H60
    Date: 2021
  13. By: Yasuo Hirose; Takushi Kurozumi; Willem Van Zandweghe
    Abstract: Empirical studies have documented that the persistence of the gap between inflation and its trend declined after the Volcker disinflation. Previous research into the source of the decline has offered competing views while sidestepping the possibility of equilibrium indeterminacy. This paper examines the source by estimating a medium-scale DSGE model using a Bayesian method that allows for indeterminacy. The estimated model shows that the Fed's change from a passive to an active policy response to the inflation gap or a decrease in firms' probability of price change can fully account for the decline in inflation gap persistence by ruling out indeterminacy that induces persistent dynamics of the economy.
    Keywords: Inflation gap persistence; Predictability; Equilibrium indeterminacy; Monetary policy; Non-CES aggregator
    JEL: C62 E31 E52
    Date: 2021–02–22
  14. By: Tanaka, Yasuhito
    Abstract: The existence of involuntary unemployment advocated by J. M. Keynes is a very important problem of the modern economic theory. Using a three-generations overlapping generations model, we show that the existence of involuntary unemployment is due to the instability of the economy. Instability of the economy is the instability of the difference equation about the equilibrium price around the full-employment equilibrium, which means that a fall in the nominal wage rate caused by the presence of involuntary unemployment further reduces employment. This instability is due to the negative real balance effect that occurs when consumers’ net savings (the difference between savings and pensions) are smaller than their debt multiplied by the marginal propensity to consume from childhood consumption. Also we present a discussion about fiscal policy by seigniorage to realize full-employment.
    Keywords: overlappling generations model, involuntary unemployment, instability of the economy, negative real balance effect, fiscal policy by seigniorage
    JEL: E12 E24
    Date: 2021–02–19
  15. By: Aleksandar Vasilev (Lincoln International Business School, UK.)
    Abstract: Stochastic risk aversion is introduced into a real-business-cycle setup augmented with a detailed government sector. The model is calibrated to Bulgarian data for the period following the introduction of the currency board arrangement (1999-2018). The quantitative importance of the presence of shocks to risk aversion is investigated for the propagation of cyclical fluctuations in Bulgaria. In particular, allowing for a stochastic risk aversion in the setup improves the model fit vis-a-vis data by increases variability of employment and decreasing the variability of investment. However, those improvements are at the cost of decreasing the volatility of investment and wages.
    Keywords: business cycles, stochastic risk aversion, Bulgaria.
    JEL: E24 E32
    Date: 2021–01
  16. By: Diego Wachs; Jorge Onrubia
    Abstract: In this paper, we used an overlapping generations model to analyse the effects of such reforms over fiscal sustainability, adequacy, and fairness of public pension systems. We looked at three scenarios defined by the mechanisms indexing retirement age: a constant pensions fiscal balance, constant life expectancy after retirement, and constant disability-free life expectancy after retirement.
    Date: 2021–01
  17. By: Jeremy Greenwood (University of Pennsylvania); Nezih Guner (Centro de Estudios Monetarios y Financieros (CEMFI)); Ricardo Marto (University of Pennsylvania)
    Abstract: The 20th century beheld a dramatic transformation of the family. Some Kuznets style facts regarding structural change in the family are presented. Over the course of the 20th century in the United States fertility declined, educational attainment waxed, housework fell, leisure increased, and marriage waned. These trends are also observed in the cross-country data. A model is developed, and then calibrated, to address the trends in the US data. The calibration procedure is closely connected to the underlying economic logic. Three drivers of the great transition are considered: neutral technological progress, skilled-biased technological change, and drops in the price of labor-saving household durables.
    Keywords: average weekly hours, blue-collar jobs, calibration, college premium, education, family economics, fertility, housework. Kuznets, leisure, market work, marriage, neutral technological progress, price of labor-saving household durables, skilled-biased technological change, white-collar jobs
    JEL: D10 E13 J10 O10
    Date: 2021–03
  18. By: Tatyana Koreshkova (Concordia University and CIREQ); Minjoon Lee (Carleton University)
    Abstract: We build an equilibrium model of a nursing home market with decision-makers on both sides of the market. On the demand side, heterogeneous households with stochastic needs for long-term care solve dynamic optimization problems, choosing between in-home and nursing-home care. On the supply side, locally competitive nursing homes decide prices and intensities of care given the household demand. The government subsidizes long-term care of the poorest. The quantitative model successfully generates key empirical patterns. Evaluation of long-term care policies shows that the equilibrium approach is important for the welfare and distributional effects of policies targeting either side of the market.
    Keywords: Long-term Care, Nursing Home, Medicaid.
    JEL: D15 E21 I11 I13
    Date: 2021–01
  19. By: Alessandro Ferrari (Bank of Italy); Valerio Nispi Landi (Bank of Italy)
    Abstract: We study the effects of a temporary Green QE, defined as a policy that temporarily tilts the central bank's balance sheet toward green bonds, i.e. bonds issued by firms in non-polluting sectors. To this purpose, we merge a standard DSGE framework with an environmental model, in which detrimental emissions increase the stock of pollution. Imperfect substitutability between green and brown bonds is a necessary condition for the effectiveness of Green QE. While a temporary Green QE is an effective tool in mitigating detrimental emissions, it has limited effects in reducing the stock of pollution, if pollutants, such as CO2, stay in the atmosphere for a long time. The welfare gains of Green QE are positive but small. Welfare gains are larger if the flow of emissions negatively affects the utility of households.
    Keywords: central bank, monetary policy, quantitative easing, climate change
    JEL: E52 E58 Q54
    Date: 2021–02
  20. By: Jessica Gallant (University of Toronto); Kory Kroft (University of Toronto - Department of Economics; NBER); Fabian Lange (McGill University - Department of Economics; NBER); Matthew J. Notowidigdo (University of Chicago - Booth School of Business; NBER)
    Abstract: This paper develops a search-and-matching model that incorporates temporary unemployment and applies the model to study the labor market dynamics of the COVID-19 recession in the US. We calibrate the model using panel data from the Current Population Survey for 2001-2019, and we find that the model-based job finding rates match observed job finding rates during the entire sample period and out-of-sample up through July 2020. We also find that the Beveridge curve is well-behaved and displays little change in market tightness in 2020 once we use the calibrated model to adjust for changes in the composition of the unemployed. We then use the model to project the path of unemployment over the next 18 months. Under a range of assumptions about job losses and labor demand, our model predicts a more rapid recovery compared to a model that does not distinguish between temporary and permanent unemployment and compared to professional and academic forecasts. We find that in order to rationalize the professional forecasts of the unemployment rate, some combination of the vacancy rate, job separation rate, and the recall rate of workers on temporary layoff must deteriorate substantially from current levels in the next several months.
    Date: 2020
  21. By: Chaoran Chen; Ashique Habib; Xiaodong Zhu
    Abstract: In the standard macro-finance model, financial constraints affect small or young firms but not large or old ones, and the implied dispersion in the marginal revenue product of capital (MRPK) of a firm cohort is less persistent compared to the data. We extend the model by allowing firm productivity to be endogenous to firms' financial constraints. With endogenous productivity, a firm's optimal demand for capital increases with collateral, financial constraints and dispersion of MRPK persist, and even large firms are likely to be constrained. Our model with endogenous productivity also amplifies productivity loss arising from financial frictions by two-fold.
    Keywords: Collateral Constraint, Endogenous Firm Productivity, Firm Dynamics, Misallo- cation, Aggregate Productivity, China
    JEL: E13 G31 L16 L26 O41
    Date: 2021–02–19
  22. By: Adrien Bilal (University of Chicago - Becker Friedman Institute); Hugo Lhuillier (Princeton University - Department of Economics)
    Abstract: Outsourced workers experience large wage declines, yet domestic outsourcing may raise aggregate productivity. To study this equity-efficiency trade-off, we contribute a framework in which more productive firms either post higher wages along a job ladder to sustain a larger in-house workforce, comprised of many imperfectly substitutable worker types and subject to decreasing returns to scale, or rent labor services from contractors who hire in the same frictional labor markets. Three implications arise: more productive firms are more likely to outsource to save on higher wage premia; outsourcing raises output at the firm level; labor service providers endogenously locate at the bottom of the job ladder, implying that outsourced workers receive lower wages. Using firm-level instruments for outsourcing and revenue productivity, we find empirical support for all three predictions in French administrative data. After structurally estimating the model, we show that the rise in outsourcing in France between 1997 and 2007 increased aggregate output by 1% and reduced the labor share by 3 percentage points.
    Date: 2020
  23. By: Ferreira, Pedro Cavalcanti; Peruffo, Marcel Cortes; Cordeiro Valério, André
    Abstract: This article studies the short -and long-term effects of Universal Basic Income programs - a uniform transfer to every individual in society - in the context of a developing economy and compares this policy with other schemes that condition the transfer on household characteristics such as income and education. We construct a dynastic heterogeneous-agent model, featuring uninsurable idiosyncratic risk, investment in physical and human capital, and choice of labor effort. We calibrate the model to Brazilian data and introduce a UBI transfer equivalent to roughly 4.5% of average household income. We find that, over the short run, this policy alleviates poverty and increases welfare, especially for the poor. Over time, however, income falls and poverty and inequality increase as fewer people stay in school, labor supply decreases, and savings fall. We then explore the consequences of an equivalent transfer that is both subject to means testing and requires recipients to enroll their children in school. This policy outperforms the UBI in several dimensions, increasing overall income, reducing poverty and inequality, and improving welfare. This result is robust to varying the magnitude of the cash transfer. We then investigate which aspects of the CCT make it so effective, and find that the schooling conditionality is crucial in ensuring its long- and even short- run success.
    Date: 2021
  24. By: Atahan Afsar; José Elías Gallegos; Richard Jaimes; Edgar Silgado Gómez; José Elías Gallegos; Richard Jaimes; Edgar Silgado Gómez
    Abstract: Abstract Structural estimates of the standard New Keynesian model are at odds with microeconomic estimates. To reconcile these findings, we develop and estimate a behav- ioral New Keynesian model augmented with backward-looking households and firms. We find (i) strong evidence for bounded rationality, with a cognitive discount fac- tor estimate of 0.4 at quarterly frequency; and (ii) that the behavioral setting with backward-looking agents helps us in harmonizing the New Keynesian theory with em- pirical studies. We suggest that both cognitive discounting and anchoring are essential, first, to match empirical estimates for certain parameters of interest, and second, to obtain the hump-shaped and initially muted impulse-response functions that we observe in the data.
    Keywords: New Keynesian, Bounded Rationality, Bayesian Estimation.
    JEL: E27 E52 E71
    Date: 2020–12–17
  25. By: Eliezer Borenstein (Bank of Israel); Alex Ilek (Bank of Israel)
    Abstract: We examine the potential effectiveness of asset purchases (AP) in small open economies. To that end we extend the model of Gertler and Karadi (2011) to a small open economy, in which households and firms can borrow and lend in the global. financial market. Our results confirm a previous finding of the literature: In a small open economy, the response of the main variables to AP is weaker than in a closed economy. However, this weaker response does not necessarily imply a weaker benefit of AP: We show that even in a small open economy AP can improve welfare, and that the improvement could potentially be larger than in a closed economy. The reason is that conducting AP allows the economy to restore a more efficient financing structure, in the sense that it reduces intermediation costs paid to foreign lenders.
    Date: 2021–01
  26. By: Michael Barnett (Arizona State University - W.P. Carey School of Business); Greg Buchak (Stanford University - Graduate School of Business); Constantine Yannelis (University of Chicago - Booth School of Business)
    Abstract: We examine how policymakers should react to a pandemic when there is significant uncertainty regarding key parameters relating to the disease. In particular, this paper explores how optimal mitigation policies change when incorporating uncertainty regarding the Case Fatality Rate (CFR) and the Basic Reproduction Rate (R0) into a macroeconomic SIR model in a robust control framework. This paper finds that optimal policy under parameter uncertainty generates an asymmetric optimal mitigation response across different scenarios: when the disease’s severity is initially underestimated the planner increases mitigation to nearly approximate the optimal response based on the true model, and when the disease’s severity is initially overestimated the planner maintains lower mitigation as if there is no uncertainty in order to limit excess economic costs.
    Keywords: COVID-19, coronavirus, model uncertainty, dynamic general equilibrium
    JEL: E1 H0 I1
    Date: 2020
  27. By: Corina Boar (New York University - Department of Economics); Simon Mongey (University of Chicago - Department of Economics)
    Abstract: The CARES Act resulted in many unemployed workers receiving benefits that exceeded wages at their previous job. Given this, would an unemployed worker reject an offer to return to their former job at the same wage? Qualitatively, we provide a very simple dynamic model that incorporates four reasons the answer could be ‘no’: (i) the temporary nature of the CARES Act, (ii) uncertainty that their return-to-work offer might expire, (iii) search frictions, and (iv) wage losses out of unemployment in a recession. Quantitatively, when evaluated under empirically relevant parameters, we find it unlikely a worker would reject an offer to return to work at the same wage. We show special cases where this is not true and relate these to anecdotal evidence.
    Date: 2020
  28. By: Larsen, Birthe (Department of Economics, Copenhagen Business School); Waisman, Gisela (Sulcis, Stockholm University and Finansdepartementet, Stockholm)
    Abstract: This paper examines the impact of unemployment insurance and social assistance on wages, unemployment, education and inequality when educational choice and the decision to pay into an unemployment insurance fund is endogenous and when workers are heterogenous in terms of initial wealth. The higher the worker’s wealth, the lower social assistance the worker receives if unemployed. The model can help shed light on the puzzle why only some workers pay into an unemployment insurance fund as well as the relative compressed wage structure in countries with generous social assistance and unemployment insurance. We use this set up to consider whether we should as society increase social assistance or unemployment insurance, if the aim is to reduce inequality.
    Keywords: Voluntary unemployment insurance; Unemployment; Search; Education; Welfare; Inequality
    JEL: I24 J60
    Date: 2021–02–10
  29. By: Rafael Dix-Carneiro (Duke University); Pinelopi K. Goldberg (Cowles Foundation, Yale University); Costas Meghir (Cowles Foundation, Yale University); Gabriel Ulyssea (University College London)
    Abstract: We build an equilibrium model of a small open economy with labor market frictions and imperfectly enforced regulations. Heterogeneous ï¬ rms 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
  30. By: Carolin E. Pflueger (University of Chicago - Harris School of Public Policy; National Bureau of Economic Research (NBER)); Gianluca Rinaldi (Harvard University, Department of Economics)
    Abstract: We build a new model integrating a work-horse New Keynesian model with investor risk aversion that moves with the business cycle. We show that the same habit preferences that explain the equity volatility puzzle in quarterly data also naturally explain the large high-frequency stock response to Federal Funds rate surprises. In the model, a surprise increase in the short-term interest rate lowers output and consumption relative to habit, thereby raising risk aversion and amplifying the fall in stocks. The model explains the positive correlation between changes in breakeven inflation and stock returns around monetary policy announcements with long-term inflation news.
    Date: 2020
  31. By: Gustafsson, Johan (Department of Economics, Umeå University)
    Abstract: This paper studies the life-cycle effects of favorable marginal tax treatment of older workers on their optimal life-cycle labor supply, retirement timing, and savings. I develop a structural model in continuous time where the life-cycle of a representative agent is divided into three distinct phases: pre-treatment, post-treatment, and retirement. Solutions for consumption/savings, labor supply/leisure, and retirement timing are then obtained by solving the model as a salvage value problem. I then calibrate the model to Swedish earnings data and find that the increased extensive margin labor supply is partially offset by a reduction of the hours of work in the pre-treatment period. The total effect is however an increase in life-cycle labor supply, and consumption.
    Keywords: Retirement age; life cycle; tax heterogeneity; savings; consumption; leisure
    JEL: D15 J22 J26
    Date: 2021–02–04

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