nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2021‒03‒08
nineteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. The role of banking and credit in business cycle fluctuations in Kazakhstan By Nurdaulet Abilov
  2. The role of labor market structure and shocks for monetary policy in Kazakhstan By Alisher Tolepbergen
  3. Macroprudential policy interactions in a sectoral DSGE model with staggered interest rates By Hinterschweiger, Marc; Khairnar, Kunal; Ozden, Tolga; Stratton, Tom
  4. A structural investigation of quantitative easing By Böhl, Gregor; Goy, Gavin; Strobel, Felix
  5. Should the ECB Adjust its Strategy in the Face of a Lower r*? By Philippe Andrade; Jordi Galí; Hervé Le Bihan; Julien Matheron
  6. Sovereign default and imperfect tax enforcement By Francesco Pappadà; Yanos Zylberberg
  7. Relationships that Last: Job Creation vs Job Duration By Britta Gehrke; Jacob Wong
  8. Expectations switching in a DSGE model of the UK By Anette Borge; Gunnar Bårdsen; Junior Maih
  9. Child Labor, Corruption, and Development By Toshiki Miyashita; Kohei Okada; Kei Takakura
  10. Declining natural interest rate in the US: the pension system matters By Jacopo Bonchi; Giacomo Caracciolo
  11. Replicating Business Cycles and Asset Returns with Sentiment and Low Risk Aversion By Kevin J. Lansing
  12. The "Matthew Effect" and Market Concentration: Search Complementarities and Monopsony Power By Jesús Fernández-Villaverde; Federico Mandelman; Yu Yang; Francesco Zanetti
  13. Learning, expectations and monetary policy By Pablo Garcia
  14. Frictions financières et Dynamique macroéconomique : Examen des régularités cycliques By Katuala, Hénock M.
  15. On global determinacy of New Keynesian models By Kim, Minseong
  16. Optimal policy with occasionally binding constraints: piecewise linear solution methods By Harrison, Richard; Waldron, Matt
  17. Re-allocating taxing rights and minimum tax rates in international profit taxation By Kempkes, Gerhard; Stähler, Nikolai
  18. Fixed exchange rate - a friend or foe of labor cost adjustments? By Milivojevic, Lazar; Tatar, Balint
  19. Limited Household Risk Sharing: General Equilibrium Implications for the Term Structure of Interest Rates By Indrajit Mitra; Yu Xu

  1. By: Nurdaulet Abilov (NAC Analytica, Nazarbayev University)
    Abstract: We analyze the role of banking sector and credit in business cycle fluctuations in Kazakhstan by adopting the dynamic stochastic general equilibium (DSGE) model with financial frictions and banks. We introduce financial frictions that lead to the amplification of the effects of shocks in the economy. We find that bank capital adjustment costs are essential in the model due to the large capital adjustment cost parameter. This implies that banks' capital adjusts very slowly to exogenous shocks in the economy. We also analyze impulse responses of endogenous variables to exogenous shocks, including a negative bank capital shock, in order to understand the propagation mechanisms of the shocks. The results from the historical decomposition exercise show us that the financial shocks have played an important role in business cycle fluctuations in Kazakhstan since 2015.
    Keywords: DSGE; financial frictions; banking sector; Kazakhstan
    JEL: C11 E32 E37 E44 E51
    Date: 2020–12
  2. By: Alisher Tolepbergen (NAC Analytica, Nazarbayev University)
    Abstract: In this paper we study the role of labor market structure and shocks for monetary policy in Kazakhstan employing a New Keynesian model with labor market rigidities. First, we examine to what extent more flexible labor market affects the transmission of monetary policy in the calibrated version of the model. The results show that more flexible wage-setting process improves the transmission mechanism. A monetary policy shock translates faster to inflation. Further, we find that the relevance of other features of labor market for the transmission of monetary policy shocks is limited. Second, we estimate the model using Bayesian techniques to identify labor market shocks that are important for monetary policy making. The estimation results suggest that shocks to the bargaining power of workers explain most of output and inflation fluctuations and thus should be closely monitored by the central bank.
    Keywords: DSGE; labor market; wage rigidity; Bayesian estimation
    JEL: E32 E52 J64 C11
    Date: 2020–12
  3. By: Hinterschweiger, Marc (Bank of England); Khairnar, Kunal (Toulouse School of Economics); Ozden, Tolga (University of Amsterdam); Stratton, Tom (Bank of England)
    Abstract: We develop a two-sector DSGE model with a detailed banking sector along the lines of Clerc et al (2015) to assess the impact of macroprudential tools (minimum, countercyclical and sectoral capital requirements, as well as a loan-to-value limit) on key macroeconomic and financial variables. The banking sector features residential mortgages and corporate lending subject to staggered interest rates à la Calvo (1983), which is motivated by the sluggish movement of lending rates due to fixed interest rate loan contracts. Other distortions in the model include limited liability, bankruptcy costs and penalty costs for deviations from regulatory capital. We estimate the model using Bayesian methods based on quarterly UK data over 1998 Q1–2016 Q2. Our contributions are threefold. We show that: (i) co-ordination of macroprudential tools may have a welfare-improving effect, (ii) macroprudential tools would have improved some macroeconomic indicators but, within our model, not have prevented the Global Financial Crisis, (iii) staggered interest rates may alter the transmission of macroprudential tools that work through interest rates.
    Keywords: Sectoral DSGE model; macroprudential policy; interest rate stickiness
    JEL: E32 E58 G18 G21
    Date: 2021–01–22
  4. By: Böhl, Gregor; Goy, Gavin; Strobel, Felix
    Abstract: Did the Federal Reserve's Quantitative Easing (QE) in the aftermath of the financial crisis have macroeconomic effects? To answer this question, we estimate a large-scale DSGE model over the sample from 1998 until 2020, including data of the Fed's balance sheet. We allow for QE to affect the economy via multiple channels that arise from several financial frictions. Our nonlinear Bayesian likelihood approach fully accounts for the zero lower bound on nominal interest rates. We find that QE increased output by about 1.2 percent, reflecting a net increase in investment of nearly 9 percent accompanied by a 0.7 percent drop in aggregate consumption. Both government bond and capital asset purchases effectively improved financing conditions. Especially capital asset purchases significantly facilitated new investment and increased the production capacity. Against the backdrop of a fall in consumption, supply side effects dominated, leading to a disinflationary effect of about 0.25 percent annually.
    Keywords: Quantitative Easing,Liquidity Facilities,Zero Lower Bound,Nonlinear Bayesian Estimation
    JEL: C62 C63 E32 E58 E63
    Date: 2021
  5. 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 significant 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: 2021–02
  6. By: Francesco Pappadà (PSE - Paris School of Economics - ENPC - École des Ponts ParisTech - ENS Paris - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - UP1 - Université Paris 1 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, Banque de France - Banque de France - Banque de France); Yanos Zylberberg (University of Bristol [Bristol], CEPR - Center for Economic Policy Research - CEPR)
    Abstract: The effect of fiscal policy on default risk is mitigated by the response of tax compliance. To explore the consequences of this stylized fact, we build a model of sovereign debt with limited commitment and imperfect tax enforcement. Fiscal policy persistently affects the size of the informal economy, which impacts future fiscal revenues and default risk. The interaction of imperfect tax enforcement and limited commitment strongly constrains the dynamics of optimal fiscal policy and leads to costly uctuations in consumption.
    Keywords: Sovereign default,Imperfect tax enforcement,Fiscal policy
    Date: 2021–02
  7. By: Britta Gehrke (Universitat Rostock & IAB); Jacob Wong (School of Economics, University of Adelaide)
    Abstract: This paper documents observations about the duration of jobs created by establishments at various points along an establishment age curve. Using an employer-employee matched dataset from Germany, we observe a checkmark-shaped relationship between expected job duration and establishment age at the time of job creation. A simple frictional labour market model with two-sided heterogeneity featuring on-the-job search, a simple learning mechanism about worker ability and a life cycle productivity profile for firms is built to frame a discussion around the empirical finding. The model's mechanical job-ladder is shown to be able to produce such stylized correlations.
    Keywords: job duration,firm age, frictional labour markets
    JEL: E24 J63 J64
    Date: 2021–03
  8. By: Anette Borge; Gunnar Bårdsen; Junior Maih
    Abstract: Rational expectations (RE) has been dominant both in the economic literature and in the macromodels routinely used in central banks. The RE assumption has recently come under attack as one of the drawbacks of the Dynamic Stochastic General Equilibrium (DSGE modeling) paradigm. This study attempts to investigate whether other ways of modeling expectations would necessarily find a better support in the data. We investigate the relevance of the RE assumption by introducing regime switching into the expectations formation of an otherwise standard DSGE model by Justiniano and Preston (2010). In our model, expectations switch between RE and Adaptive expectations (AE). The model is estimated on UK data using Bayesian techniques. By introducing a switching mechanism, the model explains the data better than both the pure RE and the pure AE models. Expectation formation switches to AE during changes in monetary policy and the financial crisis. The dynamics of the economic system is different under the two expectation regimes. Hence, should the UK economy switch to an AE regime after Brexit, or as a consequence of the COVID-19 pandemic, the dynamics of the economic system could be substantially more uncertain than under RE, given the model.
    Date: 2019–10
  9. By: Toshiki Miyashita (Graduate School of Economics, Osaka University); Kohei Okada (Graduate School of Economics, Osaka University); Kei Takakura (Graduate School of Economics, Osaka University)
    Abstract: Employing an overlapping-generations model with endogenous education choice and corruption, we investigate how child labor and corruption influence human capital accumulation and development. We show that multiple steady-states exist in the economy. One steady-state has a high level of human capital, and the other has a low level of human capital. In the steady-state with a low level of human capital, child labor and corruption exist and welfare is low. In the steady-state with a high level of human capital, child labor and corruption are diminished and welfare is high. In addition, we show that it is dicult to steer an economy away from a poverty trap with child labor and corruption because bureaucrats of the current generation are opposed to policy changes such as reinforcement of monitoring and penal regulations. However, we can apply the Pareto-improving policy to this poverty trap, for e.g., the government receives funds from an international organization and distributes them among bureaucrats, which keeps them from being corrupt.
    Keywords: Child labor, corruption, human capital accumulation, development
    JEL: D73 E24 I25 J13
    Date: 2021–01
  10. By: Jacopo Bonchi (LUISS); Giacomo Caracciolo (Bank of Italy)
    Abstract: The natural interest rate is the level of the real interest rate compatible with potential output and stable prices. We develop a life-cycle model and calibrate it to the US economy to quantify the role of the public pension scheme for the past and future evolution of the natural interest rate. Between 1970 and 2015, the pension reforms have overall mitigated the secular decline in the natural interest rate, raising it by around one percentage point and thus counteracting the downward pressure from adverse demographic and productivity patterns. As regards the future, we simulate the effects of the demographic trends, expected between 2015 and 2060, combined with alternative pension reforms and productivity growth scenarios. We rank the different policy options according to a welfare criterion and study the implications for the natural interest rate. A reduction in the replacement rate outperforms, in terms of welfare, an increase in the contribution rate in the “normal growth” scenario and vice versa in the “stagnant growth” case.
    Keywords: natural interest rate, pensions, population ageing, secular stagnation, demography, social security
    JEL: E60 H55
    Date: 2021–02
  11. By: Kevin J. Lansing
    Abstract: This paper develops a real business cycle model with eight fundamental shocks and one ìequity sentiment shockî that captures belief-driven áuctuations. I solve for the time series of shock realizations that allow the model to exactly replicate the observed time paths of U.S. macroeconomic variables and asset returns over the past six decades. The representative agentís perception that movements in equity value are partly driven by sentiment is close to self-fulÖlling. The model-identiÖed sentiment shock is strongly correlated with other fundamental shocks and implies ìpessimismîrelative to fundamental equity value in steady state. Counterfactual scenarios show that the sentiment shock and shocks that appear in the law of motion for capital (representing Önancial frictions) have large impacts on the levels of macroeconomic variables and the size of the equity risk premium. Other shocks have large impacts on the growth rates of macroeconomic variables. Four of the model-identiÖed shocks help to predict the equity risk premium or the bond term premium in the next quarter. Overall, the results support a narrative in which a large number of correlated shocks have combined to deliver the historical outcomes observed in U.S. data.
    Keywords: Belief-driven business cycles; Sentiment; Animal spirits; Risk aversion; Equity risk premium; Bond term premium
    JEL: E32 E44 O41
    Date: 2021–01–11
  12. By: Jesús Fernández-Villaverde; Federico Mandelman; Yu Yang; Francesco Zanetti
    Abstract: This paper develops a dynamic general equilibrium model with heterogeneous firms that face search complementarities in the formation of vendor contracts. Search complementarities amplify small differences in productivity among firms. Market concentration fosters monopsony power in the labor market, magnifying profits and further enhancing high-productivity firms’ output share. Firms want to get bigger and hire more workers, in stark contrast with the classic monopsony model, where a firm aims to reduce the amount of labor it hires. The combination of search complementarities and monopsony power induces a strong “Matthew effect” that endogenously generates superstar firms out of uniform idiosyncratic productivity distributions. Reductions in search costs increase market concentration, lower the labor income share, and increase wage inequality.
    Keywords: market concentration, superstar firms, search complementarities, monopsony power in the labor market
    JEL: C63 C68 E32 E37 E44 G12
    Date: 2021
  13. By: Pablo Garcia
    Abstract: I present a New Keynesian model in which the central bank’s anti-inflationary preferences change over time. Agents do not observe the current monetary regime, but rationally learn about it using Bayes theorem. The model provides a structural interpretation for the contractionary effects of monetary policy uncertainty shocks as recently documented in the empirical literature. In addition, the model shows that learning reduces the effects of monetary policy on the economy by softening the link between fundamentals and equilibrium prices and allocations.
    Keywords: C11, D83, E52
    JEL: C11 D83 E52
    Date: 2021–02
  14. By: Katuala, Hénock M.
    Abstract: La récente crise financière s’est accompagnée des chocs affectant les marchés interbancaires et immobiliers des économies, suite à quoi, des modèles avec des marchés financiers imparfaits ont été utilisés pour étudier des questions d’actualité importantes (Gerali et al., 2010; Christiano et al., 2010). De ce fait, il a été admis que le développement et les frictions du système financier peuvent avoir un impact décisif sur la croissance économique et sur la stabilité de l’économie (Bernanke et al., 1999; Gertler and Karadi, 2011). En recourant au modèle DSGE de type Néokeynésien pour une petite économie fermée, nous analysons les implications macroéconomiques des chocs affectants le système financier et vérifions la convergence entre les régularités cycliques théoriques et celles empiriques afin de valider le modèle pour le cas de la RDC. Nos résultats attestent que les chocs affectant l’économie réelle exercent une influence sur la dynamique du secteur financier alors que les frictions financières n’ont aucune incidence sur le cadre macroéconomique. Aussi, le recourt au Matching moment nous a permis d’affirmer que les régularités cycliques issues des moments théoriques et empiriques convergent.
    Keywords: Frictions financières; Dynamique macroéconomique; Modèle DSGE Néokeynésien; Régularités cycliques; Comouvements; Volatilité; Persistance
    JEL: C61 E32 E44
    Date: 2021–02
  15. By: Kim, Minseong
    Abstract: New Keynesian models assume that inflation rate and output level are endogenous variables. However, given that firms are price setters and suppliers in the models, it is more reasonable to assume that, absent equilibrium coordination (or tatonnement) issues usually abstracted away, both variables actually are state variables determined by expectations in the past. This secures global equilibrium determinacy and a previously unavailable account of inflation rate for New Keynesian models. Furthermore, the principle of effective demand is implemented via the expectation channel.
    Date: 2021–02–14
  16. By: Harrison, Richard (Bank of England); Waldron, Matt (Bank of England)
    Abstract: This paper develops a piecewise linear toolkit for optimal policy analysis of linear rational expectations models, subject to occasionally binding constraints on (multiple) policy instruments and other variables. Optimal policy minimises a quadratic loss function under either commitment or discretion. The toolkit accounts for the presence of ‘anticipated disturbances’ to the model equations, allowing optimal policy analysis around scenarios or forecasts that are not produced using the model itself (for example, judgement-based forecasts such as those often produced by central banks). The flexibility and applicability of the toolkit to very large models is demonstrated in a variety of applications, including optimal policy experiments using a version of the Federal Reserve Board’s FRB/US model.
    Keywords: Optimal policy; commitment; discretion; occasionally binding constraints
    JEL: C61 C63 E61
    Date: 2021–02–26
  17. By: Kempkes, Gerhard; Stähler, Nikolai
    Abstract: What are the macroeconomic implications of re-allocating taxing rights away from source countries (where goods are produced) to market countries (where goods are consumed) and introducing minimum rates in international profit taxation? We assess this question in a dynamic macroeconomic model that gives a meaningful role to profit taxation. We find that, in low tax economies, the average profit tax rate will rise. On the one hand, this reduces price competitiveness of firms located in these regions and, thereby, output. On the other hand, higher profit tax revenues help to reduce other taxes. Moreover, lower expected future output requires less capital in production in the long run. Firms hence invest less and (temporarily) augment dividend payments. This raises disposable income of households, who (at least temporarily) increase consumption. The opposite holds for high tax economies. When taxing rights are re-allocated, wealth transfers between regions mitigate these effects. In terms of welfare, low tax economies can benefit from an increase in profit taxation.
    Keywords: Re-Allocating Profit Taxing Rights,Minimum Taxation,InternationalMacro
    JEL: H25 L52 E20 E62 L10
    Date: 2021
  18. By: Milivojevic, Lazar; Tatar, Balint
    Abstract: This paper examines the effectiveness of labor cost reductions as a means to stimulate economic activity and assesses the differences which may occur with the prevailing exchange rate regime. We develop a medium-scale three-region DSGE model and show that the impact of a cut in employers' social security contributions rate does not vary significantly under different exchange rate regimes. We find that both the interest rate and the exchange rate channel matters. Furthermore, the measure appears to be effective even if it comes along with a consumption tax increase to preserve long-term fiscal sustainability. Finally, we assess whether obtained theoretical results hold up empirically by applying the local projection method. Regression results suggest that changes in employers' social security contributions rates have statistically significant real effects - a one percentage point reduction leads to an average cumulative rise in output of around 1.3 percent in the medium term. Moreover, the outcome does not differ significantly across the different exchange rate regimes.
    Keywords: Structural policies,Labor cost adjustments,Exchange rate regime,Local projection,DSGE
    JEL: C53 C54 E32 E37 E61 E62 F41 F45 F47
    Date: 2021
  19. By: Indrajit Mitra; Yu Xu
    Abstract: We present a theory in which limited risk sharing of idiosyncratic labor income risk plays a key role in determining the dynamics of interest rates. Our production-based model relates the cross-sectional distribution of labor income risk to observable aggregate labor market variables. Our model makes two key predictions. First, it predicts positive risk premia for long-term bonds while simultaneously matching key macroeconomic moments. Second, it predicts a negative correlation between current labor market conditions (as measured by labor market tightness or the job-finding rate) and future bond excess returns. We provide evidence for these predictions.
    Keywords: interest rates; nondiversifiable labor income risk; labor market frictions; bond risk premia
    JEL: A12 E24 E43 E44 G12 J64
    Date: 2020–11–09

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