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on Dynamic General Equilibrium |
| By: | Verónica Acurio Vásconez; Olivier Damette; David W. Shanafelt |
| Abstract: | Despite the fact that the current covid-19 pandemic was neither the first nor the last disease to threaten a pandemic, only recently have studies incorporated epidemiology into macroeconomic theory. In our paper, we use a dynamic stochastic general equilibrium (dsge) model with a financial sector to study the economic impacts of epidemics and the potential for unconventional monetary policy to remedy those effects. By coupling a macroeconomic model to a traditional epidemiological model, we are able to evaluate the pathways by which an epidemic affects a national economy. We find that no unconventional monetary policy can completely remove the negative effects of an epidemic crisis, save perhaps an exogenous increase in the shares of claims coming from the Central Bank (“epi loans”). To the best of our knowledge, our paper is the first to incorporate disease dynamics into a dsge-sir model with a financial sector and examine the effects of unconventional monetary policy. |
| Keywords: | New-Keynesian model, dsge, covid-19, epidemiology. |
| JEL: | D58 E32 E52 |
| Date: | 2021 |
| URL: | http://d.repec.org/n?u=RePEc:ulp:sbbeta:2021-04&r=all |
| By: | Busch, Christopher; Ludwig, Alexander |
| Abstract: | We extend the canonical income process with persistent and tran- sitory risk to cyclical shock distributions with left-skewness and excess kurtosis. We estimate our income process by GMM for US household data. We find countercyclical variance and procyclical skewness of per- sistent shocks. All shock distributions are highly leptokurtic. The tax and transfer system reduces dispersion and left-skewness. We then show that in a standard incomplete-markets life-cycle model, first, higher- order risk has sizable welfare implications, which depend on risk atti- tudes; second, it matters quantitatively for the welfare costs of cyclical idiosyncratic risk; third, it has non-trivial implications for self-insurance against shocks. |
| Keywords: | Idiosyncratic Income Risk,Cyclical Income Risk,Life-Cycle Model |
| Date: | 2021 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:icirwp:3621&r=all |
| By: | Marcin Kolasa; Grzegorz Wesołowski |
| Abstract: | Large international capital movements tend to be associated with strong fluctuations in asset prices and credit, contributing to domestic financial cycles and posing challenges for stabilization policies, especially in emerging market economies. In this paper we argue that these challenges are particularly severe if the global financial cycle is driven by quantitative easing (QE) in the US, and when the local banking sector has large holdings of government bonds, like in many Latin American countries. We first show empirically that a typical round of QE by the US Fed leads to a persistent expansion in credit to households and a significant loss of price competitiveness in this group of economies. We next develop a quantitative macroeconomic model of a small open economy with segmented asset markets and banks, which accounts for these observations. In this framework, foreign QE creates tensions between macroeconomic and financial stability as a contractionary impact of exchange rate appreciation is accompanied by booming credit and house prices. As a consequence, conventional monetary policy accommodation aimed at stabilizing output and inflation would further exacerbate domestic financial cycle. We show that an effective way of resolving this trade-off is to impose a time-varying tax on capital inflows. Combining foreign exchange interventions with tightening of local credit policies can also restore macroeconomic and financial stability, but at the expense of a large redistribution of wealth between borrowers and savers. |
| Keywords: | quantitative easing, global financial cycle, domestic credit, exchange rate interventions, capital controls, macroprudential policy |
| JEL: | E44 E58 F41 F42 F44 |
| Date: | 2021–03 |
| URL: | http://d.repec.org/n?u=RePEc:sgh:kaewps:2021063&r=all |
| By: | Youngsoo Jang; Soyoung Lee |
| Abstract: | Default risk models have been widely employed to assess the ability of households and sovereigns to insure themselves against shocks. Grid search has often been used to solve these models because the complexity of the problem prevents the use of faster but less general methods. In this paper, we propose an extension of the endogenous grid method for default risk models, which is faster and more accurate than grid search. In particular, we find that our solution method leads to a more accurate bond price function, thus making substantial differences in the model’s main predictions. When applied to Arellano’s (2008) model, our approach predicts a standard deviation of the interest rate spread one-third lower and defaults 3 to 5 times less frequently than does the conventional approach. On top of that, our method is efficient. It is approximately 4 to 7 times faster than grid search when applied to a canonical model of Arellano (2008) and 19 to 27 times faster than grid search when applied to the richer model of Nakajima and Ríos-Rull (2014). Finally, we show that our method is applicable to a broad class of default risk models by characterizing sufficient conditions. |
| Keywords: | Credit and credit aggregates; Credit risk management |
| JEL: | C63 E37 |
| Date: | 2021–03 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:21-11&r=all |
| By: | Laurence M. Ball; N. Gregory Mankiw |
| Abstract: | This paper examines the optimal accumulation of capital and the effects of government debt in neoclassical growth models in which firms have market power and therefore charge prices above marginal cost. In this environment, the real interest rate earned by savers is less than the net marginal product of capital. We establish a new method for evaluating dynamic efficiency that can be applied in such economies. A plausible calibration suggests that the wedge between the real interest rate and the marginal product of capital is more than 4 percentage points and that the U.S. economy is dynamically efficient. In addition, government Ponzi schemes can have different implications for welfare than they do under competition. Even if the government can sustain a perpetual rollover of debt and accumulating interest, the policy may nonetheless reduce welfare by depressing steady-state capital and aggregate consumption. These findings suggest that even with low interest rates, as have been observed recently, fiscal policymakers should still be concerned about the crowding-out effects of government debt. |
| JEL: | E13 E22 E62 H63 O41 |
| Date: | 2021–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:28538&r=all |
| By: | Jesús Fernández-Villaverde; Federico Mandelman; Yang Yu; 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. |
| JEL: | C63 C68 E32 |
| Date: | 2021–02 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:28495&r=all |
| By: | Theodosios Dimopoulos (University of Lausanne - School of Economics and Business Administration (HEC-Lausanne); Swiss Finance Institute); Norman Schürhoff (University of Lausanne; Swiss Finance Institute; Centre for Economic Policy Research (CEPR)) |
| Abstract: | In a dynamic model of optimal bailouts, we show how borrower myopia affects the severity of debt crises. Myopic borrowers misprice the option to default with a U-shaped negative pricing error. The myopia discount changes the optimal bailout policy. Myopia gets punished when the distortions from default mispricing outweigh the future bailout costs, resulting in procrastinated default and protracted crises. The model shows that (i) myopia is an important determinant for bailout policy, (ii) myopic default can be cheaper to resolve than rational default, (iii) rational agents can benefit from a myopic sovereign borrower, and (iv) credit spread dynamics are more asymmetric under myopia than rationality, consistent with empirical evidence. |
| Date: | 2021–02 |
| URL: | http://d.repec.org/n?u=RePEc:chf:rpseri:rp2111&r=all |
| By: | Lei Fang; Fang Yang |
| Abstract: | We document large differences between the United States and France in allocations of consumption expenditures and time by age. Using a life-cycle model, we quantify to what extent tax and transfer programs and market and home productivity can account for the differences. We find that while labor efficiency by age and home-production productivity are crucial in accounting for the differences in the allocation of time, the consumption tax and social security are more important regarding allocation of expenditures. Adopting the U.S. consumption tax decreases welfare in France, and adopting the U.S. social security system increases welfare in France. |
| Keywords: | consumption expenditure; home production; labor supply; fiscal policy |
| JEL: | E21 E62 J22 O57 H31 |
| Date: | 2021–01–29 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedawp:90077&r=all |
| By: | Jiaqi Li |
| Abstract: | This paper studies the impact of imperfect banking competition on aggregate fluctuations using a DSGE framework that features a Cournot banking sector. The paper highlights a new propagation mechanism of imperfect banking competition that operates via the dynamics of the expected marginal product of capital. Since capital is partly financed by bank loans, a higher expected return on capital implies that firms are more willing to borrow to invest in capital, making their capital and thus loan demand more inelastic. Market power enables banks to take advantage of the lower loan demand elasticity by charging a higher loan rate markup. Given that different shocks affect the dynamics of the expected return on capital differently, this paper finds that while the loan rate markup after a contractionary monetary policy shock increases and thus amplifies aggregate fluctuations, the impact of imperfect banking competition after a productivity shock is less clear and depends on the persistence of the shock. |
| Keywords: | Business fluctuations and cycles; Financial institutions; Interest rates |
| JEL: | E44 G21 L13 |
| Date: | 2021–03 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:21-12&r=all |
| By: | Nezih Guner (CEMFI); Javier López-Segovia (CEMFI); Roberto Ramos (Banco de España) |
| Abstract: | Can the Spanish government generate more tax revenue by making personal income taxes more progressive? To answer this question, we build a life-cycle economy with uninsurable labor productivity risk and endogenous labor supply. Individuals face progressive taxes on labor and capital incomes and proportional taxes that capture social security, corporate income, and consumption taxes. Our answer is yes, but not much. A reform that increases labor income taxes for individuals who earn more than the mean labor income and reduces taxes for those who earn less than the mean labor income generates a small additional revenue. The revenue from labor income taxes is maximized at an effective marginal tax rate of 51.6% (38.9%) for the richest 1% (5%) of individuals, versus 46.3% (34.7%) in the benchmark economy. The increase in revenue from labor income taxes is only 0.82%, while the total tax revenue declines by 1.55%. The higher progressivity is associated with lower aggregate labor supply and capital. As a result, the government collects higher taxes from a smaller economy. The total tax revenue is higher if marginal taxes are raised only for the top earners.The increase, however, must be substantial and cover a large segment of top earners. The rise in tax collection from a 3 percentage points increase on the top 1% is just 0.09%. A 10 percentage points increase on the top 10% of earners (those who earn more than €41,699) raises total tax revenue by 2.81%. |
| Keywords: | taxation, progressivity, top earners, labor supply, Laffer curve |
| JEL: | E21 E6 H2 J2 |
| Date: | 2020–12 |
| URL: | http://d.repec.org/n?u=RePEc:bde:wpaper:2043&r=all |
| By: | Juliane Begenau; Tim Landvoigt |
| Abstract: | How does the shadow banking system respond to changes in capital regulation of commercial banks? We propose a quantitative general equilibrium model with regulated and unregulated banks to study the unintended consequences of regulation. Tighter capital requirements for regulated banks cause higher convenience yield on debt of all banks, leading to higher shadow bank leverage and a larger shadow banking sector. At the same time, tighter regulation eliminates the subsidies to commercial banks from deposit insurance, reducing the competitive pressures on shadow banks to take risks. The net effect is a safer financial system with more shadow banking. Calibrating the model to data on financial institutions in the U.S., the optimal capital requirement is around 16%. |
| JEL: | E41 E44 G21 G23 G28 |
| Date: | 2021–02 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:28501&r=all |
| By: | C Bora Durdu; Molin Zhong |
| Abstract: | We explore the structural drivers of bank and nonbank credit cycles using a medium-scale DSGE model with two types of financial intermediation. We posit economy-wide and sectoral disturbances in both macro and financial sectors. We estimate that sectoral shocks to the balance sheets of entrepreneurs are important for fluctuations in bank and nonbank credit growth at the business cycle frequency. Economy-wide entrepreneurial risk shocks gain predominance for explaining the lower frequency co-movement between the two series. Macro shocks play very little role in explaining financial cycles. |
| Keywords: | emerging bond markets, credit risk, currency risk, Twin Ds, affine model |
| JEL: | E3 E44 G01 G21 |
| Date: | 2021–01 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:919&r=all |
| By: | Stefano Carattini; Garth Heutel; Givi Melkadze |
| Abstract: | We study climate and macroprudential policies in an economy with financial frictions. Using a dynamic stochastic general equilibrium model featuring both a pollution market failure and a market failure in the financial sector, we explore transition risk – whether ambitious climate policy can lead to macroeconomic instability. It can, but the risk can be alleviated through macroprudential policies – taxes or subsidies on banks’ assets. Then, we explore efficient climate and macroprudential policy in the long run and over business cycles. The presence of financial frictions affects the steady-state value and dynamic properties of the efficient carbon tax. Macroprudential policy alone, without a carbon tax, is not very effective at addressing the pollution externality. |
| JEL: | E32 G18 Q58 |
| Date: | 2021–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:28525&r=all |
| By: | Anna Belianska (Aix Marseille Univ, CNRS, AMSE, Marseille, France.); Aurélien Eyquem (Univ Lyon, Université Lumière Lyon 2, GATE L-SE UMR 5824 and IUF.); Céline Poilly (Aix Marseille Univ, CNRS, AMSE, Marseille, France. CEPR and DIW Berlin.) |
| Abstract: | Higher uncertainty about government spending generates a persistent decline in the economic activity in the Euro Area. This paper emphasizes the transmission channels explaining this empirical fact. First, a Stochastic Volatility model is estimated on European government consumption to build a measure of government spending uncertainty. Plugging this measure into a SVAR model, we stress that government spending uncertainty shocks have recessionary, persistent and humped-shaped effects. Second, we develop a New Keynesian model with financial frictions applying to a portfolio of equity and long-term government bonds. We argue that a portfolio effect-resulting from the imperfect substitutability among both assets-acts as a critical amplifier of the usual transmission channels. |
| Keywords: | government spending uncertainty, stochastic volatility, portfolio adjustment cost |
| JEL: | E62 E52 |
| Date: | 2021–03 |
| URL: | http://d.repec.org/n?u=RePEc:aim:wpaimx:2115&r=all |
| By: | Kohei Hasui (Faculty of Economics, Matsuyama University); Teruyoshi Kobayashi (Faculty of Economics, Kobe University); Tomohiro Sugo (Bank of Japan) |
| Abstract: | Real-world central banks have a strong aversion to policy reversals. Nevertheless, theoretical models of monetary policy within the dynamic general equilibrium framework normally ignore the irreversibility of interest rate control. In this paper, we develop a formal model that incorporates a central bank's discretionary optimization problem with an aversion to policy reversals. We show that, even under a discretionary regime, the optimal timing of liftoff from the zero lower bound is characterized by its history dependence, which arises from the option value to waiting, and there exists an optimal degree of policy irreversibility at which the social loss is minimized. |
| Date: | 2021–02 |
| URL: | http://d.repec.org/n?u=RePEc:koe:wpaper:2109&r=all |
| By: | Michele Belot (Cornell University); Philipp Kircher (Cornell University); Paul Muller (Vrije Universiteit Amsterdam) |
| Abstract: | We propose a simple method for eliciting individual time preferences without estimating utility functions even in settings where background consumption changes over time. It relies on lottery tickets with high rewards. In a standard intertemporal choice model high rewards decouple lottery choices from variation in background consumption. We validate our elicitation method experimentally on two student samples: one asked in December when their current budget is reduced by extraordinary expenditures for Christmas gifts; the other asked in February when no such extra constraints exist. We illustrate an application of our method with unemployed job seekers which naturally have income/consumption variation. |
| Keywords: | time preferences, experimental elicitation, job search, hyperbolic discounting |
| JEL: | J64 D90 |
| Date: | 2021–02–05 |
| URL: | http://d.repec.org/n?u=RePEc:tin:wpaper:20210013&r=all |
| By: | HOSONO Kaoru |
| Abstract: | I examine the epidemiological and economic effects of two types of lockdowns during the COVID-19 pandemic in Japan: a voluntary lockdown by which people voluntarily stay at home in response to the risk of infection, and a request-based lockdown by which the government requests that people stay at home without legal enforcements. I use empirical evidence on these two types of lockdowns to extend an epidemiological and economic model: the SIR-Macro model. I calibrate this extended model to Japanese data and conduct some numerical experiments. The results show that the interaction of these two types of lockdowns plays an important role in the low share of infectious individuals and the large decrease in consumption in Japan. Moreover, the welfare gains of a request-based lockdown greatly differ across individuals and can be negative for some when a voluntary lockdown exists. |
| Date: | 2021–02 |
| URL: | http://d.repec.org/n?u=RePEc:eti:dpaper:21009&r=all |
| By: | Kenichiro McAlinn; Kosaku Takanashi |
| Abstract: | This paper studies the asymptotic convergence of computed dynamic models when the shock is unbounded. Most dynamic economic models lack a closed-form solution. As such, approximate solutions by numerical methods are utilized. Since the researcher cannot directly evaluate the exact policy function and the associated exact likelihood, it is imperative that the approximate likelihood asymptotically converges -- as well as to know the conditions of convergence -- to the exact likelihood, in order to justify and validate its usage. In this regard, Fernandez-Villaverde, Rubio-Ramirez, and Santos (2006) show convergence of the likelihood, when the shock has compact support. However, compact support implies that the shock is bounded, which is not an assumption met in most dynamic economic models, e.g., with normally distributed shocks. This paper provides theoretical justification for most dynamic models used in the literature by showing the conditions for convergence of the approximate invariant measure obtained from numerical simulations to the exact invariant measure, thus providing the conditions for convergence of the likelihood. |
| Date: | 2021–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2103.06483&r=all |
| By: | Mitman, Kurt (Stockholm University); Rabinovich, Stanislav (University of North Carolina, Chapel Hill) |
| Abstract: | We investigate the optimal response of unemployment insurance to economic shocks, both with and without commitment. The optimal policy with commitment follows a modified Baily-Chetty formula that accounts for job search responses to future UI benefit changes. As a result, the optimal policy with commitment tends to front-load UI, unlike the optimal discretionary policy. In response to shocks intended to mimic those that induced the COVID-19 recession, we find that a large and transitory increase in UI is optimal; and that a policy rule contingent on the change in unemployment, rather than its level, is a good approximation to the optimal policy. |
| Keywords: | unemployment insurance, unemployment, optimal policy, COVID-19 |
| JEL: | J65 E6 H1 |
| Date: | 2021–01 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp14085&r=all |
| By: | Gaillard, Alexandre; Kankanamge, Sumudu |
| Abstract: | We evaluate the effects of unemployment insurance variations in a general equilibrium occupational choice model of entrepreneurship. We establish that the occupational flow from unemployment to entrepreneurship is remarkably sensitive to unemployment insurance generosity, corroborating our empirical findings. Beyond direct effects on unemployment, we find large reallocations between employment and entrepreneurship relative to changes in generosity. They contribute to an empirically consistent stable aggregate employment rate, despite increasing unemployment. We show that an insurance coverage effect, i.e. a change in the relative riskiness between occupations with respect to generosity, is a key driver of our results. |
| Keywords: | Entrepreneurship; Unemployment Insurance; Labor Market Mobility |
| JEL: | E24 J65 E61 |
| Date: | 2021–02–08 |
| URL: | http://d.repec.org/n?u=RePEc:tse:wpaper:125253&r=all |
| By: | Isaac Ehrlich; Yun Pei |
| Abstract: | We evaluate the economic consequences of immigration in a two-country, two-skill, overlapping-generations framework, where immigration, population, human and physical capital formation, and economic growth are endogenous variables. We go beyond extant literature by integrating physical capital in our model. This enables the derivation of new insights about the induced-immigration effects of exogenous triggers, including pull and push factors and policy variables, on the dynamic evolution of the “immigration surplus” in the short run versus the long run, in destination vs. source countries and in the global economy. The policy shifts we analyze include the easing of constraints on potential migrants’ labor and physical capital mobility, and the role of physical capital endowments. We also discuss the policy implications of asymmetries in the net benefits from immigration across destination and source countries. |
| JEL: | F22 F43 J11 J24 O15 |
| Date: | 2021–02 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:28504&r=all |
| By: | ; ; William B. Peterman |
| Abstract: | Uncertainty surrounding if and when the U.S. government will implement a federal climate policy introduces risk into the decision to invest in capital used in conjunction with fossil fuels. To quantify the macroeconomic impacts of this climate policy risk, we develop a dynamic, general equilibrium model that incorporates beliefs about future climate policy. We find that climate policy risk reduces carbon emissions by causing the capital stock to shrink and become relatively cleaner. Our results reveal, however, that a carbon tax could achieve the same reduction in emissions at less than half the cost. |
| Date: | 2021–02–16 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:90131&r=all |
| By: | Kevin Genna (Aix-Marseille Univ., CNRS, AMSE, Marseille, France); Christian Ghiglino (Department of Economics, University of Essex, UK); Kazuo Nishimura (RIEB, Kobe University, Japan); Alain Venditti (Aix-Marseille Univ, CNRS, AMSE, Marseille & EDHEC Business School, France) |
| Abstract: | How will structural change unfold beyond the rise of services? Motivated by the observed dynamics within the service sector we propose a model of structural change in which productivity is endogenous and output is produced with two intermediate substitutable capital goods. In the progressive sector the accumulation of knowledge leads to an unbounded increase in TFP, as sector becoming asymptotically dominant. We are then able to recover the increasing shares of workers, the increasing real and nominal shares of the output observed in progressive service and IT sectors in the US. Interestingly, the economy follows a growth path converging to a particular level of wealth that depends on the initial price of capital and knowledge. As a consequence, countries with the same fundamentals but lower initial wealth will be characterized by lower asymptotic wealth. |
| Keywords: | two-sector model, technological knowledge, constant elasticity of substitution, non-balanced endogenous growth, structural change, Kaldor and Kuznets facts |
| JEL: | C62 E32 O41 |
| Date: | 2021–03 |
| URL: | http://d.repec.org/n?u=RePEc:aim:wpaimx:2119&r=all |