nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2021‒05‒17
39 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Aggregate and Intergenerational Implications of School Closures: A Quantitative Assessment By Jang, Youngsoo; Yum, Minchul
  2. Redistributive effects of pension reforms: Who are the winners and losers? By Sanchez-Romero, Miguel; Schuster, Philip; Prskawetz, Alexia
  3. Bewley Banks By Jamilov, Rustam; Monacelli, Tommaso
  4. Optimal bailouts in banking and sovereign crises By Sewon Hur; César Sosa-Padilla; Zeynep Yom
  5. Business Cycle Implications of Firm Market Power in Labor and Product Markets By Sami Alpanda; Sarah Zubairy
  6. Fiscal Stimulus in Liquidity Traps: Conventional or Unconventional Policies? By Lemoine, Matthieu; Lindé, Jesper
  7. Parental Time Investment and Intergenerational Mobility By Yum, Minchul
  8. Wage Risk and Government and Spousal Insurance By De Nardi, Mariacristina; Fella, Giulio; Paz-Pardo, Gonzalo
  9. Optimal Sustainable Intergenerational Insurance By Lancia, Francesco; Russo, Alessia; Worrall, Tim S
  10. Human Capital Investment and Development: The Role of On-the-job Training By Xiao Ma; Alejandro Nakab; Daniela Vidart
  11. Do exchange rates absorb demand shocks at the ZLB? By Hoffmann, Mathias; Hürtgen, Patrick
  12. Doves for the Rich, Hawks for the Poor? Distributional Consequences of Systematic Monetary Policy By Nils Gornemann; Keith Kuester; Makoto Nakajima
  13. Temporary VAT Reduction during the Lockdown By Marius Clemens; Werner Röger
  14. Nonlinear Search and Matching Explained By ; Alexander W. Richter; Nathaniel A. Throckmorton
  15. Environment, public debt and epidemics By Marion Davin; Mouez Fodha; Thomas Seegmuller
  16. Fiscal Multipliers: A Heterogeneous-Agent Perspective By Broer, Tobias; Krusell, Per; Öberg, Erik
  17. Inflation -- who cares? Monetary Policy in Times of Low Attention By Oliver Pf\"auti
  18. News Shocks under Financial Frictions By Christoph Gortz; John Tsoukalas; Francesco Zanetti
  19. How Does International Capital Flow? By Kumhof, Michael; Rungcharoenkitkul, Phurichai; Sokol, Andrej
  20. Job stability, earnings dynamics, and life-cycle savings By Kuhn, Moritz; Ploj, Gasper
  21. Slow recoveries, endogenous growth and macroprudential policy By Bonciani, Dario; Gauthier, David; Kanngiesser, Derrick
  22. Quantifying market power and business dynamism in the macroeconomy By Jan de Loecker; Jan Eeckhout; Simon Mongey
  23. Uncertainty shocks in currency unions By Born, Benjamin; Müller, Gernot; Pfeifer, Johannes
  24. Aggregate-Demand Amplification of Supply Disruptions: The Entry-Exit Multiplier By Bilbiie, Florin Ovidiu; Melitz, Marc J
  25. The aggregate-demand doom loop: Precautionary motives and the welfare costs of sovereign risk By Francisco Roldán
  26. Consumer Credit with Over-Optimistic Borrowers By Exler, Florian; Livshits, Igor; MacGee, Jim; Tertilt, Michèle
  27. Accounting for the Decline in Homeownership among the Young By Yuxi Yao
  28. Should we Revive PAYG? On the Optimal Pension System in View of Current Economic Trends By Westerhout, Ed; Meijdam, Lex; Ponds, Eduard; Bonenkamp, Jan
  29. Parallel Digital Currencies and Sticky Prices By Uhlig, Harald; Xie, Taojun
  30. Uncertainty Premia, Sovereign Default Risk, and State-Contingent Debt By Francisco Roch; Francisco Roldán
  31. Monetary Policy, Sectoral Comovement and the Credit Channel By Federico Di Pace; Christoph Gortz
  32. Technology Adoption and Leapfrogging: Racing for Mobile Payments By Pengfei Han; Zhu Wang
  33. Sovereign debt standstills By Juan Carlos Hatchondo; Leonardo Martínez; César Sosa-Padilla
  34. A Division of Laborers: Identity and Efficiency in India By Cassan, Guilhem; Keniston, Daniel; Kleineberg, Tatjana
  35. Estimating macro models and the potentially misleading nature of Bayesian estimation By Meenagh, David; Minford, Patrick; Wickens, Michael R.
  36. Quantifying Market Power and Business Dynamism in the Macroeconomy By Jan De Loecker; Jan Eeckhout; Simon Mongey
  37. Marginal tax changes with risky investment By Raffaele Rossi
  38. Is there consumer risk-pooling in the open economy? The evidence reconsidered By Minford, Patrick; Ou, Zhirong; Zhu, Zheyi
  39. Human Capital, Female Employment, and Electricity: Evidence from the Early 20th Century United States By Daniela Vidart

  1. By: Jang, Youngsoo; Yum, Minchul
    Abstract: This paper quantitatively investigates the macroeconomic and distributional consequences of school closures through intergenerational channels in the medium- and long-term. The model economy is a dynastic overlapping generations general equilibrium model in which schools, in the form of public education investments, complement parental investments in producing children's human capital. We find that unexpected school closure shocks have moderate long-lasting adverse effects on macroeconomic aggregates and reduce intergenerational mobility, especially among older children. Lower substitutability between public and parental investments induces larger damages in the aggregate economy and overall incomes of the affected children, while mitigating negative impacts on intergenerational mobility.
    Keywords: Intergenerational mobility, lifetime income, parental investments, aggregate loss, substitutability
    JEL: E24 I24 J22
    Date: 2020–11
  2. By: Sanchez-Romero, Miguel; Schuster, Philip; Prskawetz, Alexia
    Abstract: As the heterogeneity in life expectancy by socioeconomic status increases, pen sion systems become more regressive implying wealth transfers from short to long lived individuals. Various pension reforms aim to reduce these inequali ties that are caused by ex-ante differences in life expectancy. However, these pension reforms may themselves induce redistribution effects since a) life ex pectancy is not perfectly correlated to socioeconomic status and b) pension reforms themselves will have an impact on life cycle decisions (education, con sumption, health, labor supply) and ultimately also on life expectancy and the composition of the population. To account for these feedback effects of pension reforms in heterogenous aging societies we propose an OLG framework that is populated by heterogeneous individuals that initially differ by their learning ability and disutility from the effort of attending schooling. These initial hetero geneities imply differences in ex ante life expectancies. Within this framework we study two pension reforms that aim to account for these differences in ex ante life expectancies. We show that by including the feedback of pension reforms on individual behavior, new redistributions may result.
    Keywords: Overlapping generations,Mortality and fertility differentials,Inequality,Life cycle,Pensions,Progressivity
    Date: 2021
  3. By: Jamilov, Rustam; Monacelli, Tommaso
    Abstract: We develop a non-linear, quantitative macroeconomic model with heterogeneous monopolistic financial intermediaries, incomplete markets, default risk, endogenous bank entry, and aggregate uncertainty. The model generates a bank net worth distribution fluctuation problem analogous to the canonical Bewley-Huggett-Aiyagari-Imrohoglu environment. Our framework nests Gertler-Kyiotaki (2010) and the standard Real Business Cycle model as special cases. We present four general results. First, relative to the GK benchmark, banks' balance sheet-driven recessions can be significantly amplified, depending on the interaction of endogenous credit margins, the cyclicality of a precautionary lending motive and the (counter-) cyclicality of intermediaries' idiosyncratic risk. Second, equilibrium responses to aggregate exogenous shocks depend explicitly on the conditional distributions of bank net worth and leverage, which are endogenous time-varying objects. Aggregate shocks to banks' balance sheets that hit a concentrated and fragile banking distribution cause significantly larger recessions. A persistent consolidation in the U.S. banking sector that matches the one observed over 1980-2020 generates a large economic contraction and an increase in financial instability. Third, we document, and match, novel stylized facts on both the cross-section of credit margins and the cyclical properties of the first three moments of the cross-sectional distributions of financial intermediary assets, net worth, leverage, loan margins, and default risk. We find that shocks to capital quality and to leverage constraint tightness (``financial shocks'') can match fluctuations in the U.S. financial sector very well. Finally, we use the model to identify and characterize episodes of systemic banking crises. Such events are associated with large economic recessions, spikes in bank leverage, and large drops in the number of intermediaries.
    Keywords: Aggregate fluctuations; financial intermediaries; Heterogeneity; incomplete markets; monopolistic competition
    JEL: E32 E44
    Date: 2020–11
  4. By: Sewon Hur (Federal Reserve Bank of Dallas); César Sosa-Padilla (University of Notre Dame/NBER); Zeynep Yom (Villanova University)
    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 bank- ing 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: 2021–04
  5. By: Sami Alpanda (University of Central Florida, Department of Economics); Sarah Zubairy (Texas A&M University, Department of Economics)
    Abstract: In this paper, we analyze the business cycle implications of firms having oligopsony power in labor markets, as well as oligopoly power in product markets, within the context of a New Keynesian dynamic stochastic general equilibrium model with firm entry and exit. Relative to the standard setup with monopolistic competition in both goods and labor markets, the strategic interaction between intermediate goods firms in the current setup results in larger price markups as well as wage markdowns, while the slopes of the aggregate price and wage Phillips curves become flatter. These effects are strengthened in a strongly non-linear fashion as the number of firms in each sector decline. Oligopsonistic labor markets also render wage shocks expansionary, unlike in the standard setup. Results indicate that a secular increase in industry concentration would not only reduce the labor share of income, but also weaken the pass-through from firms' marginal costs to prices and from productivity increases to real wages.
    Keywords: Market power, oligopoly, oligopsony, New Keynesian DSGE model, entry-exit.
    JEL: E25 E32 L13
    Date: 2021–04–29
  6. By: Lemoine, Matthieu; Lindé, Jesper
    Abstract: Recent influential work argue that a gradual increase in sales tax stimulates economic activity in a liquidity trap by boosting inflation expectations. Higher public infrastructure investment should also be more expansive in a liquidity trap than in normal times by raising the potential interest rate and increasing aggregate demand. We analyze the relative merits of these policies in New Keynesian models with and without endogenous private capital formation and heterogeneity when monetary policy does not respond by raising policy rates. Our key finding is that the effectiveness of sales tax hikes differs notably across various model specifications, whereas the benefits of higher public infrastructure investment are more robust in alternative model environments. We therefore conclude that fiscal policy should consider public investment opportunities and not merely rely on tax policies to stimulate growth during the COVID-19 crisis.
    Keywords: DSGE model; liquidity trap; monetary policy; Public investments; Sales tax; zero lower bound
    JEL: E52 E58
    Date: 2020–12
  7. By: Yum, Minchul
    Abstract: This paper constructs a quantitative model of intergenerational mobility in which lifetime income mobility is shaped by various channels including parental time investments in children. The calibrated model delivers positive educational gradients in parental time investment, as observed in the data, and also successfully accounts for untargeted distributional aspects of income mobility, captured in the income quintile transition matrix. The model implies that removing the positive educational gradients in parental time investment during the whole childhood would reduce intergenerational income persistence nearly by 40 percent. Policy experiments suggest that subsidies to childhood investments that can diminish positive educational gradients in parental time investments would increase intergenerational mobility, and that there are better ways of subsidizing investments to achieve greater mobility in terms of aggregate output and welfare.
    Keywords: Intergenerational elasticity; quintile transition matrix; parental investments; college education
    JEL: E24 I24 J22
    Date: 2020–11
  8. By: De Nardi, Mariacristina; Fella, Giulio; Paz-Pardo, Gonzalo
    Abstract: The extent to which households can self-insure and the government can help them to do so depends on the wage risk that they face and their family structure. We study wage risk in the UK and show that the persistence and riskiness of wages depends on one's age and position in the wage distribution. We also calibrate a model of couples and singles with two alternative processes for wages: a canonical one and a flexible one that allows for the much richer dynamics that we document in the data. We use our model to show that allowing for rich wage dynamics is important to properly evaluate the effects of benefit reform: relative to the richer process, the canonical process underestimates wage persistence for women and generates a more important role for in-work benefits relative to income support. The optimal benefit configuration under the richer wage process, instead, is similar to that in place in the benchmark UK economy before the Universal Credit reform. The Universal Credit reform generates additional welfare gains by introducing an income disregard for families with children. While families with children are better off, households without children, and particularly single women, are worse off.
    Date: 2020–12
  9. By: Lancia, Francesco; Russo, Alessia; Worrall, Tim S
    Abstract: Optimal intergenerational insurance is examined in a stochastic overlapping generations endowment economy with limited enforcement of risk-sharing transfers. Transfers are chosen by a benevolent planner who maximizes the expected discounted utility of all generations while respecting the participation constraint of each generation. We show that the optimal sustainable intergenerational insurance is history dependent. The risk from a shock is unevenly spread into the future, generating heteroscedasticity and autocorrelation of consumption even in the long run. The optimum can be interpreted as a social security scheme characterized by a minimum welfare entitlement for the old and state-contingent entitlement thresholds.
    Keywords: Intergenerational insurance; Limited Commitment; Risk Sharing; stochastic overlapping generations
    JEL: D64 E21 H55
    Date: 2020–12
  10. By: Xiao Ma (University of California-San Diego (UCSD)); Alejandro Nakab (University of California-San Diego (UCSD)); Daniela Vidart (University of Connecticut)
    Abstract: This paper offers an explanation for why workers in richer countries have faster rates of wage growth over their lifetimes than workers in poorer countries by providing theory and evidence on the differences in firm-provided training across countries. We document that the share of workers who receive firm-provided training increases with development, and that this is a key determinant of worker human capital investments. We then build a general equilibrium search model with firm-training investments and frictional labor markets. Our model suggests firm-training accounts for a large share of the cross-country wage growth differences. We find that self-employment is the key factor explaining the lack of training in the poorest economies, whereas labor market frictions are key to explaining training differences as countries develop. Finally, our model predicts considerable inefficiencies in human capital investments and sizeable aggregate gains from training subsidies to firms, which may be particularly desirable in poor countries where economic environments disincentivize training.
    Keywords: On-the-job Training, Human Capital Accumulation, Lifecycle wage growth, Economic Growth, Worker Turnover
    JEL: E24 J24 O11 O15 J63 J64 M53
    Date: 2021–05
  11. By: Hoffmann, Mathias; Hürtgen, Patrick
    Abstract: According to the two-country full information New Keynesian model with flexible exchange rates, the real exchange rate appreciates in response to an asymmetric negative demand shock at the zero lower bound (ZLB) and exacerbates the adverse macroeconomic effects. This finding requires inflation expectations to adjust counterfactually large. When modeling inflation expectations consistent with survey expectations using imperfect information, we find that exchange rates can absorb demand shocks at the ZLB. In sharp contrast to the full information model: (i) A negative demand shock concentrated in the home country causes a real exchange rate depreciation that partially absorbs the demand shock. (ii) A VAR with an identified demand shock via sign restrictions is consistent with a real exchange rate depreciation at the ZLB. (iii) When the ZLB is binding in the home country, it is optimal for the foreign policymaker to reduce rather than increase foreign interest rates. (iv) Forward guidance that reveals the true state of the economy exacerbates the negative output gap in the two countries.
    Keywords: monetary policy,inflation expectations,imperfect information,real exchange rates
    JEL: F33 E31 E32
    Date: 2021
  12. By: Nils Gornemann (Board of Governors of the Federal Reserve System, International Finance Division, Washington, D.C. 20551); Keith Kuester (University of Bonn, Adenauerallee 24-42, 53113 Bonn, Germany); Makoto Nakajima (Federal Reserve Bank of Philadelphia, Ten Independence Mall, Philadelphia, PA 19106-1574)
    Abstract: We build a New Keynesian business-cycle model with rich household heterogeneity. In the model, systematic monetary stabilization policy affects the distribution of income, income risks, and the demand for funds and supply of assets: the demand, because matching frictions render idiosyncratic labor-market risk endogenous; the supply, because markups, adjustment costs, and the tax system mean that the average profitability of firms is endogenous. Disagreement about systematic monetary stabilization policy is pronounced. The wealth rich or retired tend to favor inflation targeting. The wealth-poor working class, instead, favors unemployment-centric policy. One- and two-agent alternatives can show unanimous disapproval of inflation-centric policy, instead. We highlight how the political support for inflation-centric policy depends on wage setting, the tax system, and the portfolio that households have.
    Keywords: Monetary Policy, Unemployment, Search and Matching, Heterogeneous Agents, General Equilibrium, Dual Mandate
    JEL: E12 E21 E24 E32 E52 J64
    Date: 2021–05
  13. By: Marius Clemens; Werner Röger
    Abstract: This paper evaluates the temporary VAT reduction introduced by the German government over the third and fourth quarter of 2020 as most controversial part of the COVID-19 stimulus package. Critics argue that VAT reductions are ineffective because of limited pass-through of temporary measures to consumer prices and in presence of lockdown measures. Advocates emphasize positive effects on durables and stress that a VAT reduction can at least partly substitute for a limited monetary policy response under the ZLB. We build a DSGE model which is capable to address these channels. Our model distinguishes between sectors directly and indirectly affected by the lockdown. This allows us to trace economic spillovers of lockdown measures to the rest of the economy and the differentiated impact of VAT measures on both sectors. We disaggregate consumption into durables and non-durables for both financially constrained and unconstrained households and we allow for imperfect pass-through of VAT measures into consumer prices. In general, if we include the durable investment channel we find robust sizeable effects of VAT changes on consumption even under a limited VAT pass-through. For the specific situation in Germany, we analyze the impact of the VAT reduction in conjunction with the lockdowns in 2020 Q2 to Q4. We use non-linear solution techniques to solve the model in the presence of a ZLB, forced savings and a lockdown constraint. We find a VAT short-term multiplier of one, which reduces over the medium term. Thus, the temporary VAT reduction is an effective instrument in the short-term but not efficient with regard to medium-term budget sustainability. Furthermore, we can show that the VAT reduction is able to mimic the macroeconomic effects of a central bank reaction according to a Taylor rule in case of a lockdown shock. However, compared to the monetary policy reaction the VAT reduction has only small direct effects on private investments.
    Keywords: Fiscal policy, DSGE modelling, COVID-19 lockdown, tax multiplier
    JEL: E62 E65 H21
    Date: 2021
  14. By: ; Alexander W. Richter; Nathaniel A. Throckmorton
    Abstract: Competing explanations for the sources of nonlinearity in search and matching models indicate that they are not fully understood. This paper derives an analytical solution to a textbook model that highlights the mechanisms that generate nonlinearity and quantifies their contributions. Procyclical variation in the matching elasticity creates nonlinearity in the job finding rate, which interacts with the law of motion for unemployment. These results show the matching function choice is not innocuous. Quantitatively, the Den Haan et al. (2000) matching function more than doubles the skewness of unemployment and welfare cost of business cycles, compared to the Cobb-Douglas specification.
    Keywords: Matching Function; Matching Elasticity; Complimentarity; Unemployment
    JEL: E24 E32 E37 J63 J64
    Date: 2021–05–11
  15. By: Marion Davin (CEE-M, Univ Montpellier, CNRS, INRAE, SupAgro, Montpellier, France.); Mouez Fodha (University Paris 1 Panthéon-Sorbonne and Paris School of Economics, Paris, France.); Thomas Seegmuller (Aix Marseille Univ, CNRS, AMSE, Marseille, France.)
    Abstract: We study whether fiscal policies, especially public debt, can help to curb the macroeconomic and health consequences of epidemics. Our approach is based on three main features: we introduce the dynamics of epidemics in an overlapping generations model to take into account that old people are more vulnerable; people are more easily infected when pollution is high; public spending and public debt can be used to tackle the effects of epidemics. We show that fiscal policies can promote the convergence to a stable steady state with no epidemics. When public policies are not able to permanently eradicate the epidemic, public debt and income transfers could reduce the number of infected people and increase capital and GDP per capita. As a prerequisite, pollution intensity should not be too high. Finally, we define a household subsidy policy which eliminates income and welfare inequalities between healthy and infected individuals.
    Keywords: epidemics, pollution, overlapping generations, public debt
    JEL: E6 I18 Q59
    Date: 2021–05
  16. By: Broer, Tobias; Krusell, Per; Öberg, Erik
    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.
    Date: 2021–01
  17. By: Oliver Pf\"auti
    Abstract: Based on a model of optimal information acquisition, I propose an approach to measure attention to inflation in the data. Applying this approach to US consumers and professional forecasters provides substantial evidence that attention to inflation in the US decreased significantly over the last five decades. Consistent with the theoretical model, attention is higher in times of volatile inflation. To examine the consequences of limited attention for monetary policy, I augment the standard New Keynesian model with a lower-bound constraint on the nominal interest rate and inflation expectations that are characterized by limited attention. Accounting for the lower bound fundamentally alters the normative implications of low attention. While lower attention raises welfare absent the lower-bound constraint, it decreases welfare when accounting for the lower bound. In the presence of the lower bound, limited attention can lead to inflation-attention traps: prolonged periods of a binding lower bound and low inflation due to slowly-adjusting inflation expectations. To prevent these traps, it is optimal to increase the inflation target as attention declines.
    Date: 2021–05
  18. By: Christoph Gortz (University of Birmingham); John Tsoukalas (University of Glasgow); Francesco Zanetti (University of Oxford)
    Abstract: We examine the dynamic effects and empirical role of TFP news shocks in the context of frictions in financial markets. We document two new facts using VAR methods. First, a (positive) shock to future TFP generates a significant decline in various credit spread indicators considered in the macro-finance literature. The decline in the credit spread indicators is associated with a robust improvement in credit supply indicators, along with a broad based expansion in economic activity. Second, VAR methods also establish a tight link between TFP news shocks and shocks that explain the majority of un-forecastable movements in credit spread indicators. These two facts provide robust evidence on the importance of movements in credit spreads for the propagation of news shocks. A DSGE model enriched with a financial sector generates very similar quantitative dynamics and shows that strong linkages between leveraged equity and excess premiums, which vary inversely with balance sheet conditions, are critical for the amplification of TFP news shocks. The consistent assessment from both methodologies provides support for the traditional 'news view' of aggregate fluctuations.
    Keywords: TFP News shocks, Business cycles, DSGE, VAR, Bayesian estimation
    JEL: E2 E3
    Date: 2021–05
  19. By: Kumhof, Michael; Rungcharoenkitkul, Phurichai; Sokol, Andrej
    Abstract: Understanding gross capital flows is increasingly viewed as crucial for both macroeconomic and financial stability policies, but theory is lagging behind many key policy debates. We fill this gap by developing a 2-country DSGE model that tracks domestic and cross-border gross positions between banks and households, with explicit settlement of all transactions through banks. We formalize the conceptual distinction between cross-border saving and financing, which often move in opposite directions in response to shocks. This matters for at least four policy debates. First, current accounts are poor indicators of financial vulnerability, because in a crisis creditors stop financing debt rather than current accounts, and because following a crisis current accounts are not the primary channel through which balance sheets adjust. Second, we re-interpret the global saving glut hypothesis by submitting that US households do not finance current account deficits with foreigners' physical saving, but with digital purchasing power, created by banks that are more likely to be domestic than foreign. Third, Triffin's current account dilemma is not in fact a dilemma, because the creation of additional US dollars requires dollar credit creation by domestic or foreign banks rather than US current account deficits. Finally, we show that the observed high correlation of gross capital inflows and outflows is overwhelmingly an automatic consequence of double entry bookkeeping, rather than the result of two separate and synchronized sets of economic decisions.
    Keywords: bank lending; current account; global saving glut; Gross capital flows; International Capital Flows; money creation; Sudden stops; Triffin's dilemma
    JEL: E44 E51 F41 F44
    Date: 2020–12
  20. By: Kuhn, Moritz; Ploj, Gasper
    Abstract: Labor markets are characterized by large heterogeneity in job stability. Some workers hold lifetime jobs, whereas others cycle repeatedly in and out of employment. This paper explores the economic consequences of such heterogeneity. Using Survey of Consumer Finances (SCF) data, we document a systematic positive relationship between job stability and wealth accumulation. Per dollar of income, workers with more stable careers hold more wealth. We also develop a life-cycle consumption-saving model with heterogeneity in job stability that is jointly consistent with empirical labor market mobility, earnings, consumption, and wealth dynamics. Using the structural model, we explore the consequences of heterogeneity in job stability at the individual and macroeconomic level. At the individual level, we find that a bad start to the labor market leaves long-lasting scars. The income and consumption level for a worker who starts working life from an unstable job is, even 25 years later, 5 percent lower than that of a worker who starts with a stable job. For the macroeconomy, we find welfare gains of 1.6 percent of lifetime consumption for labor market entrants from a secular decline in U.S. labor market dynamism.
    Keywords: consumption-saving behavior; Employment risk; Job stability
    JEL: E21 E24 J64
    Date: 2020–11
  21. By: Bonciani, Dario (Bank of England); Gauthier, David (Bank of England); Kanngiesser, Derrick (Bank of England)
    Abstract: Banking crises have severe short and long‑term consequences. We develop a general equilibrium model with financial frictions and endogenous growth in which macroprudential policy supports economic activity and productivity growth by strengthening bank’s resilience to adverse financial shocks. The improved intermediation capacity of a safer banking system leads to a higher steady state growth rate. The optimal bank capital ratio of 18% increases welfare by 6.7%, 14 times more than in the case without endogenous growth. When the economy enters a liquidity trap, the effects of financial disruptions and thus the benefits of macroprudential policy are even more significant.
    Keywords: Slow recoveries; endogenous growth; financial stability; macroprudential policy
    JEL: E32 E44 E52 G01 G18
    Date: 2021–04–23
  22. By: Jan de Loecker; Jan Eeckhout; Simon Mongey
    Abstract: We propose a general equilibrium model with oligopolistic output markets where two channels can cause a change in market power: (i) technology, via changes to productivity shocks and the cost of entry, (ii) market structure, via changes to the number of potential competitors. First, we disentangle these narratives by matching data on markups, labor reallocation and costs, finding that both channels are necessary to account for the data. Second, we show that changes in technology and market structure yield positive welfare effects through reallocation and selection, but off-setting negative effects from dead-weight loss and overhead. Overall, welfare is 9 percent lower in 2016 than in 1980. Third, the changes we identify explain and decompose cross-sectional patterns in declining business dynamism, declining equilibrium wages and labor force participation via reallocation toward larger, more productive firms.
    Keywords: business dynamism, market power in the aggregate economy, technological change, market structure, reallocation, Endogenous markups, wage stagnation, labor share, passthrough
    JEL: C6 D4 D5 L1
    Date: 2021–04
  23. By: Born, Benjamin; Müller, Gernot; Pfeifer, Johannes
    Abstract: Uncertainty shocks cause economic activity to contract and more so, if monetary policy is constrained by an effective lower bound on interest rates. In this paper, we investigate whether countries within currency unions are also particularly prone to suffer from the adverse effects of heightened uncertainty because they lack monetary independence. First, we estimate a Bayesian VAR on quarterly time series for Spain. We find that country-specific uncertainty shocks impact economic activity adversely. Second, we calibrate a DSGE model of a small open economy and show that it is able to account for the evidence. Finally, we show that currency-union membership strongly reduces the effects of uncertainty shocks because it anchors long-run expectations of the price level and thus alleviates precautionary price setting in the face of increased uncertainty.
    Keywords: Euro Area; Euro crisis; Exchange Rate Regime; monetary policy; Uncertainty shocks
    JEL: E44 F41
    Date: 2020–12
  24. By: Bilbiie, Florin Ovidiu; Melitz, Marc J
    Abstract: The response of entry and exit to adverse supply shocks, such as COVID-19, is amplified by nominal rigidities. This leads to further amplification in the response of aggregate demand. Firms' inability to adjust their prices induces further changes in profitability that engender additional entry-exit dynamics. These changes in net entry, in turn, amplify the initial response to the shock by generating additional curvature in the relationship between the shock and aggregate demand. Even in our baseline model with efficient equilibrium entry, this entry-exit multiplier triggers a substantial magnification of the welfare losses due to a negative shock through these second-order effects. Nominal rigidities may also induce a first-order effect when entry is no longer efficient. Our model highlights how the addition of endogenous entry to a benchmark New Keynesian model radically changes the consequences of nominal rigidities. We focus on the amplification of aggregate demand to supply shocks, but also highlight other key divergences that can potentially resolve some empirical discrepancies associated with the workhorse New-Keynesian model.
    Keywords: Aggregate Demand and Supply; COVID-19; Entry-Exit; Recessions; sticky prices; Variety
    JEL: E3 E4 E5 E6
    Date: 2020–12
  25. By: Francisco Roldán (International Monetary Fund)
    Abstract: I examine the role of households' precautionary savings motive in amplifying and propagating changes in sovereign spreads. I study this mechanism in a model where the government of a small open economy borrows from foreigners but the debt is then partially held by heterogeneous domestic savers. In a calibration to Spain in the 2000s, default risk accounts for about half of the output contraction. More generally, sovereign risk exacerbates volatility in consumption over time and across agents, creating large and unequal welfare costs even if default does not materialize.
    Keywords: Sovereign risk default aggregate demand precautionary motives heterogeneous agents
    JEL: E21 F34 H63
    Date: 2021–04
  26. By: Exler, Florian; Livshits, Igor; MacGee, Jim; Tertilt, Michèle
    Abstract: There is active debate over whether borrowers' cognitive biases create a need for regulation to limit the misuse of credit. To tackle this question, we incorporate over-optimistic borrowers into an incomplete markets model with consumer bankruptcy. Lenders price loans, forming beliefs - type scores - about borrowers' types. Since over-optimistic borrowers face worse income risk but incorrectly believe they are rational, both types behave identically. This gives rise to a tractable theory of type scoring as lenders cannot screen borrower types. Since rationals default less often, the partial pooling of borrowers generates cross-subsidization whereby over-optimists face lower than actuarially fair interest rates. Over-optimists make financial mistakes: they borrow too much and default too late. We calibrate the model to the US and quantitatively evaluate several policies to address these frictions: reducing the cost of default, increasing borrowing costs, imposing debt limits, and providing financial literacy education. While some policies lower debt and filings, they do not reduce overborrowing. Financial literacy education can eliminate financial mistakes, but it also reduces behavioral borrowers' welfare by ending cross-subsidization. Score-dependent borrowing limits can reduce financial mistakes but lower welfare.
    Keywords: bankruptcy; Consumer credit; Cross-subsidization; financial literacy; Financial Mistakes; financial regulation; Over-Optimism; Type Score
    JEL: E21 E49 G18 K35
    Date: 2020–12
  27. By: Yuxi Yao (University of Western Ontario)
    Abstract: This paper documents that the drop in young homeownership is more persistent among non-college graduates compared to college graduates: while some college graduates postpone home purchasing, non-college graduates are more likely to remain longterm renters. I develop a model showing that the combination of a higher share of college graduates and a widening education-driven income gap accounts for the delayed home purchasing of college graduates and the lack of purchasing among non-college graduates. Exploiting cross-city variation, I find that the mechanism can quantitatively account for the diverging ownership decisions between the two education groups from 1980 to 2019.
    Keywords: Housing Tenure Choice, College Share, Household Income, Housing Prices, General Equilibrium Effects
    JEL: E21 E60 R21
    Date: 2021–04–29
  28. By: Westerhout, Ed (Tilburg University, School of Economics and Management); Meijdam, Lex (Tilburg University, School of Economics and Management); Ponds, Eduard (Tilburg University, School of Economics and Management); Bonenkamp, Jan
    Date: 2021
  29. By: Uhlig, Harald; Xie, Taojun
    Abstract: The recent rise of digital currencies opens the door to their use in parallel alongside official currencies (``dollar'') for pricing and transactions. We construct a simple New Keynesian framework with parallel currencies as pricing units and sticky prices. Relative prices become a state variable. Exchange rate shocks can arise even without other sources of uncertainty. A one-time exchange rate appreciation for a parallel currency leads to persistent redistribution towards the dollar sector and dollar inflation. The share of the non-dollar sector increases when prices in the dollar sector become less sticky and when firms can choose the pricing currency.
    Keywords: currency choice; digital currency; monetary policy; New Keynesian Model; sticky prices
    JEL: E30 E52
    Date: 2020–12
  30. By: Francisco Roch (International Monetary Fund); Francisco Roldán (International Monetary Fund)
    Abstract: We analyze how concerns for model misspecification on the part of international lenders affect the desirability of issuing state-contingent debt instruments in a stan- dard sovereign default model à la Eaton and Gersovitz (1981). We show that for the commonly used threshold state-contingent bond structure (e.g., the GDP-linked bond issued by Argentina in 2005), the model with robustness generates ambiguity premia in bond spreads that can explain most of what the literature has labeled as novelty premium. While the government would be better off with this bond when facing rational expectations lenders, this additional source of premia leads to welfare losses when facing robust lenders. Finally, we characterize the optimal design of the state-contingent bond and show how it varies with the level of robustness. Our find- ings rationalize the little use of these instruments in practice and shed light on their optimal design.
    Keywords: Sovereign debt default state-contingent debt instruments robust control ambiguity premia
    JEL: E43 E44 F34 G12 H63 O16
    Date: 2021–03
  31. By: Federico Di Pace (Bank of England); Christoph Gortz (University of Birmingham)
    Abstract: Using a structural vector autoregression, we document that a contractionary monetary policy shock triggers a decline in durable and non-durable outputs as well as a contraction in bank equity and a rise in the excess bond premium. The latter points to an important transmission channel of monetary policy via financial markets. It has long been recognized that a standard two-sector New Keynesian model, where durable goods prices are flexible and prices of non-durables and services sticky, does not generate the empirically observed sectoral co-movement across expenditure categories in response to a monetary policy shock. We show that introducing frictions in financial markets in a two-sector New Keynesian model can resolve its disconnect with the empirical evidence - a monetary tightening generates not only co-movement, but also a rise in credit spreads and a deterioration in bank equity.
    Keywords: financial intermediation, sectoral comovement, monetary policy, financial frictions, credit spreads.
    JEL: E22 E32 E44 E52
    Date: 2021–04
  32. By: Pengfei Han; Zhu Wang
    Abstract: Paying with a mobile phone is a cutting-edge innovation transforming the global payments industry. However, some advanced economies like the U.S. are lagging behind in mobile payment adoption. We construct a dynamic model with sequential payment innovations to explain this puzzle, which uncovers how advanced economies' past success in adopting card-payment technology holds them back in the mobile-payment race. Our calibrated model matches the cross-country adoption patterns of card and mobile payments and also explains why advanced and developing countries favor different mobile payment solutions. Based on the model, we conduct several quantitative exercises for welfare and policy analyses.
    Keywords: Technology adoption; Sunk cost; Payment system
    JEL: E4 G2 O3
    Date: 2021–03–01
  33. By: Juan Carlos Hatchondo (University of Western Ontario); Leonardo Martínez (International Monetary Fund); César Sosa-Padilla (University of Notre Dame / NBER)
    Abstract: As a response to economic crises triggered by COVID-19, sovereign debt standstill proposals emphasize debt payment suspensions without haircuts on the face value of debt obligations. We quantify the effects of standstills using a standard default model. We find that a one-year standstill generates welfare gains for the sovereign equivalent to a permanent consumption increase of between 0.1% and 0.3%, depending on the initial shock. However, except when it avoids a default, the standstill also implies capital losses for creditors of between 9% and 27%, which is consistent with their reluctance to participate in these operations and indicates that this reluctance would persist even without a free-riding or holdout problem. Standstills also generate a form of "debt overhang" and thus the opportunity for a "voluntary debt exchange": complementing the standstill with haircuts could reduce creditors’ losses and simultaneously increase welfare gains. Our results cast doubts on the emphasis on standstills without haircuts.
    Keywords: Debt relief Standstill, Haircuts COVID-19 Default Debt Overhang Voluntary Debt Exchange
    JEL: F34 F41
    Date: 2021–04
  34. By: Cassan, Guilhem (University of Namur and CAGE); Keniston, Daniel (Louisiana State University); Kleineberg, Tatjana (World Bank)
    Abstract: Workers’ social identity affects their choice of occupation, and therefore the structure and prosperity of the aggregate economy. We study this phenomenon in a setting where work and identity are particularly intertwined: the Indian caste system. Using a new dataset that combines information on caste, occupation, wages, and historical evidence of subcastes’ traditional occupations, we show that caste members are still greatly overrepresented in their traditional occupations. To quantify the effects of caste-level distortions on aggregate and distributional outcomes, we develop a general equilibrium Roy model of occupational choice. We structurally estimate the model and evaluate counterfactuals in which we remove castes’ ties to their traditional occupations- both through their direct preferences, and also via their parental occupations and social networks. We find that the share of workers employed in their traditional occupation decreases substantially. However, effects on aggregate output and productivity are very small and in some counterfactuals even negative–because gains from a more efficient human capital allocation are offset by productivity losses from weaker caste networks and reduced learning across generations. Our findings emphasize the importance of caste identity in coordinating workers into occupational networks which enable productivity spillovers.
    Keywords: JEL Classification:
    Date: 2021
  35. By: Meenagh, David; Minford, Patrick; Wickens, Michael R.
    Abstract: We ask whether Bayesian estimation creates a potential estimation bias as compared with standard estimation techniques based on the data, such as maximum likelihood or indirect estimation. We investigate this with a Monte Carlo experiment in which the true version of a New Keynesian model may either have high wage/price rigidity or be close to pure flexibility; we treat each in turn as the true model and create Bayesian estimates of it under priors from the true model and its false alternative. The Bayesian estimation of macro models may thus give very misleading results by placing too much weight on prior information compared to observed data; a better method may be Indirect estimation where the bias is found to be low.
    Keywords: Bayesian; Estimation Bias; indirect inference; maximum likelihood
    JEL: C11 E12
    Date: 2021–01
  36. By: Jan De Loecker; Jan Eeckhout; Simon Mongey
    Abstract: We propose a general equilibrium economy with oligopolistic output markets in which two channels can cause a change in market power: (i) technology, via changes to productivity shocks and the cost of entry, (ii) market structure, via changes to the number of potential competitors. First, we disentangle these narratives by matching time-series on markups, labor reallocation and costs between 1980 and 2016, finding that both channels are necessary to account for the data. Second, we show that changes in technology and market structure over this period yielded positive welfare effects from reallocation and selection, but off-setting negative effects from deadweight loss and overhead. Overall, welfare is 9 percent lower in 2016 than in 1980. Third, the changes we identify replicate cross-sectional patterns in declining business dynamism, declining equilibrium wages and labor force participation, and sales reallocation toward larger, more productive firms.
    JEL: E0 L1
    Date: 2021–05
  37. By: Raffaele Rossi (University of Manchester)
    Abstract: Using an estimated life-cycle model, we quantify the role of heterogeneity in wealth returns for the response of income to marginal tax changes. In our economy, agents who are sufficiently productive can obtain higher returns by choosing to be entrepreneurs. Return heterogeneity amplifies the responsiveness of total income to marginal tax changes along the entire income distribution with the top 1 percent displaying the highest elasticities. Return heterogeneity increases the incentives to invest for the richest, high-return entrepreneurs, thus amplifying their income responses to marginal tax changes. This reallocation of capital increases aggregate productivity, generating a larger boost in equilibrium wages. This in turn strengthens the income response of the bottom 90 percent, but nevertheless, their response is smaller than at the top.
    Keywords: risky investment, elasticity of taxable income, life-cycle, entrepreneurs, structural estimation
    JEL: E62 H21 H24
    Date: 2021–04
  38. By: Minford, Patrick; Ou, Zhirong; Zhu, Zheyi
    Abstract: We revisit the evidence on consumer risk-pooling and uncovered interest parity. Widely used single equation tests are strongly biased against both. Using the full-model, Indirect Inference test, which is unbiased and has Goldilocks power by Monte Carlo experiments, we find that both the risk-pooling hypothesis and its weaker UIP version are generally accepted as part of a full world DSGE model. The fact that the risk-pooling hypothesis, with its implication of strong cross-border consumer linkage, has passed this test with generally the highest p-value, suggests that it deserves serious attention from policy-makers looking for a relevant model to discuss international monetary and other business cycle issues.
    Keywords: consumer risk-pooling; full-model test; indirect inference; Open economy; UIP
    JEL: C12 E12 F41
    Date: 2021–01
  39. By: Daniela Vidart (University of Connecticut)
    Abstract: This paper revisits the link between electrification and the rise in female labor force participation (LFP), and presents theoretical and empirical evidence showing that elec-trification triggered a rise in female LFP by increasing market opportunities for skilled women. I formalize my theory in an overlapping generations model, and find that my mechanism explains one third of the rise in female LFP during the rollout of electricity in the US (1880-1960), and matches the slow decline in female home-production hours during this period. I then present micro-evidence supporting my theory using newly digitized data on the early electrification of the US.
    Keywords: Female Labor Force Participation, Human Capital Accumulation, Electrification, Skill-biased Technical Change, Home to Market Transition, Brain vs. Brawn
    JEL: O33 J24 E24 O11 J22
    Date: 2021–05

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