nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2021‒07‒26
twenty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Emigration and Fiscal Austerity in a Depression By Guilherme Bandeira; Jordi Caballe; Eugenia Vella
  2. Monetary Policy and Wealth Effects: The Role of Risk and Heterogeneity By Nicolas Caramp; Dejanir H. Silva
  3. Debt Management in a World of Fiscal Dominance By Boris Chafwehé; Charles de Beauffort; Rigas Oikonomou
  4. Real indeterminacy and dynamics of asset price bubbles in general equilibrium By Stefano Bosi; Cuong Le Van; Ngoc-Sang Pham
  5. U.S. Monetary Policy Spillovers to Emerging Markets: Both Shocks and Vulnerabilities Matter By Shaghil Ahmed; Ozge Akinci; Albert Queraltó
  6. Oligopoly Banking, Risky Investment, and Monetary Policy By Altermatt, Lukas; Wang, Zijian
  7. Fair Pension Policies with Occupation-Specific Aging By Volker Grossmann; Johannes Schünemann; Holger Strulik
  8. The eurozone: what is to be done? By Minford, Patrick; Ou, Zhirong; Wickens, Michael; Zhu, Zheyi
  9. Near-Rational Equilibria in Heterogeneous-Agent Models: A Verification Method By Leonid Kogan; Indrajit Mitra
  10. The Side Effects of Safe Asset Creation By Sushant Acharya; Keshav Dogra
  11. ToTEM III: The Bank of Canada’s Main DSGE Model for Projection and Policy Analysis By Paul Corrigan; Hélène Desgagnés; José Dorich; Vadym Lepetyuk; Wataru Miyamoto; Yang Zhang
  12. Progressive Pensions as an Incentive for Labor Force Participation By Fabian Kindermann; Veronika Püschel
  13. Analyse de la politique budgétaire en Côte d’ivoire à partir d’une estimation Bayésienne d’un modèle d'Equilibre Général Dynamique Stochastique (DSGE) By Koffi, Siméon
  14. Fiscal policy and inequality in a model with endogenous positional concerns By Kirill Borissov; Nigar Hashimzade
  15. Mobilty Decisions, Economic Dynamics and Epidemic By Giorgio Fabbri; Salvatore Federico; Davide Fiaschi; Fausto Gozzi
  16. Foreign Exchange Intervention, Capital Flows, and Liability Dollarization By Paul Castillo; Juan Pablo Medina
  17. Impulse-Based Computation of Policy Counterfactuals By James Hebden; Fabian Winkler
  18. Countercyclical Fluctuations in Uncertainty are Endogenous By Joshua Bernstein; Michael D. Plante; Alexander W. Richter; Nathaniel A. Throckmorton
  19. A matching model of the market for migrant smuggling services By Naiditch, Claire; Vranceanu, Radu
  20. Heterogeneity in Individual Expectations, Sentiment, and Constant-Gain Learning By Cole, Stephen J.; Milani, Fabio
  21. Reputation and Partial Default By Manuel Amador; Christopher Phelan

  1. By: Guilherme Bandeira (New South Wales Treasury); Jordi Caballe (Universitat Autonoma de Barcelona and Barcelona GSE); Eugenia Vella
    Abstract: This paper studies the role of emigration in a deep recession when the government implements fiscal consolidation. We build a small open economy New Keynesian model with search and matching frictions, emigration of the labour force, and fiscal details. Our simulations for the austerity mix during the Greek Depression show that fiscal austerity accounts for one third of the output drop and more than 10% of migration outflows, whereas the rest is attributed to the macroeconomic environment. A counterfactual without migration underestimates the fall in output by one fifth. The model also sheds light on the two-way relation between emigration and austerity. Labour income tax hikes induce prolonged migration outflows, while spending cuts exert only a small effect on emigration which can be positive or negative depending on opposite demand and wealth effects. On the flip side, emigration increases the required tax hike and time to meet a given debt target due to endogenous revenue leakage. For tax hikes, emigration acts as an absorber of the austerity shock by diluting the output costs per resident through shrinking population. Yet, in terms of unemployment, temporary gains are reversed over time due to the distortionary effects of taxes on employment.
    Keywords: fiscal consolidation, emigration of employed, on the job search, matching frictions, Greek crisis.
    JEL: E32 F41
    Date: 2020–06–23
  2. By: Nicolas Caramp; Dejanir H. Silva (Department of Economics, University of California Davis)
    Abstract: We study the role of wealth effects, i.e. the revaluation of stocks, bonds, and human wealth, in the monetary policy transmission mechanism. The analysis of wealth effects requires to incorporate realistic asset-pricing dynamics and heterogeneous households’ portfolios. Thus, we build an analytical heterogeneous-agents model with two main ingredients: i) rare disasters and ii) positive private debt. The model captures time-varying risk premia and precautionary savings in a linearized setting that nests the textbook New Keynesian model. Quantitatively, the model matches the empirical response of asset prices as well as the heterogeneous impact on borrowers and savers. We find that wealth effects induced by time-varying risk and private debt account for the bulk of the output response to monetary policy.
    Keywords: Monetary Policy, Wealth Effects, Asset Prices, Heterogeneity
    JEL: E21 E52 E44
    Date: 2021–07–15
  3. By: Boris Chafwehé (Joint Research Centre European Commission); Charles de Beauffort (National Bank of Belgium and IRES/LIDAM, UCLouvain); Rigas Oikonomou (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES))
    Abstract: We study the impact of debt maturity management in an economy where monetary policy is ’passive’ and subservient to fiscal policy. We setup a tractable model, to characterize analytically the dynamics of inflation, as well as other macroeconomic variables, showing their dependence on the monetary policy rule and on the maturity of debt. Debt maturity becomes a key variable when the monetary authority reacts to inflation and the appropriate maturity of debt can restore the efficacy of monetary policy in controlling inflation. This requires debt management to focus on issuing long bonds. Moreover, we propose a novel framework of Ramsey optimal coordinated debt and monetary policies, to derive analytically the interest rate rule followed by the monetary authority as a function of debt maturity. The optimal policy model leads to the same prescription, long term debt financing enables to stabilize inflation. Lastly, the relevance of debt maturity in reducing inflation variability is also confirmed in a medium scale DSGE model estimated with US data.
    Keywords: Passive monetary policy, Govenment debt management, Fiscal and monetary policy interactions, Bayesian estimation, Ramsey policy
    JEL: E31 E52 E58 E62 C11
    Date: 2021–07–13
  4. By: Stefano Bosi (EPEE - Centre d'Etudes des Politiques Economiques - UEVE - Université d'Évry-Val-d'Essonne - Université Paris-Saclay, Université Paris-Saclay); Cuong Le Van (CNRS - Centre National de la Recherche Scientifique, 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, IPAG Business School, TIMAS - Institute of Mathematics and Applied Science, CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Ngoc-Sang Pham (Métis Lab EM Normandie - EM Normandie - École de Management de Normandie)
    Abstract: We show that both real indeterminacy and asset price bubble may appear in an infinite-horizon exchange economy with infinitely lived agents and an imperfect financial market. We clarify how the asset structure and heterogeneity (in terms of preferences and endowments) affect the existence and the dynamics of asset price bubbles as well as the equilibrium indeterminacy. Moreover, this paper bridges the literature on bubbles in models with infinitely lived agents and that in overlapping generations models (Tirole, 1985).
    Keywords: in- tertemporal equilibrium,borrowing constraint,real indeterminacy,asset price bubble
    Date: 2020–11–06
  5. By: Shaghil Ahmed; Ozge Akinci; Albert Queraltó
    Abstract: Using a macroeconomic model, we explore how sources of shocks and vulnerabilities matter for the transmission of U.S. monetary changes to emerging market economies (EMEs). We utilize a calibrated two-country New Keynesian model with financial frictions, partly-dollarized balance sheets, and imperfectly anchored inflation expectations. Contrary to other recent studies that also emphasize the sources of shocks, our approach allows the quantification of effects on real macroeconomic variables as well, in addition to financial spillovers. Moreover, we model the most relevant vulnerabilities structurally. We show that higher U.S. interest rates arising from stronger U.S. aggregate demand generate modestly positive spillovers to economic activity in EMEs with stronger fundamentals, but can be adverse for vulnerable EMEs. In contrast, U.S. monetary tightenings driven by a more-hawkish policy stance cause a substantial slowdown in activity in all EMEs. Our model also captures the challenging policy tradeos that EME central banks face. We show that these tradeoffs are more favorable when inflation expectations are well anchored.
    Keywords: Financial frictions; U.S. monetary policy spillovers; Adaptive expectations
    JEL: E32 E44 F41
    Date: 2021–07–15
  6. By: Altermatt, Lukas; Wang, Zijian
    Abstract: Oligopolistic competition in the banking sector and risk in the real economy are important characteristics of developed economies, but have so far mostly been abstracted from in monetary economics. We build a dynamic general equilibrium model of monetary policy transmission that incorporates both of these features and document that including them leads to important insights in our understanding of the transmission mechanism. Various equilibrium cases can occur, and policies have differing effects in these cases. We calibrate the model to the U.S. economy in 2016-2019 in order to study how changes in the degree of banking competition or the policy rate would have affected equilibrium outcomes. We find that doubling banking competition would have increased welfare by 1.02\%, but at the cost of increasing the probability of bank default from 0.02\% to 0.44\%. We further find that the policy rate was set optimally to minimize the probability of bank default, but that a decrease in the policy rate by 1pp would have increased welfare by 0.40\%. We also show that bank profits are increasing in the policy rate, in particular when interest rates are low. Thus, a 1pp reduction in the policy rate would have reduced profits per bank by 35.5\% in our calibrated economy. Finally, we document that monetary policy pass-through is incomplete under imperfect competition in the banking sector, as a change in the policy rate by 1pp leads to a change of only 0.92pp in the loan rate, while pass-through to the deposit rate is nearly complete for rate increases, but almost zero for rate reductions due to the zero-lower bound.
    Keywords: Oligopoly competition, Risky investment, Monetary policy, Financial intermediation
    Date: 2021–07–13
  7. By: Volker Grossmann; Johannes Schünemann; Holger Strulik
    Abstract: We discuss public pension systems in a multi-period overlapping generations model with gerontologically founded human aging and a special focus on occupation-specific morbidity and mortality. We examine how distinct replacement rates for white-collar and blue-collar workers and early retirement policies could be designed to provide a fair and aggregate welfare-enhancing public pension system. Calibrating the model to Germany, we find that a pension system that equalizes relative pension contributions and the relative present-discounted value of expected benefits across occupational groups calls for a significant increase in replacement rates of blue-collar workers. If the statutory retirement age is sufficiently high or the life expectancy gap across occupations is sufficiently large, fair pensions raise aggregate welfare and should feature early retirement incentives.
    Keywords: fair pensions, early retirement, occupation, health gradient, life expectancy, replacement rate
    JEL: H55 I14 I24
    Date: 2021
  8. By: Minford, Patrick (Cardiff Business School); Ou, Zhirong (Cardiff Business School); Wickens, Michael (Cardiff Business School); Zhu, Zheyi (Cardiff Business School)
    Abstract: We construct a macro DSGE model of the eurozone and its two main regions, the North and the South, with the aim of matching the macro facts of these economies by indirect inference and using the resulting empirically-based model to assess possible new policy regimes. The model we have found to fit the facts suggests that substantial gains in macro stability and consumer welfare are possible if the fiscal authority in each region is given the freedom to respond to its own economic situation. Further gains could come with the restoration of monetary independence to the two regions, in effect creating a second 'southern euro' bloc.
    Keywords: eurozone; macro stability; fiscal policy; monetary independence
    JEL: E32 E52 E62 F41
    Date: 2021–06
  9. By: Leonid Kogan; Indrajit Mitra
    Abstract: We propose a general simulation-based procedure for estimating the quality of approximate policies in heterogeneous-agent equilibrium models, which allows verification that such approximate solutions describe a near-rational equilibrium. Our procedure endows agents with superior knowledge of the future path of the economy, while imposing a suitable penalty for such foresight. The relaxed problem is more tractable than the original, and it results in an upper bound on agents’ welfare. Our method is general and straightforward to implement, and it can be used in conjunction with various solution algorithms. We illustrate our approach in two applications: the incomplete-markets model of Krusell and Smith (1998) and the heterogeneous firm model of Khan and Thomas (2008).
    Keywords: numerical solutions; accuracy; approximations; simulations
    JEL: E24 E62 J22
    Date: 2021–06–21
  10. By: Sushant Acharya; Keshav Dogra
    Abstract: We present an incomplete markets model to understand the costs and benefits of increasing government debt when an increased demand for safety pushes the natural rate of interest below zero. A higher demand for safe assets causes the ZLB to bind, increasing unemployment. Higher government debt satiates the demand for safe assets, raising the natural rate and restoring full employment. However, this entails permanently lower investment, which reduces welfare, since our economy is dynamically efficient even when the natural rate is negative. Despite this, increasing debt until the ZLB no longer binds raises welfare when alternative instruments are unavailable. Higher in inflation targets instead allow for negative real interest rates and achieve full employment without reducing investment.
    Keywords: Fiscal policy; Monetary policy implementation
    JEL: E3 E4 E5 G1 H6
    Date: 2021–07
  11. By: Paul Corrigan; Hélène Desgagnés; José Dorich; Vadym Lepetyuk; Wataru Miyamoto; Yang Zhang
    Abstract: We present a technical description of the second large-scale update to the Terms-of-Trade Economic Model: ToTEM III. This updated version of the model replaced ToTEM II in 2017. ToTEM III's structure includes key aspects of household indebtedness and improved modelling of the housing market. These new features allow Bank staff to address a broader range of economic issues. Moreover, the model is estimated using a Bayesian methodology with informative priors and a larger set of observable variables, including improved measures of the factors explaining non-commodity exports. These enhancements in the model structure and estimation have contributed to significant improvements in the empirical properties of the model. We also compare the new model’s responses to key macroeconomic shocks with those of ToTEM II and explore two important policy applications.
    Keywords: Business fluctuations and cycles, Economic models, Housing, Interest rates, Monetary policy
    JEL: E65 F41 G51
    Date: 2021
  12. By: Fabian Kindermann (University of Regensburg); Veronika Püschel (University of Regensburg)
    Abstract: In this paper, we challenge the conventional idea that an increase in the progressivity of old-age pensions unanimously distorts the labor supply decision of households. So far, the literature has argued that higher pension progressivity leads to more redistribution and insurance provision on the one hand, but increases implicit taxes and therefore distorts labor supply choices on the other. In contrast, we show that a well-designed reform of the pension system has the potential to encourage labor force participation. We propose a progressive pension component linked to the employment decision of households, which implicitly subsidizes employment of the productivity poor. A simulation analysis in a quantitative stochastic overlapping generations model with productivity and longevity risk indicates that this positive employment effect can be sizable and welfare enhancing.
    Keywords: progressive pensions, Labor Supply, employment incentives
    JEL: D15 H31 H55 J21 J22
    Date: 2021–07
  13. By: Koffi, Siméon
    Abstract: La présente étude met en lumière l’effet de la politique budgétaire sur l’économie ivoirienne en mesurant la valeur des différents multiplicateurs keynésiens et en identifiant les origines possibles de la fluctuation du PIB. La méthode quantitative adoptée est l’estimation Bayésienne d’un modèle d’Equilibre Général Dynamique et Stochastique (DSGE) à partir des données de la Direction des Prévisions, des Politiques et des Statistiques Economiques (DPPSE), de la Direction Générale du Budget et des Finances et de la base de données de la Banque Mondiale sur la période 2000Q1-2019Q4. Les résultats montrent que (i) la hausse des dépenses d’investissements publics a un effet positif sur la consommation des ménages, le secteur privé et sur la production nationale. Le multiplicateur keynésien de l’investissement public a été évalué à k_IG = 0,20 ; (ii) la baisse des taux d’imposition est susceptible de relancer l’économie mais son impact demeure faible ; (iii) les dépenses de consommations publiques notamment les dépenses liées au personnel ont un effet négatif sur l’économie ivoirienne.
    Keywords: Estimation bayésienne; DSGE; Multiplicateur keynésien; Politique budgétaire
    JEL: E32 E62
    Date: 2021–07
  14. By: Kirill Borissov; Nigar Hashimzade
    Abstract: We investigate the dynamics of wealth inequality in an economy where households have positional preferences, with the strength of the positional concern determined endogenously by inequality of wealth distribution in the society. We demonstrate that in the long run such an economy converges to a unique egalitarian steady-state equilibrium, with all households holding equal positive wealth, when the initial inequality is sufficiently low. Otherwise, the steady state is characterised by polarisation of households into rich, who own all the wealth, and poor, whose wealth is zero. A fiscal policy with government consumption funded by taxes on labour income and wealth can move the economy from any initial state towards an egalitarian equilibrium with a higher aggregate wealth.
    Date: 2021–07
  15. By: Giorgio Fabbri (Université de Grenoble); Salvatore Federico (Università degli studi di Genova); Davide Fiaschi (Università degli studi di Pisa); Fausto Gozzi (LUISS Guido Carli, Roma)
    Abstract: In this paper we propose a theoretical model including a susceptible-infectedrecovered-dead (SIRD) model of epidemic in a dynamic macroeconomic general equilibrium framework with agents' mobility. The latter affect both their income (and consumption) and their probability of infecting and of being infected. Strategic complementarities among individual mobility choices drive the evolution of aggregate economic activity, while infection externalities caused by individual mobility affect disease diffusion. Rational expectations of forward looking agents on the dynamics of aggregate mobility and epidemic determine individual mobility decisions. The model allows to evaluate alternative scenarios of mobility restrictions, especially policies dependent on the state of epidemic. We prove the existence of an equilibrium and provide a recursive construction method for finding equilibrium(a), which also guides our numerical investigations. We calibrate the model by using Italian experience on COVID-19 epidemic in the period February 2020 - May 2021. We discuss how our economic SIRD (ESIRD) model produces a substantially different dynamics of economy and epidemic with respect to a SIRD model with constant agents' mobility. Finally, by numerical explorations we illustrate how the model can be used to design an efficient policy of state-of-epidemic-dependent mobility restrictions, which mitigates the epidemic peaks stressing health system, and allows for trading-off the economic losses due to reduced mobility with the lower death rate due to the lower spread of epidemic
    Keywords: Strategic complementarities, ESIRD, COVID-19, Mitigation policies, Pandemic possibilities frontier
    JEL: E1 H0 I1 C72 C73 C62
    Date: 2021–07–09
  16. By: Paul Castillo (Central Bank of Peru); Juan Pablo Medina (Universidad Adolfo Ibanez, Chile)
    Abstract: This paper investigates the relevance of foreign exchange intervention in dealing with the global financial cycle in emerging economies. We show in a VAR analysis that a shock to global capital flows has a sizable effect on economic activity, and this effect is amplified in emerging economies with liability dollarization. However, countries that systematically rely on sterilized foreign exchange intervention display lower output and real exchange rate volatility in response to global capital flows shocks. We then develop a small open economy model with liability dollarization and balance sheets effects calibrated to an emerging economy. The model is consistent with the empirical evidence. Model simulations show that liability dollarization amplifies the effects of the global financial cycle and that foreign exchange intervention can reduce macroeconomic volatility and improve welfare. These results point to the importance of foreign exchange reserves in insulating emerging economies from shocks to global capital flows.
    Keywords: Foreign Exchange Intervention; Global Financial Cycle; Liability Dollarization; Balance Sheet Effects; Emerging Economies
    JEL: E58 F31 F41
    Date: 2021–06–25
  17. By: James Hebden; Fabian Winkler
    Abstract: We propose an efficient procedure to solve for policy counterfactuals in linear models with occasionally binding constraints. The procedure does not require knowledge of the structural or reduced-form equations of the model, its state variables, or its shock processes. Forecasts of the variables entering the policy problem, and impulse response functions of these variables to anticipated policy shocks under an arbitrary policy, constitute sufficient information to construct valid counterfactuals. We show how to compute solutions for instrument rules and optimal discretionary and commitment policies with multiple policy instruments, and discuss various extensions including imperfect information, asymmetric objectives, and limited commitment. Our procedure facilitates the comparison of the effects of policy regimes across models. As an application, we compute counterfactual paths of the US economy around 2015 for several monetary policy regimes.
    Keywords: Computation; DSGE; Occasionally Binding Constraints; Optimal Policy; Commitment; Discretion
    JEL: C61 C63 E52
    Date: 2021–07–15
  18. By: Joshua Bernstein; Michael D. Plante; Alexander W. Richter; Nathaniel A. Throckmorton
    Abstract: This paper uses a battery of calibrated and estimated structural models to determine the causal drivers of the negative correlation between output and aggregate uncertainty. We find the transmission of uncertainty shocks to output is weak, while aggregate uncertainty endogenously responds to first moment shocks in the presence of labor market search frictions. This indicates that countercyclical movements in aggregate uncertainty are endogenous responses to changes in output, rather than exogenous impulses. A vector autoregression on simulated data shows recursive identification techniques do not robustly identify structural uncertainty shocks.
    Keywords: Uncertainty Shocks; Endogenous Uncertainty; Variance Decomposition; Nonlinear
    JEL: C13 D81 E32 E37 J64
    Date: 2021–07–02
  19. By: Naiditch, Claire (Université de Lille); Vranceanu, Radu (ESSEC Research Center, ESSEC Business School)
    Abstract: The important flows of irregular migration could not exist without the emergence of a criminal market for smuggling services. A matching model à la Pissarides (2000) provides a well-suited framework to analyze such a flow market with significant trade frictions. Our analysis considers the competitive segment of this underground market in which small-business smugglers can freely enter. The model allows us to determine the equilibrium number of smugglers, the matching probability, the number of successful irregular migrants and, as an original concept, the equilibrium migrant welfare. Changes in parameters can be related to the various policies implemented by destination countries to cut down irregular migration.
    Keywords: Smuggling; Irregular migration; Matching model; Migrant welfare
    JEL: F22 J46 O15
    Date: 2020–01–30
  20. By: Cole, Stephen J. (Department of Economics Marquette University); Milani, Fabio (University of California Irvine)
    Abstract: This paper uses adaptive learning to understand the heterogeneity of individual-level expectations. We exploit individual Survey of Professional Forecasters data on output and inflation forecasts. We endow all forecasters with the same information set that they would have as economic agents in a benchmark New Keynesian model. Forecasters are, however, allowed to differ in the constant gain values that they use to update their beliefs and in their sentiments. The latter are defined as the degrees of excess optimism or pessimism about the economy that cannot be justified by the learning model. Our results highlight the heterogeneity in the gain coefficients adopted by forecasters. The median values of the gain coefficients occasionally jump to higher values in the 1970-80s, and stabilize in the 1990s and 2000s. Individual sentiment is also persistent and heterogeneous. Differences in sentiment, however, do not simply cancel out in the aggregate: the majority of forecasters exhibit excess optimism, or excess pessimism, at the same time.
    Keywords: individual survey forecasts, heterogeneous expectations, constant-gain learning, new Keynesian model, sentiment shocks, waves of optimism and pessimism, evolving beliefs
    JEL: C54 D84 E32 E50 E60 E70 E71
    Date: 2021–06
  21. By: Manuel Amador; Christopher Phelan
    Abstract: This paper presents a continuous-time reputation model of sovereign debt allowing for both varying levels of partial default and full default. In it, a government can be a non-strategic commitment type, or a strategic opportunistic type, and a government's reputation is its equilibrium Bayesian posterior of being the commitment type. Our equilibrium has that for bond levels reachable by both types without defaulting, bigger partial defaults (or bigger haircuts for bond holders) imply higher interest rates for subsequent bond issuances, as in the data.
    JEL: F34 F41
    Date: 2021–07

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