nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2021‒08‒23
twenty-six papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Tax Policy and Aggregate Stability in an Overlapping Generations Model By Jang-Ting Guo; Yan Zhang
  2. Welfare-Based Optimal Macroprudential Policy with Shadow Banks By Gebauer Stefan
  3. Procyclical Fiscal Policy and Asset Market Incompleteness By Andrés Fernández; Daniel Guzman; Ruy E. Lama; Carlos A. Vegh
  4. Should the ECB Adjust its Strategy in the Face of a Lower r*? By Andrade Philippe,; Galí Jordi,; Le Bihan Hervé,; Matheron Julien.
  5. Public spending, currency mismatch and financial frictions By Hory Marie Pierre,; Levieuge Grégory,; Onori Daria.
  6. Can Monetary Policy Create Fiscal Capacity? By Vadim Elenev; Tim Landvoigt; Patrick J. Shultz; Stijn Van Nieuwerburgh
  7. Volatile hiring: uncertainty in search and matching models By Den Haan, Wouter J.; Freund, Lukas; Kaerner Rendahl, Pontus
  8. Pensions, Income Taxes and Homeownership: A Cross-Country Analysis By Hans Fehr; Maurice Hofmann; George Kudrna
  9. No country is an island. International cooperation and climate change. By Ferrari Massimo,; Pagliari Maria Sole,
  10. Green Technology Policies versus Carbon Pricing: An Intergenerational Perspective By Sebastian Rausch; Hidemichi Yonezawa
  11. Unconventional Fiscal Policy in HANK By Hannah Seidl; Fabian Seyrich
  12. Sharing asymmetric tail risk smoothing, asset pricing and terms of trade By Giancarlo Corsetti; Anna Lipínska; Giovanni Lombardo
  13. Job Polarization and the Flattening of the Price Phillips Curve By Siena Daniele,; Zago Riccardo.
  14. Mr. Keynes and the “Classics”; A Suggested Reinterpretation By Gauti B. Eggertsson; Cosimo Petracchi
  15. The Gender Pay Gap:Micro Sources and Macro Consequences By Iacopo Morchio; Christian Moser
  16. Inflation tolerance ranges in the New Keynesian model By Le Bihan Hervé,; Marx Magali,; Matheron Julien.
  17. The Decline of Drudgery and the Paradox of Hard Work By Brendan Epstein; Miles S. Kimball
  18. Animal spirits and fiscal policy By De Grauwe, Paul; Foresti, Pasquale
  19. Business Cycles and Environmental Policy: Literature Review and Policy Implications By Barbara Annicchiarico; Stefano Carattini; Carolyn Fischer; Garth Heutel
  20. The Patterns of Parental Intervivos Transfers to Adult Children By Marla Ripoll
  21. The Full Recession: Private Versus Social Costs of COVID-19 By Marla Ripoll
  22. Inequality in Life and Death By Martin S. Eichenbaum; Sergio Rebelo; Mathias Trabandt
  23. Soaking Up the Sun: Battery Investment, Renewable Energy, and Market Equilibrium By R. Andrew Butters; Jackson Dorsey; Gautam Gowrisankaran
  24. Pricing Carbon in a Multi-Sector Economy with Social Discounting By Oliver Kalsbach; Sebastian Rausch
  25. Household Consumption Heterogeneity and the Real Exchange Rate By Robert Kollmann
  26. Liquidity Provision and Financial Stability By William Chen; Gregory Phelan

  1. By: Jang-Ting Guo (Department of Economics, University of California Riverside); Yan Zhang (Zhongnan University of Economics and Law)
    Abstract: In the context of a two-period non-monetary overlapping generations model with Cobb-Douglas preference and technological specifications, this paper explores the quantitative interrelations between equilibrium (in)determinacy versus (i) a progressive tax schedule on wage income and (ii) a balanced-budget rule with endogenous labor taxation. In sharp contrast to previous studies on a one-sector representative-agent macroeconomy, we find that both fiscal formulations are stabilizing instruments against cyclical fluctuations driven by agents' self-fulfilling beliefs. The key policy implication of our no-indeterminacy result is that depending on what is the underlying analytical environment, countercyclical income taxation may stabilize or destabilize the business cycle.
    Keywords: Tax Policy; Equilibrium Indeterminacy; Overlapping Generations Model.
    JEL: E32 E62
    Date: 2021–08
  2. By: Gebauer Stefan
    Abstract: In this paper, I show that the existence of non-bank financial institutions (NBFIs) has implications for the optimal regulation of the traditional banking sector. I develop a New Keynesian DSGE model for the euro area featuring a heterogeneous financial sector allowing for potential credit leakage towards unregulated NBFIs. Introducing NBFIs raises the importance of credit stabilization relative to other policy objectives in the welfare-based loss function of the regulator. The resulting optimal policy rule indicates that regulators adjust dynamic capital requirements more strongly in response to macroeconomic shocksdue to credit leakage. Furthermore, introducing non-bank finance not only alters the cyclicality of optimal regulation, but also has implications for the optimal steady-state level of capital requirements and loan-to-value ratios. Sector-specific characteristics such as bank market power and risk affect welfare gains from traditional and NBFI credit.
    Keywords: Macroprudential Regulation, Monetary Policy, Optimal Policy, Non-Bank Finance,Shadow Banking, Financial Frictions.
    JEL: E44 E61 G18 G23 G28
    Date: 2021
  3. By: Andrés Fernández; Daniel Guzman; Ruy E. Lama; Carlos A. Vegh
    Abstract: To explain the fact that government spending and tax policy are procyclical in emerging and developing countries, we develop a model for the joint behavior of optimal tax rates and government spending over the business cycle. Our set-up relies on financial frictions, which have been shown to be critical features of emerging markets, captured by various degrees of asset market incompleteness as well as varying levels of debt-elastic interest rate spreads. We first uncover a novel theoretical result within a simple static framework: incomplete markets can account for procyclical government spending but not necessarily procyclical tax policy. Explaining procyclical tax policy also requires that the ratio of private to public consumption comoves positively with the business cycle, which leads to larger fluctuations in the tax base. We then show that the procyclicality of tax policy holds in a more realistic DSGE model calibrated to emerging markets. Finally, we illustrate how larger financial frictions, which amplify the business cycle through more procyclical fiscal policies, have sizeable Lucas-type welfare costs.
    JEL: F41 F44 H21 H30
    Date: 2021–08
  4. By: Andrade Philippe,; Galí Jordi,; Le Bihan Hervé,; Matheron Julien.
    Abstract: We address this question using an estimated New Keynesian DSGE model of the Euro Area with trend inflation, imperfect indexation, and a lower bound on the nominal interest rate. In this setup, a decrease in the steady-state real interest rate, r*, increases the probability of hitting the lower bound constraint, which entails significant welfare costs and warrants an adjustment of the monetary policy strategy. Under an unchanged monetary policy rule, an increase in the inflation target of eight tenth the size of the drop in the real natural rate of interest is warranted. Absent an increase in the inflation target, and assuming the effective lower bound prevents the ECB from implementing more aggressive negative interest rate policies, adjusting the monetary strategy requires considering alternative instruments or policy rules, such as committing to make-up for recent, below-target inflation realizations.
    Keywords: Inflation Target; Effective Lower Bound; Monetary Policy Strategy; Euro Area.
    JEL: E31 E52 E58
    Date: 2021
  5. By: Hory Marie Pierre,; Levieuge Grégory,; Onori Daria.
    Abstract: In this paper, we demonstrate that the size of the fiscal multiplier depends both on currency mismatch and home bias. Our demonstration is based on a real two-country dynamic stochastic general equilibrium model with incomplete and imperfect international financial markets, external debt and financial frictions. We show that if home bias is high, the terms of trade improve following a fiscal stimulus. This reduces the private real debt burden denominated in foreign currency, decreases the external finance premium born by firms, and stimulates investment. Thus, the larger the proportion of firms' debt denominated in foreign currency is, the higher the fiscal multiplier. In contrast, the terms of trade deteriorate when home bias is low. This increases the real debt burden and the external finance premium. Hence, in this case, the fiscal multiplier decreases as the share of firms' debt denominated in foreign currency increases.
    Keywords: Fiscal Multiplier, Terms of Trade, Currency Mismatch, DSGE Model, Financial Frictions.
    JEL: E62 F34 F41
    Date: 2021
  6. By: Vadim Elenev; Tim Landvoigt; Patrick J. Shultz; Stijn Van Nieuwerburgh
    Abstract: Governments around the world have gone on a massive fiscal expansion in response to the Covid crisis, increasing government debt to levels not seen in 75 years. How will this debt be repaid? What role do conventional and unconventional monetary policy play? We investigate debt sustainability in a New Keynesian model with an intermediary sector, realistic fiscal and monetary policy, endogenous convenience yields, and substantial risk premia. When conventional monetary policy is constrained by the ZLB during an economic crisis, increased government spending and lower tax revenue lead to a large rise in government debt and raise the risk of future tax increases. We find that quantitative easing (QE), forward guidance, and an expansion in government discretionary spending all contribute to lowering debt/GDP ratio and reducing this fiscal risk. A transitory QE policy deployed during a crisis stimulates aggregate demand.
    JEL: E1 E12 E13 E2 E31 E32 E37 E4 E42 E43 E44 E6 E62 E63 G12 G18 G21
    Date: 2021–08
  7. By: Den Haan, Wouter J.; Freund, Lukas; Kaerner Rendahl, Pontus
    Abstract: In search-and-matching models, the nonlinear nature of search frictions increases average unemployment rates during periods with higher volatility. These frictions are not, however, by themselves sufficient to raise unemployment following an increase in perceived uncertainty; though they may do so in conjunction with the common assumption of wages being determined by Nash bargaining. Importantly, option-value considerations play no role in the standard model with free entry. In contrast, when the mass of entrepreneurs is finite and there is heterogeneity in firm-specific productivity, a rise in perceived uncertainty robustly increases the option value of waiting and reduces job creation.
    Keywords: uncertainty; search frictions; unemployment; option value
    JEL: E24 E32 J64
    Date: 2021–07–28
  8. By: Hans Fehr; Maurice Hofmann; George Kudrna
    Abstract: This paper studies the role of pensions and income taxes in determining homeownership and household wealth. It provides a cross-country analysis, using tax and pension policy designs in Germany, the US and Australia. These developed nations have similar incomes per capita but very different homeownership rates, with the US and Australia having much higher homeownership compared to Germany. The question is to what extent the observed differences in homeownership are induced by national tax and transfer policies. To that end, we develop a stochastic, overlapping generations (OLG) model with tenure choice. The model is calibrated to Germany featuring German statutory public pension and dual income tax systems, and then applied to study the effects of alternative income tax and pension policy structures. Our simulation results indicate that the US and Australian policy designs have a dramatic impact on homeownership, explaining more than half of the observed differentials. We also show significant macroeconomic effects due to differences in tax and pension policies.
    Keywords: housing demand, social security, income taxation, stochastic general equilibrium
    JEL: R21 H55 H31 H24 C68
    Date: 2021
  9. By: Ferrari Massimo,; Pagliari Maria Sole,
    Abstract: In this paper we explore the cross-country implications of climate-related mitigation policies. Specifically, we set up a two-country, two-sector (brown vs green) DSGE model with negative production externalities stemming from carbon-dioxide emissions. We estimate the model using US and euro area data and we characterize welfare-enhancing equilibria under alternative containment policies. Three main policy implications emerge: i) fiscal policy should focus on reducing emissions by levying taxes on polluting production activities; ii) monetary policy should look through environmental objectives while standing ready to support the economy when the costs of the environmental transition materialize; iii) international cooperation is crucial to obtain a Pareto improvement under the proposed policies. We finally find that the objective of reducing emissions by 50%, which is compatible with the Paris agreement's goal of limiting global warming to below 2 degrees Celsius with respect to pre-industrial levels, would not be attainable in absence of international cooperation even with the support of monetary policy.
    Keywords: DSGE model, open-economy macroeconomics, optimal policies, climate modelling.
    JEL: F42 E50 E60 F30
    Date: 2021
  10. By: Sebastian Rausch (ZEW Leibniz Centre for European Economic Research, Mannheim, Germany, Department of Economics, Heidelberg University, Germany, Centre for Energy Policy and Economics at ETH Zurich, Switzerland, and Joint Program on the Science and Policy of Global Change at Massachusetts Institute of Technology, Cambridge, USA); Hidemichi Yonezawa (Division for Energy and Environmental Economics at the Research Department at Statistics Norway)
    Abstract: Technology policy is the most widespread form of climate policy and is often preferred over seemingly efficient carbon pricing. We propose a new explanation for this observation: gains that predominantly accrue to households with large capital assets and that influence majority decisions in favor of technology policy. We study climate policy choices in an overlapping generations model with heterogeneous energy technologies and distortionary income taxation. Compared to carbon pricing, green technology policy leads to a pronounced capital subsidy effect that benefits most of the current generations but burdens future generations. Based on majority voting which disregards future generations, green technology policies are favored over a carbon tax. Smart “polluter-pays” financing of green technology policies enables obtaining the support of current generations while realizing efficiency gains for future generations.
    Keywords: Climate Policy; Green Technology Policy; Carbon Pricing; Overlapping Generations; Intergenerational Distribution; Social Welfare; General Equilibrium
    JEL: Q54 Q48 Q58 D58 H23
    Date: 2021–08
  11. By: Hannah Seidl; Fabian Seyrich
    Abstract: In HANK, we show that fiscal policy is an appropriate macroeconomic stabilization tool at the ZLB. Fiscal policy achieves the same macroeconomic aggregates and the same welfare as hypothetically unconstrained monetary policy by replicating its transmission mechanism. Consumption taxes and labor taxes replicate the effects of monetary policy through the intertemporal substitution channel. Debt-financed lumpsum transfers and a permanent increase in the government debt level replicate the effects of monetary policy through the redistribution channel.
    Keywords: Unconventional fiscal policy, heterogeneous agents, incomplete markets, liquidity trap, sticky prices
    JEL: E12 E21 E24 E43 E52
    Date: 2021
  12. By: Giancarlo Corsetti; Anna Lipínska; Giovanni Lombardo
    Abstract: Crises and tail events have asymmetric effects across borders, raising the value of arrangements improving insurance of macroeconomic risk. Using a two-country DSGE model, we provide an analytical and quantitative analysis of the channels through which countries gain from sharing (tail) risk. Riskier countries gain in smoother consumption but lose in relative wealth and average consumption. Safer countries benefit from higher wealth and better average terms of trade. Calibrated using the empirical distribution of moments of GDP-growth across countries, the model suggests significant quantitative effects. We offer an algorithm for the correct solution of the equilibrium using DSGE models under complete markets, at higher order of approximation.
    Keywords: international risk sharing, asymmetry, fat tails, welfare
    JEL: F15 F41 G15
    Date: 2021–08
  13. By: Siena Daniele,; Zago Riccardo.
    Abstract: This paper shows that the change in the occupational composition of the labor market in favour of non-routine jobs -i.e. job polarization- flattens the price Phillips Curve (PC). Using data from the European Monetary Union and exploiting the fact that job polarization accelerates during recessions, we obtain two results. First, countries experiencing a bigger shift in the occupational structure during a downturn exhibit a flatter PC afterward. Second, the occupational shifts experienced during the Great Recession and the Sovereign Debt Crisis explain up to a forth of the flattening of the curve in the 2002-2018 period. We reconcile this evidence through a New Keynesian model with unemployment and search and matching frictions. Heterogeneity in the fluidity across segments of the labor market -i.e. differences in the separation and hiring rate across jobs- is the source of PC flattening.
    Keywords: Phillips Curve, Job Polarization, Occupational Composition, Monetary Policy,Labor Market Fluidity.
    JEL: E31 E32 J21
    Date: 2021
  14. By: Gauti B. Eggertsson; Cosimo Petracchi
    Abstract: This paper revisits and proposes a resolution to an empirical and theoretical controversy between Keynes and the “classics” (or monetarists). The controversy dates to Keynes’s General Theory (1936)—most famously formalized in Hicks’s (1937) classic Econometrica article, in which the IS-LM model is first formally stated. We first replicate empirical tests formulated in the late 1960s and ’70s and show that more recent data have more statistical power and resolve the empirical debate in favor of the Keynesians, at least according to the criteria of the literature at that time. We then show, using a simple dynamic stochastic general equilibrium (DSGE) model, that the empirical tests suffer from the Lucas (1976) critique, as the conclusion fundamentally depends upon the assumed policy regime. Nevertheless, we argue, this new empirical result is useful: it provides evidence for the existence of a “Keynesian policy regime” according to which traditional monetary expansion loses its impact in the absence of a policy regime change, in the sense of Sargent (1982).
    JEL: B0 B1 B22 E0 E12 E13 E4 E5 E50 E51 E52
    Date: 2021–08
  15. By: Iacopo Morchio; Christian Moser
    Abstract: We document that a large share of the gender pay gap in Brazil is due to women working at lower-paying employers. However, compared with that of men, women’s revealed-preference ranking of employers is less increasing in pay. To interpret these facts, we develop an empirical equilibrium search model with endogenous gender differences in pay, amenities, and recruiting intensities across employers. The estimated model suggests that compensating differentials explain one-fifth of the gender pay gap, that there are significant output and welfare gains from eliminating gender differences, and that equal-treatment policies fail to close the gender pay gap.
    Date: 2021–08–13
  16. By: Le Bihan Hervé,; Marx Magali,; Matheron Julien.
    Abstract: A number of central banks in advanced countries use ranges, or bands, around their inflation target to formulate their monetary policy strategy. The adoption of such ranges has been proposed by some policymakers in the context of the Fed and the ECB reviews of their strategies. Using a standard New Keynesian macroeconomic model, we analyze the consequences of tolerance range policies, characterized by a stronger reaction of the central bank to inflation when inflation lies outside the range than when it is close to the target, ie the central value of the band. We show that a tolerance band should not be a zone of inaction: the lack of reaction within the band endangers macroeconomic stability and leads to the possibility of multiple equilibria; the trade-off between the reaction needed outside the range versus inside seems unfavorable: a very strong reaction, when inflation is far from the target, is required to compensate a moderately lower reaction within tolerance band; these results, obtained within the framework of a stylized model, are robust to many alterations, in particular allowing for the zero lower bound.
    Keywords: Monetary policy; inflation ranges; inflation bands; ZLB; endogenous regime switching.
    JEL: E31 E52 E58
    Date: 2021
  17. By: Brendan Epstein; Miles S. Kimball
    Abstract: We develop a theory that focuses on the general equilibrium and long-run macroeconomic consequences of trends in job utility—the process benefits and costs of work. Given secular increases in job utility, work hours per population can remain approximately constant over time even if the income effect of higher wages on labor supply exceeds the substitution effect. In addition, secular improvements in job utility can be substantial relative to welfare gains from ordinary technological progress. These two implications are connected by an equation flowing from optimal hours choices: improvements in job utility that have a significant effect on labor supply tend to have large welfare effects.
    JEL: J22 J24 J28 J31 O4
    Date: 2021–07
  18. By: De Grauwe, Paul; Foresti, Pasquale
    Abstract: In this paper, we study the effects of government spending with a behavioral macroeconomic model in which agents have limited cognitive capabilities and use simple heuristics to form their expectations. However, thanks to a learning mechanism, agents can revise their forecasting rule according to its performance. This feature produces endogenous and self-fulfilling waves of optimistic and pessimistic beliefs (animal spirits). This framework allows us to show that the short-run spending multiplier is state dependent. The multiplier is stronger under either extreme optimism or pessimism and reduces in periods of tranquility. Furthermore, the more the central bank focuses on output gap stabilization, the smaller the multiplier. We also show that periods of increasing public debt are characterized by intense pessimism, while intense optimism occurs in periods of decreasing debt. This allows us to show that governments face a trade-off between the stabilization of the animal spirits and the stabilization of public debt. Then, we show that the existence of this trade-off has implications also for the stabilization of the output gap.
    Keywords: animal spirits; behavioral DSGE model; fiscal policy; policy state-dependent effects; public debt; spending multiplier
    JEL: E10 E32 E62 D83
    Date: 2020–03–01
  19. By: Barbara Annicchiarico; Stefano Carattini; Carolyn Fischer; Garth Heutel
    Abstract: We study the relationship between business cycles and the design and effects of environmental policies, particularly those with economy-wide significance like climate policies. First, we provide a brief review of the literature related to this topic, from initial explorations using real business cycle models to New Keynesian extensions, open-economy variations, and issues of monetary policy and financial regulations. Next, we provide a list of the main findings that emerge from this literature that are potentially most relevant to policymakers, including the impacts of policy on volatility and how to design policy to adjust to cycles. Finally, we propose several important remaining research questions.
    JEL: E32 Q58
    Date: 2021–07
  20. By: Marla Ripoll
    Abstract: Parental intervivos transfers to adult children occur in families across the income distribution. This paper documents and analyzes novel patterns of parental intervivos transfers that are informative to dynamic models of transfers. We sue longitudinal data on parental transfers from the 1996-2014 Health and Retirement Study to characterize the age profile of transfers, including the probability and the transfer amount (unconditional and conditional). We then follow the 1967-71 cohort to describe the frequency of transfers, the distribution of years between transfers, and the total transfers received during different age brackets. Last, we use a dynamic model of parental altruism to analyze the mechanisms generating the distinct transfer types observed in the data. We find that in addition to the cross-sectional patterns documented in the literature, parental altruism is essential to explain the novel dynamic facts on intervivos transfers from longitudinal data.
    Date: 2021–01
  21. By: Marla Ripoll
    Abstract: Official recession figures ignore the costs associated with the loss of human life due to COVID-19. This paper constructs full recession measures that take into account the death toll. Our model features tractable heterogeneity, constant relative risk aversion to mortality risk, and age-specific survival rates. Using an estimated one-year death toll of 500 thousand people and a 3.5% recession, we find that the corresponding full recession is 24% on average across individuals, 13% for a median voter, and 7% for planner with moderate inequality aversion.
    Date: 2021–01
  22. By: Martin S. Eichenbaum; Sergio Rebelo; Mathias Trabandt
    Abstract: We argue that the Covid epidemic disproportionately affected the economic well-being and health of poor people. To disentangle the forces that generated this outcome, we construct a model that is consistent with the heterogeneous impact of the Covid recession on low- and high-income people. According to our model, two thirds of the inequality in Covid deaths reflect pre-existing inequality in comorbidity rates and access to quality health care. The remaining third, stems from the fact that low-income people work in occupations where the risk of infection is high. Our model also implies that the rise in income inequality generated by the Covid epidemic reflects the nature of the goods that low-income people produce. Finally, we assess the health-income trade-offs associated with fiscal transfers to the poor and mandatory containment policies.
    JEL: E1 H0 I1
    Date: 2021–07
  23. By: R. Andrew Butters; Jackson Dorsey; Gautam Gowrisankaran
    Abstract: We develop a dynamic competitive equilibrium model of battery adoption and operations to evaluate the social value and adoption trajectory of utility-scale batteries and examine policy counterfactuals. The first battery unit breaks even in 2027 when renewable energy share reaches 52% and expected capital costs are $259/kWh. While the competitive market will install 10 MWh by 2030, competitive adoption does not reach 5,000 MWh until 2043 because the marginal value of investment sharply declines in aggregate capacity. California's 1,300 MW battery mandate implies subsidies of 49% and creates deadweight losses of $433 million relative to a competitive battery market.
    JEL: L94 Q40 Q48 Q55
    Date: 2021–08
  24. By: Oliver Kalsbach (CER–ETH – Center of Economic Research at ETH Zurich, Switzerland); Sebastian Rausch (ZEW Leibniz Centre for European Economic Research, Mannheim, Germany, Department of Economics, Heidelberg University, Germany, Centre for Energy Policy and Economics at ETH Zurich, Switzerland, and Joint Program on the Science and Policy of Global Change at Massachusetts Institute of Technology, Cambridge, USA)
    Abstract: Economists tend to view a uniform emissions price as the most cost-effective approach to reducing greenhouse gas emissions. This paper offers a different view, focusing on economies where society values the well-being of future generations more than private actors. Employing analytical and numerical general equilibrium models, we show that a uniform carbon price is efficient only under restrictive assumptions about technology homogeneity and intertemporal decision-making. Non-uniform pricing spurs capital accumulation and benefits future generations. Depending on sectoral heterogeneity in the substitutability between capital and energy inputs, we find that optimal carbon prices differ widely across sectors and yield substantial welfare gains relative to uniform pricing.
    Keywords: Sectoral Carbon Pricing, Differentiated Carbon Taxes, Climate Policy, Social Discounting
    JEL: Q54 Q58 Q43 H23 C61
    Date: 2021–08
  25. By: Robert Kollmann
    Abstract: Does household heterogeneity matter for exchange rate determination? This paper tests Kocherlakota and Pistaferri’s (2007) prominent heterogeneous agent model, in which the real exchange rate perfectly tracks relative domestic/foreign moments of cross-household consumption distributions. The evidence presented here indicates that the real exchange rate is disconnected from relative cross-household consumption moments.
    Keywords: Household consumption heterogeneity; International and domestic risk sharing; Real exchange rate.
    Date: 2021–08
  26. By: William Chen (Department of Economics, Massachusetts Institute of Technology); Gregory Phelan (Department of Economics, Williams College)
    Abstract: When financial intermediaries’ key characteristic is provision of liquidity through their liabilities, with financial frictions the financial sector in the aggregate is likely to over-accumulate equity, thus decreasing liquidity provision and household welfare. Aggregate household welfare is therefore decreasing in the level of aggregate intermediary equity even though the individual value of intermediaries is increasing in equity, which is why intermediaries over-accumulate equity. Subsidizing intermediary dividends can improve welfare by encouraging earlier payout and decreasing aggregate equity in the financial sector. This policy increases the likelihood that intermediaries provide more liquidity and improves the stability of the economy, even though asset prices fall.
    Keywords: Financial stability, Macroeconomic instability Macroprudential policy, Banks
    JEL: E44 E52 E58 G01 G12 G20 G21
    Date: 2021–08–03

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