nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2021‒08‒30
fourteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. A Baseline DSGE model of Climate Change for Climate Policy Analysis By Xu, Wenli
  2. Demographics, Wealth, and Global Imbalances in the Twenty-First Century By Adrien Auclert; Hannes Malmberg; Frederic Martenet; Matthew Rognlie
  3. The Neoclassical Model and the Welfare Costs of Selection By Fabrice Collard; Omar Licandro
  4. Wage Setting Under Targeted Search By Anton A. Cheremukhin; Paulina Restrepo-Echavarria
  5. Sharing Asymmetric Tail Risk: Smoothing, Asset Prices and Terms of Trade By Giancarlo Corsetti; Anna Lipinska; Giovanni Lombardo
  6. Borrowing to Finance Public Investment: A Politico-economic Analysis of Fiscal Rules By Uchida, Yuki; Ono, Tetsuo
  7. Default of Depreciate By Yasin Kürsat Önder; Enes Sunel
  8. Understanding Why Fiscal Stimulus Can Fail through the Lens of the Survey of Professional Forecasters By Hyeongwoo Kim; Shuwei Zhang
  9. Polygyny, Timing of Marriage and Economic Shocks in Sub-Saharan Africa By Tapsoba, Augustin
  10. Public Debt Bubbles in Heterogeneous Agent Models with Tail Risk By Narayana R. Kocherlakota
  11. What Can We Learn from Idiosyncratic Wage Changes? By Cynthia L. Doniger
  12. Fiscal Policy at the Zero Lower Bound without Rational Expectations By Riccardo Bianchi Vimercati; Martin S. Eichenbaum; Joao Guerreiro
  13. Ageing and Welfare-State Policy Making: Macroeconomic Perspective By Assaf Razin; Alexander Horst Schwemmer
  14. Does class size matter? How, and at what cost? By Kedagni, Desire; Krishna, Kala; Megalokonomou, Rigissa; Zhao, Yingyan

  1. By: Xu, Wenli
    Abstract: This note documents a DSGE model of Climate Change. I extend the NK model with geophisical variables, such as greenhouse gas emissions, the carbon cycle, radiative forcing, and climate change. In this model, I specify five different climate policy regimes: no policy, cap, intensive, tax, and mandate.
    Keywords: DSGE, climate change, climate policy
    JEL: E6 Q5
    Date: 2020–09–26
  2. By: Adrien Auclert; Hannes Malmberg; Frederic Martenet; Matthew Rognlie
    Abstract: We use a sufficient statistic approach to quantify the general equilibrium effects of population aging on wealth accumulation, expected asset returns, and global imbalances. Combining population forecasts with household survey data from 25 countries, we measure the compositional effect of aging: how a changing age distribution affects wealth-to-GDP, holding the age profiles of assets and labor income fixed. In a baseline overlapping generations model this statistic, in conjunction with cross-sectional information and two standard macro parameters, pins down general equilibrium outcomes. Since the compositional effect is positive, large, and heterogeneous across countries, our model predicts that population aging will increase wealth-to- GDP ratios, lower asset returns, and widen global imbalances through the twenty-first century. These conclusions extend to a richer model in which bequests, individual savings, and the tax-and-transfer system all respond to demographic change.
    JEL: E21 F21 J11
    Date: 2021–08
  3. By: Fabrice Collard; Omar Licandro
    Abstract: This paper embeds firm dynamics into the Neoclassical model and provides a simple framework to solve for the transitional dynamics of economies moving towards more selection. As in the Neoclassical model, markets are perfectly competitive, there is only one good and two production factors (capital and labor). At equilibrium, aggregate technology is Neoclassical, but the average quality of capital and the depreciation rate are both endogenous and positively related to selection. At steady state, output per capita and welfare both raise with selection. However, the selection process generates transitional welfare losses that may reduce in around 60% long term (consumption equivalent) welfare gains. The same property is shown to be true in a standard general equilibrium model with entry and fixed production costs.
    Keywords: firm dynamics and selection, neoclassical model, capital irreversibility, investment distortions, transitional dynamics, welfare gains
    JEL: E13 E23 D60 O40
    Date: 2021
  4. By: Anton A. Cheremukhin; Paulina Restrepo-Echavarria
    Abstract: When setting initial compensation, some firms set a fixed, non-negotiable wage while others bargain. In this paper we propose a parsimonious search and matching model with two-sided heterogeneity, where the choice of wage-setting protocol, wages, search intensity and degree of randomness in matching are endogenous. We find that posting and bargaining coexist as wage-setting protocols if there is sufficient heterogeneity in match quality, search costs or market tightness and that labor market tightness and relative costs of search play a key role in the optimal choice of the wage-setting mechanism. Finally, we show that bargaining prevalence is positively correlated with wages, residual wage dispersion and labor market tightness, both in the model and in the data.
    Keywords: wage posting; bargaining; search and matching; information
    JEL: J64 E24 J31
    Date: 2021–08–12
  5. By: Giancarlo Corsetti; Anna Lipinska; 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 non-negligible 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: 2021–08–06
  6. By: Uchida, Yuki; Ono, Tetsuo
    Abstract: The golden rule of public finance distinguishes public investment from consumption spending when borrowing, permitting the finance of public investment only. This study focuses on public investment in human capital and compares this rule with the balanced budget rule, which rules out debt finance, in an overlapping generations model. In the model, fiscal policy is endogenous, chosen each period by a short-lived government representing existing generations. We evaluate the government's choice and the resulting political distortions for a given fiscal rule from the long-lived planner's perspective. We find that a country with a larger preference for public consumption can minimize distortions by lowering the fraction of debt-financed public investment. We calibrate the model to a sample of OECD countries. On the one hand, we find that the golden rule of public finance in human capital is optimal and politically supported in Greece; on the other hand, the balanced budget rule (no borrowings for human capital investment) is optimal and politically supported in Germany and to a lesser extent in Japan and the United States.
    Keywords: Balanced Budget Rule; Golden Rule of Public Finance; Probabilistic Voting, Overlapping Generations
    JEL: D70 E62 H63
    Date: 2021–08–22
  7. By: Yasin Kürsat Önder; Enes Sunel (-)
    Abstract: We propose a theory of domestic and foreign currency debt and limited commitment to exchange-rate and debt repayment policies. Exchange-rate depreciation is costly, but reduces the real value of domestic-currency debt and helps smooth consumption without the full punishment of default. However, during a global liquidity shock, government debt balances endogenously tilt towards hard-currency as in the data, although issuing local-currency debt to foreigners is needed the most to transfer the currency risk. This is because foreign lenders become more risk averse to holding nominal sovereign debt during stress episodes. We show that a modest depreciation of currency following adverse shocks precludes a sovereign default by inflating away outstanding local-currency debt burdens in contrast to a counterfactual economy with fully dollarized sovereign debt. The quantitative application of our theory accounts for the business cycle properties and the currency composition of sovereign debt in Mexico.
    Keywords: Sovereign default, inflationary bias, investor base, original sin
    JEL: E31 F34 F45
    Date: 2021–08
  8. By: Hyeongwoo Kim; Shuwei Zhang
    Abstract: This paper shows that fiscal policy in the U.S. has become ineffective due to lack of coordination between monetary and fiscal policy. We present a New Keynesian model that generates strong output effects of government spending shocks only when monetary policy coordinates well with fiscal policy. Employing the post-war U.S. data, we report strong stimulus effects of fiscal policy during the pre-Volcker era, which rapidly dissipate when we shift the sample period to the post-Volcker era. Finding a negligible role of the real interest rate in the propagation of government spending shocks, we propose an alternative explanation using a sentiment channel. Employing the Survey of Professional Forecasters data, we show that forecasters tend to systematically over-estimate real GDP growth in response to positive innovations in government spending when policies coordinate well with each other. On the other hand, they are likely to formulate pessimistic forecasts when the monetary authority maintains a hawkish stance that conflicts with the fiscal stimulus. The fiscal stimulus, under such circumstances, may generate consumer pessimism, which decreases private spending and ultimately weakens the output effects of fiscal policy. We also provide statistical evidence that confirms an important role of the sentiment channel under different regimes of policy coordination.
    Keywords: Fiscal Policy; Time-varying Effectiveness; Policy Coordination; Sentiment; Survey of Professional Forecasters
    JEL: E32 E61 E62
    Date: 2021–08
  9. By: Tapsoba, Augustin
    Abstract: This paper studies how local polygyny norms affect the equilibrium response of marriage markets to short-term changes in aggregate economic conditions. It develops a simple equilibrium marriage market framework with overlapping generations in which polygyny is modeled as a sequential one-to-one matching. The model generates predictions that are tested by revisiting the impact of rainfall shocks on the timing of marriage in Sub-Saharan Africa. Consistent with the model’s predictions, I find that the effect of droughts on child marriage is weaker where polygyny is more commonly practiced. The same shock leads to a large increase in the annual hazard of child marriage in monogamous areas but has no detectable effect in areas with high polygyny levels. In these areas, there is instead an increase in the market shares of young men that are looking for first/unique spouses at the expense of older men that are looking for second spouses. The differences in equilibrium outcomes on the marriage markets translate into differences in fertility onset and long term fertility levels.
    Keywords: Marriage market, local norms, polygyny, bride price, income shocks, informal insurance, Africa
    Date: 2021–08–25
  10. By: Narayana R. Kocherlakota
    Abstract: This paper studies the public debt implications of a class of Aiyagari (1994)-Bewley (1977)-Huggett (1993) (ABH) models of incomplete insurance in which agents face a near-zero probability of a highly adverse outcome. In generic models of this kind, there exists a public debt bubble, so that the government is able to borrow at a real interest rate that is perpetually below the economic growth rate. Given an equilibrium with a public debt bubble, the primary deficit and the level of debt are both strictly increasing in the real interest rate and in the fraction of government expenditures used for lumpsum transfers. There is no upper bound on the deficit level or long-run debt level that is sustainable in equilibrium. In a public debt bubble, regardless of its size, agents are better off in the long run if the government chooses policies that give rise to a larger debt and primary deficit.
    JEL: E62 H62 H63
    Date: 2021–08
  11. By: Cynthia L. Doniger
    Abstract: I document six facts about wage changes. First, most pay revisions occur at yearly frequency, but a small proportion occur at idiosyncratic times. Second, idiosyncratic pay changes are larger and more dispersed than year-end pay changes and resemble more pay changes occurring at job-to-job transitions. Third, idiosyncratic pay changes are more common for workers with less experience and, forth, in firms higher on the job-ladder. Fifth, industries in which the incidence of idiosyncratic raises have risen have experienced greater declines in labor share. Sixth, industries in which more firms report willingness to negotiate wages have greater concentrations of idiosyncratic revisions. An on-the-job search model with heterogeneous wage contracts can rationalize these facts.
    Keywords: Labor contracts; Idiosyncratic wage changes; Labor share; Job ladder
    JEL: E24 E25 J31 J33 M55 M52
    Date: 2021–08–12
  12. By: Riccardo Bianchi Vimercati; Martin S. Eichenbaum; Joao Guerreiro
    Abstract: We address the question of how sensitive is the power of fiscal policy in the ZLB to the assumption of rational expectations. We do so through the lens of a standard NK model in which people are level-k thinkers. Our analysis weakens the case for using government spending to stabilize the economy when the ZLB binds. The less sophis- ticated people are, the smaller is the size of the government-spending multiplier. Our analysis strengthens the case for using tax policy to stabilize output when the ZLB is binding. The power of tax policy to stabilize the economy during the ZLB period is essentially undiminished when agents do not have rational expectations. Finally, we show that the way in which tax policy is communicated is critical to its effectiveness.
    JEL: E0 E32 E62
    Date: 2021–08
  13. By: Assaf Razin; Alexander Horst Schwemmer
    Abstract: It has been well recognized that population ageing could generate structural changes centered around the dwindling labor force, on one hand, and the expanding dependency on the generosity of the welfare state, on the other hand. Ageing-related welfare state policy entails both fiscal issues and migration issues. The paper employs a general-equilibrium model with a policy-making focus, to help understand the mechanism governing the provision of social benefits, labor income taxation, capital income taxation, migration curbs on low skilled and high skilled, driven by the ageing of the population. Greater generosity of the welfare state comes together with policy, incentive compatible with the interests of the majority voters, of a more liberal migration policy.
    JEL: F3 H0
    Date: 2021–08
  14. By: Kedagni, Desire; Krishna, Kala; Megalokonomou, Rigissa; Zhao, Yingyan
    Abstract: Using high quality administrative data on Greece we show that class size has a hump shaped effect on achievement. We do so both nonparametrically and parametrically, while controlling for potential endogeneity and allowing for quantile effects. We then embed our estimates for this relationship in a dynamic structural model with costs of hiring and firing.We argue that the linear specification form used in past work may be why it found mixed results. Our work suggests that while discrete reductions in class size may have mixed effects, discrete increases are likely to have very negative effects while marginal changes in class size would have small negative effects.We find optimal class sizes around 27 in the absence of adjustment costs and achievement maximizing ones around 15, and firing costs much larger than hiring costs consistent with the presence of unions. Despite this, reducing firing costs actually reduces achievement. Reducing hiring costs raises achievement and reduces class size. We show that class size caps are costly, and more so for small schools, even when set at levels well above average.
    Date: 2021–04–01

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