nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2021‒09‒06
sixteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Sovereign Default Risk, Macroeconomic Fluctuations and Monetary-Fiscal Stabilization By Markus Kirchner; Malte Rieth
  2. Intergenerational redistributive effects of monetary policy By Marcin Bielecki; Michał Brzoza-Brzezina; Marcin Kolasa
  3. A Model-Based Comparison of Macroprudential Tools By Eyno Rots; Barnabas Szekely
  4. Monetary Policy over the Lifecycle By R. Anton Braun; Daisuke Ikeda
  5. The Dynamic Effects of Environmental and Fiscal Policy Shocks By Richard Jaimes
  6. Idiosyncratic income risk and aggregate fluctuations By Davide Debortoli; Jordi Galí
  7. Interest Rate Cuts vs. Stimulus Payments: An Equivalence Result By Christian K. Wolf
  8. UNCERTAINTY AND MONETARY POLICY DURING THE GREAT RECESSION By Giovanni Pellegrino; Efrem Castelnuovo; Giovanni Caggiano
  9. Fiscal policy in a monetary union with downward nominal wage rigidity By Matthias Burgert; Philipp Pfeiffer; Werner Roeger
  10. Banks’ internalization effect and equilibrium By Chrysanthopoulou, Xakousti
  11. Monetary policy and COVID-19 By Michał Brzoza-Brzezina; Marcin Kolasa; Krzysztof Makarski
  12. Welfare Implications of Asset Pricing Facts: Should Central Banks Fill Gaps or Remove Volatility? By Pierlauro Lopez
  13. Interest Rate Rules, Rigidities and Inflation Risks in a Macro-Finance Model By Roman Horvath; Lorant Kaszab; Ales Marsal
  14. The aggregate and redistributive effects of emigration By Małgorzata Walerych
  15. Expectational and Portfolio-Demand Shifts in a Keynesian Model of Monetary Growth Fluctuations By Greg Philip Hannsgen; Tai Young-Taft
  16. Returns to labor mobility. Layoff costs and quit turbulence By Isaac Baley; Lars Ljungqvist; Thomas J. Sargent

  1. By: Markus Kirchner; Malte Rieth
    Abstract: This paper examines the role of sovereign default beliefs for macroeconomic fluctuations and stabilization policy in a small open economy where fiscal solvency is a critical problem. We set up and estimate a DSGE model on Turkish data and show that accounting for sovereign risk significantly improves the fit of the model through an endogenous amplification between default beliefs, exchange rate and inflation movements. We then use the estimated model to study the implications of sovereign risk for stability, fiscal and monetary policy, and their interaction. We find that a relatively strong fiscal feedback from deficits to taxes, some exchange rate targeting, or a monetary response to default premia are more effective and efficient stabilization tools than hawkish inflation targeting.
    Keywords: Small open economies, sovereign risk, monetary policy, exchange rates, business cycles, DSGE models
    JEL: E58 E63 F41
    Date: 2021
  2. By: Marcin Bielecki; Michał Brzoza-Brzezina; Marcin Kolasa
    Abstract: This paper investigates the distributional consequences of monetary policy across generations. We use a life-cycle model with a rich asset structure as well as nominal and real rigidities calibrated to the euro area using both macroeconomic aggregates and microeconomic evidence from the Household Finance and Consumption Survey. We show that the life-cycle profi les of income and asset accumulation decisions are important determinants of redistributive effects of monetary shocks and ignoring them can lead to highly misleading conclusions. The redistribution is mainly driven by nominal assets and labor income, less by real and housing assets. Overall, we find that a typical monetary policy easing redistributes welfare from older to younger generations.
    Keywords: monetary policy, life-cycle models, wealth redistribution
    JEL: E31 E52 J11
    Date: 2021–03
  3. By: Eyno Rots (Magyar Nemzeti Bank (Central Bank of Hungary)); Barnabas Szekely (Goethe University)
    Abstract: We develop a DSGE model to analyze a macroprudential policy framework. We use it to describe the Hungarian economy and the key regulatory constraints implemented there: the loan-to-value and the debt-service-to-income caps imposed on mortgage borrowers and the minimum capital requirement imposed on banks. Our model is novel in the way it treats the borrowing caps as soft constraints, which makes it easy to analyze multiple non-redundant borrowing constraints. We also show an estimation strategy that involves a variation of impulse-response matching and accounts for the lack of historical data concerning the conduct of macroprudential policy, a common problem.
    Keywords: DSGE, macroprudential, DSTI, LTV, capital requirement, Covid†19.
    JEL: E37 E44
    Date: 2021
  4. By: R. Anton Braun (Federal Reserve Bank of Atlanta (E-mail:; Daisuke Ikeda (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:
    Abstract: A tighter monetary policy is generally associated with higher real interest rates on deposits and loans, weaker performance of equities and real estate, and slower growth in employment and wages. How does a household's exposure to monetary policy vary with its age? The size and composition of both household income and asset portfolios exhibit large variation over the lifecycle in Japanese data. We formulate an overlapping generations model that reproduces these observations and use it to analyze how household responses to monetary policy shocks vary over the lifecycle. Both the signs and the magnitudes of the responses of a household's net worth, disposable income and consumption depend on its age.
    Keywords: Monetary policy, Lifecycle, Portfolio choice, Nominal government debt
    JEL: E52 E62 G51 D15
    Date: 2021–08
  5. By: Richard Jaimes
    Abstract: This paper studies the effects of aggregate shocks to government spending and to the available abatement technology in an economy with a polluting intermediate goods sector and nominal rigidities. The model implies that an abatement cost shock leads to a decline in both output and consumption regardless the type of climate regulation in place. Nonetheless, it turns out that these negative responses are attenuated when environmental policy revenues are used to diminish either consumption or labor income taxes instead of rebating them via lump-sum transfers. On the other hand, the positive effects of a government spending shock on output are maximized when both prices and wages are rigid, there is a carbon tax scheme instead of a cap-and-trade system, and the expansion in public expenditures is financed through lump-sum taxation.
    Keywords: New Keynesian model, environmental policy, macroeconomic dynamics, and fiscal policy
    JEL: E32 E50 Q58
    Date: 2021–08–25
  6. By: Davide Debortoli; Jordi Galí
    Abstract: We study the role of idiosyncratic income shocks for aggregate fluctuations within a simple heterogeneous household framework with no binding borrowing constraints. We derive analytically an Euler equation for (log) aggregate consumption, and show that the impact of idiosyncratic risk on aggregate consumption works through two channels: (i) changes in average consumption uncertainty and (ii) changes in the cross-sectional dispersion of consumption. We show that these two channels are related and tend to offset each other. Their net effect is captured by a sufficient statistic, the consumption-weighted average of changes in uncertainty. We apply this framework to two example economies -an endowment economy and a New Keynesian economy- and show that the net effect of heterogeneity is quantitatively small. By contrast, that effect becomes more significant when considering that borrowing constraints are binding for a sizable fraction of the population.
    Keywords: heterogeneous agents, economic fluctuations, aggregate shocks, idiosyncratic shocks, monetary policy, HANK models.
    JEL: E21 E32 E50
    Date: 2021–07
  7. By: Christian K. Wolf
    Abstract: In a textbook New Keynesian model extended to allow for uninsurable household income risk, any path of inflation and output implementable via interest rate policy is similarly implementable through uniform lump-sum transfers ("stimulus checks"). A dual-mandate policymaker can thus use checks to perfectly substitute for conventional monetary policy when rates are constrained by a lower bound. In a quantitative heterogeneous-agent (HANK) model, the stimulus check policy that implements a given monetary allocation is well-characterized by a small number of measurable sufficient statistics. In the household cross-section, the transfer policy is associated with lower consumption inequality than the equivalent rate cut.
    JEL: E2 E3 E6
    Date: 2021–08
  8. By: Giovanni Pellegrino (Aarhus University); Efrem Castelnuovo (University of Padova); Giovanni Caggiano (Monash University and University of Padova)
    Abstract: We employ a nonlinear VAR framework and a state-of-the-art identification strategy to document the large response of real activity to a financial uncertainty shock during and in the aftermath of the great recession. We replicate this evidence with an estimated DSGE framework featuring a concept of uncertainty comparable to that in our VAR. We then use the estimated framework to quantify the output loss due to the large uncertainty shock that materialized in 2008Q3. We find such a shock to be able to explain about 60% of the output loss in the 2008-2014 period. The same estimated model unveils the role successfully played by the Federal Reserve in limiting the output loss that would otherwise have occurred had monetary policy been conducted as in normal times. Finally, we show that the rule estimated during the great recession is able to deliver an economic outcome closer to the flexible price one than the rule describing the Federal Reserve's conduct in normal times.
    Keywords: Uncertainty shock, nonlinear IVAR, nonlinear DSGE framework, minimum-distance estimation, great recession
    JEL: C22 E32 E52
    Date: 2021–03
  9. By: Matthias Burgert; Philipp Pfeiffer; Werner Roeger
    Abstract: We estimate an open economy DSGE model to study the fiscal policy implications of downward nominal wage rigidity (DNWR) in a monetary union. DNWR has significantly exacerbated the recession in the southern euro area countries and is important for the design of fiscal policy. We show that a cut in social security contributions paid by employers (equivalent to wage subsidies) is particularly effective in a deep recession with limited wage adjustment. Such cuts strengthen domestic demand and international competitiveness. Compared to government expenditure increases, the reduction in social security contributions provides more persistent growth effects and enhances the fiscal position. Non-linear estimation methods establish a strong state-dependence of policy.
    Keywords: Downward nominal wage rigidity, currency union, fiscal policy, nonlinear estimation
    JEL: E3 F41 F45
    Date: 2021
  10. By: Chrysanthopoulou, Xakousti
    Abstract: This paper extends the standard New Keynesian model to allow for the presence of large banks, when the cost channel of monetary policy matters. It is shown that once the presence of large banks is taken into account the severity of the firms’ credit constraints, the aggressiveness of the central bank in stabilizing inflation and the degree of loan setting centralization jointly affect the steady state output. Moreover, it turns out that the indeterminacy region is not only shrunk due to the presence of a finite number of large banks but also dependent – among others - on the way in which the central bank and the macroprudential authority systematically behave.
    Keywords: Large banks; Cost channel; Indeterminacy; Countercyclical capital buffer
    JEL: E32 E44 E52
    Date: 2021–08–20
  11. By: Michał Brzoza-Brzezina; Marcin Kolasa; Krzysztof Makarski
    Abstract: We study the macroeconomic effects of the COVID-19 epidemic in a quantitative dynamic general equilibrium setup with nominal rigidities. We evaluate various containment policies and show that they allow to dramatically reduce the welfare cost of the disease. Then we investigate the role that monetary policy, in its capacity to manage aggregate demand, should play during the epidemic. We show that treating the observed output contraction as a standard recession leads to a bad policy, irrespective of the underlying containment measures. Then we check how monetary policy should solve the trade-off between stabilizing the economy and containing the epidemic. If no administrative restrictions are in place, the second motive prevails and, in spite of the deep recession, optimal monetary policy is in fact contractionary. Only if sufficient containment measures are being introduced should central bank interventions be expansionary and help stabilize economic activity.
    Keywords: COVID-19; Epidemics; Containment measures; Monetary policy
    JEL: E1 E5 E6 H5 I1 I3
    Date: 2021–07
  12. By: Pierlauro Lopez
    Abstract: More than 20 years of financial market data suggest a term structure of the welfare cost of economic uncertainty that is downward-sloping on average, especially during downturns. This evidence offers guidance in selecting a model to study the benefits of macroeconomic stabilization from a structural perspective. The addition of nonlinear external habit formation to a textbook monetary model can rationalize the evidence. The model is observationally equivalent in its quantity implications to a standard New Keynesian model with CRRA utility, but the optimal policy prescription is overturned. In the model the central bank should prioritize removing consumption volatility (a targeting of risk premia) over filling the gap between consumption and its flexible-price counterpart (inflation targeting).
    Keywords: Welfare cost of business cycles; Macroeconomic priorities; Equity and bond yields; Optimal monetary policy; Financial Stability
    JEL: E32 E44 E61 G12
    Date: 2021–08–30
  13. By: Roman Horvath (Charles University, Prague); Lorant Kaszab (Magyar Nemzeti Bank (Central Bank of Hungary)); Ales Marsal (National Bank of Slovakia)
    Abstract: Long-term bond yields contain a risk-premium, an important part of which is compensation for inflation risks. The substantial increase in the Fed funds rate in the mid-2000s did not raise long-term US Treasury yields due to the reduction in the term premium (so-called Greenspan conundrum) which was typically thought to be exogenous for monetary policy. We show using a New Keynesian macro-finance model that the term premium is endogenous and is greatly influenced by the specification of the Taylor rule. Finally, we extend the model with frictions (richer fiscal setup and wage rigidity) that are known to help jointly match macro and finance data and estimate the model on US data in 1961-2007 by the generalized methods of moments and simulated methods of moments.
    Keywords: zero-coupon bond, nominal term premium, inflation risk, Taylor rule, New Keynesian, labor income taxation, wage rigidity, GMM, SMM
    JEL: E13 E31 E43 E44
    Date: 2021
  14. By: Małgorzata Walerych
    Abstract: The 2004 EU enlargement has triggered large and rapid migration movements from the new to the old member states. The scale of this outflow was unprecedented in the CEE history and its structure was also different from previous emigration waves as it was more heavily biased towards young and educated people. I exploit this post-accession emigration wave to study the aggregate and redistributive effects of emigration. Using a two-country general equilibrium model with heterogeneous agents and endogenous migration choice calibrated to Polish data, I show that emigration lowers output per capita and improves the international investment position of the source country. Changes in population structure resulting from population outflows affect the wage distribution between high-skilled and low-skilled workers, thereby increasing economic inequalities. Moreover, I find that lifting labour mobility barriers is beneficial not only for people who move abroad, but also for skilled never-migrants.
    Keywords: migration, sending country, heterogenous agents, EU accession
    JEL: F22 J61 D31 D58
    Date: 2021–05
  15. By: Greg Philip Hannsgen; Tai Young-Taft
    Abstract: We develop a pair of models to show how non-ad-hoc shifts to expectational variables can be used to model tendencies toward crisis. In the Shackle model, as developed in the book Keynesian Kaleidics (1974), uncertainty can lead to a collapse in the marginal efficiency of investment and a jump in liquidity preference. In the Minsky version of the model, excessive private debt can lead to a financial collapse–again an endogenous breakdown in forces supporting growth. We extend the models to indicate how the dynamics of inflation and distribution affect the dynamics.
    Keywords: Post Keynesian macro model, Poisson model of financial fragility, Keynesian dynamics, Hyman Minsky, G.L.S. Shackle, Keynesian Kaleidics, endogenous MEI and liquidity preference, financial fragility hypothesis
    JEL: E12 E32
    Date: 2021–08
  16. By: Isaac Baley; Lars Ljungqvist; Thomas J. Sargent
    Abstract: Although they are studied too rarely, returns to labor mobility transmit important forces that decisively shape outcomes in macro-labor models. By focusing on returns to labor mobility, this paper sheds new light on calibrations of influential macro-labor studies and resolves an issue about the turbulence-theoretic explanation of trans-Atlantic unemployment experiences. It does so by invoking a cross-phenomenon restriction - in our case, how returns to labor mobility determine effects on unemployment of changes in layoff costs, on the one hand, and changes in quit turbulence, on the other hand. We also spotlight two distinct perspectives and associated sources of data: one from labor economics and another from the economics of industrial organization. Ultimately, we are reminded of the rule that new theories “must not throw out all the successes of former theories. . . . to preserve the successes of the past is not only a constraint, but also a guide.
    Keywords: labor mobility, quits, turnover, layoff cost, turbulence, unemployment, human capital, skills, matching model, search-island model.
    JEL: E24 J63 J64
    Date: 2021–07

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