nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2021‒10‒18
fifteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Fiscal policy shocks and stock prices in the United States By Haroon Mumtaz; Konstantinos Theodoridis
  2. Precautionary Liquidity Shocks, Excess Reserves and Business Cycles By Bratsiotis, George J.; Theodoridis, Konstantinos
  3. Switching-track after the Great Recession By Vinci, Francesca; Licandro, Omar
  4. State dependence in labour market fluctuations By Carlo Pizzinelli; Konstantinos Theodoridis; Francesco Zanetti
  5. Why does risk matter more in recessions than in expansions? By Andreasen, Martin M.; Caggiano, Giovanni; Castelnuovo, Efrem; Pellegrino, Giovanni
  6. Forward Guidance in an Advanced Small Open Economy in the Effective Lower Bound By Charlotte André Marine; Guido Traficante
  7. The Productivity Puzzle and the Decline of Unions By Mitra, Aruni
  8. Wage and employment cyclicalities at the establishment level By Merkl, Christian; Stüber, Heiko
  9. Preventive monetary and macroprudential policy response to anticipated shocks to financial stability By Konstantin Styrin; Alexander Tishin
  10. E-QUEST – A Multi-Region Sectoral Dynamic General Equilibrium Model with Energy Model Description and Applications to Reach the EU Climate Targets By Janos Varga; Werner Roeger; Jan in ’t Veld
  11. Small firms and domestic bank dependence in Europe’s Great Recession By Mathias Hoffmann; Egor Maslov; Bent E. Sørensen
  12. Global models for a global pandemic: the impact of COVID-19 on small euro area economies By Garcia, Pablo; Jacquinot, Pascal; Lenarčič, Črt; Lozej, Matija; Mavromatis, Kostas
  13. Fiscal Reform in the Republic of Moldova. Stochastic Dynamic General Equilibrium (SDGE) simulation By Vîntu, Denis
  14. Energy Efficiency and Fluctuations in CO2 Emissions By Soojin Jo; Lilia Karnizova
  15. The global financial resource curse By Gianluca Benigno; Luca Fornaro; Martin Wolf

  1. By: Haroon Mumtaz (Queen Mary University); Konstantinos Theodoridis (ESM)
    Abstract: This paper uses structural vector autoregressive models (SVARs) to show that the response of US stock prices to fiscal shocks changed in 1980. Over the period 1955-1979, an expansionary spending or revenue shock was associated with higher stock prices. After 1980, the response of stock prices to the same shock became negative. Using a dynamic stochastic general equilibrium (DSGE) model with a detailed fiscal sector, we show the pre-1980 results may be driven by an expansion in supply after the fiscal shock. In contrast, endogenous growth mechanisms appear to be weaker in the post-1980 period with positive fiscal shocks pushing down consumption, total factor productivity (TFP), and causing inflation and the real interest rate to rise.
    Keywords: Fiscal policy shocks, Stock prices, VAR, FAVAR, DSGE
    JEL: E24 E32 J64 C11
    Date: 2021–05–17
  2. By: Bratsiotis, George J.; Theodoridis, Konstantinos
    Abstract: This paper identifies a precautionary banking liquidity shock via a set of sign, zero and forecast variance restrictions imposed. The shock proxies the banking sector's reluctance to lend to the real economy induced by an exogenous preference change for liquid assets. Through the lens of a DSGE model, the precautionary liquidity shock is shown to work through two channels: reserves (balance sheet) and the deposit rate (intertemporal effect). The overall effect is a downward co-movement in output, consumption, investment, and prices, which is amplified the higher are the long-run risks in the economy and banks' responsiveness to potential risk.
    Keywords: SVAR,Sign and Zero Restrictions,DSGE,Precautionary Liquidity Shock,Excess Reserves,Deposit Rate,Risk,Financial Intermediation
    JEL: C10 C32 E30 E43 E51 G21
    Date: 2021
  3. By: Vinci, Francesca; Licandro, Omar
    Abstract: We propose a theoretical framework to reconcile episodes of V-shaped and L-shaped recovery, encompassing the behaviour of the U.S. economy before and after the Great Recession. In a DSGE model with endogenous growth, negative demand shocks destroy productive capacity, moving GDP to a lower trajectory. A Taylor rule policy designed to reduce the output gap may counterbalance the shocks, preventing the destruction of economic capacity and inducing a V-shaped recovery. However, when shocks are deep and persistent enough, like during the Great Recession, they call for a downward revision of potential output measures, the so-called switching-track, weakening the recovering role of monetary policy and inducing an L-shaped recovery. When calibrated to the U.S. economy, the model replicates well the L-shaped recovery and switching-track that followed the Great Recession, as well as the V-shaped recoveries that followed the oil shock recessions. JEL Classification: E12, E22, E32, O41, E52
    Keywords: economic capacity, economic recovery, endogenous growth, monetary policy, supply destruction prevention
    Date: 2021–10
  4. By: Carlo Pizzinelli (IMF); Konstantinos Theodoridis (ESM); Francesco Zanetti (University of Oxford)
    Abstract: This paper documents state dependence in labour market fluctuations. Using a Threshold Vector Autoregression model (TVAR), we establish that the unemployment rate, the job separation rate, and the job finding rate exhibit a larger response to productivity shocks during periods with low aggregate productivity. A Diamond-Mortensen-Pissarides model with endogenous job separation and on-the-job search replicates these empirical regularities well. We calibrate the model to match the standard deviation of the job-transition rates explained by productivity shocks in the TVAR, and show that the model explains 88 percent of the state dependence in the unemployment rate, 76 percent for the separation rate and 36 percent for the job finding rate. The key channel underpinning state dependence in both job separation and job finding rates is the interaction of the firm's reservation productivity level and the distribution of match-specific idiosyncratic productivity. Results are robust across several variations to the baseline model.
    Keywords: Search and Matching Models, State Dependence in Business Cycles, Threshold Vector Autoregression
    JEL: E24 E32 J64 C11
    Date: 2020–12–18
  5. By: Andreasen, Martin M.; Caggiano, Giovanni; Castelnuovo, Efrem; Pellegrino, Giovanni
    Abstract: This paper uses a nonlinear vector autoregression and a non-recursive identification strategy to show that an equal-sized uncertainty shock generates a larger contraction in real activity when growth is low (as in recessions) than when growth is high (as in expansions). An estimated New Keynesian model with recursive preferences and approximated to third order around its risky steady state replicates these state-dependent responses. The key mechanism behind this result is that firms display a stronger upward nominal pricing bias in recessions than in expansions, because recessions imply higher inflation volatility and higher marginal utility of consumption than expansions.
    Date: 2021–10–05
  6. By: Charlotte André Marine; Guido Traficante
    Abstract: We examine forward guidance (with known and uncertain duration) in a New Keynesian model for an advanced small open economy, showing that the response of the economy to this policy depends, both quantitatively and qualitatively, on some structural features through calibrations for Sweden and Spain. In particular, an announcement of future expansionary policy is positively related to the exchange rate pass-through and is larger than in the closed economy counterpart because of a better inflation-output trade-off and the exchange rate channel. We also show that multiple equilibria could arise and that the real exchange rate is a key variable driving this result. In particular, the response of output and inflation is amplified when aggregate supply is negatively related to the real exchange rate. These results could not necessarily be extended to emerging market economies.
    JEL: E31 E52
    Date: 2021–10
  7. By: Mitra, Aruni
    Abstract: What explains the sudden vanishing of the procyclicality of productivity in the U.S. during the 1980s? Using cross-sectional evidence from states and industries, this paper argues that lower costs of hiring and firing workers due to rapid de-unionization can help explain the productivity puzzle. Lower cost of changing employment prompts firms to rely less on labour hoarding, thereby making productivity less procyclical. In a model with endogenous worker-effort and costly employment adjustment, allowing the hiring cost to decrease by the same amount as the decline in union density can match almost the entire drop in cyclical productivity correlations.
    Keywords: productivity, unions, hiring cost, factor utilization, DSGE
    JEL: E22 E23 E24 E32 J50
    Date: 2021–10–03
  8. By: Merkl, Christian; Stüber, Heiko
    Abstract: We document substantial cross-sectional heterogeneity of German establishments' real wage cyclicality over the business cycle. While wages of the median establishment are moderately procyclical, 36 percent of establishments have countercyclical wages. We estimate a negative connection between establishments' wage cyclicality and their employment cyclicality, thereby providing a benchmark for quantitative macroeconomic models. We propose and calibrate a labor market ow model to match various empirical facts and to perform counterfactual exercises. If all establishments behaved as the most procyclical ones, labor market amplification would drop by one-third. If all followed Nash bargaining, it would drop by more than two-thirds.
    Keywords: Wage Cyclicality,Employment Cyclicality,Labor Market Flow Model,Labor Market Dynamics,Establishments,Administrative Data
    JEL: E32 E24 J64
    Date: 2021
  9. By: Konstantin Styrin (Bank of Russia, Russian Federation); Alexander Tishin (Bank of Russia, Russian Federation)
    Abstract: In this paper, we develop a simple framework to study the optimal macroprudential and monetary policy interactions in response to financial shocks. Our model combines nominal rigidities and capital accumulation, features that have usually been studied separately in previous literature. In our model, we show that agents do not internalise how their asset purchases affect asset prices. Thus, when crises occur, there are fire sales: less demand for capital further reduces prices and agents are worse off. Policy interventions (both monetary and macroprudential) can improve allocations by restricting borrowing ex-ante (during the accumulation of risks and imbalances) and stimulating the economy ex-post (during crises). As a result, we find a complementary relationship between ex-ante monetary policy and preventive macroprudential policy. We also compare this result with a flexible-price model and a frictionless model and conduct several sensitivity analysis exercises.
    Keywords: Macroprudential policy, monetary policy, pecuniary externalities, nominal rigidities, financial frictions, capital accumulation.
    JEL: E44 E58 G28 D62
    Date: 2021–09
  10. By: Janos Varga; Werner Roeger; Jan in ’t Veld
    Abstract: This paper describes a micro-founded, fully forward-looking dynamic general equilibrium (DGE) model with energy sectors that is used to analyse the macroeconomic impact of climate mitigation policy in the European Union (EU). The paper presents simulation results for the transitional costs of moving towards a net zero emissions economy. It does not attempt to assess the effects on growth of the green investments envisaged in the framework of the European Green Deal or the Recovery and Resilience Facility. Our model allows for substitutability between fossil fuels and clean energy inputs and considers different recycling options for the revenues collected by carbon taxes. We find that the costs of moving towards a net zero emissions economy can be significantly reduced when carbon taxes are used and are recycled to reduce other distortive taxes, or for subsidising clean energy.
    JEL: D5 Q43 Q50
    Date: 2021–09
  11. By: Mathias Hoffmann; Egor Maslov; Bent E. Sørensen
    Abstract: After the inception of the euro, the real economy in most member countries remained dependent on credit by domestic banks, which increasingly funded themselves through cross-border interbank funding. We find that this pattern of ‘double-decker’ banking integration exposed domestic banks to sharp declines in cross-border interbank lending during the eurozone crisis. As a result, domestic banks reduced lending which led to large declines in output in sectors with many small (bank-dependent) firms. We propose a quantitative small open economy model to account for these patterns and conclude that a global banking shock leading to a sudden stop in cross-border interbank lending in the eurozone is required to account for them.
    Keywords: Small and medium enterprises, sme access to finance, banking integration, domestic bank dependence, interbank dependence, international transmission, eurozone crisis
    JEL: F30 F36 F40 F45
    Date: 2021–10
  12. By: Garcia, Pablo; Jacquinot, Pascal; Lenarčič, Črt; Lozej, Matija; Mavromatis, Kostas
    Abstract: This paper analyses the effects of the COVID-19 pandemic shock on small open economies in a monetary union with an application to the euro area. Accounting for a high degree of openness and a strong dependence on intra and extra union trade, we focus on the size and the direction of international spillovers - both from the shock itself and from the ensuing fiscal response. To do so, we use a unified modelling framework: The Euro Area and the Global Economy (EAGLE) model. Furthermore, within this general framework, we assess the extent to which specific modelling features shape the dynamic responses to the COVID-19 pandemic. The main messages are as follows. First, fiscal spillovers from the rest of the monetary union do matter. Second, the effective lower bound amplifies the size of the spillovers. Third, the design of wage negotiations leads to wage subsidies having negative international fiscal policy spillovers. Fourth, import content of government spending interacts with the effective lower bound, strongly affecting the size and sign of spillovers. Fifth, when households have finite lifetimes, the responses of output and inflation are amplified compared to the case with infinitely lived households. Finally, a next generation EU instrument is more effective when financed using a tax on consumption. JEL Classification: C53, E32, E52, F45
    Keywords: COVID-19, DSGE modelling, euro area, international spillovers, monetary union
    Date: 2021–10
  13. By: Vîntu, Denis
    Abstract: The article describes a dynamic general equilibrium for the Republic of Moldova, in the context of declining oil prices and COVID-19. We try to introduce an intergenerational model with the stochastic component, where we describe each self-employed agent, rather we try to adapt the model in a simulative tax reform, a transition from the progressive system that currently we have to a flat tax. For our hypothesis, it is assumed that there are 4 cohorts of population, selected by level of education (secondary, high school, university and lifelong learning) that pay taxes in a system based on social solidarity. Thus, the first conclusions can be drawn, namely that the tax system with 4 different rates 12, 15, 19 and 23% is the one that best approaches the Pareto type optimum, as opposed to the flat tax, which respects dynamic equilibrium. Public budget revenues are simulated in IS-LM-Laffer framework. And the forecast of budget accumulation is made using 4 distinct prediction models: naïve random walk, ARIMA, univariate model (AR) and vector error correction model (VECM). In addition, the main result is placed on the hypothesis that the empirical testing suggest that, unlike complicated models that have difficulty overcoming naïve random walk imitation, using techniques of associating and including monetary and fiscal indicators in linear regression, as well as adding structural shapes, some parameters of the models are quite significant. Of these, it seems that the closest to the economic reality of the country is the univariate model (AR), being also the most relevant for predicting the out-put gap, but also the stochastic component: the basic interest rate of the NBM's monetary policy.
    Keywords: fiscal reform, monetary policy, cross-country convergence, prediction and forecasting methods, dynamic general equilibrium model, Pareto optimal balance, ARIMA modeling, time series analysis, Box – Jenkins method.
    JEL: C10 C15 E23 E31 E52 E62
    Date: 2021–04–30
  14. By: Soojin Jo; Lilia Karnizova
    Abstract: CO2 emissions are commonly perceived to rise and fall with aggregate output. Yet many factors, including energy-efficiency improvements, emissions coefficient variations and shifts to cleaner energy, can break the positive emissions-output relationship. To evaluate the importance of such factors, we uncover shocks that by construction reduce emissions without lowering output. These novel shocks explain a substantial fraction of emissions fluctuations. After extensively examining their impacts on macroeconomic and environmental indicators, we interpret these shocks as changes in the energy efficiency of consumer products. Our results imply that models omitting energy efficiency likely overestimate the trade-off between environmental protection and economic performance.
    Keywords: Business fluctuations and cycles; Climate change; Econometric and statistical methods
    JEL: E32 Q43 Q55
    Date: 2021–10
  15. By: Gianluca Benigno; Luca Fornaro; Martin Wolf
    Abstract: Since the late 1990s, the United States has received large capital flows from developing countries - a phenomenon known as the global saving glut - and experienced a productivity growth slowdown. Motivated by these facts, we provide a model connecting international financial integration and global productivity growth. The key feature is that the tradable sector is the engine of growth of the economy. Capital flows from developing countries to the United States boost demand for U.S. non-tradable goods, inducing a reallocation of U.S. economic activity from the tradable sector to the non-tradable one. In turn, lower profits in the tradable sector lead firms to cut back investment in innovation. Since innovation in the United States determines the evolution of the world technological frontier, the result is a drop in global productivity growth. This effect, which we dub the global financial resource curse, can help explain why the global saving glut has been accompanied by subdued investment and growth, in spite of low global interest rates.
    Keywords: global saving glut, global productivity growth, international financial integration, capital flows, U.S. productivity growth slowdown, low global interest rates, Bretton Woods II, export-led growth
    JEL: E44 F21 F41 F43 F62 O24 O31
    Date: 2019–12

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