nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2021‒10‒25
fourteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Greta Thunberg effect and Business Cycle Dynamics: A DSGE model By Busato, Francesco; Chiarini, Bruno; Cisco, Gianluigi; Ferrara, Maria
  2. An Analysis of Monetary and Macroprudential Policies in a DSGE Model with Reserve Requirements and Mortgage Lending By Ben-Gad, M.; Pearlman, J.; Sabuga, I.
  3. Discount rates, debt maturity, and the fiscal theory By Corhay, Alexandre; Kind, Thilo; Kung, Howard; Morales, Gonzalo
  4. The Geography of Job Creation and Job Destruction By Moritz Kuhn; Iourii Manovskii; Xincheng Qiu
  5. Prevention and Mitigation of Epidemics: Biodiversity Conservation and Confinement Policies By Emmanuelle Augeraud-Véron; Giorgio Fabbri; Katheline Schubert
  6. Expectations and Aggregate Risk By Lorenzo Bretscher; Aytek Malkhozov; Andrea Tamoni
  7. Corporate debt and state-dependent effects of fiscal policy By Daichi SHIRAI
  8. Job Applications and Labour Market Flows By Serdar Birinci; Kurt See; Shu Lin Wee
  9. Why Do Couples and Singles Save During Retirement? By De Nardi, M.; French, E.; Bailey Jones, J.; McGee, R.
  10. A Global Shock with Idiosyncratic Pains: State-Dependent Debt Limits for LATAM during the COVID-19 pandemic By Juan C. Méndez-Vizcaíno; Nicolás Moreno-Arias
  11. Education Quality, Green Technology, and the Economic Impact of Carbon Pricing By Macdonald, Kevin; Patrinos, Harry Anthony
  12. Firm Heterogeneity, Market Power and Macroeconomic Fragility By Alessandro Ferrari; Francisco Queirós
  13. An evaluation of alternative fiscal adjustment plans By Acocella Nicola; Beqiraj Elton; Di Bartolomeo Giovanni; Di Pietro Marco; Felici Francesco
  14. Fiscal and Monetary Stabilization Policy at the Zero Lower Bound: Consequences of Limited Foresight By Michael Woodford; Yinxi Xie

  1. By: Busato, Francesco; Chiarini, Bruno; Cisco, Gianluigi; Ferrara, Maria
    Abstract: The increasing concerns for the future effects of global warming have given rise to an unprecedented wave of environmental activism. This paper studies how this call for stronger climate actions could influence macroeconomic dynamics. We explore this topic, employing a Dynamic Stochastic General Equilibrium (DSGE) model extended to consider two classes of goods (i.e., Green and Dirty), variable green preferences, and a "Greta Thunberg" shock affecting consumers' sustainable attitudes. We find that: (i) environmental awareness plays a key role in reducing carbon emissions and green preferences; (ii) Greta Thunberg effect slows down aggregate output and investment; (iii) a green preference shock contributes to around 15 and 29 % of consumption, investment, and labor volatilities at the aggregate level.
    Keywords: Carbon Emissions, Environmental Awareness, DSGE model, General Equilibrium, Global Warming, Green Consumer Behavior
    JEL: E32 Q51 Q54
    Date: 2021–10–14
  2. By: Ben-Gad, M.; Pearlman, J.; Sabuga, I.
    Abstract: We propose a general equilibrium framework that highlights the interaction of reserve requirements and a conventional monetary policy in a model that combines endogenous housing loan defaults and financial intermediation frictions due to the costs of enforcing contracts. We use the model to examine how the interaction of these policies affect (i) the credit and business cycle; (ii) the distribution of welfare between savers and borrowers; (iii) the overall welfare objectives when monetary and macroprudential policies are optimised together or separately. We find that models with an optimised reserve ratio rule are effective in reducing the sudden boom and bust of credit and the business cycle. We also find that there are a distributive implications of the introduction of reserve ratio where borrowers gain at the expense of savers. However, there is no difference in the overall welfare results whether monetary and macroprudential policies are optimised together or separately.
    Keywords: Reserve requirements; endogenous loan defaults; welfare
    Date: 2021
  3. By: Corhay, Alexandre; Kind, Thilo; Kung, Howard; Morales, Gonzalo
    Abstract: This paper examines how the transmission of government portfolio risk arising from maturity operations depends on the stance of monetary/fiscal policy. Accounting for risk premia in the fiscal theory allows the government portfolio to affect the expected inflation, even in a frictionless economy. The effects of maturity rebalancing on expected inflation in the fiscal theory directly depend on the conditional nominal term premium, giving rise to an optimal debt maturity policy that is state dependent. In a calibrated macro-finance model, we demonstrate that maturity operations have sizable effects on expected inflation and output through our novel risk transmission mechanism.
    Keywords: Term structure of interest rates,Fiscal theory of the price level,Bond risk premia,Government debt,DSGE models,Nonlinear solution methods
    Date: 2021
  4. By: Moritz Kuhn (University of Bonn, Department of Economics); Iourii Manovskii (University of Pennsylvania, Department of Economics); Xincheng Qiu (University of Pennsylvania, Department of Economics)
    Abstract: Spatial differences in labor market performance are large and highly persistent. Using data from the United States, Germany, and the United Kingdom, we document striking similarities in spatial differences in unemployment, vacancies, job finding, and job filling within each country. This robust set of facts guides and disciplines the development of a theory of local labor market performance. We find that a spatial version of a Diamond-Mortensen-Pissarides model with endogenous separations and on-the-job search quantitatively accounts for all the documented empirical regularities. The model also quantitatively rationalizes why differences in job-separation rates have primary importance in inducing differences in unemployment across space while changes in the job-finding rate are the main driver in unemployment fluctuations over the business cycle.
    Keywords: Local Labor Markets, Unemployment, Vacancies, Search and Matching
    JEL: J63 J64 E24 E32 R13
    Date: 2021–10
  5. By: Emmanuelle Augeraud-Véron (GREThA - Groupe de Recherche en Economie Théorique et Appliquée - UB - Université de Bordeaux - CNRS - Centre National de la Recherche Scientifique); Giorgio Fabbri (GAEL - Laboratoire d'Economie Appliquée de Grenoble - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement - Grenoble INP - Institut polytechnique de Grenoble - Grenoble Institute of Technology - UGA - Université Grenoble Alpes - CNRS - Centre National de la Recherche Scientifique - UGA - Université Grenoble Alpes); Katheline Schubert (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)
    Abstract: This paper presents a first model integrating the relation between biodiversity loss and zoonotic pandemic risks in a general equilibrium dynamic economic set-up. The occurrence of pandemics is modeled as Poissonian leaps in economic variables. The planner can intervene in the economic and epidemiological dynamics in two ways: first (prevention), by deciding to conserve a greater quantity of biodiversity to decrease the probability of a pandemic occurring, and second (mitigation), by reducing the death toll through a lockdown policy, with the collateral effect of affecting negatively labor productivity. The policy is evaluated using a social welfare function embodying society's risk aversion, aversion to fluctuations, degree of impatience and altruism towards future generations. The model is explicitly solved and the optimal policy described. The dependence of the optimal policy on natural, productivity and preference parameters is discussed. In particular the optimal lockdown is more severe in societies valuing more human life, and the optimal biodiversity conservation is larger for more "forward looking" societies, with a small discount rate and a high degree of altruism towards future generations. Moreover, societies accepting a large welfare loss to mitigate the pandemics are also societies doing a lot of prevention. After calibrating the model with COVID-19 pandemic data we compare the mitigation efforts predicted by the model with those of the recent literature and we study the optimal prevention–mitigation policy mix.
    Keywords: Biodiversity,COVID-19,prevention,mitigation,epidemics,Poisson processes,recursive preferences.
    Date: 2021
  6. By: Lorenzo Bretscher (London Business School - Department of Finance); Aytek Malkhozov (Board of Governors of the Federal Reserve System); Andrea Tamoni (Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick)
    Abstract: We estimate agents’ expectations about future fundamentals using a dynamic stochastic general equilibrium model augmented with anticipated shocks. Accounting for agents’ expectations at the business cycle horizon results in aggregate risk factor innovations that have significant explanatory power for the cross section of stock and bond returns. Further, exposure to macroeconomic fluctuations driven purely by expectations is important to explain the value premium. In contrast, exposure to macroeconomic fluctuations due to realized changes in fundamentals is important for the pricing of long-term bonds and cash-flow duration portfolios. We conclude that accounting for agents’ expectations advances our understanding of the aggregate risk.
    Keywords: News Shocks, Consumption-CAPM, Cross Section of Returns, Market-to-Book Decomposition
    JEL: G12 E32 E21 C63
    Date: 2021–10
  7. By: Daichi SHIRAI
    Abstract: This study analyzes fiscal policies in a business cycle model with an endogenous borrowing constraint when firms are heavily in debt. The tightness of the borrowing constraint for working capital loans depends on the level of corporate debt. When the level of corporate debt is modest, an increase in corporate debt amplifies corporate tax cut multipliers. Because the difference in debt levels due to the temporary tax cut remains for a long time, the cumulative effect on welfare becomes large. If the debt level exceeds a certain threshold, it remains at this level and depresses an economy permanently. In this situation, a permanent spending expansion changes the firms capital structure and can eliminate this inefficiency in the long run.
    Date: 2021–10
  8. By: Serdar Birinci; Kurt See; Shu Lin Wee
    Abstract: Job applications have risen over time, yet job-finding rates have remained unchanged. Meanwhile, job separations have declined. We argue that an increase in the number of applications raises the probability of finding a good match rather than the probability of finding a job. Using a search model with multiple applications and costly information, we show that when applications increase, firms invest in identifying good matches, thereby reducing separations. Concurrently, increased congestion and selectivity over which offer to accept temper increases in job-finding rates. Our framework contains testable implications for changes in offers, acceptances, reservation wages, applicants per vacancy, and tenure, factors that enable us to generate the trends in unemployment flows.
    Keywords: Labour markets; Productivity
    JEL: E24 J64
    Date: 2021–10
  9. By: De Nardi, M.; French, E.; Bailey Jones, J.; McGee, R.
    Abstract: While the savings of retired singles tend to fall with age, those of retired couples tend to rise. We estimate a rich model of retired singles and couples with bequest motives and uncertain longevity and medical expenses. Our estimates imply that while medical expenses are an important driver of the savings of middle-income singles, bequest motives matter for couples and highincome singles and generate transfers to nonspousal heirs whenever a household member dies. The interaction of medical expenses and bequest motives is a crucial determinant of savings for all retirees. Hence, to understand savings, it is important to model household structure, medical expenses, and bequest motives.
    Keywords: Savings, bequests, medical spending
    JEL: C51 D14 D15 I14
    Date: 2021–10–20
  10. By: Juan C. Méndez-Vizcaíno; Nicolás Moreno-Arias
    Abstract: Fiscal sustainability in five of the largest Latin American economies is examined before and after the COVID-19 pandemic. For this purpose, the DSGE model in Bi(2012) and Hürtgen (2020) is used to estimate the Fiscal Limits and Fiscal Spaces for Peru, Chile, Mexico, Colombia, and Brazil. These estimates advance the empirical literature for Latin America on fiscal sustainability by offering new calculations stemming from a structural framework with alluring novel features: government default on the intensive margin; dynamic Laffer curves; utility-based stochastic discount factor; and a Markov-Switching process for public transfers with an explosive regime. The most notable additions to the existing literature for Latin America are the estimations of entire distributions of public debt limits for various default probabilities and that said limits critically hinge on both current and future states. Results obtained indicate notorious contractions of Fiscal Spaces among all countries during the pandemic, but the sizes of these were very heterogeneous. Countries that in 2019 had positive spaces and got closer to negative spaces in 2020, have since seen deterioration of their sovereign debt ratings or outlooks. Colombia was the only country to lose its positive Fiscal Space and investment grade, thereby joining Brazil, the previously sole member of both groups. **** RESUMEN: Antes y después de la pandemia de COVID-19 se examina la sostenibilidad fiscal de cinco de las economías más grandes de Latinoamérica. A través de métodos globales se resuelve el modelo DSGE, desarrollado en Bi(2012) y Hürtgen (2020), para estimar los Límites y Espacios Fiscales de Perú, Chile, México, Colombia y Brasil. Estas estimaciones expanden la literatura empírica sobre la sostenibilidad fiscal en Latinoamérica, al ofrecer nuevos cálculos provenientes de un modelo con varias características enriquecedoras: default del gobierno en el margen intensivo; curvas de Laffer dinámicas; factor de descuento estocástico de hogares aversos al riesgo; y transferencias públicas que siguen un proceso de Markov-Switching con un régimen explosivo. Las adiciones más destacables a la literatura existente para Latinoamérica son las estimaciones de distribuciones de límites de deuda pública para distintas probabilidades de default y que éstas dependen de los estados presentes y futuros de la economía. Los resultados indican que en 2020, si bien hubo heterogeneidad, se dieron contracciones notorias de los Espacios Fiscales en todos los países a raíz de la pandemia. Los países que en 2019 tuvieron espacios positivos y se acercaron a espacios negativos en 2020 han experimentado desde entonces deterioros de las calificaciones crediticias (o perspectivas) de su deuda soberana. Colombia fue el único país que en la pandemia perdió su Espacio Fiscal positivo y el grado de inversión de su deuda; antes del choque sólo Brasil tenía estas características.
    Keywords: State-Dependent Debt Limits, Latin America, Fiscal Space, Fiscal Sustainability, Default, Public Debt, COVID-19, Global Methods, Límites de Deuda Estado-Dependientes, Latinoamérica, Espacio Fiscal, Sostenibilidad Fiscal, Default, Deuda Pública, COVID-19, Métodos Globales
    JEL: E32 E62 H20 H30 H50 H60
    Date: 2021–10
  11. By: Macdonald, Kevin; Patrinos, Harry Anthony
    Abstract: Carbon pricing is increasingly used by governments to reduce emissions. The effect of carbon pricing on economic outcomes as well as mitigating factors has been studied extensively since the early 1990s. One mitigating factor that has received less attention is education quality. If technological change that reduces the reliance of production on emissions is skill-biased, then carbon pricing may increase the skill premium of earnings and subsequent wage inequality; however, a more elastic skill supply through better education quality may mitigate adverse economic outcomes, including wage inequality, and enhance the effect of carbon pricing on technological change and subsequently emissions. A general equilibrium, overlapping-generations model is proposed, with endogenous skill investment in which the average skill level of the workforce can affect the need for emissions in an aggregate production function. This study uses data on industrial emissions linked to the Organisation for Economic Co-operation and Development's Programme for International Assessment of Adult Competencies dataset for European Union countries. The findings show that, within countries, cognitive skills are positively associated with employment in industries that rely less on emissions for production and in industries that, over time, have been able to reduce their reliance on emissions for production. In the estimated general equilibrium model, higher cognitive skills reduce their reliance on emissions for production. Having higher quality education-defined as the level of cognitive skills attained by workers per unit of cost-increases the elasticity of skill supply and, as a result, mitigates a carbon tax's economic costs including output loss and wage inequity, and enhances its effect on emissions reduction. The implication is that investments in education quality are needed for better enabling green technological innovation and adaptation and reducing inequality that results from carbon pricing.
    Keywords: Carbon pricing,Education,Skills,Learning outcomes
    JEL: Q43 O47 Q56 O41
    Date: 2021
  12. By: Alessandro Ferrari (University of Zurich); Francisco Queirós (Università di Napoli Federico II and CSEF)
    Abstract: We investigate how firm heterogeneity and market power affect macroeconomic fragility, defined as the probability of long-lasting recessions. We propose a theory in which the positive interaction between firm entry, competition and factor supply can give rise to multiple steady-states. We show that when firm heterogeneity is large, even small temporary shocks can trigger firm exit and make the economy spiral in a competition-driven poverty trap. Calibrating our model to incorporate the well-documented trends in increasing firm heterogeneity we find that, relative to 2007, an economy with the 1985 level of firm heterogeneity is 5 to 9 times less likely to experience a very persistent recession. We use our framework to study the 2008-09 recession and show that the model can rationalize the persistent deviation of output and most macroeconomic aggregates from trend, including the behavior of net entry, markups and the labor share. Post-crisis cross-industry data corroborates our proposed mechanism. Firm subsidies can be powerful in preventing quasi-permanent recessions and can lead to a 21% increase in welfare.
    Keywords: Firm heterogeneity, Competition, Market power, Poverty traps, Great recession.
    JEL: E22 E24 E25 E32 L16
    Date: 2021–10–07
  13. By: Acocella Nicola; Beqiraj Elton; Di Bartolomeo Giovanni; Di Pietro Marco; Felici Francesco
    Abstract: What advice can be given to the policymaker to reduce the burden of public debt after a crisis? In this situation, the debt consolidation calls for fiscal surplus based on increases in taxes and/or reductions in public spending. This paper aims at answering to the above question. Specifically, it evaluates different policy options on the table using the estimated model of the Italian dynamic General Equilibrium Model (IGEM). Our main message is that plans aimed at reducing the public debt based on tax increases rather than expenditure reductions are more effective. Therefore, consolidation should be designed on the former.
    Date: 2020–12
  14. By: Michael Woodford; Yinxi Xie
    Abstract: This paper reconsiders the degree to which macroeconomic stabilization is possible when the zero lower bound is a relevant constraint on the effectiveness of conventional monetary policy, under an assumption of bounded rationality. In particular, we reconsider the potential role of countercyclical fiscal transfers as a tool of stabilization policy. Because Ricardian equivalence no longer holds when planning horizons are finite (even when relatively long), we find that fiscal transfers can be a powerful tool to reduce the contractionary impact of an increased financial wedge during a crisis and can even make possible complete stabilization of both aggregate output and inflation under certain circumstances, despite the binding lower bound on interest rates. However, the power of such policies depends on the degree of monetary policy accommodation. We also show that a higher level of welfare is generally possible if both monetary and fiscal authorities commit themselves to history-dependent policies in the period after the financial disturbance that causes the lower bound to bind has dissipated.
    Keywords: Business fluctuations and cycles; Central bank research; Fiscal policy; Monetary policy
    JEL: E52 E63 E7
    Date: 2021–10

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