nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2021‒12‒06
fourteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Precautionary saving and un-anchored expectations By Grimaud, Alex
  2. Pay-as-you-go social security and educational subsidy in an overlapping generations model with endogenous fertility and endogenous retirement By Chen, Hung-Ju; Miyazaki, Koichi
  3. Generational Distribution of Fiscal Burdens: A Positive Analysis By Uchida, Yuki; Ono, Tetsuo
  4. Choosing the European Fiscal Rule By Ginters Buss; Patrick Gruning; Olegs Tkacevs
  5. No Regret Fiscal Reforms By Pierre-Edouard Collignon
  6. Social Capital and Monetary Policy By Rustam Jamilov
  7. The natural rate of interest through a hall of mirrors By Phurichai Rungcharoenkitkul; Fabian Winkler
  8. Discount Rates, Debt Maturity, and the Fiscal Theory By Alexandre Corhay; Thilo Kind; Howard Kung; Gonzalo Morales
  9. Do NBFCs Propagate Real Shocks? By Ghosh, Saurabh; Mazumder, Debojyoti
  10. Do term premiums matter? Transmission via exchange rate dynamics By Mitsuru Katagiri; Koji Takahashi
  11. Open Economy Secular Stagnation and Financial Integration By Jean-Baptiste Michau
  12. The Effect of Wages on Human Capital Investment By Lartigue-Mendoza, Jacques; Domínguez, Salomón
  13. When is a life worth living? A dynastic efficiency criterion for fertility By Pierre-Edouard Collignon
  14. Heterogeneity, convergence and imbalances in the Euro area By Stéphane Auray; Aurélien Eyquem

  1. By: Grimaud, Alex
    Abstract: This paper investigates monetary policy in a heterogeneous agent new Keynesian (HANK) model where agents face idiosyncratic income risk and use adaptive learning in order to form their expectations. Households experience different histories and observe different idiosyncratic variables. This gives rise to idiosyncratic learning processes, which naturally implies the existence of heterogeneous expectations. In HANK models, supply shocks generate precautionary saving. The learning setup amplifies this effect and can result in long-lasting disinflationary traps. Dovish Taylor rules focused on closing the output gap dampen the learning effects. Price level targeting improves the inflation and output stabilization trade-off by better anchoring expectations.
    Keywords: Adaptive learning, precautionary saving, restricted perception equilibrium heterogeneous expectations, heterogeneous agents
    JEL: E25 E31 E52
    Date: 2021–07–05
  2. By: Chen, Hung-Ju; Miyazaki, Koichi
    Abstract: This study analytically investigates the effects of pay-as-you-go social security and educational subsidies on the fertility rate, retirement age, and GDP per capita growth rate in an overlapping generations model, where parents invest resources toward their children's human capital. We find that an old agent retires fully when his or her labor productivity is low and retires later when the labor productivity is high. Under the unique balanced-growth-path (BGP) equilibrium, when an old agent is still engaged in work, tax rates are neutral to the fertility rate, higher tax rates encourage him or her to retire earlier, a higher social security tax rate depresses the GDP per capita growth rate, and a higher tax rate for educational subsidies can accelerate growth. However, when an old agent fully retires, higher tax rates increase the fertility rate, a higher social security tax rate lowers the GDP per capita growth rate, and a higher tax rate for educational subsidies boosts growth. Additionally, if an old agent's labor productivity increases, the fertility rate also increases. We also conduct numerical simulations and analyze how an old agent's labor productivity affects the retirement age, fertility rate, and GDP per capita growth rate under the BGP equilibrium.
    Keywords: Pay-as-you-go social security; educational subsidy; fertility; endogenous retirement; GDP per capita growth rate
    JEL: H55 I25 J13 J26
    Date: 2021–11–11
  3. By: Uchida, Yuki; Ono, Tetsuo
    Abstract: This study presents a political economy model with overlapping generations to analyze the effects of population aging on fiscal policy formation and the resulting distribution of the fiscal burden across generations. The analysis shows that both an increased life expectancy and a decreased population growth rate increase the ratios of government debt and labor income tax revenue to GDP. However, they decrease the ratio of capital income tax revenue to GDP. Furthermore, it also shows that the increased political weight of the elderly creates an increase in the ratios of public debt and labor income tax revenue to GDP, as well as an initial decrease followed by an increase in the ratio of capital income tax revenue to GDP.
    Keywords: Generational burden, Overlapping generations, Political economy, Population aging, Public debt
    JEL: D70 E24 E62 H60
    Date: 2021–11–11
  4. By: Ginters Buss (Latvijas Banka); Patrick Gruning (Latvijas Banka, Vilnius University); Olegs Tkacevs (Latvijas Banka)
    Abstract: Contributing to the ongoing discussions at the European Union level about the potential simplification of its fiscal framework, we evaluate the economic and public finance stabilization properties of two benchmark fiscal rules – the structural balance rule and the expenditure growth rule – using a New Keynesian small open economy model. If these fiscal rules are implemented one at a time, having just an expenditure growth rule tends to yield more stable macroeconomic outcomes, but more volatile public finances, as compared to having only a structural balance rule. Much of the quantitative differences in relative volatilities can be accounted for by the modifications of the public expenditure definition in the expenditure growth rule, in particular, the removal of debt service payments. Accounting for debt service payments in fiscal rules strengthens the monetary-fiscal policy interaction but it may turn vicious to macroeconomic stability at business cycle frequencies. Strong-enough debt correction for either fiscal rule contains public debt volatility at little expense to macroeconomic stability in the long run. The households' welfare gain from having the expenditure growth rule instead of the structural balance rule is 4% for a small country in a monetary union and 5% for a country with sovereign monetary policy.
    Keywords: fiscal policy, DSGE, small open economy, fiscal-monetary policy interaction
    JEL: E0 E2 E3 E6 F4 H2 H3 H6
    Date: 2021–11–17
  5. By: Pierre-Edouard Collignon (CREST-Ecolepolytechnique, France)
    Abstract: How should fiscal policy react to shocks ex-post while preserving incentives to work and save ex-ante? The standard solution involves a commitment to a contingent policy, whereby the initial government sets all the policies for all future states of the world. Contingent policies are unrealistic. As an alternative, I introduce ”No Regret Fiscal Reforms”: the government has the discretion to change its fiscal policy provided households do not regret their past decisions. Hence flexibility is provided and incentives to work and save are preserved. Such reforms can be achieved by changing taxes on both capital and labor such that wealth effects exactly compensate substitution effects. In a representative agent framework, I study how a benevolent government uses No Regret fiscal reforms and I make comparisons to the optimal contingent policy. Both approaches yield very similar policies and allocations but No Regret reforms entail a small welfare loss. Second, I consider robustness to Near-Rational Expectations i.e the government is uncertain of the households’ beliefs about the distribution of shocks and implements a policy robust to this uncertainty. No Regret fiscal reforms are fully robust to this departure from rational expectations. Finally, I characterize No Regret fiscal reforms with wealth and skill heterogeneity.
    Keywords: Ramsey model, stochastic publics pending, fiscal rule, discretion
    JEL: E61 E62 H21 H63
    Date: 2021–11–08
  6. By: Rustam Jamilov
    Abstract: This paper studies the social capital channel of monetary non-neutrality in the United States. Empirically, identification is achieved by combining state-level local projections and high-frequency monetary surprises with survey data on trust, historical accounts of slavery from the 1860 Census, and the Trump vote. I find that states with high social capital - as measured by high trust towards institutions, low slavery intensity, or low Trump vote - are more responsive to monetary policy shocks. Theoretically, I embed a micro-founded circle of trust block into the New Keynesian model in continuous time. Equilibrium reduces to a four-equation NK model with distrust dampening the potency of monetary policy shocks, like in the data, and reducing the possibility of determinate equilibria. The framework also formalizes an equilibrium interaction between social capital, monetary policy and populism cycles - an exogenous decline in institutional trust boosts scepticism and weakens monetary policy.
    Keywords: Social capital, trust, monetary policy, central banking, macroeconomics, populism
    Date: 2021–10–22
  7. By: Phurichai Rungcharoenkitkul; Fabian Winkler
    Abstract: Prevailing justifications of low-for-long interest rates appeal to a secular decline in the natural interest rate, or r-star, due to factors outside monetary policy's control. We propose informational feedback via learning as an alternative explanation for persistently low rates, where monetary policy plays a crucial role. We extend the canonical New Keynesian model to an incomplete information setting where the central bank and the private sector must learn about r-star and infer each other's information from observed macroeconomic outcomes. An informational feedback loop emerges when each side underestimates the effect of its own action on the other's inference, leading to large and persistent changes in perceived r-star disconnected from fundamentals. Monetary policy, through its influence on the private sector's beliefs, endogenously determines r-star as a result. We simulate a calibrated model and show that this 'hall of mirrors' effect can explain much of the decline in real interest rates since 2008.
    JEL: E43 E52 E58 D82 D83
    Date: 2021–11
  8. By: Alexandre Corhay; Thilo Kind; Howard Kung; Gonzalo Morales
    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: Fiscal policy; Interest rates; Monetary policy
    JEL: E44 E63 G12
    Date: 2021–11
  9. By: Ghosh, Saurabh; Mazumder, Debojyoti
    Abstract: In this paper, we try to explain the role of Non-bank Financial Intermediation (NBFI) to percolate and propel a real shock to the rest of the economy through the bank-NBFI interactions. We propose a simple theoretical model which identifies the channels and distinguishes between idiosyncratic, structural and sectoral shocks, cleanly. In our model, the non-deposit taking Non-bank Financial companies (NBFCs) which are the provider of risky, small and fragmented loans, are financed by borrowing from commercial banks. This link connects the NBFCs with the commercial banks and, in turn, with the rest of the economy. A higher realization of the failed firms (idiosyncratic shock) in the NBFC financed sector and a rise in the sector-wide productivity risk (sectoral risk) increase the interest rate charged by the banks and unemployment rate but reduces the real wages and per capita capital formation of the economy. However, when the average number of failed firms increases (structural shock), the reverse happens.
    Keywords: NBFC, Bank-NBFC interaction, Real Shock, Search and matching unemployment
    JEL: E44 G21 G23 J64
    Date: 2021–11–11
  10. By: Mitsuru Katagiri; Koji Takahashi
    Abstract: The macroeconomic effect of term premiums is a controversial issue both theoretically and quantitatively. In this paper, we explore the possibility that term premiums affect inflation and the real economy via exchange rate dynamics. For this purpose, we construct a small open economy model with limited asset market participation, focusing on the empirical observation that uncovered interest parity holds better for longer-term interest rate differentials. A quantitative exercise using Japanese and U.S. data shows that changes in term premiums, particularly those made by the central bank's bond purchases, have sizable effects on Japanese inflation rates via exchange rate dynamics.
    JEL: E31 E52 E58
    Date: 2021–10
  11. By: Jean-Baptiste Michau (Ecole Polytechnique, France)
    Abstract: What is the optimal policy response to secular stagnation within a small open economy? Secular stagnation is characterized by a persistent lack of demand, resulting in under-employment. Within a small open economy, the degree of fi nancial integration determines the nature of the secular stagnation equilibrium. Under perfect capital mobility, stagnation is due to downward nominal wage rigidities; while under financial autarky, it is due to an excessively high real interest rate. I characterize the planners optimal allocation of resources and solve for the tax policy that implements it within a stagnating economy. Under perfect fi nancial integration, payroll taxes should be falling and labor income taxes rising such as to relax the downward nominal wage rigidity; while under fi nancial autarky, the opposite policy should be implemented such as to generate inflation. Alternatively, full employment can be achieved by setting a sufficiently inflation target and by relying on an exchange rate policy to import inflation from abroad. Policy options are more limited under a fixed exchange rate regime, where effciency can either be reached through a coordinated policy response or by abandoning the peg.
    Keywords: Financial integration, Liquidity trap, Secular stagnation
    JEL: E31 E63 F38 F41
    Date: 2021–11–02
  12. By: Lartigue-Mendoza, Jacques; Domínguez, Salomón
    Abstract: This paper provides economic theory with a dynamic structural model able to explain the effect of wages on workers' human capital intertemporal investment decisions and proves the existence of a virtuous dynamic cycle between wages and human capital. Among the desired characteristics of the proposed model is that it has an analytical solution, permitting the achievement of an optimal decision rule for each choice variable and the calibration of its parameters using observed data; this favors an easy implementation by policymakers and researchers. Through its empirical counterpart, it is possible to witness that the model closely replicates what is observed in the Mexican developing economy, in the sense that workers facing higher wages invest more in their own education. Given the noticed parallel dependence of wages on human capital, the virtuous dynamic cycle is closed.
    Keywords: Human capital,Education,Wages,Dynamic structural model,Virtuous dynamic cycle
    JEL: I24 I26 J24 J31 C61
    Date: 2021
  13. By: Pierre-Edouard Collignon (CREST-Ecolepolytechnique, France)
    Abstract: This paper extends the Pareto efficiency to setups with endogenous fertility. Adding an extra child will be a social improvement if her life is worth living. For any criterion for lives worth living, an allocation is efficient when it is Pareto efficient (i.e. with a fixed population) and when no one with a life (not) worth living can be added (removed) without reducing someone’s well-being. I also define the ALW(All LivesWorth Living) equity criterion which requires that all agents have lives worth living. The first welfare theorem stands and I connect with results in the literature (e.g. Golosov, Jones, and Tertilt (2007)). Furthermore, I show that binding constraints on bequests are not necessarily inefficient. Criteria for lives worth living necessarily convey value judgements. As a benchmark, I propose a Dynastic criterion relying solely on parents’ revealed preferences: a child’s life is worth living when, ceteris paribus, her altruistic parent is better off with her being born. Then, setting constraints on bequests exactly such that parents may be paid back for the raising costs implies that the equilibrium is efficient and that all children have lives worth living. Finally, putting these concepts at work, I explore real world policy implications. I show that 1) direct population control (e.g. China’s one-child policy) may be efficient and 2) with external effects to childbearing, Pigouvian taxes restore efficiency.
    Keywords: Pareto efficiency, fertility, altruism, bequests
    JEL: D61 H21 J13
    Date: 2021–10–27
  14. By: Stéphane Auray; Aurélien Eyquem (UL2 - Université Lumière - Lyon 2)
    Abstract: The inception of the euro allowed countries from the periphery to experience a large fall in the cost of borrowing. Lower nominal rates were only partially offset by lower inflation rates. We rationalize this real interest rate reversal using a two-region model of a monetary union where, consistently with real interest rate data, discount factors are initially heterogeneous, leading the periphery to be borrowing-constrained. We model the inception of the euro as a partial convergence process in inflation rates and a slow rise in the discount factor of the periphery, relaxing the borrowing constraint. This simple setup accounts for the bulk of post-euro fluctuations in both regions. In particular, it replicates very well the observed joint dynamics of current accounts and terms of trade.
    Keywords: monetary union,inflation convergence,current account imbalances,borrowing constraints
    Date: 2021–06

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