nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2021‒12‒20
twelve papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. The impact of U.S. employer-sponsored insurance in the 20th century By Vegard M. Nygaard; Gajendran Raveendranathan
  2. Financial frictions: micro vs macro volatility By Lee, Seungcheol; Luetticke, Ralph; Ravn, Morten O.
  3. Asset Prices and Business Cycles with Liquidity Shocks By Mahdi Nezafat; Ctirad Slavik
  4. Evaluating the Accuracy of Counterfactuals The Role of Heterogeneous Expectations in Life Cycle Models By de Bresser, Jochem
  5. Firestorm: Multiplicity in Models with Full Information By Jonathan J Adams
  6. The Geography of Job Creation and Job Destruction By Moritz Kuhn; Iourii Manovskii; Xincheng Qiu
  7. Financial constraints, risk sharing, and optimal monetary policy By Zaretski, Aliaksandr
  8. Evaluating the Accuracy of Counterfactuals The Role of Heterogeneous Expectations in Life Cycle Models By de Bresser, Jochem
  9. The Aggregate-Demand Doom Loop: Precautionary Motives and the Welfare Costs of Sovereign Risk By Francisco Roldán
  10. Can Sticky Portfolios Explain International Capital Flows and Asset Prices? By Philippe Bacchetta; Margaret Davenport; Eric van Wincoop
  11. The Macroeconomic Effects of Corporate Tax Reforms By Francesco Furno
  12. Sovereign Debt Standstills By Mr. Leonardo Martinez; Juan Carlos Hatchondo; Cesar Sosa Padilla

  1. By: Vegard M. Nygaard; Gajendran Raveendranathan
    Abstract: The introduction of employer-sponsored insurance (ESI) in the 1940s led to the largest decline in the uninsurance rate in U.S. history. To study the fiscal and welfare implications of this insurance expansion, we endogenize the selection of workers into jobs with and without ESI in a general equilibrium life-cycle model where consumers face idiosyncratic health shocks. Our model rationalizes non-targeted empirical patterns related to ESI coverage between 1940 and 2010 and in recent cross-sectional data. ESI leads to moderate welfare gains in the short run (0.5 percent of lifetime consumption for the average consumer) but zero gains or even moderate losses in the long run. The reason is that the health insurance benefit provided by ESI dominates in the short run but the tax increase required to offset ESI tax exemptions dominates in the long run. We substantiate these welfare estimates by showing that our model rationalizes both the level and rise in total ESI tax exemptions. Finally, we show that tax-financed universal health insurance — considered among policymakers in the 1930s — would have led to significantly higher welfare gains.
    Keywords: employer-sponsored insurance; general equilibrium life-cycle; heterogeneous agents; universal health-care insurance; welfare.
    JEL: E24 H51 I13 J33
    Date: 2021–12
  2. By: Lee, Seungcheol; Luetticke, Ralph; Ravn, Morten O.
    Abstract: We introduce frictional financial intermediation into a HANK model. Households are subject to idiosyncratic and aggregate risk and smooth consumption through savings and consumer loans intermediated by banks. The banking friction introduces an endogenous countercyclical spread between the interest rate on savings and on loans. This interacts with incomplete markets because borrowers and savers face different intertemporal prices, and induces a time-varying mass point of high MPC households. Aggregate shocks through their impact on the spread give rise to consumption inequality. We show this mechanism to be empirically relevant. Ex-ante macro prudential regulation reduces welfare by reducing consumption smoothing. JEL Classification: C11, D31, E32, E63
    Keywords: business cycles, incomplete markets, macroprudential regulation, monetary policy, financial frictions
    Date: 2021–12
  3. By: Mahdi Nezafat; Ctirad Slavik
    Abstract: We develop a production based asset pricing model with financially constrained firms to explain the observed high equity premium and low risk-free rate volatility. Investment opportunities are scarce and firms face productivity and liquidity shocks. A negative liquidity shock forces firms to liquidate a fraction of their assets. We calibrate the model to U.S. data and find that it generates an equity premium and a level and volatility of risk-free rate comparable to those observed in the data. The model also fits key aspects of the behavior of aggregate quantities, in particular, the volatility of aggregate consumption and investment.
    Keywords: general equilibrium; business cycles; production based asset pricing; equity premium and risk-free rate puzzles;
    JEL: E20 E32 G12
    Date: 2021–11
  4. By: de Bresser, Jochem (Tilburg University, Center For Economic Research)
    Keywords: Subjective expectations; life cycle model
    Date: 2021
  5. By: Jonathan J Adams (Department of Economics, University of Florida)
    Abstract: Dynamic stochastic models with full information and rational expectations (FIRE) are not as well determined as is commonly believed. In general, FIRE models exhibit a multiplicity that is implicitly ruled out by standard solution methods, which conjecture that equilibria are functions of past shocks alone. The multiplicity is due to the endogenous feedback from choices to information to choices, which in equilibrium may contain self-fulfilling news about future shocks. I demonstrate the multiplicity in several examples, including canonical asset pricing and business cycle models. Then I study how the multiplicity arises in a dynamic programming problem with decentralized markets. Finally, I conclude that the business cycle literature must adopt information frictions.
    JEL: C62 D50 D84 E32
    Date: 2021–12
  6. By: Moritz Kuhn; Iourii Manovskii; Xincheng Qiu
    Abstract: Spatial di erences 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 di erences in unemployment, vacancies, job nding, and job lling within each country. This robust set of facts guides and disciplines the development of a theory of local labor market performance. We nd that a spatial version of a Diamond- Mortensen-Pissarides model with endogenous separations and on-the-job search quanti- tatively accounts for all the documented empirical regularities. The model also quanti- tatively rationalizes why di erences in job-separation rates have primary importance in inducing di erences in unemployment across space while changes in the job- nding rate are the main driver in unemployment uctuations over the business cycle.
    Keywords: Local Labor Markets, Unemployment, Vacancies, Search and Matching
    JEL: J63 J64 E24 E32 R13
    Date: 2021–12
  7. By: Zaretski, Aliaksandr
    Abstract: I characterize optimal government policy in a sticky-price economy with different types of consumers and endogenous financial constraints in the banking and entrepreneurial sectors. The competitive equilibrium allocation is constrained inefficient due to a pecuniary externality implicit in the collateral constraint and other externalities arising from consumer type heterogeneity. These externalities can be corrected with appropriate fiscal instruments. Independently of the availability of such instruments, optimal monetary policy aims to achieve price stability in the long run and approximate price stability in the short run, as in the conventional New Keynesian environment. Compared to the competitive equilibrium, the constrained efficient allocation significantly improves between-agent risk sharing, approaching the unconstrained Pareto optimum and leading to sizable welfare gains. Such an allocation has lower leverage in the banking and entrepreneurial sectors and is less prone to the boom-bust financial crises and zero-lower-bound episodes observed occasionally in the decentralized economy.
    Keywords: constrained efficiency; effective lower bound; financial constraints; leverage limits; optimal monetary policy; Ramsey equilibrium
    JEL: E32 E44 E52 E63 G28
    Date: 2021–05–16
  8. By: de Bresser, Jochem (Tilburg University, School of Economics and Management)
    Date: 2021
  9. By: Francisco Roldán
    Abstract: Sovereign debt crises coincide with deep recessions. I propose a model of sovereign debt that rationalizes large contractions in economic activity via an aggregate-demand amplification mechanism. The mechanism also sheds new light on the response of consumption to sovereign risk, which I document in the context of the Eurozone crisis. By explicitly separating the decisions of households and the government, I examine the interaction between sovereign risk and precautionary savings. When a default is likely, households anticipate its negative consequences and cut consumption for self-insurance reasons. Such shortages in aggregate spending worsen economic conditions through nominal wage rigidities and boost default incentives, restarting the vicious cycle. I calibrate the model to Spain in the 2000s and find that about half of the output contraction is caused by default risk. More generally, sovereign risk exacerbates volatility in consumption over time and across agents, creating large and unequal welfare costs even if default does not materialize.
    Keywords: Sovereign risk;default;heterogeneous agents;precautionary motives;aggregate demand;WP;default probability;government debt;debt price;default incentive;open economy
    Date: 2020–12–18
  10. By: Philippe Bacchetta (University of Lausanne; Centre for Economic Policy Research (CEPR); Swiss Finance Institute); Margaret Davenport (University of Lausanne); Eric van Wincoop (University of Virginia - Department of Economics; National Bureau of Economic Research (NBER))
    Abstract: Recently portfolio choice has become an important element of many DSGE open economy models. Yet, a substantial body of evidence is inconsistent with standard frictionless portfolio choice models. In this paper we introduce a quadratic cost of changes in portfolio allocation into a two-country DSGE model. We investigate the level of portfolio frictions most consistent with the data and the impact of portfolio frictions on asset prices and net capital flows. We find the portfolio friction accounts for (i) micro evidence of portfolio inertia by households, (ii) macro evidence of the price impact of financial shocks and related disconnect of asset prices from fundamentals, (iii) a broad set of moments related to the time series behavior of saving, investment and net capital flows, and (iv) other phenomena relating to excess return dynamics. Financial and saving shocks each account for close to half of the variance of net capital flows.
    Date: 2021–12
  11. By: Francesco Furno
    Abstract: This paper extends a standard general equilibrium framework with a corporate tax code featuring two key elements: tax depreciation policy and the distinction between c-corporations and pass-through businesses. In the model, the stimulative effect of a tax rate cut on c-corporations is smaller when tax depreciation policy is accelerated, and is further diluted in the aggregate by the presence of pass-through entities. Because of a highly accelerated tax depreciation policy and a large share of pass-through activity in 2017, the model predicts small stimulus, large payouts to shareholders, and a dramatic loss of corporate tax revenues following the Tax Cuts and Jobs Act (TCJA-17). These predictions are consistent with novel micro- and macro-level evidence from professional forecasters and sectoral tax returns. At the same time, because of less-accelerated tax depreciation and a lower pass-through share in the early 1960s, the model predicts sizable stimulus in response to the Kennedy's corporate tax cuts - also supported by the data. The model-implied corporate tax multipliers for Trump's TCJA-17 and Kennedy's tax cuts are +0.6 and +2.5, respectively.
    Date: 2021–11
  12. By: Mr. Leonardo Martinez; Juan Carlos Hatchondo; Cesar Sosa Padilla
    Abstract: As a response to economic crises triggered by COVID-19, sovereign debt standstill proposals emphasize debt payment suspensions without haircuts on the face value of debt obligations. We quantify the effects of standstills using a standard default model. We find that a one-year standstill generates welfare gains for the sovereign equivalent to a permanent consumption increase of between 0.1% and 0.3%, depending on the initial shock. However, except when it avoids a default, the standstill also implies capital losses for creditors of between 9% and 27%, which is consistent with their reluctance to participate in these operations and indicates that this reluctance would persist even without a free-riding or holdout problem. Standstills also generate a form of “debt overhang” and thus the opportunity for a “voluntary debt exchange”: complementing the standstill with haircuts could reduce creditors’ losses and simultaneously increase welfare gains. Our results cast doubts on the emphasis on standstills without haircuts.
    Keywords: Standstill;Haircuts;COVID-19;Default;Debt Overhang;Voluntary Debt Exchange;WP;Pareto gain;debt level;default probability;welfare gain;bond price increase;long-term debt
    Date: 2020–12–18

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