nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2022‒01‒03
twenty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Non-Linear Employment Effects of Tax Policy By Domenico Ferraro; Giuseppe Fiori
  2. Monetary Policy over the Life Cycle By R. Anton Braun; Daisuke Ikeda
  3. Does the Central Bank of Peru Respond to Exchange Rate Movements? A Bayesian Estimation of a New Keynesian DSGE Model with FX Interventions By Gabriel Rodríguez; Paul Castillo; Harumi Hasegawa; Hernán B. Garrafa-Aragón
  4. Rethinking fiscal rules By Luis Carranza Ugarte; Julian Diaz Saavedra; Jose Enrique Galdon-Sanchez
  5. Zero Lower Bound on Inflation Expectations By Yuriy Gorodnichenko; Dmitriy Sergeyev
  6. A Worker’s Backpack as an alternative to PAYG pension systems By Julian Diaz Saavedra; Ramon Marimon; Joao Brogueira de Sousa
  7. Financial Constraints, Sectoral Heterogeneity, and the Cyclicality of Investment By Cooper Howes
  8. Budget-neutral capital tax cuts By Frédéric Dufourt; Lisa Kerdelhué; Océane Piétri
  9. Monetary policy and endogenous financial crises By F. Boissay; F. Collard; Jordi Galí; C. Manea
  10. Macroprudential policies and Brexit: A welfare analysis By Margarita Rubio
  11. Asymmetries in Risk Premia, Macroeconomic Uncertainty and Business Cycles By Christoph Görtz; Mallory Yeromonahos
  12. Larger transfers financed with more progressive taxes? On the optimal design of taxes and transfers By Axelle Ferriere; Philipp Grubener; Gaston Navarro; Oliko Vardishvili
  13. Is There News in Inventories? By Christoph Görtz; Christopher Gunn; Thomas A. Lubik
  14. Moderating Macroeconomic Bubbles Under Dispersed Information By Jonathan J Adams
  15. Central Bank Digital Currency and Banking: Macroeconomic Benefits of a Cash-Like Design By Jonathan Chiu; Mohammad Davoodalhosseini
  16. Comparative analysis of quantitative easing and money-financed fiscal stimulus By Jan Lutynski
  17. Present-biased Government, Creative Accounting and a Pitfall in Balanced Budget Rules By Marcela De Castro-Valderrama
  18. China's Easily Overlooked Monetary Transmission Mechanism:Real Estate Monetary Reservoi By Xiao Shuguang; Lai Xinglin
  19. Accuracy in recursive minimal state space methods By Pierri, Damian Rene
  20. Production and Inventory Dynamics under Ambiguity Aversion By Yulei Luo; Jun Nie; Xiaowen Wang; Eric R. Young
  21. High Discounts and Low Fundamental Surplus: An Equivalence Result for Unemployment Fluctuations By Indrajit Mitra; Taeuk Seo; Yu Xu

  1. By: Domenico Ferraro; Giuseppe Fiori
    Abstract: We study the non-linear propagation mechanism of tax policy in a heterogeneous agent equilibrium business cycle model with search frictions in the labor market and an extensive margin of employment adjustment. The model exhibits endogenous job destruction and endogenous hiring standards in the form of occasionally-binding zero-surplus constraints. After parameterizing the model using U.S. data, we find that the dynamic response of employment to a temporary change in the labor income tax is highly non-linear, displaying sizable asymmetries and state-dependence. Notably, the response to a tax rate cut is at least twice as large in a recession as in an expansion.
    Keywords: Search frictions; Job destruction; Heterogeneity; Aggregation; Tax policy
    JEL: E12 E24 E32 E62
    Date: 2021–12–20
  2. By: R. Anton Braun; Daisuke Ikeda
    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: D15 E52 E62 G51
    Date: 2021–08–20
  3. By: Gabriel Rodríguez (Departamnento de Economía, Pontificia Universidad Católica del Perú.); Paul Castillo (Banco Central de Reserva, Pontificia Universidad Católica del Perú.); Harumi Hasegawa (Pontificia Universidad Católica de Chile); Hernán B. Garrafa-Aragón (Escuela de Ingeniería Estadística de la Universidad Nacional de Ingeniería)
    Abstract: This paper assess the role played by the exchange rate and FX intervention in setting monetary policy interest rates in Peru. We estimate a Taylor rule that includes inflation, output gap and the exchange rate using a New Keynesian DSGE model that follows closely Schmitt-Grohé and Uribe (2017). The model is extended to include an explicit sterilized FX intervention rule as in Faltermeier et al. (2017). The main empirical results show, for the pre Inflation Targeting (IT) and IT periods, that the model that clearly outperforms in terms of marginal log density, features a Taylor rule that does not respond to changes in the nominal exchange rate and an active use of FX intervention by the Central Bank. We also find that the coefficient associated with the response of the Taylor rule to inflation is close to 2 and the one associated with the output gap is greater than 1; and that FX intervention has become more responsive to exchange rate fluctuations during the IT period. Finally, the estimated IRFs shows that FX intervention has contributed to reduce the volatility of GDP in response to productivity and terms of trade shocks in Peru. JEL Classification-JE: C22, C52, F41.
    Keywords: Small Open Economy; Taylor Rule; Monetary Policy Rule; Exchange Rate; Bayesian Methodology; Peruvian Economy; FX interventions; New Keynesian DSGE Model.
    Date: 2021
  4. By: Luis Carranza Ugarte (Universidad San Martin de Porres.); Julian Diaz Saavedra (Department of Economic Theory and Economic History, University of Granada.); Jose Enrique Galdon-Sanchez (Universidad Publica de Navarra.)
    Abstract: The Covid 19 pandemic has caused both a decrease in tax revenues and an increase in public spending, forcing governments to increase fiscal deficits to unprecedented levels. Given these circumstances, it is foreseeable that fiscal rules will play a predominant role in the design of many countries’ recovery policies. We develop a general equilibrium, overlapping generations model for a small, open economy in order to study the impact of several fiscal rules upon welfare, public expenditures and growth. We calibrate the model to the Peruvian economy. In this economy, fiscal rules have been widely used and, unlike in other Latin American countries, they have been relatively successful. We find that fiscal rules will generate better results in terms of output and welfare if, in addition to maintaining control over the fiscal result, they also eliminate the bias in favor of current expenditure. We also find that the performance of economies that implement structural rules tends to be better than the performance of economies that implement rules based on current results.
    Keywords: Fiscal policy, Infrastructure, Public spending, Public Deficit, Debt limits.
    JEL: E62 H54 O23
    Date: 2021–12–03
  5. By: Yuriy Gorodnichenko; Dmitriy Sergeyev
    Abstract: We document a new fact: in U.S., European and Japanese surveys, households do not expect deflation, even in environments where persistent deflation is a strong possibility. This fact stands in contrast to the standard macroeconomic models with rational expectations. We extend a standard New Keynesian model with a zero-lower bound on inflation expectations. Unconventional monetary policies, such as forward guidance, are weaker. In liquidity traps, the government spending output multiplier is finite, and adverse aggregate supply shocks are not expansionary. The possibility of confidence-driven liquidity traps is attenuated.
    JEL: E5 E7 G4
    Date: 2021–11
  6. By: Julian Diaz Saavedra (Department of Economic Theory and Economic History, University of Granada.); Ramon Marimon (European University Institute, UPF - Barcelona GSE, CEPR and NBER.); Joao Brogueira de Sousa (Nova School of Business and Economics.)
    Abstract: With ageing population and historical trends of low employment rates, pay-as-you-go (PAYG) pension systems, currently in place in several European countries, imply very large economic and welfare costs in the coming decades, threatening the sustainability of these systems. In an overlapping generations economy with incomplete insurance markets and frictional labour markets, an employment fund, which can be used while unemployed or retired can enhance production efficiency and social welfare. With an appropriate design, the sustainable Backpack employment fund (BP) can greatly outperform – measured by average social welfare in the economy – existing pay-as-you go systems and also Pareto dominate a full privatization of the pension system, as well as a standard fully funded defined contribution pension system. We show this in a calibrated model of the Spanish economy, by comparing steady-state economies after the ongoing demographic transition under these different pension systems and by showing how a front-loaded transition from the PAYG to the BP system, ahead of the ‘ageing transition’, can be Pareto improving (i.e. without losers), while minimizing the cost of the reform.
    Keywords: Social security reform, Ageing, Taxation.
    JEL: C68 H55 J26
    Date: 2021–12–03
  7. By: Cooper Howes
    Abstract: While investment in most sectors declines in response to a contractionary monetary policy shock, investment in the manufacturing sector increases. Using manually digitized aggregate income and balance sheet data for the universe of U.S. manufacturing firms, I show this increase is driven by the types of firms that are least likely to be financially constrained. A two-sector New Keynesian model with financial frictions can match these facts; unconstrained firms are able to take advantage of the decline in the user cost of capital caused by the monetary contraction, while constrained firms are forced to cut back.
    Keywords: Monetary Policy; Investments; Financial Frictions
    JEL: E22 E32 E52
    Date: 2021–08–27
  8. By: Frédéric Dufourt (AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique); Lisa Kerdelhué (AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique); Océane Piétri (AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique)
    Abstract: We revisit the canonical policy of eliminating capital taxation by increasing labor taxation in a endogenous-labor, heterogeneous-agent model with income and wealth heterogeneity, when the government is subject to a strict (per-period) balancedbudget constraint. By contrast with its non-budget neutral equivalent-associated with a constant tax rate over time and a permanent increase in the level of public debt-we show that the obtained endogenous path for the labor tax rate is sharply increasing in the initial period and decreasing over time. The policy then generates a deeper recession in the short-run and a greater expansion in the long-run, as well as a smaller decline in wealth inequality associated with a reduced incentive to save for precautionary motives. Overall, the policy still generates significant losses in average welfare.
    Keywords: Fiscal Policy,Capital Tax Cut,Tax Composition,Heterogeneous Agents,Wealth Redistribution
    Date: 2021–06–30
  9. By: F. Boissay; F. Collard; Jordi Galí; C. Manea
    Abstract: We study whether a central bank should deviate from its objective of price stability to promote financial stability. We tackle this question within a textbook New Keynesian model augmented with capital accumulation and microfounded endogenous financial crises. We compare several interest rate rules, under which the central bank responds more or less forcefully to inflation and aggregate output. Our main findings are threefold. First, monetary policy affects the probability of a crisis both in the short run (through aggregate demand) and in the medium run (through savings and capital accumulation). Second, a central bank can both reduce the probability of a crisis and increase welfare by departing from strict inflation targeting and responding systematically to fluctuations in output. Third, financial crises may occur after a long period of unexpectedly loose monetary policy as the central bank abruptly reverses course.
    Keywords: Financial crisis, monetary policy
    Date: 2021–12
  10. By: Margarita Rubio
    Abstract: Brexit will bring many economic and institutional consequences. Among other, Brexit will have implications on financial stability and the implementation of macroprudential policies. One immediate effect of Brexit is the fact that the United Kingdom (UK) will no longer be subject to the jurisdiction of the European Supervisory Authorities (ESAs) nor the European Systemic Risk Board (ESRB). This paper studies the welfare implications of this change of regime, both for the UK and the European Union (EU). By means of a Dynamic Stochastic General Equilibrium model (DSGE), I compare the pre-Brexit scenario with the new one, in which the UK sets macroprudential policy independently. I find that, after Brexit, the UK is better off by setting its own macroprudential policy without taking into account Europe's welfare as a whole. Given the small relative size of the UK, this implies just slight welfare loss in the EU.
    Keywords: Brexit, macroprudential policy, DSGE, welfare
    Date: 2021
  11. By: Christoph Görtz (Department of Economics, University of Birmingham, UK; Rimini Centre for Economic Analysis); Mallory Yeromonahos (Department of Economics, University of Birmingham, UK)
    Abstract: A large literature suggests that the expected equity risk premium is countercyclical. Using a variety of different measures for this risk premium, we document that it also exhibits growth asymmetry, i.e. the risk premium rises sharply in recessions and declines much more gradually during the following recoveries. We show that a model with recursive preferences, in which agents cannot perfectly observe the state of current productivity, can generate the observed asymmetry in the risk premium. Key for this result are endogenous fluctuations in uncertainty which induce procyclical variations in agent's nowcast accuracy. In addition to matching moments of the risk premium, the model is also successful in generating the growth asymmetry in macroeconomic aggregates observed in the data, and in matching the cyclical relation between quantities and the risk premium.
    Keywords: Risk Premium, Business cycles, Bayesian Learning, Asymmetry, Uncertainty, Nowcasting
    JEL: E2 E3 G1
    Date: 2021–12
  12. By: Axelle Ferriere (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, PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement); Philipp Grubener (Goethe-University - Goethe-Universität Frankfurt am Main); Gaston Navarro (Federal Reserve Board); Oliko Vardishvili (Yale University [New Haven])
    Abstract: We study the optimal joint design of targeted transfers and progressive income taxes. We develop a simple analytical model and demonstrate an optimally negative relation between transfers and income-tax progressivity, due to both efficiency and redistribution concerns. That is, higher transfers should be financed with lower income-tax progressivity. We next quantify the optimal fiscal plan in a rich dynamic model calibrated to the U.S. economy. Transfers should be generous and financed with moderate income-tax progressivity. To redistribute while preserving efficiency, average tax-and-transfer rates should be more progressive than marginal rates. Transfers, even if lump-sum, precisely allow to disentangle average from marginal rates. Targeted transfers further implement non-monotonic marginal rates, but generate only modest additional gains relative to a lump-sum transfer. Quantitatively, the left tail of the income distribution determines the optimal size of the transfer, while the right tail drives the optimal income-tax progressivity.
    Keywords: Fiscal Policy,Optimal Taxation,Redistribution,Heterogeneous Agents
    Date: 2021–12
  13. By: Christoph Görtz (Department of Economics, University of Birmingham, UK; Rimini Centre for Economic Analysis); Christopher Gunn (Department of Economics, Carleton University, Canada); Thomas A. Lubik (Research Department, Federal Reserve Bank of Richmond, USA)
    Abstract: We identify total factor productivity (TFP) news shocks using standard VAR methodology and document a new stylized fact: in response to news about future increases in TFP, inventories rise and comove positively with other major macroeconomic aggregates. We show that the standard theoretical model used to capture the effects of news shocks cannot replicate this fact when extended to include inventories. We derive the conditions required to generate a procyclical inventory response by using a wedges approach. To explain the empirical inventory behavior, we consider two mechanisms: sticky wages and the presence of knowledge capital accumulated through learning-by-doing. Only the latter moves the wedges to qualitatively match the empirical behaviour. The desire to take advantage of higher future TFP through knowledge capital drives output and hours choices on the arrival of news and leads to inventory accumulation alongside the other macroeconomic variables. The broad-based comovement a model with knowledge capital can generate supports the view that news shocks are an important driver of aggregate fluctuations.
    Keywords: News shocks, business cycles, inventories, knowledge capital, VAR
    JEL: E2 E3
    Date: 2021–12
  14. By: Jonathan J Adams (Department of Economics, University of Florida)
    Abstract: Can waves of optimism and pessimism produce large macroeconomic bubbles, and if so, is there anything that policymakers can do about them? Yes and yes. I study a business cycle model where agents with rational expectations receive noisy signals about future productivity. The model features dispersed information, which allows aggregate noise shocks to produce frequent large bubbles in the capital stock. Because of the information friction, a policymaker with an informational advantage can improve outcomes. I consider policies that affect investment incentives by distorting the intertemporal wedge. I calculate the optimal policy rule, and find that policymakers should discourage investment booms after aggregate news shocks.
    JEL: D84 E21 E32
    Date: 2020–09
  15. By: Jonathan Chiu; Mohammad Davoodalhosseini
    Abstract: Should a central bank digital currency (CBDC) be issued? Should its design be cash- or deposit-like? To answer these questions, we theoretically and quantitatively assess the effects of a CBDC on consumption, banking and welfare. Our model introduces new general equilibrium linkages across different types of retail transactions as well as a novel feedback effect from transactions to deposit creation. The general equilibrium effects of a CBDC are decomposed into three channels: payment efficiency, price effects and bank funding costs. We show that a cash-like CBDC is more effective than a deposit-like CBDC in promoting consumption and welfare. Interestingly, a cash-like CBDC can also crowd in banking, even in the absence of bank market power. In a calibrated model, at the maximum, a cash-like CBDC can increase bank intermediation by 5.8% and capture up to 25% of the payment market. In contrast, a deposit-like CBDC can crowd out banking by up to 2.6%, thereby grabbing a market share of about 16.7%.
    Keywords: Digital currencies and fintech; Monetary policy; Monetary policy framework
    JEL: E58
    Date: 2021–12
  16. By: Jan Lutynski (Group for Research in Applied Economics (GRAPE))
    Abstract: I study two types of unconventional monetary policy: quantitative easing (QE) and money-financed fiscal stimulus (MFFS), in a modified New Keynesian framework. I compare their effectiveness in stabilizing output and inflation when monetary policy is constrained by the effective lower bound. Money-financed fiscal stimulus performs better than quantitative easing, except the case of the TFP shock. It tends to cause lower inflation and output volatility. Nevertheless, it might be substantially more problematic in implementation as it demands cooperation between the central bank and the fiscal authority. Real reserve targeting (RRT) delivers similar outcomes as quantitative easing but is easier to implement.
    Keywords: unconventional monetary policy, quantitative easing, money-financed fiscal stimulus,
    JEL: E21 E30 E50 E58 E61
    Date: 2021
  17. By: Marcela De Castro-Valderrama
    Abstract: I propose a general equilibrium model with a quasi-hyperbolic discounting government that optimally decides upon using creative accounting in order to evaluate a balanced budget rule and a debt rule. In that context, I find that a binding balanced budget rule could fail to properly constrain public overindebtedness when government uses creative accounting while a debt rule is effective, since targets are set on total public liabilities. Results suggest that a balanced budget fiscal rule can also deteriorate welfare due to the higher interest rates derived from doing operations under the line, implying future expenditure cuts that are harmful for households, who value public goods and services. A debt rule is also preferred for its capacity to reverse some welfare losses generated by the present-biased government. **** RESUMEN: En un modelo de equilibrio general con un gobierno que descuenta cuasi-hiperbólicamente se evalúan dos reglas fiscales. Los resultados sugieren que una regla fiscal sobre el balance activa y vinculante no garantiza acotar el crecimiento del endeudamiento público cuando el gobierno puede hacer trucos contables y puede generar mayores pérdidas de bienestar en la economía. Por el otro lado, una regla sobre la deuda es efectiva y logra recuperar parte de la pérdida de bienestar generada por el gobierno que descuenta cuasi-hiperbólicamente.
    Keywords: Quasi-Hyperbolic Discounting, Creative Accounting, Balanced Budget Rule, Fiscal Policy, Public Overindebtness, Welfare Analysis, descuento cuasi-hiperbólico, Contabilidad Creativa, Regla Fiscal sobre el balance, Política Fiscal, Sobre endeudamiento público, Análisis de bienestar.
    JEL: E61 E62 G28 H61 H63 E21
    Date: 2021–12
  18. By: Xiao Shuguang; Lai Xinglin
    Abstract: While the traditional monetary transmission mechanism usually uses the equity and capital markets as monetary reservoirs, due to China's unique fiscal and financial system, the real estate sector has become China's 'invisible' non-traditional monetary reservoir for many years. Firstly, based on the perspective of the real estate sector as a monetary reservoir, this paper constructs a dynamic general equilibrium model that includes fiscal investment and financing and uses Chinese housing market data as well as central bank data on refinancing rates to financial institutions and GDP data for parameter estimation to reveal the laws of the monetary transmission mechanism of the monetary reservoir-fiscal financing investment: firstly, an asset can be financed as long as it satisfies the three criteria of a leveraged trading system:First,there is a commitment to pay and the existence of government utility; second, local governments have an incentive to carry out credit expansion and investment and also financing operations through money pool assets, and there is a financing effect when the tax return on fiscal investment is higher than fiscal financing; third, the bubble effect is greater than the financing effect and it will push the monetisation of fiscal deficits when the financing effect is greater than the bubble effect and then the economic growth masks the credit expansion of local governments.To address the problem of monetary transmission mechanism under the perspective of real estate monetary reservoir, this paper carries out the design of a de-bubble financing mechanism for monetary reservoir assets.
    Date: 2021–11
  19. By: Pierri, Damian Rene
    Abstract: The existence of a recursive minimal state space (MSS) representation is notalways guaranteed. However, because of its numerical efficiency, this type of equilibrium is frequently used in practice. What are the consequences of computing and simulating a model without a constructive proof? To answer this question, we identify a condition which is associated with a convergent and computable MSSrepresentation in a RBC model with state contingent taxes. This condition ensures the existence of a benchmark equilibrium that can be used to test frequently used algorithms. To verify the accuracy of simulations even if this condition does not hold, we derive a closed form recursive equilibrium which contains the MSS representation. Both benchmark representations are accurate and ergodic. We showthat state of the art algorithms, even if they are numerically convergent, may underestimate capital (and thus overestimate the benefits of capital taxes) by at least 65%, a figure which is in line with recent findings using accurate benchmarks. When an existence proof is not available, we found 2 sources of inaccuracy: the lack of a convergent operator and the absence of a well-defined (stochastic) steady state.Moreover, we identify a connection between lack of convergence and the equilibrium budget constraint which implies that simulated paths may be distorted not only in the long run but also in any period. When we have a constructive proof, inaccuracy is generated by the lack of qualitative properties in the computed policy functions.
    Keywords: Accuracy; Recursive Equilibrium; State Contingent Fiscal Policy
    Date: 2021–12–13
  20. By: Yulei Luo; Jun Nie; Xiaowen Wang; Eric R. Young
    Abstract: We propose a production-cost smoothing model with Knightian uncertainty due to ambiguity aversion to study the joint behavior of production, inventories, and sales. Our model can explain four facts that previous studies find difficult to account for simultaneously: (i) the high volatility of production relative to sales, (ii) the low ratio of inventory-investment volatility to sales volatility, (iii) the positive correlation between sales and inventories, and (iv) the negative correlation between the inventory-to-sales ratio and sales. We find that the stock-out avoidance motive (Kahn 1987) emerges endogenously in our model, reconciling the long debate in the inventory literature over the production- cost smoothing and the stock-out avoidance models.
    Keywords: Ambiguity Aversion; Robustness; Knightian Uncertainty; Inventories; Production Cost Smoothing
    JEL: D83 E21 F41 G15
    Date: 2021–08–02
  21. By: Indrajit Mitra; Taeuk Seo; Yu Xu
    Abstract: Ljungqvist and Sargent (2017) (LS) show that unemployment fluctuations can be understood in terms of a quantity they call the “fundamental surplus.” However, their analysis ignores risk premia, a force that Hall (2017) shows is important in understanding unemployment fluctuations. We show how the LS framework can be adapted to incorporate risk premia. We derive an equivalence result that relates parameters in economies with risk premia to those of an artificial economy without risk premia. We show how to use properties of the artificial economy to deduce how risk premia affect unemployment dynamics in the original economy.
    Keywords: risk premia; fundamental surplus; time-varying discounts; unemployment fluctuations
    JEL: E23 E24 E32 E44 J23 J24 J31 J41 J63
    Date: 2021–09–24

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