nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2022‒01‒24
23 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. A Quantitative Microfounded Model for the Integrated Policy Framework By Christopher J. Erceg; Jesper Lindé; Mr. Tobias Adrian; Pawel Zabczyk; Marcin Kolasa
  2. Doves for the Rich, Hawks for the Poor? Distributional Consequences of Systematic Monetary Policy By Nils Gornemann; Keith Kuester; Makoto Nakajima
  3. Equilibrium Job Turnover and the Business Cycle By Carrillo-Tudela, Carlos; Clymo, Alex; Coles, Melvyn
  4. Firm Heterogeneity, Capital Misallocation and Optimal Monetary Policy By Beatriz González; Galo Nuño; Dominik Thaler; Silvia Albrizio
  5. Learning and Cross-Country Correlations in a Multi-Country DSGE Model By Volha Audzei
  6. A Real-Business-Cycle model with robots: Lessons for Bulgaria By Aleksandar Vasilev
  7. Exchange rate disconnect and the general equilibrium puzzle By Yu-chin Chen; Ippei Fujiwara; Yasuo Hirose
  8. Endogenous Fluctuations and International Business Cycles By Stephen McKnight; Laura Povoledo
  9. Tariffs and Macroeconomic Dynamics By Marco A. Hernández Vega
  10. Uniformly Self-Justified Equilibria By Felix Kubler; Simon Scheidegger
  11. Equilibrium Worker-Firm Allocations and the Deadweight Losses of Taxation By Bagger, Jesper; Moen, Espen R.; Vejlin, Rune Majlund
  12. Real-Time Forecast of DSGE Models with Time-Varying Volatility in GARCH Form By Sergey Ivashchenko; Semih Emre Cekin; Rangan Gupta
  13. Electricity and Firm Productivity: A General-Equilibrium Approach By Stephie Fried; David Lagakos
  14. Finding General Equilibria in Many-Agent Economic Simulations Using Deep Reinforcement Learning By Michael Curry; Alexander Trott; Soham Phade; Yu Bai; Stephan Zheng
  15. Real Exchange Rates and Primary Commodity Prices: Mussa Meets Backus-Smith By Joao Ayres; Constantino Hevia; Juan Pablo Nicolini
  16. The Trend-cycle Connection By Florencia S. Airaudo; Hernán D. Seoane
  17. Complete Markets with Bankruptcy Risk and Pecuniary Default Penalties By Victor Filipe Martins da Rocha; Rafael Mouallem Rosa
  18. Pandemic-Induced Wealth and Health Inequality and Risk Exposure By Konstantinos Angelopoulos; Spyridon Lazarakis; Rebecca Mancy; Max Schroeder
  19. Welfare gains in a small open economy with a dual mandate for monetary policy By Punnoose Jacob; Murat Özbilgin
  20. The Wobbly Economy; Global Dynamics with Phase Transitions and State Transitions By Tomohiro HIRANO; Joseph E. Stiglitz
  21. Identifying Monetary Policy Shocks Using the Central Bank's Information Set By Ruediger Bachmann; Isabel Gödl-Hanisch; Eric R. Sims
  22. News versus Surprise in Structural Forecasting Models: Central Bankers' Practical Perspective By Karel Musil; Stanislav Tvrz; Jan Vlcek
  23. Land Speculation and Wobbly Dynamics with Endogenous Phase Transitions By Tomohiro HIRANO; Joseph E. Stiglitz

  1. By: Christopher J. Erceg; Jesper Lindé; Mr. Tobias Adrian; Pawel Zabczyk; Marcin Kolasa
    Abstract: We develop a microfounded New Keynesian model to analyze monetary policy and financial stability issues in open economies with financial fragilities and weakly anchored inflation expectations. We show that foreign exchange intervention (FXI) and capital flow management tools (CFMs) can improve monetary policy tradeoffs under some conditions, including by reducing the need for procyclical tightening in response to capital outflow pressures. Moreover, they can be used in a preemptive way to reduce the risk of a “sudden stop” through curbing a buildup in leverage. While these tools can materially improve welfare, mainly by dampening inefficient fluctuations in risk premia, our analysis also highlights potential limitations, including the possibility that their deployment may forestall needed adjustment in the external balance. Finally, our results also emphasize the power of FXIs to provide domestic stimulus in a liquidity trap.
    Keywords: Monetary Policy, FX Intervention, Capital Controls, Sudden Stops, DSGE Model
    Date: 2021–12–17
  2. By: Nils Gornemann; Keith Kuester; Makoto Nakajima
    Abstract: We build a New Keynesian business-cycle model with rich household heterogeneity. In the model, systematic monetary stabilization policy affects the distribution of income, income risks, and the demand for funds and supply of assets: the demand, because matching frictions render idiosyncratic labor-market risk endogenous; the supply, because markups, adjustment costs, and the tax system mean that the average profitability of firms is endogenous. Disagreement about systematic monetary stabilization policy is pronounced. The wealth-rich or retired tend to favor inflation targeting. The wealth-poor working class, instead, favors unemployment-centric policy. One- and two-agent alternatives can show unanimous disapproval of inflation-centric policy, instead. We highlight how the political support for inflation-centric policy depends on wage setting, the tax system, and the portfolio that households have.
    Keywords: Monetary policy; Unemployment; Search and matching; Heterogeneous agents; General equilibrium; Dual mandate
    JEL: E12 E21 E24 E32 E52 J64
    Date: 2021–06–29
  3. By: Carrillo-Tudela, Carlos (University of Essex); Clymo, Alex (University of Essex); Coles, Melvyn (University of Essex)
    Abstract: This paper develops and estimates a fully microfounded equilibrium business cycle model of the US labor market with aggregate productivity shocks. Those microfoundations are consistent with evidence regarding the underlying distribution of firm growth rates across firms [by age and size] and, when aggregated, are consistent with macro-evidence regarding gross job creation and job destruction flows over the cycle. By additionally incorporating on-the-job search, we systematically characterise the stochastic relationships between aggregate job creation and job destruction flows across firms, gross hire and quit flows [churning] by workers across firms, as well as the persistence and volatility of unemployment and worker job finding rates over the cycle.
    Keywords: business cycle, firm dynamics, job search
    JEL: E24 E32 J62 J63
    Date: 2021–11
  4. By: Beatriz González; Galo Nuño; Dominik Thaler; Silvia Albrizio
    Abstract: We analyze monetary policy in a New Keynesian model with heterogeneous firms and financial frictions. Firms differ in their productivity and net worth and face collateral constraints that cause capital misallocation. TFP endogenously depends on the time-varying distribution of firms. Although a reduction in real rates increases misallocation in partial equilibrium, general-equilibrium effects overturn this result: a monetary expansion increases the investment of high-productivity firms relatively more than that of low-productivity ones, crowding out the latter and increasing TFP. We provide empirical evidence based on Spanish granular data supporting this mechanism. This has important implications for optimal monetary policy. We show how a central bank without pre-commitments engineers an unexpected monetary expansion to increase TFP in the medium run. In the event of a cost-push shock, the central bank leans with the wind to increase demand and reduce misallocation.
    Keywords: monetary policy, firm heterogeneity, financial frictions, misallocation
    JEL: E12 E22 E43 E52 L11
    Date: 2021
  5. By: Volha Audzei
    Abstract: International spillovers in estimated multi-country DSGE models with trade are usually limited. The correlation of nominal and real variables across countries is small unless correlation of exogenous shocks is imposed. In this paper, I show that introducing adaptive learning (AL) with time-varying coefficients as in Slobodyan and Wouters (2012b and 2012a) increases the international correlation. I use an estimated large-scale model as in de Walque et al. (2017), which has reasonable forecasting performance under rational expectations (RE). The model features the euro area, the US, and an exogenous rest of the world, with endogenous exchange rate determination. I show that the increase in international correlation stems from the varying coefficients and the use of simple forecasting models. The increase in the correlation of international variables goes through two channels: larger shock spillovers through the exchange rate, and correlated adjustment of agents' forecasting model coefficients.
    Keywords: Adaptive learning, Bayesian estimation, Multi-Country DSGE
    JEL: D83 D84 E17 E31
    Date: 2021–12
  6. By: Aleksandar Vasilev (Lincoln International Business School, UK.)
    Abstract: Robots are introduced into a real-business-cycle setup augmented with a detailed government sector. Robots are modelled as an imperfect substitute for labor services. The model is calibrated to Bulgarian data for the period following the introduction of the currency board arrangement (1999-2020). The quantitative importance of the presence of robots in the economy is investigated for business cycle fluctuations inBulgaria. In the presence of robots, wages increase, but employment falls after a technology shock. However, for plausible parameter values, the effect is predicted to be quite small.
    Keywords: business cycles; robots; Bulgaria
    JEL: E24 E32
    Date: 2022–01
  7. By: Yu-chin Chen; Ippei Fujiwara; Yasuo Hirose
    Abstract: This paper conducts general equilibrium (GE) estimation to evaluate the empirical contributions of macroeconomic shocks in explaining the exchange rate disconnect, excess volatility, and the uncovered interest parity (UIP) puzzles. We embed stochastic volatilities and limits-to-international arbitrage in a two-country New Keynesian model and estimate the GE system for the US and Euro area using higher-order approximation and full-information Bayesian methods. Assessing the roles of level vs. volatility shocks and linear vs. higher-order approximations, we find that shocks to macroeconomic fundamentals together with their uncertainties can account for a sizable portion—over 40%—of the observed exchange rate variations. Using the GE estimates, we then evaluate whether the fundamental shocks in our model can deliver the UIP relationship observed in the data, and more importantly, whether the results may differ conditionally vs. unconditionally. In line with findings in previous literature, several fundamental shocks individually can indeed generate patterns consistent with data. However, their contributions unconditionally in the GE setting are quantitatively insufficient to resolve the UIP puzzle. The presence of multiple shocks, their potential interactions, and the need for estimators to fit empirical dynamics of all observables beyond just the exchange rate are all likely reasons behind this “General Equilibrium Puzzle,” which underscores the importance of GE estimation beyond simulations or partial-equilibrium analyses.
    Keywords: Exchange rate, risk premium, international risk sharing, stochastic volatility, nonlinear estimation.
    JEL: E52 F31 F41
    Date: 2021–10
  8. By: Stephen McKnight (El Colegio de México); Laura Povoledo (University of the West of England)
    Abstract: We introduce equilibrium indeterminacy into a two-country incomplete asset model with imperfect competition to analyze the role of self-fulfilling expectations or beliefs in explaining international business cycles. We find that when self-fulfilling beliefs are correlated with tecnology shocks, the model can account for the counter-cyclical behavior observed for the terms of trade and real net exports, while simultaneously generating higher volatilities relative to output, as in the data. The choice of the labor supply elasticity is shown to be critical for generating a negative correlation between the real exchange rate and relative consumption, thereby resolving the Backus-Smith puzzle.
    Keywords: Indeterminacy, Sunspots and Self-Fulfilling Expectations, International Business Cycles, Net Exports, Terms of Trade, Consumption-Real Exchange Rate Anomaly, Combined Impulse Responses
    JEL: E32 F41 F44
    Date: 2021–11
  9. By: Marco A. Hernández Vega
    Abstract: This paper studies the macroeconomic impact of higher tariffs using a two-country DSGE model with endogenous trade and heterogeneous firms. The analysis consists of two scenarios. First, we assume that one country increases tariffs while the other does not. Second, both countries raise tariffs. In the first case, the country that did not raise tariffs suffers an economic contraction due to lower external demand. In turn, the one that imposed higher tariffs ends with a slight gain in output triggered by a surge in internal consumption originated from the transfer of tariff revenue to households. In the second case, however, both countries suffer a significant drop in exports, reducing dividends and wages paid, and decreasing consumption and output.
    JEL: F12 F13 F17 F41 F62
    Date: 2021–12
  10. By: Felix Kubler; Simon Scheidegger
    Abstract: We consider dynamic stochastic economies with heterogeneous agents and introduce the concept of uniformly self-justified equilibria (USJE) -- temporary equilibria for which forecasts are best uniform approximations to a selection of the equilibrium correspondence. In a USJE, individuals' forecasting functions for the next period's endogenous variables are assumed to lie in a compact, finite-dimensional set of functions, and the forecasts constitute the best approximation within this set. We show that USJE always exist and develop a simple algorithm to compute them. Therefore, they are more tractable than rational expectations equilibria that do not always exist. As an application, we discuss a stochastic overlapping generations exchange economy and provide numerical examples to illustrate the concept of USJE and the computational method.
    Date: 2021–12
  11. By: Bagger, Jesper (Royal Holloway, University of London); Moen, Espen R. (Norwegian Business School (BI)); Vejlin, Rune Majlund (Aarhus University)
    Abstract: We analyse the deadweight losses of tax-induced labor misallocation in an equilibrium model of the labour market where workers search to climb a job ladder and firms post vacancies. Workers differ in abilities. Jobs differ in productivities and amenities. A planner uses affine tax functions to finance lump-sum transfers to all workers and unemployment benefits. The competitive search equilibrium maximizes after-tax utility subject to resource constraints and the tax policy. A higher tax rate distorts search effort, job ranking and vacancy creation. Distortions vary on the job ladder, but always result in deadweight losses. We calibrate the model using matched employer-employee data from Denmark. The marginal deadweight loss is 33 percent of the tax base, and primarily arise from distorted search effort and vacancy creation. Steeply rising deadweight losses from distorted vacancy creation imply that the deadweight loss in the calibrated economy exceeds those incurred by very inequality averse social planners.
    Keywords: vacancy creation, job ranking, job search, labour allocation, redistribution, optimal taxation, deadweight loss, amenities, matched employer-employee data
    JEL: H21 H30 J63 J64
    Date: 2021–11
  12. By: Sergey Ivashchenko (The North-Western Main Branch of the Bank of Russia; The Institute of Regional Economy Studies (Russian Academy of Sciences); The Financial Research Institute); Semih Emre Cekin (Department of Economics, Turkish-German University, Istanbul, Turkey); Rangan Gupta (Department of Economics, University of Pretoria, Private Bag X20, Hatfield 0028, South Africa)
    Abstract: Recent research shows that time-varying volatility plays a crucial role in nonlinear modeling. Contributing to this literature, we suggest a DSGE-GARCH approach that allows for straight-forward computation of DSGE models with time-varying volatility. As an application of our approach, we examine the forecasting performance of the DSGE-GARCH model using Eurozone real-time data. Our findings suggest that the DSGE-GARCH approach is superior in out-of-sample forecasting performance in comparison to various other benchmarks for the forecast of inflation rates, output growth and interest rates, especially in the short term. Comparing our approach to the widely used stochastic volatility specification using in-sample forecasts, we also show that the DSGE-GARCH is superior in in-sample forecast quality and computational effciency. In addition to these results, our approach reveals interesting properties and dynamics of time-varying correlations (conditional correlations).
    Keywords: DSGE, forecasting, GARCH, stochastic volatility, conditional correlations
    JEL: C32 E30 E37
    Date: 2022–01
  13. By: Stephie Fried; David Lagakos
    Abstract: Many policymakers view power outages as a major constraint on firm productivity in developing countries. Yet empirical studies find modest short-run effects of outages on firm performance. This paper builds a dynamic macroeconomic model to study the long-run general-equilibrium effects of power outages on productivity. Outages lower productivity in the model by creating idle resources, depressing the scale of incumbent firms and reducing entry of new firms. Consistent with the empirical literature, the model predicts small short-run effects of eliminating outages. However, the long-run general-equilibrium effects are much larger, supporting the view that eliminating outages is an important development objective.
    Date: 2021
  14. By: Michael Curry; Alexander Trott; Soham Phade; Yu Bai; Stephan Zheng
    Abstract: Real economies can be seen as a sequential imperfect-information game with many heterogeneous, interacting strategic agents of various agent types, such as consumers, firms, and governments. Dynamic general equilibrium models are common economic tools to model the economic activity, interactions, and outcomes in such systems. However, existing analytical and computational methods struggle to find explicit equilibria when all agents are strategic and interact, while joint learning is unstable and challenging. Amongst others, a key reason is that the actions of one economic agent may change the reward function of another agent, e.g., a consumer's expendable income changes when firms change prices or governments change taxes. We show that multi-agent deep reinforcement learning (RL) can discover stable solutions that are epsilon-Nash equilibria for a meta-game over agent types, in economic simulations with many agents, through the use of structured learning curricula and efficient GPU-only simulation and training. Conceptually, our approach is more flexible and does not need unrealistic assumptions, e.g., market clearing, that are commonly used for analytical tractability. Our GPU implementation enables training and analyzing economies with a large number of agents within reasonable time frames, e.g., training completes within a day. We demonstrate our approach in real-business-cycle models, a representative family of DGE models, with 100 worker-consumers, 10 firms, and a government who taxes and redistributes. We validate the learned meta-game epsilon-Nash equilibria through approximate best-response analyses, show that RL policies align with economic intuitions, and that our approach is constructive, e.g., by explicitly learning a spectrum of meta-game epsilon-Nash equilibria in open RBC models.
    Date: 2022–01
  15. By: Joao Ayres (Inter-American Development Bank); Constantino Hevia (Universidad Torcuato Di Tella); Juan Pablo Nicolini (Federal Reserve Bank of Minneapolis / Universidad Torcuato Di Tella)
    Abstract: We show that explicitly modeling primary commodities in an otherwise totally standard incomplete markets open economy model can go a long way in explaining the Mussa puzzle and the Backus-Smith puzzle, two of the main puzzles in the international economics literature.
    Keywords: primary commodity prices, Mussa puzzle, Backus-Smith puzzle.
    JEL: F31 F41
    Date: 2021–10
  16. By: Florencia S. Airaudo (Universidad Carlos III); Hernán D. Seoane (Universidad Carlos III)
    Abstract: Long-run growth in Latin America over the last 50 years has been low and volatile inthe presence of frequent Sudden Stops. We develop a theory that links long-run growth,financial frictions, and Sudden Stops in Emerging countries. Our theory exploits thefact that reversals in trade balance during Sudden Stops occur through sharp declinesin imports, particularly of imported investment, rather than increases in exports. Imported investment, in turn, has a permanent impact on economic growth. We find thattrend growth deteriorates during Sudden Stops and, even though trend shocks play acrucial role, financial frictions and shocks have a significant impact on its dynamics.We apply our model to the Sudden Stops in Argentina since the 1950s and find thatfinancial crises have a strong permanent effect on the trend. Hence, to a large extent,the trend is the cycle.Long-run growth in Latin America over the last 50 years has been low and volatile inthe presence of frequent Sudden Stops. We develop a theory that links long-run growth,financial frictions, and Sudden Stops in Emerging countries. Our theory exploits thefact that reversals in trade balance during Sudden Stops occur through sharp declinesin imports, particularly of imported investment, rather than increases in exports. Imported investment, in turn, has a permanent impact on economic growth. We find thattrend growth deteriorates during Sudden Stops and, even though trend shocks play acrucial role, financial frictions and shocks have a significant impact on its dynamics.We apply our model to the Sudden Stops in Argentina since the 1950s and find thatfinancial crises have a strong permanent effect on the trend. Hence, to a large extent,the trend is the cycle.Long-run growth in Latin America over the last 50 years has been low and volatile in the presence of frequent Sudden Stops. We develop a theory that links long-run growth, financial frictions, and Sudden Stops in Emerging countries. Our theory exploits the fact that reversals in trade balance during Sudden Stops occur through sharp declines in imports, particularly of imported investment, rather than increases in exports. Imported investment, in turn, has a permanent impact on economic growth. We find that trend growth deteriorates during Sudden Stops and, even though trend shocks play a crucial role, financial frictions and shocks have a significant impact on its dynamics. We apply our model to the Sudden Stops in Argentina since the 1950s and find that financial crises have a strong permanent effect on the trend. Hence, to a large extent, the trend is the cycle.
    Keywords: Emerging markets; Real business cycle; trend shocks; Financial Frictions.
    JEL: F32 F34 F41
    Date: 2021–12
  17. By: Victor Filipe Martins da Rocha (LEDa - Laboratoire d'Economie de Dauphine - CNRS - Centre National de la Recherche Scientifique - IRD - Institut de Recherche pour le Développement - Université Paris Dauphine-PSL - PSL - Université Paris sciences et lettres, EESP - Sao Paulo School of Economics - FGV - Fundacao Getulio Vargas [Rio de Janeiro]); Rafael Mouallem Rosa (EESP - Sao Paulo School of Economics - FGV - Fundacao Getulio Vargas [Rio de Janeiro])
    Abstract: For an infinite horizon economy with complete contingent markets and bankruptcy risk, like the one studied by Araujo and Sandroni (1999) and Araujo, da Silva and Faro (2016), we show that an equilibrium may fail to exist even if agents' beliefs are homogeneous. In order to discourage agents from making promises that they know in advance they will not be able to keep, default penalties must be harsh enough. The minimum level of penalty compatible with equilibrium depends on the agents' distribution of beliefs and utility functions. When beliefs are asymptotically homogeneous, it is possible to find a uniform lower bound for the severity of the penalty. When beliefs are asymptotically singular, it is still possible to find default penalties compatible with equilibrium but they must be stochastic and unbounded in the long run. We also show how these positive results depend crucially on the interpretation of default penalties. In particular, if we consider explicit economic punishments, similar to those in Kehoe and Levine (1993), then an equilibrium never exists, even if agents' beliefs are homogeneous.
    Date: 2022
  18. By: Konstantinos Angelopoulos; Spyridon Lazarakis; Rebecca Mancy; Max Schroeder
    Abstract: The main waves of a pandemic and subsequent disease outbreaks in the following years influence the evolution of the distributions of health and wealth, leading to differences in the ability to mitigate future income shocks. We study consumption smoothing and precautionary behaviour associated with the main pandemic waves and recurrent outbreak risk in a model in which health and wealth are jointly determined under income and health risk that are related to disease outbreak risk. We calibrate the model to the UK and find that the impact shock of COVID-19 and recurrent outbreak risk amplify existing inequalities in wealth and health, implying persistent increases in wealth inequality that are characterised by increases in wealth for households in higher income groups and/or with higher initial wealth, and decreases for those in lower income groups and/or with lower wealth. These changes lead to inequality in exposure to post-pandemic income risk and, in particular, an increase in the vulnerability of those already with very little wealth prior to the pandemic. We assess public insurance policy to mitigate income losses for those with low wealth and find that, by disincentivising wealth accumulation and incentivising investment in health for those with low wealth and health, it reduces health inequality and, in the short run, the probability of low consumption, but increases wealth inequality and, in the medium run, the probability of low consumption.
    Keywords: pandemics, outbreak risk, wealth inequality, health inequality, risk exposure
    JEL: E21 D31 I14 D15 E62
    Date: 2021
  19. By: Punnoose Jacob; Murat Özbilgin
    Abstract: In March 2019, the Reserve Bank of New Zealand was entrusted with a new employment stabilisation objective, that complements its traditional price-stability mandate. Against this backdrop, we assess whether the central bank’s stronger emphasis on the stabilisation of employment, and more broadly, resource utilisation, enhances social welfare. We calibrate an open-economy growth model to New Zealand data. In a second order approximation of the model, we evaluate how lifetime household utility is affected by a wide range of simple and implementable monetary policy rules that target both inflation and resource utilisation. We find that additionally stabilising resource utilisation always improves social welfare at any given level of inflation stabilisation. However, the welfare gains from stabilising resource utilisation get milder as the central bank is increasingly sensitive to inflation.
    Keywords: Optimal simple rules, welfare analysis, monetary policy, dual mandate
    JEL: F41 E52
    Date: 2021–10
  20. By: Tomohiro HIRANO; Joseph E. Stiglitz
    Abstract: This paper develops a model providing a markedly different picture of the dynamics of capitalism from the standard model with infinitely lived individuals with rational expectations. Using the standard life-cycle model with production, we show that under not implausible conditions, we show that starting from any initial conditions, there can be a plethora of rational expectations dynamics, including wobbly macro-dynamics i.e. the macroeconomy can bounce around infinitely without converging depending on peoples beliefs without regular periodicity. As a result, laissez-faire market economies can be plagued by repeated periods of instabilities, inefficiencies, and unemployment. The characteristics associated with wobbly dynamics is that the state of the economy endogenously changes from a state with a unique momentary equilibrium into a state with multiple momentary equilibria, or vice versa, which we call a phase transition. Depending on how phase transitions occur, various patterns of wobbly dynamics can occur. We identify all possible patterns of dynamics (e.g. unique and multiple, stable and unstable, steady states, with or without wobbly dynamics), providing a complete characterization of the parameter values under which each may occur. Moreover, we provide a complete analytic representation of all the possible state transitions, i.e. how a change in some key parameter changes abruptly the set of feasible global dynamics. In some cases, if a stable high output (an economic boom) benefits from an above trend temporary productivity increase, there is a state transition from a stable regime to an unstable one. The economy enters into a situation where there are multiple equilibria, with the boom now being unstable, leading to the possibility of a large-scale collapse; the economy can enter a stagnation trap characterized by involuntary unemployment. In other cases, an increase in productivity shifts the economy from the economy from the stable boom to a completely wobbly economy in which the economy endogenously fluctuates in both full-employment and involuntary unemployment regions. Thus, the economy can exhibit long run hysteresis effects. There are government interventions which can stabilize the economy and increase societal welfare.
    Date: 2021–12
  21. By: Ruediger Bachmann; Isabel Gödl-Hanisch; Eric R. Sims
    Abstract: We identify monetary policy shocks by exploiting variation in the central bank’s information set. To be specific, we use differences between nowcasts of the output gap and inflation with final, revised estimates of these series to isolate movements in the policy rate unrelated to economic conditions. We then compute the effects of a monetary policy shock on the aggregate economy using local projection methods. We find that a contractionary monetary policy shock has a limited negative effect on output but a persistent negative impact on prices. In contrast to alternative identification approaches, we do not observe a price puzzle when analyzing the period from 1987 to 2008. Further, we validate the identification approach in a simple New Keynesian model, augmented by the assumption that the central bank observes the ingredients of the Taylor rule with error.
    JEL: E31 E52 E58
    Date: 2021–12
  22. By: Karel Musil; Stanislav Tvrz; Jan Vlcek
    Abstract: The paper deals with the treatment of shocks in central banks' forecasts. Within the rational expectations (RE) concept, which is widely used in structural macroeconomic models, the paper highlights the differences between news and surprise shocks and argues that most shocks in central bank forecasts should be treated as news. The paper also points out some drawbacks of news shocks under the assumption of full information from the practical point of view of forecasting and policy decision-making at central banks. As a potential solution, the paper refers to the LIRE concept as introduced in Brazdik et al. (2020). The paper discusses the properties of the LIRE concept and finds it versatile and useful in dealing with news shocks without abandoning the RE framework. The paper concludes that LIRE can be effectively used for practical structural macroeconomic modelling.
    Keywords: Anticipated shocks, conditional forecast, DSGE models, rational expectations
    JEL: D58 D84 E37 E52
    Date: 2021–12
  23. By: Tomohiro HIRANO; Joseph E. Stiglitz
    Abstract: This paper examines the global macro-dynamics of a dynamic model with capital and land with rational expectations. Through the interactions between capital accumulation and land prices, the economy experiences phase transitions, endogenously moving from back and forth from situations with unique and multiple momentary equilibria. Consequently, there can be a plethora of rational expectation equilibria trajectories, without any smooth convergence properties, neither converging to a steady state or even to a limit cycle—what we call wobbly macro-dynamics. The price of land and other key macro variables (wages, interest rates, output, consumption, wealth, capital stock) endogenously fluctuate within a well-identified range with boom-bust cycles repeatedly. The key disturbance to the economy is endogenous; even with rational expectations, there can be real estate booms, with resource allocation deteriorating as land prices increase, crowding out productive investments; but such unsustainable land price booms inevitably are followed by a crash. We analyze the set of parameter values for which wobbly fluctuations occur, show that with some parameter values, the only r.e. trajectories involve such wobbly dynamics, demonstrate how changes in parameters affect global macro-dynamics, and show how policy interventions can affect stability and social welfare.
    Date: 2021–12

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