nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2022‒03‒28
eighteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. A DSGE model with partial euroization: the case of the Macedonian economy By Mihai Copaciu; Joana Madjoska; Mite Miteski
  2. Student Debt, College Cost, and Wage Inequality By Heejeong Kim; Jung Hwan Kim
  3. Inflationary Redistribution, Trading Opportunities and Consumption Inequality By Timothy Kam; Junsang Lee
  4. The Dispersion of Mark-ups in an Open Economy By Stéphane Auray; Aurélien Eyquem
  5. (In)Efficient Commuting And Migration Choices: Theory And Policy In An Urban Search Model By Luca Marchiori; Julien Pascal; Olivier Pierrard
  6. Environment, public debt and epidemics * By Marion Davin; Mouez Fodha; Thomas Seegmuller
  7. Robustly optimal monetary policy in a behavioral environment By Lahcen Bounader; Guido Traficante
  8. Household Income, Liquidity, and Optimal Unemployment Insurance By Stéphane Auray; David L. Fuller; Nicolas Lepage-Saucier
  9. Financial Transaction Tax, macroeconomic effects and tax competition issues: a two-country financial DSGE model By Olivier Damette; Karolina Sobczak; Thierry Betti
  10. To Comply or not to Comply: Persistent Heterogeneity in Tax Compliance and Macroeconomic Dynamics By Leonardo Barros Torres; Jaylson Jair da Silveira, Gilberto Tadeu Lima
  11. Why women work the way they do in Japan: Roles of fiscal policies By Sagiri Kitao; Minamo Mikoshiba
  12. Planning and saving for retirement By Sulka, Tomasz
  13. Asymmetric Information and Sovereign Debt Disclosure By Bulent Guler; Yasin Kursat Onder; Temel Taskin
  14. Risk Appetite Fluctuations in the Insurance Industry By Elisa Luciano; Jean Charles Rochet
  15. Housing, Distribution and Welfare By Nobuhiro Kiyotaki; Alexander Michaelides; Kalin Nikolov
  16. Designing “Win-Win” Rate Caps By Gajendran Raveendranathan; Georgios Stefanidis
  17. Trade Wars, Currency Wars By Stéphane Auray; Michael B. Devereux; Aurélien Eyquem
  18. The Emergence of Market Structure By Maryam Farboodi; Gregor Jarosch; Robert Shimer

  1. By: Mihai Copaciu (National Bank of Romania); Joana Madjoska; Mite Miteski (National Bank of the Republic of North Macedonia)
    Abstract: This paper describes the theoretical structure and estimation results for a DSGE model for the Macedonian economy. Having as benchmark the model of Copaciu et al. (2015), modified to allow for a fixed exchange rate, we are able to match relatively well the volatility observed in the data. Given the monetary policy regime in place, the debt deflation channel is more important relative to the financial accelerator one when compared to the flexible exchange rate case. The lack of balance sheet effects results in no significant differences in terms of net worth evolution across the two types of entrepreneurs when impulse response functions are evaluated. However, the shocks related to the financial sector appear to be especially important for investment, for the domestic interest rate and interest rate spreads, illustrating the relevance of including financial frictions in the model. With the exchange rate not acting as a shock absorber, the external shocks are more relevant for the CPI inflation and the domestic interest rate. The drop in GDP associated with the pandemic mainly reflects the negative innovations to the consumption preference shock and to the permanent technology shock.
    Keywords: DSGE model, Financial frictions, Partial euroization, Small open economy, Bayesian estimation
    JEL: E0 E3 F0 F4 G0 G1
    Date: 2022
  2. By: Heejeong Kim (Concordia University); Jung Hwan Kim (Concordia University)
    Abstract: We study the quantitative effects of rising college costs and wage inequality on the rising student debt in the U.S. We build an incomplete-markets overlapping-generation (OLG) model with a discrete college education choice, student debt, and a delinquency choice. Solving transitional dynamics with the estimated increase in college costs and wage inequality, we find that these sources can explain 50 percent of the observed increase in student debt in the U.S. since 1979. Importantly, the rising college cost and wage inequality explain changes in college choices and borrowing behavior over time, successfully accounting for the dynamics of student debt held by individuals under age 30. College cost is the critical determinant for the borrowing behavior of college students and thus for the rising student debt, while wage inequality is crucial for the college choice. Lastly, we find that the increasing wage inequality is welfare-improving for college graduates, but they experience significant welfare losses from the increased college cost. In net, students entering colleges in 2015 enjoy the welfare gain of 3 percent of lifetime consumption.
    Keywords: Student Debt, College Cost, College Choice, Wage Inequality
    Date: 2022–02
  3. By: Timothy Kam; Junsang Lee
    Abstract: We study competitive search in goods markets in a heterogeneous-agent monetary model. The model accounts for three stylized facts connecting inflation to consumption inequality, to price dispersion, and to the speed of monetary payments. With competitive search, individuals’ endogenous probabilities on trading events give rise to a trading-opportunity (extensive-margin) force that works in opposite direction to well-known redistributive (intensive-margin) effect of inflation. This implies a new trade-off in response to long-run inflation targets. Welfare falls but liquid-wealth inequality falls and then rises with inflation as an extensive margin of trade dominates the redistributive intensive margin, when inflation is sufficiently high.
    Keywords: Competitive Search; Inflation; Policy Trade-offs; Redistribution; Computational Geometry
    JEL: E0 E4 E5 E6 C6
    Date: 2022–03
  4. By: Stéphane Auray (CREST-Ensai and ULCO, France); Aurélien Eyquem (Université Lumière Lyon2, France)
    Abstract: We introduce heterogeneous mark-ups through Bertrand competition in a two-country model with endogenous firms' entry and tradability à la Ghironi and Melitz (2005). Bertrand competition generates a distribution of mark-ups according to which firms that are larger and more productive charge lower prices, attract larger market shares and extract larger mark-ups. First, we characterize first-best allocations and their implementation. We find that they are independent from the degree of mark-ups' heterogeneity, suppress the dispersion of mark-ups and imply zero distortions on labor as well as substantial subsidies to preserve firm's incentives to enter. Second, second-best alternative policies with a restricted number ofi nstruments and a balanced budget significantly reduce the potential welfare gains from fiscal policies. Third, the total welfare losses from passive policies are lower under heterogeneous mark-ups than under homogeneous mark-ups: while th edispersion of mark-ups has negative effects on the intensive margin, output per firm, it also raises expected profits for potential entrants and raises the extensive margin, the number of firms in both domestic and export markets, pushing them closer to their efficient levels. Fourth, we also investigate the dynamic properties of allocations under passive and optimal policies considering aggregate productivity shocks and trade liberalization experiments.
    Keywords: Heterogeneous firms, Endogenous Entry, Open economy, Strategic pricing, Optimal taxation
    JEL: D4 E20 E32
    Date: 2021–06–15
  5. By: Luca Marchiori (Banque centrale du Luxembourg, Département Économie et Recherche); Julien Pascal (Banque centrale du Luxembourg, Département Économie et Recherche); Olivier Pierrard (Banque centrale du Luxembourg, Département Économie et Recherche)
    Abstract: We develop a monocentric urban search-and-matching model in which workers can choose to commute or to migrate within the region. The equilibrium endogenously allocates the population into three categories: migrants (relocate from their hometown to the city), commuters (traveling to work in the city) and home stayers (remaining in their hometown). We prove that the market equilibrium is usually not optimal: a composition externality may generate under- or over-migration with respect to the central planner’s solution, which in all cases results in under-investment in job vacancies and therefore production. We calibrate the model to the Greater Paris area to reproduce several gradients observed in the data, suggesting over-migration. We show how policy interventions can help to reduce inefficiencies.
    Keywords: Migration, Commuting, Urban search-and-matching, Efficiency, Policy
    JEL: E24 J68 R13 R23
    Date: 2022–03–18
  6. By: Marion Davin (CEE-M - Centre d'Economie de l'Environnement - Montpellier - UMR 5211 - UM - Université de Montpellier - CNRS - Centre National de la Recherche Scientifique - Montpellier SupAgro - Institut national d’études supérieures agronomiques de Montpellier - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement); Mouez Fodha (CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Thomas Seegmuller (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 study whether fiscal policies, especially public debt, can help to curb the macroeconomic and health consequences of epidemics. Our approach is based on three main features: we introduce the dynamics of epidemics in an overlapping generations model to take into account that old people are more vulnerable; people are more easily infected when pollution is high; public spending in health care and public debt can be used to tackle the effects of epidemics. We show that fiscal policies can promote convergence to a stable disease-free steady state. When public policies are not able to permanently eradicate the epidemic, public debt, and income transfers could reduce the number of infected people and increase capital and GDP per capita. As a prerequisite, pollution intensity should not be too high. Finally, we define a household subsidy policy that eliminates income and welfare inequalities between healthy and infected individuals.
    Keywords: public debt,overlapping generations,pollution,Epidemics
    Date: 2021–12–06
  7. By: Lahcen Bounader (International Monetary Fund); Guido Traficante (European University of Rome)
    Abstract: This paper studies robustly optimal monetary policy in a behavioral New Keynesian model, where the private sector has myopia, while the central bank has Knightian uncertainty about the degree of myopia of the private sector and the degree of price stickiness. In such a setup the central bank solves an optimal robust monetary policy problem. We show that under uncertainty in myopia the Brainard’s attenuation principle holds, while under uncertainty on price stickiness, alone or in addition to myopia, monetary policy becomes more aggressive.
    Keywords: Optimal monetary policy, bounded rationality, min- max, parameter uncertainty
    JEL: E
    Date: 2022
  8. By: Stéphane Auray (CREST-Ensai and ULCO, France); David L. Fuller (University of Wisconsin-Oshkosh, USA); Nicolas Lepage-Saucier (Toulouse School of Economics, France)
    Abstract: We examine the optimal provision of unemployment insurance (UI) benefits in a directed search model with matching frictions. Workers have differing levels of liquidity to smooth consumption during an unemployment spell. The model allows workers to choose between paying a fixed cost to collect the government provided UI benefits, or to forgo this scheme. Non-collectors do not receive liquid UI benefits, but do experience a shorter expected unemployment duration. Using data from the SIPP and a Mixed Proportional Hazard (MPH) model, we estimate jointly the decision to collect UI benefits and the risk of going back to work, which yields several novel results with policy implications. Households with lower liquidity are less likely to opt into the government UI scheme, as the need to find a job quickly outweighs the short-lived liquidity provided by UI benefits. The MPH estimation also finds that collecting benefits significantly lengthens the duration of unemployment. The model is calibrated to the empirical results. The optimal policy in the calibrated economy features a relatively high replacement rate and short potential duration.
    Keywords: unemployment insurance, liquidity, moral hazard, search, calibration
    JEL: E61 J32 J64 J65
    Date: 2021–09–17
  9. By: Olivier Damette; Karolina Sobczak; Thierry Betti
    Abstract: We document how introducing a financial transaction tax affects real and financial activity in a general equilibrium framework. Our model replicates some interesting stylised facts about financial markets. Informed, or rational, traders follow the standard rational expectations, while exogenous disturbances, such as optimism or pessimism shocks, affect the expectations of noise traders. An entry cost is introduced to endogenise the entry of noise traders in the financial markets. In contrast to the previous literature, financial contagion and international spillovers are considered in a two-country financial DSGE model. A welfare analysis is performed and we show that the effects of the financial transaction tax on welfare are non-linear and mainly depend on the composition of the financial market. In addition, introducing a financial transaction tax allows volatility to be reduced in both the real and financial sectors, and this result is robust to several model specifications. In a context where only one country implements the tax, we identify some externalities, as the country with the tax is likely to export stability or instability through the flows of traders. Like in the Heckscher-Ohlin-Samuelson (HOS) model in which capital and labor move internationally when countries trade, we assume that there are trader flows when traders invest abroad. As a consequence, noise traders can implicitly move to the foreign country to escape the tax, and this means that countries have conflicting interests. When markets are liquid with a large proportion of noise traders, countries do not internalise that they export noise traders and then some instability to the other market and so they set a tax rate that is higher than the optimal. At the opposite end of the scale, when markets are less liquid and the proportion of noise traders is small, some positive externalities (like financial stability) are overlooked, and so the tax rate is set too low and is sub-optimal. A cooperative situation where countries set a common tax rate is the best solution ans is welfare-enhancing. These results have important policy implications, since the existence of the tax competition issues revealed by our two-country framework might explain why the European Commission proposal initially discussed in 2011 is so contested and has been rejected by several countries.
    Keywords: Financial Transaction Tax, DSGE, Welfare, Noise Traders, Tax coordination, EU tax project.
    JEL: E22 E44 E62
    Date: 2022–03–24
  10. By: Leonardo Barros Torres; Jaylson Jair da Silveira, Gilberto Tadeu Lima
    Abstract: We set forth an overlapping generations model in which the microdynamics of tax compliance is coupled to the macrodynamics of the economy. We specify the proportion of individuals who do not comply with their tax obligations as endogenously time-varying using the discrete choice approach, which allows considering both deterministic components and idiosyncratically subjective motivations and proclivities (such as tax morale) as drivers of tax compliance. The model replicates (and hence provides an analytical framework for a potential interpretation of) some pieces of evidence on tax evasion. First, heterogeneity in tax compliance exhibits persistence and fluctuations over the long run. Second, the proportion of non-compliant taxpayers varies positively with the tax rate and negatively with the probability of detection of tax evaders. Third, the impact of a change in the proportion of non-compliant taxpayers on the per capita output over the long run is ambiguous.
    Keywords: Tax compliance; discrete choice modeling; tax morale; heterogeneous behavior; macrodynamics
    JEL: H62 H40 C02 C62 E13
    Date: 2022–03–22
  11. By: Sagiri Kitao; Minamo Mikoshiba
    Abstract: Women work less often and earn significantly less than men in Japan. We use panel data to investigate employment and earnings dynamics of single and married women over the life-cycle and build a structural model to study the roles of fiscal policies in accounting for their behavior. We show that eliminating spousal deductions, social insurance premium exemptions and survivors’ pension benefits for low-income spouses would significantly raise the labor supply of women and their earnings. More women would opt for regular jobs rather than contingent jobs, accumulate more human capital, and enjoy higher income growth. The government would earn higher net revenues and there is a welfare gain when additional taxes are transferred back.
    Keywords: Female labor force participation, life-cycle, human capital accumulation, spousal deductions and exemptions, survivors’ benefits, two-tiered employment system, Japan
    JEL: D15 H2 H31 J22 J24
    Date: 2022–03
  12. By: Sulka, Tomasz
    Abstract: Planning for retirement and subsequent execution of the plan are difficult, but essential for financial security in old age. To formally analyse the interplay between planning and self-control, I introduce cognitive costs of formulating a plan into the dual-self model of impulse control. The resulting model can generate rational inaction in pension choices, with the agent's self-control and level of income playing a role of inputs into the decision whether or not to undertake costly planning. Furthermore, when they do plan, agents characterised by poor self-control save over shorter horizons and accumulate lower pension wealth. The possibility of rational inaction can explain other robustly observed behaviours, such as disproportionately low savings of individuals on low incomes and non-fungibility between public and private pension wealth. The model is applied to study welfare and savings implications of automatic enrolment into private pensions. The default option effect on plan participation arises due to the fact that counterfactual non-savers have the lowest threshold for accepting the default scheme. Nevertheless, the impact of automatic enrolment on total savings is ambiguous in general, because in addition to the counterfactual non-savers, the default may anchor contributions of a counterfactual active saver to a low default contribution rate. Consequently, although raising the default contribution rate itself has an ambiguous impact on aggregate savings, it always reduces the dispersion in pension wealth accumulation.
    Keywords: Planning,Self-Control,Cognitive Costs,Pensions,Automatic Enrolment
    JEL: D14 D15 D91 E21 E71 H55 J32
    Date: 2022
  13. By: Bulent Guler (Indiana University Bloomington); Yasin Kursat Onder (Ghent University); Temel Taskin (Bank of Canada)
    Abstract: This paper studies sovereign debt and default dynamics under alternative disclosure arrangements in a sovereign default model incorporated with asymmetric information and long-term debt. Government is assumed to have access to both international bond financing and non-Paris club lending (a hidden and collateralized debt). Our results show that with a shift from partial disclosure to full disclosure regime governments can borrow at more favorable terms conditional on the same levels of debt and income. However, due to lack of commitment, favorable bond prices encourage governments to borrow more and experience higher default rates in the long-run equilibrium of the full disclosure regime. As a result, the switch from partial disclosure to full disclosure generates small welfare losses contrary to conventional wisdom.
    Keywords: Hidden debt, Sovereign debt, Sovereign default, Collateralized debt, Asymmetric information, Debt disclosure
    Date: 2022–03
  14. By: Elisa Luciano; Jean Charles Rochet
    Abstract: The risk appetite of insurance companies fluctuates over time in a quasi cyclical fashion. When their capitalization is high (low), companies choose portfolios with a high (small) share of risky assets. We show that this phenomenon may have the same source as the un derwriting cycle, namely recapitalization costs. We build a simple dynamic model of the insurance sector where financial frictions prevent companies from maintaining a target leverage. Portfolio decisions of insurers fluctuate with their aggregate capitalization. The model rationalizes two apparently disjoint pieces of evidence: long-standing empirical evidence on underwriting cycles and more recent evidence on the fluctuations of insurance companies’ risk appetite
    Keywords: endogenous risk appetite, macro finance, insurance cycles, insurance asset allocation
    Date: 2021
  15. By: Nobuhiro Kiyotaki (Princeton University); Alexander Michaelides (Imperial College London); Kalin Nikolov (European Central Bank)
    Abstract: Housing is a long-lived asset whose value is sensitive to variations in long-term growth and interest rates. When a large fraction of the population is leveraged, housing price fluctuations cause large-scale redistribution and consumption volatility. We examine policies to mitigate the impact of housing fluctuations on vulnerable households. We find that the most practical way to insure the young and the poor from the housing cycle is through a well-functioning rental market. In practice, home-ownership subsidies keep the rental market small and the housing cycle affects aggregate consumption. Removing home-ownership subsidies hurts older home-owners, while leverage limits hurt younger home-owners.
    Keywords: Housing prices, credit constraints, distribution, rental markets, welfare
    JEL: D15 D58 E02 E21
    Date: 2020–04
  16. By: Gajendran Raveendranathan; Georgios Stefanidis
    Abstract: We show how a rate cap can be designed to improve both consumer and lender welfare in the credit card market. We analyze transition paths resulting from different rate caps in a model with revolving credit lines, search frictions, and lender market power. Our analysis shows that if a rate cap only applies to new credit card issuance and not existing accounts, it can improve lender welfare. Incumbent lenders benefit because they can retain their customers for a longer time. New issuers are not affected as long as the posting of credit offers is competitive (zero expected profits in equilibrium). Consumers benefit because of lower interest rates. The rate cap that maximizes consumer welfare leads to gains to consumers and lenders that are equivalent to a onetime transfer worth 0.44 percent of disposable income. The gains to consumers amount to 73 percent of the value of credit access.
    Keywords: revolving credit; credit search; rate cap; welfare
    JEL: E21 E44 E65 G28 G50
    Date: 2022–03
  17. By: Stéphane Auray (CREST-Ensai and Université du Littoral Côte d’Opale, France); Michael B. Devereux (Vancouver School of Economics, University of British Columbia, Canada); Aurélien Eyquem (Université Lumière Lyon2, France)
    Abstract: Countries distort trade patterns (‘trade wars’) to gain strategic advantage relative to one another. At the same time, monetary policies are set independently and have spillover effects on partner countries (‘currency wars’). We combine these two scenarios, and show that they interact in deep and interesting ways. The stance of monetary policy has substantial effects on the equilibrium degree of protection in a Nash equilibrium of the monetary and trade policy game. Trade wars lead to higher equilibrium inflation rates. Cooperation in monetary policy leads to both higher inflation and greater degree of trade protection. By contrast, when monetary policy is constrained by pegged exchange rates or the zero lower bound on interest rates, equilibrium tariffs are lower. Finally, when one country has the dominant currency in trade, it gains a large advantage in a trade war.
    Keywords: Protectionism, Currency Wars, Trade Wars
    JEL: F30 F40 F41
    Date: 2021–09–19
  18. By: Maryam Farboodi (MIT); Gregor Jarosch (Princeton University); Robert Shimer (University of Chicago)
    Abstract: What market structure emerges when market participants can choose the rate at which they contact others? We show that traders who choose a higher contact rate emerge as intermediaries, earning profits by taking asset positions that are misaligned with their preferences. Some of them, middlemen, are in constant contact with other traders and so pass on their position immediately. As search costs vanish, traders still make dispersed investments and trade occurs in intermediation chains, so the economy does not converge to a centralized market. When search costs are a differentiable function of the contact rate, the endogenous distribution of contact rates has no mass points. When the function is weakly convex, faster traders are misaligned more frequently than slower traders. When the function is linear, the contact rate distribution has a Pareto tail with parameter 2 and middlemen emerge endogenously. These features arise not only in the (inefficient) equilibrium allocation, but also in the optimal allocation. Moreover, we show that intermediation is key to the emergence of the rest of the properties of this market structure.
    Keywords: Over-the-Counter Markets, Intermediation, Middlemen, Random Matching, Endogenous Search Intensity, Network Formation, Pareto Distribution, Welfare
    JEL: E44 G12 G20
    Date: 2020–05

This nep-dge issue is ©2022 by Christian Zimmermann. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.