nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2022‒04‒25
twenty-two papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. A Tractable Overlapping Generations Structure for Quantitative DSGE Models By Kollmann, Robert
  2. Unemployment insurance and labour productivity over the business cycle By Rujiwattanapong, W. Similan
  3. Computers, Programming and Dynamic General Equilibrium Macroeconomic Modeling By Bongers, Anelí; Molinari, Benedetto; Torres, José L.
  4. Disinflation Costs and Macroprudential Policies: Real and Welfare Effects By Busato, Francesco; Ferrara, Maria; Varlese, Monica
  5. Existence and uniqueness of solutions to dynamic models with occasionally binding constraints By Holden, Tom D.
  6. An Augmented Steady-State Kalman Filter to Evaluate the Likelihood of Linear and Time-Invariant State-Space Models By Johannes Huber
  7. Liquidity constraints and fiscal multipliers By Sá, Diogo
  8. Estimation of a Life-Cycle Model with Human Capital, Labor Supply and Retirement By Xiaodong Fan; Ananth Seshadri; Christopher R. Taber
  9. Globalization, trade imbalances and labor market adjustment By Dix-Carneiro, Rafael; Pessoa, João Paulo; Reyes-Heroles, Ricardo; Traiberman, Sharon
  10. Asset Prices and Unemployment Fluctuations: A Resolution of the Unemployment Volatility Puzzle By Patrick J. Kehoe; Pierlauro Lopez; Virgiliu Midrigan; Elena Pastorino
  11. Minimum Wages, Efficiency and Welfare By David W. Berger; Kyle F. Herkenhoff; Simon Mongey
  12. Consumption Heterogeneity and Monetary Policy in an Open Economy By Sihao Chen; Michael B. Devereux; Kang Shi; Jenny Xu
  13. The Wobbly Economy: Global Dynamics with Phase and State Transitions By Tomohiro Hirano; Joseph E. Stiglitz
  14. Consumption and Saving after Retirement By Bent Jesper Christensen; Malene Kallestrup-Lamb; John Kennan
  15. Progressing Towards Efficiency: The Role for Labor Tax Progression in Reforming Social Security By Makarski, Krzysztof; Tyrowicz, Joanna; Komada, Oliwia
  16. Risk Aversion and Recessive Impacts of Austerity By Vaz de Castro, Afonso
  17. Tax policies, informality, and real wage rigidities By Salazar, M.
  18. Oil price shocks, government revenues and public investment: The case of Ecuador By Díaz-Kovalenko, Igor E.; Torres, José L.
  19. Two Types of Asset Bubbles in a Small Open Economy By Takashi Kamihigashi; Ryonghun Im
  20. The effect of a carbon tax rise on Iceland’s economy By Hansjörg Blöchliger; Sigurdur Johannesson; Marias Halldor Gestsson
  21. FinTech Lending, Social Networks and the Transmission of Monetary Policy By Xiaoqing Zhou
  22. Optimal Nonlinear Savings Taxation By Brendon, C.

  1. By: Kollmann, Robert
    Abstract: This paper develops a novel tractable overlapping generations (OLG) structure that is suitable for use in rich quantitative dynamic stochastic general equilibrium (DSGE) models. The OLG structure assumes that newborn agents receive a wealth transfer such that that their equilibrium consumption represents a time-invariant share of aggregate consumption. Under efficient risk sharing across contemporaneous cohorts, this implies that aggregate consumption obeys a (quasi-)Euler equation that is isomorphic to the Euler equation of an infinitely-lived representative agent. As a result, DSGE models, with the proposed OLG structure, can be solved as conveniently as standard DSGE models with infinitely-lived representative agents. The great tractability of the OLG structure here constitutes an important advantage over conventional OLG models, especially when agents are long-lived. While highly tractable, the present OLG structure maintains key predictions of standard OLG models, namely the possibility of low (even negative) real interest rates and of equilibrium indeterminacy.
    Keywords: overlapping generations; dynamic stochastic general equilibrium models; Euler equation; subjective discount factor; transversality condition; multiple equilibria.
    JEL: C6 E1 E3
    Date: 2022–03–27
  2. By: Rujiwattanapong, W. Similan
    Abstract: This paper quantifies the effects of the increasing maximum unemployment insurance (UI) duration during recessions on the drop in the correlation between output and labour productivity in the U.S. since the early 1980s – the so-called productivity puzzle. Using a general equilibrium search and matching model with stochastic UI duration, heterogeneous match quality, variable search intensity and on-the-job search, I demonstrate that the model can explain over 40 percent of the drop in this correlation (28 percent when the Great Moderation is taken into account). More generous UI extensions during recent recessions cause workers to be more selective with job offers and lower job search effort. The former channel raises the overall productivity in bad times. The latter prolongs UI extensions since in the U.S. they are triggered by high unemployment.
    Keywords: business cycles; labour productivity; match quality; search and matching; unemployment insurance
    JEL: E24 E32 J24 J64 J65
    Date: 2021–09–15
  3. By: Bongers, Anelí; Molinari, Benedetto; Torres, José L.
    Abstract: Dynamic stochastic general equilibrium (DSGE) models nowadays undertake the bulk of macroeconomic analysis. Their widespread use during the last 40 years reflects their usefulness as a scientific laboratory in which to study the aggregate economy and its responses to different shocks, to carry out counterfactual experiments and to perform policy evaluation. A key characteristic of DSGE models is that their computation is numerical and requires intensive computational power and the handling of numerical methods. In fact, the main advances in macroeconomic modeling since the 1980s have been possible only because of the increasing computational power of computers, which has supported the expansion of DSGE models as more and more accurate reproductions of the actual economy, thus becoming the prevailing modeling strategy and the dominant paradigm in contemporaneous macroeconomics. Along with DSGE models, specific computer languages have been developed to facilitate simulations, estimations and comparisons of the aggregate economies represented by DSGE models. Knowledge of these languages, together with expertise in programming and computers, has become an essential part of the profession for macroeconomists at both the academic and the professional level.
    Keywords: Dynamic stochastic general equilibrium models; Computers; Programming languages; Codes; Computational economics; Dynare.
    JEL: C61 C63 C88 E37
    Date: 2022–03–22
  4. By: Busato, Francesco; Ferrara, Maria; Varlese, Monica
    Abstract: This paper investigates the costs of disinflation in an otherwise standard DSGE model with borrowing constraints and credit frictions, augmented with macroprudential authority. Analyzing the real and welfare effects of a permanent change in the inflation rate, we study the role of macroprudential policy and its interaction with monetary policy in ensuring financial stability. Results show that when macroprudential authority intervenes actively in order to improve financial stability, disinflation costs are limited. As for the welfare effects, disinflation is welfare improving for savers but welfare costly for borrowers and banks.
    Keywords: Disinflation, Macroprudential policy, Loan-to-value ratio, Monetary policy, Sacrifice ratio, Welfare effects
    JEL: D60 E44 E58
    Date: 2022–02–28
  5. By: Holden, Tom D.
    Abstract: Occasionally binding constraints (OBCs) like the zero lower bound (ZLB) can lead to multiple equilibria, and so to belief-driven recessions. To aid in finding policies that avoid this, we derive existence and uniqueness conditions for otherwise linear models with OBCs. Our main result gives necessary and sufficient conditions for such models to have a unique ('determinate') perfect foresight solution returning to a given steady state, for any initial condition. While standard New Keynesian models have multiple perfect-foresight paths eventually escaping the ZLB, price level targeting restores uniqueness. We also derive equilibrium existence conditions under rational expectations for arbitrary non-linear models.
    Keywords: occasionally binding constraints,zero lower bound,determinacy,existence,uniqueness,price level targeting
    JEL: C62 E3 E4 E5
    Date: 2022
  6. By: Johannes Huber (University of Augsburg, Department of Economics)
    Abstract: We propose a modified version of the augmented Kalman filter (AKF) to evaluate the likelihood of linear and time-invariant state-space models (SSMs). Unlike the regular AKF, this augmented steady-state Kalman filter (ASKF), as we call it, is based on a steady-state Kalman filter (SKF). We show that to apply the ASKF, it is sufficient that the SSM at hand is stationary. We find that the ASKF can significantly reduce the computational burden to evaluate the likelihood of medium- to large-scale SSMs, making it particularly useful to estimate dynamic stochastic general equilibrium (DSGE) models and dynamic factor models. Tests using a medium-scale DSGE model, namely the 2007 version of the Smets and Wouters model, show that the ASKF is up to five times faster than the regular Kalman filter (KF). Other competing algorithms, such as the Chandrasekhar recursion (CR) or a univariate treatment of multivariate observation vectors (UKF), are also outperformed by the ASKF in terms of computational efficiency.
    Keywords: kalman filter, dsge, bayesian estimation, maximum-likelihood estimation, computational techniques
    JEL: C18 C63 E20
    Date: 2022–04
  7. By: Sá, Diogo
    Abstract: Although recent studies identified the percentage of constrained agents as the crucial force driving many fiscal policy mechanisms, the values attained were purely the result of model calibrations. We make use of household-level data to estimate the fraction of hand-to-mouth households for several European countries. We calibrate an overlapping generations model with heterogeneous agents to match the net liquid wealth distribution and study the impact of credit constraints on the effectiveness of fiscal consolidation policies. Our findings suggest that the share of hand-to-mouth agents is no longer quantitatively relevant to explain the cross-country heterogeneity in fiscal multipliers when we calibrate the model to match empirically plausible estimates of that share. These results may be driven by the characteristics of the model we employ, which excludes the wealthy hand-to-mouth.
    Keywords: Fiscal Multipliers, Liquidity Constraints, Fiscal Consolidation, Hand-to-Mouth
    JEL: D31 E21 E62 H31
    Date: 2022–01
  8. By: Xiaodong Fan; Ananth Seshadri; Christopher R. Taber
    Abstract: We develop and estimate a life-cycle model in which individuals make decisions about consumption, human capital investment, and labor supply and use it to analyze changes in Social Security rules. The most important aspect of our paper is human capital towards the end of the life cycle which responds to changes in the rules. Retirement arises endogenously as part of the labor supply decision. The model allows for both an endogenous wage process through human capital investment (which is typically assumed exogenous in the retirement literature), an endogenous retirement decision (which is typically assumed exogenous in the human capital literature), and accounts for the Social Security system. We estimate the model using indirect inference to match the life-cycle profiles of employment and measured wages from the SIPP data. The model replicates the main features of the data—in particular the large increase in measured wages and small increase in labor supply at the beginning of the life cycle as well as the small decrease in measured wages but large decrease in labor supply at the end of the life cycle. We use the model to estimate the effects of various changes to tax and Social Security policies and show that allowing for human capital accumulation is critical.
    JEL: J22 J24 J26
    Date: 2022–04
  9. By: Dix-Carneiro, Rafael; Pessoa, João Paulo; Reyes-Heroles, Ricardo; Traiberman, Sharon
    Abstract: We study the role of global trade imbalances in shaping the adjustment dynamics in response to trade shocks. We build and estimate a general equilibrium, multi-country, multi-sector model of trade with two key ingredients: (a) Consumption-saving decisions in each country commanded by representative households, leading to endogenous trade imbalances; (b) labor market frictions across and within sectors, leading to unemployment dynamics and sluggish transitions to shocks. We use the estimated model to study the behavior of labor markets in response to globalization shocks, including shocks to technology, trade costs, and inter-temporal preferences (savings gluts). We find that modeling trade imbalances changes both qualitatively and quantitatively the short- and long-run implications of globalization shocks for labor reallocation and unemployment dynamics. In a series of empirical applications, we study the labor market effects of shocks accrued to the global economy, their implications for the gains from trade, and we revisit the “China Shock” through the lens of our model. We show that the US enjoys a 2.2% gain in response to globalization shocks. These gains would have been 73% larger in the absence of the global savings glut, but they would have been 40% smaller in a balanced-trade world.
    Keywords: global trade imbalances; labor market disruption
    JEL: F16
    Date: 2021–03–22
  10. By: Patrick J. Kehoe; Pierlauro Lopez; Virgiliu Midrigan; Elena Pastorino
    Abstract: Recent work has demonstrated that existing solutions of the unemployment volatility puzzle are at odds with the procylicality of the opportunity cost of employment, the cyclicality of wages, and the volatility of risk-free rates. We propose a model of business cycles that is immune to these critiques by incorporating two key features. First, we allow for preferences that generate time-varying risk over the business cycle to account for observed fluctuations in asset prices. Second, we introduce human capital acquisition consistent with the evidence on how wages grow with experience in the labor market. Our model reproduces the observed fluctuations in unemployment because hiring a worker is a risky investment with long-duration returns. As in the data, the price of risk in our model sharply increases in recessions. The benefit from hiring new workers therefore greatly declines, leading to a large decrease in job vacancies and an increase in unemployment of the same magnitude as in the data. We show that our results extend to versions of the model that include physical capital, a life cycle for workers, and alternative preference structures common in the asset-pricing literature.
    JEL: E3 E32 J22 J23 J24
    Date: 2022–02
  11. By: David W. Berger; Kyle F. Herkenhoff; Simon Mongey
    Abstract: It has long been argued that a minimum wage could alleviate efficiency losses from monopsony power. In a general equilibrium framework that quantitatively replicates results from recent empirical studies, we find higher minimum wages can improve welfare, but most welfare gains stem from redistribution rather than efficiency. Our model features oligopsonistic labor markets with heterogeneous workers and firms and yields analytical expressions that characterize the mechanisms by which minimum wages can improve efficiency, and how these deteriorate at higher minimum wages. We provide a method to separate welfare gains into two channels: efficiency and redistribution. Under both channels and Utilitarian social welfare weights the optimal minimum wage is $15, but alternative weights can rationalize anything from $0 to $31. Under only the efficiency channel, the optimal minimum wage is narrowly around $8, robust to social welfare weights, and generates small welfare gains that recover only 2 percent of the efficiency losses from monopsony power.
    Keywords: Minimum wages; Oligopsony; Labor markets; Market structure
    JEL: J42 J20 E20
    Date: 2022–04–06
  12. By: Sihao Chen; Michael B. Devereux; Kang Shi; Jenny Xu
    Abstract: We explore how consumption heterogeneity affects the international transmission mechanism of monetary shocks and the choice of optimal monetary policy in an open economy. Incorporating two types of agents (Ricardian versus Keynesian) into a standard open economy macro model, we find that there are sizeable ranges of household heterogeneity in which monetary policy become ineffective, but this depends sensitively on the interaction of aggregate demand and relative price effects. We derive the global optimal monetary policy with household heterogeneity under alternative pricing regimes. PPI targeting is still the optimal monetary policy under PCP and can restore the economy to the efficient equilibrium. Under LCP, however, the presence of consumption heterogeneity and currency misalignment implies that CPI inflation targeting is no longer optimal in most cases. Finally, we show that when fiscal instruments such as an import tax and export subsidy are introduced, both currency misalignment and consumption heterogeneity can be eliminated, and even under LCP, PPI targeting is the optimal monetary rule.
    JEL: F3 F4
    Date: 2022–03
  13. By: Tomohiro Hirano; Joseph E. Stiglitz
    Abstract: We analyze global dynamics in the standard life-cycle model with production, showing that there can be a plethora of rational expectations dynamics, including “wobbly macro-dynamics”. Depending on people’s beliefs, the macroeconomy can bounce around infinitely, without converging, without regular periodicity. The economy can be plagued by repeated periods of inefficiencies and unemployment. In phase transitions, the economy endogenously changes from a state with a unique momentary equilibrium into one with multiple equilibria, or vice versa. Phase transitions determine the patterns of dynamics. We identify all possible patterns of dynamics, providing a complete characterization of the parameter values under which each may occur, showing how a change in some key parameter (e.g. labor productivity) induces a “state transition,” an abrupt change in the set of feasible global dynamics: a boom can become unstable. Global dynamics exhibits strong hysteresis effects; a temporary positive productivity shock can have long run adverse effects.
    JEL: C61 E32 O11
    Date: 2022–02
  14. By: Bent Jesper Christensen; Malene Kallestrup-Lamb; John Kennan
    Abstract: The paper analyzes consumption decisions of retired workers, using Danish register data. A major puzzle, which motivates much of the analysis below, is that wealth actually increases for a large fraction of the people in our data. One would expect that wealth accumulated before retirement would be used to augment consumption in later life, with the implication that wealth should decline over time. The risk of large out-of-pocket medical expenditures is negligible in Denmark, so although explanations associated with such expenditures might explain similar patterns in U.S. data, these explanations are not plausible for Denmark (and therefore also questionable for the U.S.). Our analysis instead attempts to explain wealth paths using a model that emphasizes fluctuations in the marginal utility of consumption. The results show that a latent state variable extension of the standard life-cycle consumption model is quite successful in explaining the curious observed wealth patterns after retirement for singles.
    JEL: E21 J26
    Date: 2022–03
  15. By: Makarski, Krzysztof (Warsaw School of Economics); Tyrowicz, Joanna (University of Warsaw); Komada, Oliwia (GRAPE)
    Abstract: We study interactions between progressive labor taxation and social security reform. Increasing longevity puts fiscal strain that necessitates the social security reform. The current social security is redistributive, thus providing (at least partial) insurance against idiosyncratic income shocks, but at the expense of labor supply distortions. A reform which links pensions to individual incomes reduces distortions associated with social security contributions, but incurs insurance loss. We show that the progressive labor tax can partially substitute for the redistribution in social security, thus reducing the insurance loss.
    Keywords: social security reform, labor income tax, redistribution, insurance, welfare effects
    JEL: C68 D72 E62 H55 J26
    Date: 2022–02
  16. By: Vaz de Castro, Afonso
    Abstract: This paper aims to contribute for the vast literature on the impact of country-specific characteristics on fiscal multipliers. We argue that countries have relevant differences in risk attitudes, and that those differences are economically significant in determining output responses to fiscal consolidation programs. We start with an empirical analysis, estimating the coefficient of relative risk aversion for nine European economies, finding relevant heterogeneity across countries. Using the coefficients found, we calibrate an incomplete markets overlapping generations model and study the impacts of an unanticipated fiscal consolidation shock. We find a positive relationship between fiscal multipliers and risk aversion when there is a spending-based consolidation, showing that recessive impacts from austerity are stronger the larger the degree of risk aversion. The underlying mechanism depends on the effect of risk aversion on precautionary savings behavior and so on the share of constrained agents. Larger risk aversion induces more precautionary savings, thus shrinking the share of constrained agents. Credit-constrained agents have a less responsive labor supply with respect to spending-based fiscal consolidation shocks.
    Keywords: Fiscal Multipliers, Fiscal Consolidation, Relative Risk Aversion
    JEL: E21 E62 H31 H63 I31
    Date: 2022–01–14
  17. By: Salazar, M.
    Abstract: Developing countries have a vast informal sector generally associated with low levels of productivity. The persistence of informality could be a response to rigidities in the labor market, associated with a combination of high non-wages cost and high minimum wages. This paper proposes a theoretical framework to understand the tax policies’ role that discourages informality, such as lower payroll taxes in the formal sector or increases enforcement expenditure in an economy with real wage rigidities. I develop a search and matching model with a shirking mechanism with formal and informal workers. The simulations results suggest that the magnitud effect of tax polcies depends on real wage rigidities. In relative terms, when the economy has high real wage rigidities, the reduction of payroll taxes has a greater effect reducing the informality. In contrast, when the economy has low real wage rigidities, the enforcement expenditure has a significant effect to reduce the informality. Also, the results show the existence of tax polcies combition that reduce the informal labor in an effective way
    Keywords: Informality; Tax policies; Enforcement expenditure; Fiscal policies; Searchand matching; Efficiency wage; Shirking mechanism
    JEL: J46 E26 E62 O17 H26
    Date: 2021–12–02
  18. By: Díaz-Kovalenko, Igor E.; Torres, José L.
    Abstract: This paper studies the macroeconomic consequences of oil price shocks for small oil-exporting countries as a function of the adopted specific fiscal policy rule related to oil revenues. We focus on the particular case of Ecuador, where a large fraction of fiscal revenues depends on oil revenues, and where a fiscal policy rule implemented in 2008 establishes that public investment is a function of oil revenues. The paper develops a simple two-sector model featuring some key characteristics of the Ecuadorian economy to study the effects of international oil price shocks on macroeconomic volatility and welfare. The paper investigates alternative simple and easy practical implementation of oil revenues-related fiscal rules and compares their effects on economic activity and welfare to the existing one. We argue that a slight modification of the current fiscal rule, by linking public investment to all government revenues and not only to oil revenues, would significantly reduce the volatility of the Ecuadorian economy and cut down the welfare cost of oil price shocks.
    Keywords: Oil exporting countries; Oil price shocks; Oil windfalls; Fiscal rules; Public investment.
    JEL: E32 H3 Q32 Q48
    Date: 2022–03–07
  19. By: Takashi Kamihigashi (Research Institute for Economics and Business Administration and Center for Computational Social Science, Kobe University, JAPAN); Ryonghun Im (Faculty of Economics, Kwansei Gakuin University, JAPAN)
    Keywords: Stock market bubbles; Pure bubbles; Small open economy
    JEL: E21 E44
    Date: 2022–03
  20. By: Hansjörg Blöchliger; Sigurdur Johannesson; Marias Halldor Gestsson
    Abstract: This paper studies the potential impact of higher carbon taxation - to reach the government’s emission targets by 2030 - on Iceland’s economy. The paper is divided into two parts. First, a DSGE modelling exercise suggests that the equivalent of an oil price hike of between 30% and 55% is needed to reach the 2030 target, implying a GDP decline of between 0.3% and 0.6% by 2030. The impact on inflation would be very small. Second, a panel regression for the fishing industry reveals that a 40-50% oil price hike would be sufficient to reduce the entire fishing fleet’s emissions by 10%, raising total factor costs for the fishing companies by 4-5%. Such a cost hike would hardly threaten the competitiveness of the fishing industry. Both approaches assume that a carbon tax rise would have no effect on production technology.
    Keywords: carbon tax, DSGE modelling, environmental economics, fisheries, Iceland
    JEL: C68 H23 Q22
    Date: 2022–04–08
  21. By: Xiaoqing Zhou
    Abstract: One of the main channels through which monetary policy stimulus affects the real economy is mortgage borrowing. This channel, however, is weakened by frictions in the mortgage market. The rapid growth of financial technology-based (FinTech) lending tends to ease these frictions, given the higher quality services provided under this new lending model. This paper establishes that the role of FinTech lending in the monetary policy transmission is further amplified by consumers’ social networks. I provide empirical evidence for this network effect using county-level data and novel identification strategies. A 1 pp increase in the FinTech market share in a county’s socially connected markets raises the county’s FinTech market share by 0.23-0.26 pps. Moreover, I find that in counties where FinTech market penetration is high, the pass-through of market interest rates to borrowers is more complete. To quantify the role of FinTech lending and its network propagation in the transmission of monetary policy shocks, I build a multi-region heterogeneous-agent model with social learning that embodies key features of FinTech lending. The model shows that the responses of consumption and refinancing to a monetary stimulus are 13% higher in the presence of FinTech lending. Almost half of this improvement is accounted for by FinTech propagation through social networks.
    Keywords: FinTech; social networks; mortgage; monetary policy; regional transmission
    JEL: E21 E44 E52 G21 G23
    Date: 2022–03–25
  22. By: Brendon, C.
    Abstract: This paper analyses the design of optimal nonlinear savings taxation, in a multi-period consumption-savings economy where consumers face persistent, uninsurable shocks to the marginal value that they place on consuming. Its main contributions are: (a) to show that shocks of this kind generically justify positive marginal savings taxes, and (b) to characterise these taxes by reference to a limited number of sufficient statistics. The method for obtaining this characterisation is generalisable, and provides a roadmap for reconnecting ‘Mirrleesian’ and ‘sufficient statistics’ approaches to dynamic taxation. Intuitively, dynamic asymmetric information problems imply significant restrictions on intertemporal consumption elasticities. These restrictions keep sufficient statistics representations manageable, despite the multi-dimensional choice setting.
    Keywords: Nonlinear Taxation, Sufficient Statistics, Mirrleesian Taxation, New Dynamic Public Finance
    JEL: D82 E21 E61 H21 H24 H30
    Date: 2022–03–25

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