nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2022‒05‒30
nine papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Will the green transition be inflationary? Expectations matter By Alessandro Ferrari; Valerio Nispi Landi
  2. The Neoclassical Model and the Welfare Costs of Selection By Fabrice Collard; Omar Licandro
  3. Optimal Unemployment Insurance in a THANK Model By Stéphane Auray; Aurélien Eyquem
  4. Managing Expectations in the New Keynesian Model By Robert G. King; Yang K. Lu
  5. Sovereign Cocos By Mr. Leonardo Martinez; Juan Carlos Hatchondo; Mr. Francisco Roch; Kursat Onder
  6. Shocks to Inflation Expectations By Jonathan J. Adams; Mr. Philip Barrett
  7. The U.S. Economic Dynamics and Inflation Persistence: a Regime-Switching Perspective By Elton Beqiraj; Giuseppe Ciccarone; Giovanni Di Bartolomeo
  8. Sovereign Defaults and Debt Sustainability: The Debt Recovery Channel By Ibrahima Diarra; Michel Guillard; Hubert Kempf
  9. House price dynamics, optimal LTV limits and the liquidity trap By Ferrero, Andrea; Harrison, Richard; Nelson, Benjamin

  1. By: Alessandro Ferrari (Bank of Italy); Valerio Nispi Landi (Bank of Italy)
    Abstract: We analyse a progressive increase in the tax on emissions in a simple two-period New Keynesian model with an AS-AD representation. We find that the increase in the tax today exerts inflationary pressures, but the expected further increase in the tax tomorrow depresses current demand, putting downward pressure on prices: we show that the second effect is larger. However, if households do not anticipate a future fall in income (because they are not rational or the government is not credible), the overall effect of the transition may be inflationary in the first period. We extend the analysis in a medium-scale DSGE model and we find again that the green transition is deflationary. Also in this larger model, by relaxing the rational expectations assumption, we show the transition may initially be inflationary.
    Keywords: expectations, AS AD, aggregate prices, climate policy, pollution tax
    JEL: D84 E31 Q58
    Date: 2022–04
  2. By: Fabrice Collard (TSE - Toulouse School of Economics - UT1 - Université Toulouse 1 Capitole - Université Fédérale Toulouse Midi-Pyrénées - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, CNRS - Centre National de la Recherche Scientifique); Omar Licandro (UON - University of Nottingham, UK)
    Abstract: This paper embeds firm dynamics into the Neoclassical model and provides a simple framework to solve for the transitional dynamics of economies moving towards more selection. As in the Neoclassical model, markets are perfectly competitive, there is only one good and two production factors (capital and labor). At equilibrium, aggregate technology is Neoclassical, but the average quality of capital and the depreciation rate are both endogenous and positively related to selection. At steady state, output per capita and welfare both raise with selection. However, the selection process generates transitional welfare losses that may reduce in around 60% long term (consumption equivalent) welfare gains. The same property is shown to be true in a standard general equilibrium model with entry and fixed production costs.
    Keywords: Firm dynamics and selection,Neoclassical model,Capital irreversibility,Investment distortions,Transitional dynamics,Welfare gains
    Date: 2022–03–30
  3. By: Stéphane Auray (OFCE - Observatoire français des conjonctures économiques (Sciences Po) - Sciences Po - Sciences Po, CREST - Centre de Recherche en Économie et Statistique - ENSAI - Ecole Nationale de la Statistique et de l'Analyse de l'Information [Bruz] - X - École polytechnique - ENSAE Paris - École Nationale de la Statistique et de l'Administration Économique - CNRS - Centre National de la Recherche Scientifique); Aurélien Eyquem (OFCE - Observatoire français des conjonctures économiques (Sciences Po) - Sciences Po - Sciences Po, Université de Lyon)
    Abstract: A Tractable HANK (THANK) model with three agents, incomplete markets, unemployment and sticky prices and wages, is used to analyze the dynamics, welfare and distributional effects of Ramsey-optimal unemployment insurance (UI) policies. First, the optimal transition from a steady state that replicates several empirical regularities of the European labor market to the Ramsey steady state is analyzed. In the long run, the vacancy creation motive dominates, as the replacement rate falls, lowering the unemployment rate. In the short run however, the insurance motive dominates until unemployment falls enough to generate larger welfare gains from a lower unemployment rate. Over the business cycle around the Ramseyoptimal steady state, we nd that the optimal changes in the replacement rate depend (i) on the nature of the shock and (ii) on the presence of price and wage rigidities. After productivity shocks, the vacancy creation motive dominates. After separation shocks, the planner has almost no traction over vacancy creations. Only the insurance and aggregate demand stabilization motives remain, and both point to a counter-cyclical UI policy.
    Keywords: Incomplete markets,Borrowing constraints,Unemployment,Unemployment Insurance
    Date: 2022–04–05
  4. By: Robert G. King (Boston University and NBER); Yang K. Lu (Department of Economics, The Hong Kong University of Science and Technology)
    Abstract: We study the optimal monetary policy in a setting where the private sector is forward-looking and learning about the type of central bank in place. We consider two types of central bank, one patient type that can commit and one opportunistic type that is myopic and cannot commit. Being able to commit or not, the central bank in place chooses inflation policies optimally, taking into account the learning and rational expectation of the private sector. We show that the equilibrium can be obtained as a solution to a recursive optimization of the committed type in which the actions of the opportunistic type are subject to an incentive compatibility constraint. The numerical solution to a calibrated model reveals that the committed central bank with good initial reputation adopts policies similar to the standard solution under full commitment, whereas the committed central bank with poor initial reputation aims at building reputation with anti-inflation policies that involve real costs. If the opportunistic central bank with good initial reputation is in place, there will be lengthy real stimulations with gradually rising actual and expected inflation, followed by stagflation when the history of positive inflation surprises depletes the central bank's reputation.
    Keywords: time inconsistency, reputation game, optimal monetary policy, forwardlooking expectations
    JEL: E52 D82 D83
    Date: 2020–06
  5. By: Mr. Leonardo Martinez; Juan Carlos Hatchondo; Mr. Francisco Roch; Kursat Onder
    Abstract: We study a model of equilibrium sovereign default in which the government issues cocos (contingent convertible bonds) that stipulate a suspension of debt payments when the government faces liquidity shocks in the form of an increase of the bondholders' risk aversion. We find that in spite of reducing the frequency of defaults triggered by liquidity shocks, introducing cocos increases the overall default frequency. By mitigating concerns about liquidity, cocos make indebtedness and default risk more attractive for the government. In contrast, cocos that stipulate debt forgiveness when the government faces the shock, achieve larger welfare gains by reducing default risk.
    Keywords: Sovereign Cocos, default risk, maturity extensions, reprofiling, haircuts.; liquidity shock; default frequency; government issues coco; risk-premium shock; debt payment; Contingent convertible capital; Debt default; Debt relief; Consumption; Return on investment; Global
    Date: 2022–04–29
  6. By: Jonathan J. Adams; Mr. Philip Barrett
    Abstract: The consensus among central bankers is that higher inflation expectations can drive up inflation today, requiring tighter policy. We assess this by devising a novel method for identifying shocks to inflation expectations, estimating a semi-structural VAR where an expectation shock is identified as that which causes measured expectations to diverge from rationality. Using data for the United States, we find that a positive inflation expectations shock is deflationary and contractionary: inflation, output, and interest rates all fall. These results are inconsistent with the standard New Keynesian model, which predicts inflation and interest rate hikes. We discuss possible resolutions to this new puzzle.
    Keywords: Inflation, Sentiments, Expectations, Monetary Policy
    Date: 2022–04–29
  7. By: Elton Beqiraj; Giuseppe Ciccarone; Giovanni Di Bartolomeo
    Abstract: This paper revisits the US business cycle accounting for exogenous switches in the inflation intrinsic persistence formalized as changes in the hazard functions. After controlling for Phillips curves shifts, we identify two monetary regimes, leading to a different interpretation from that generally proposed. The Fed operates according to the Brainard Principle by gradually reacting to observed shocks and deviating only episodically to a more active regime. Quantitatively, the main drivers of the business cycle are structural changes in price settings and stochastic volatilities. We also find that structural changes in price and wage adjustments play opposite roles in the Great Inflation. In general, shifts in the Phillips curves are central for correctly understanding the Fed behavior and the business cycle dynamics.
    Keywords: duration-dependent wage adjustments; intrinsic inflation persistence; DSGE models; hybrid Phillips curves; Markow-switching
    JEL: E42 E52 E58
    Date: 2022–04
  8. By: Ibrahima Diarra; Michel Guillard; Hubert Kempf
    Abstract: This paper focuses on the debt recovery channel linking the dynamics of public debt to partial sovereign defaults. We build a simple model which incorporates sovereign default and a debt recovery rule. It depends on a parameter that allows for partial debt recovery. We show that the maximum debt-to-GDP ratio that a country can sustain without defaulting is increasing, nonlinear, and sensitive to the debt-recovery parameter. A higher debt recovery parameter increases the fiscal space but worsens the financial position of a borrowing country after a default episode. We show the empirical relevance of this channel for estimating country-specific fiscal spaces.
    Date: 2022
  9. By: Ferrero, Andrea (University of Oxford); Harrison, Richard (Bank of England); Nelson, Benjamin (RCM)
    Abstract: The global financial crisis prompted the rapid development of macro-prudential frameworks and an increased reliance on borrower-based policy tools, which influence the demand for credit. This paper studies the optimal design of one such tool, a loan-to-value (LTV) limit, and its implications for monetary policy in a model with nominal rigidities and financial frictions. The welfare-based loss function features a role for macro-prudential policy to enhance risk-sharing. Optimal LTV limits are strongly countercyclical. In a house price boom-bust episode, the active use of LTV limits alleviates debt-deleveraging dynamics and prevents the economy from falling into a liquidity trap.
    Keywords: Monetary and macro-prudential policy; financial crisis; zero lower bound
    JEL: E52 E58 G01 G28
    Date: 2022–03–25

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