nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2022‒06‒13
seventeen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. How to Redistribute the Revenues from Climate Policy? A Dynamic Perspective with Financially Constrained Households By Ulrich Eydam; Francesca Diluiso
  2. Implications for Determinacy with Average Inflation Targeting By Ahmad, Yamin; Murray, James
  3. Managing Inequality over Business Cycles: Optimal Policies with Heterogeneous Agents and Aggregate Shocks By François Le Grand; Xavier Ragot
  4. Regional Consumption Responses and the Aggregate Fiscal Multiplier By Dupor, Bill; Karabarbounis, Marios; Kudlyak, Marianna; Mehkari, M. Saif
  5. International Portfolio Rebalancing and Fiscal Policy Spillovers By Sami Alpanda; Uluc Aysun; Serdar Kabaca
  6. Optimal bank capital requirements: What do the macroeconomic models say? By Gulan, Adam; Jokivuolle, Esa; Verona, Fabio
  7. Sovereign Cocos By Juan Carlos Hatchondo; Leonardo Martinez; Yasin Kürsat Önder; Francisco Roch
  8. Labor market search, informality and schooling investments By Matteo Bobba; Luca Flabbi; Santiago Levy
  9. Uncertainty Shocks, Capital Flows, and International Risk Spillovers By Ozge Akinci; Sebnem Kalemli-Ozcan; Albert Queraltó
  10. Financial Innovations in a World with Limited Commitment: Implications for Inequality and Welfare By Saroj Dhital; Pedro Gomis-Porqueras; Joseph H. Haslag
  11. Did COVID-19 induce a reallocation wave? By Agostino Consolo; Filippos Petroulakis
  12. Q-Monetary Transmission By Priit Jeenas; Ricardo Lagos
  13. Normalizing the central bank’s balance sheet: Implications for inflation and debt dynamics By Begoña Domínguez; Pedro Gomis-Porqueras
  14. Fiscal Multipliers and Informality By Emilio Colombo; Davide Furceri; Pietro Pizzuto; Patrizio Tirelli
  15. The Financial Resource Curse Revisited: The Supply-Side Effect of Low Interest Rates By Simon Hildebrandt; Jochen Michaelis
  16. The Value of Unemployment Insurance: Liquidity vs. Insurance Value By Victor Hernandez Martinez; Kaixin Liu
  17. Optimal Vaccination in a SIRS Epidemic Model By Federico, Salvatore; Ferrari, Giorgio; Torrente, Maria-Laura

  1. By: Ulrich Eydam (University of Potsdam); Francesca Diluiso (Mercator Research Institute on Global Commons and Climate Change (MCC))
    Abstract: In light of climate change mitigation efforts, revenues from climate policies are growing, with no consensus yet on how they should be used. Potential efficiency gains from reducing distortionary taxes and the distributional implications of different revenue recycling schemes are currently debated. To account for households heterogeneity and dynamic trade-offs, we study the macroeconomic and welfare performance of different revenue recycling schemes using an Environmental Two-Agent New-Keynesian model, calibrated on the German economy. We find that, in the long run, welfare gains are higher when revenues are used to reduce distortionary taxes on capital, but this comes at the cost of higher inequality: while all households prefer labor income tax reductions to lump-sum transfers, only financially unconstrained households are better off when reducing taxes on capital income. Interestingly, we find that over the transition period relevant to meet short-medium run climate targets, labor income tax cuts are the most efficient and equitable instrument.
    Keywords: double dividend, E-DSGE, environmental tax reform, non-Ricardian households, revenue recycling
    JEL: E62 H23 H31 Q58
    Date: 2022–05
  2. By: Ahmad, Yamin; Murray, James
    Abstract: We use a standard New Keynesian model to explore implications of backward- and forward-looking windows for monetary policy with average inflation targeting and investigate the conditions for determinacy. A unique equilibrium rules out sunspot shocks that can lead to self-fulfilling shocks for inflation expectations. We find limitations for the length of the forward window and demonstrate how this depends on other parameters in the model, including parameters governing monetary policy and expectations formation.
    Keywords: Average Inflation Targeting, Determinacy, Monetary Policy
    JEL: E50 E52 E58
    Date: 2022–05–13
  3. By: François Le Grand (EM - emlyon business school, ETH Zürich - Eidgenössische Technische Hochschule - Swiss Federal Institute of Technology [Zürich]); Xavier Ragot (ECON - Département d'économie (Sciences Po) - Sciences Po - Sciences Po - CNRS - Centre National de la Recherche Scientifique, CNRS - Centre National de la Recherche Scientifique, OFCE - Observatoire français des conjonctures économiques (Sciences Po) - Sciences Po - Sciences Po)
    Abstract: We present a truncation theory of idiosyncratic histories for heterogeneous-agent models. This method allows us to solve for optimal Ramsey policies in such models with aggregate shocks. The method can be applied to a large variety of settings, with occasionally binding credit constraints. We use this theory to characterize the optimal level of unemployment insurance over the business cycle in a production economy. We find that the optimal policy is countercyclical.
    Keywords: Incomplete Markets,Optimal Policies,Heterogeneous Agent Models
    Date: 2021
  4. By: Dupor, Bill (Federal Reserve Bank of St. Louis); Karabarbounis, Marios (Federal Reserve Bank of Richmond); Kudlyak, Marianna (Federal Reserve Bank of San Francisco); Mehkari, M. Saif (University of Richmond)
    Abstract: We use regional variation in the American Recovery and Reinvestment Act (2009-2012) to analyze the effect of government spending on consumer spending. Our consumption data come from household-level retail purchases in the Nielsen scanner data and auto purchases from Equifax credit balances. We estimate that a $1 increase in county-level government spending increases local non-durable consumer spending by $0.29 and local auto spending by $0.09. We translate the regional consumption responses to an aggregate fiscal multiplier using a multi-region, New Keynesian model with heterogeneous agents, incomplete markets, and trade linkages. Our model is consistent with the estimated positive local multiplier, a result that distinguishes our incomplete markets model from models with complete markets. At the zero lower bound, the aggregate consumption multiplier is twice as large as the local multiplier because trade linkages propagate the effect of government spending across regions.
    Keywords: consumer spending, fiscal multiplier, regional variation, heterogeneous agents
    JEL: E21 E62 H31 H71
    Date: 2022–04
  5. By: Sami Alpanda (University of Central Florida, Orlando, FL); Uluc Aysun (University of Central Florida, Orlando, FL); Serdar Kabaca (Bank of Canada, Ottawa, Canada)
    Abstract: We theoretically and empirically evaluate the spillover effects of debt-financed fiscal policy interventions of the United States on other economies. We first consider a two-country dynamic stochastic general equilibrium model with international portfolio rebalancing effects arising from an imperfect substitutability between short- and long-term domestic and foreign bonds. The model shows that US fiscal expansions financed by long-term debt issuance would, on net, hinder economic activity in the rest of the world (ROW). This is despite the standard trade channel’s net positive effect on the ROW economy given the depreciation in the ROW currency. The fall in ROW output occurs mainly due to the increase in the ROW term premia and long-term rates through the portfolio rebalancing channel, as the relative demand for ROW long-term bonds decreases following the increase in the supply of US long-term bonds accompanying the fiscal expansion. Testing the predictions of our theoretical model by using panel regressions and vector autoregressions, we find empirical support for the negative relationship between ROW output and US fiscal spending. The data also confirm the positive relationship between ROW term spreads and US fiscal spending.
    Keywords: International portfolio rebalancing, international spillover effects of fiscal policy, preferred habitat, DSGE.
    JEL: E62 F41 F42
    Date: 2022–05
  6. By: Gulan, Adam; Jokivuolle, Esa; Verona, Fabio
    Abstract: The optimal level of banks' capital requirements has been a key research topic since at least the introduction of the Basel rules in the late 1980s. In this paper, we review the literature, focusing on recent findings from quantitative structural macroeconomic models. While dynamic stochastic general equilibrium models capture second-round (general equilibrium) effects such as the feedback effects from macroeconomic outcomes back to financial intermediation and the dynamic evolution of the economy following regulatory changes, they suffer from tractability issues, including treatment of nonlinear effects, that typically force modeling simplifications. Additionally, studies tend to be concerned with determining the optimal level of fixed capital requirements. Only a handful offer estimates of the optimal size of the dynamic buffers. Since optimal dynamic macroprudential policies depend heavily on the nature of the underlying shocks, questions arise regarding the robustness and potential side effects of such plicies. Despite progress, the optimal level of bank capital requirements - in either fixed or dynamic form - remains largely an open research question.
    Date: 2022
  7. By: Juan Carlos Hatchondo (Western University); Leonardo Martinez (IMF); Yasin Kürsat Önder (Ghent University); Francisco Roch (IMF)
    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.
    Date: 2022–05
  8. By: Matteo Bobba (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, IZA - Forschungsinstitut zur Zukunft der Arbeit - Institute of Labor Economics); Luca Flabbi (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, IZA - Forschungsinstitut zur Zukunft der Arbeit - Institute of Labor Economics); Santiago Levy (UNC - University of North Carolina [Chapel Hill] - UNC - University of North Carolina System)
    Abstract: We develop a search and matching model where matches (jobs) can be formal or informal. Workers choose their level of schooling and search for an employee job either as unemployed or as self-employed. Firms post vacancies in each schooling market, decide the formality status of the job, and bargain with workers over wages. The resulting equilibrium size of the informal sector is an endogenous function of labor market and institutional characteristics. We estimate the model parameters using labor force survey data from Mexico and the exogenous variation induced by the roll-out of a non-contributory social program. Counterfactual experiments based on the estimated model show that eliminating informal jobs increases schooling investments but at the cost of decreasing welfare for both workers and firms.
    Keywords: Labor market frictions,Search and matching,Nash bargaining,Informality,Returns to schooling
    Date: 2022–02
  9. By: Ozge Akinci; Sebnem Kalemli-Ozcan; Albert Queraltó
    Abstract: Foreign investors’ changing appetite for risk-taking has been shown to be a key determinant of the global financial cycle. Such fluctuations in risk sentiment also correlate with the dynamics of uncovered interest parity (UIP) premia, capital flows, and exchange rates. To understand how these risk sentiment changes transmit across borders, we propose a two-country macroeconomic framework. Our model features cross-border holdings of risky assets by U.S. financial intermediaries that operate under financial frictions and act as global intermediaries in that they take on foreign asset risk. In this setup, an exogenous increase in U.S.-specific uncertainty, modeled as higher volatility in U.S. assets, leads to higher risk premia in both countries. This occurs because higher uncertainty leads to deleveraging pressure on U.S. intermediaries, triggering higher global risk premia and lower global asset values. Moreover, when U.S. uncertainty rises, the exchange rate in the foreign country vis-a-vis the dollar depreciates, capital flows out of the foreign country, and the UIP premium increases in the foreign country and decreases in the U.S., as in the data.
    Keywords: financial frictions; risk premia; time-varying uncertainty; intermediary asset pricing; financial spillovers; global financial cycle
    JEL: E32 E44 F41
    Date: 2022–05–01
  10. By: Saroj Dhital (Economics and Business Department, Southwestern University); Pedro Gomis-Porqueras (School of Economics and Finance, Queensland University of Technology, Brisbane, Australia); Joseph H. Haslag (Department of Economics, University of Missouri-Columbia)
    Abstract: Do financial innovations benefit or harm expected welfare? For innovations that provide greater access to banks, researchers have argued that lower transaction costs and better project assessments result in expected welfare gains. Others, however, have shown that with incomplete markets, financial innovations result in expected welfare losses. In this paper, we examine the impacts of financial innovations in economies with incomplete markets and limited commitment. We show that the results critically depend on whether assets are priced fundamentally or not. When priced fundamentally, greater access does improve expected welfare, also resulting in greater consumption inequality. However, when assets carry a premium, there is an additional channel owing to limited commitment. Because of a more severe limited commitment problem, collateral is necessary. A fixed quantity of pledgeable assets are spread across a larger measure of depositors, resulting in less consumption for those with access to banks and consumption inequality decreases. Second, we consider a financial innovation that increases the pledegeability of one type of bank collateral. We also show that the results critically depend on whether assets are priced fundamentally or not. When assets are priced fundamentally, this type of financial innovation does not change welfare nor consumption inequality. In contrast, when assets carry a premium, better collateral results in more consumption for depositors with access to the more sophisticated payment option. We extend our model economy to consider an endogenous decision to access checkable deposits. This allows us to examine the effects of changes in the distribution of costs that are important to the choice of participating in observing buyers’ deposit or not. Third, our analysis demonstrates that collateral in a limited commitment framework provides a mechanism through which financial innovation can increase or decrease the impact that financial innovations have on welfare and inequality.
    Keywords: welfare, financial innovation, financial access, inequality
    JEL: E40 E61 E62 H21
    Date: 2022–05
  11. By: Agostino Consolo (European Central Bank); Filippos Petroulakis (Bank of Greece)
    Abstract: Recent research has argued that the COVID-19 shock has also brought about a real- location shock. We examine the evidence for such an occurrence in the United States, taking a broad perspective. We first consider micro data from CPS and JOLTS; there is no noticeable uptick in occupation or sector switches, nor churn, either at the aggregate level or the cross-section, or when broken down by firms’ size. We then examine whether mismatch unemployment has risen as a result of the pandemic; using an off-the-shelf multisector search and matching model, there is little evidence for an important role for mismatch in driving the elevated unemployment rate. Finally, we employ a novel Bayesian SVAR framework with sign restrictions to identify a reallocation shock; we find that it has played a relatively minor role in explaining labor market patterns in the pandemic, at least relative to its importance in earlier episodes.
    Keywords: Reallocation; COVID-19; mismatch
    JEL: E24 J63
    Date: 2022–03
  12. By: Priit Jeenas; Ricardo Lagos
    Abstract: We study the effects of monetary-policy-induced changes in Tobin's q on corporate investment and capital structure. We develop a theory of the mechanism, provide empirical evidence, evaluate the ability of the quantitative theory to match the evidence, and quantify the relevance for monetary transmission to aggregate investment.
    Keywords: Monetary transmission, stock prices, Tobin's q, investment, capital structure
    JEL: D83 E22 E44 E52 G12 G31 G32
    Date: 2022–05
  13. By: Begoña Domínguez; Pedro Gomis-Porqueras
    Abstract: We explore the effects of reducing the overall size of the central bank’s balance sheet and lowering its maturity structure. To do so, we consider an environment where fiscal policy is traditionally passive and the central bank follows the Taylor principle. In addition, the monetary authority has also explicit size and compositional rules regarding its balance sheet. Agents in this economy face limited commitment in some markets and government bonds can be used as collateral. When short and long-term public debt exhibit premia, changes in the central bank’s balance sheet have implications for long-run inflation and real allocations. To ensure a unique locally stable steady state, the central bank should target a low enough maturity composition of its balance sheet. In our numerical exercise, calibrated to the United States, we find that long-term debt holdings by the central bank should be less than 0.5 times of their short-term positions. Moreover, the process of balance sheet normalization should aggressively respond to the total debt issued in the economy relative to its target. These findings depend on the degree of liquidity of long-term bonds. The more liquid long-term bonds are, the lower is the value of the composition threshold and the parameter space consistent with unique and stable equilibria is smaller. In addition, we consider a modified Taylor rule that takes into account the premium. Such rule increases the prevalence of multiplicity of steady states and delivers lower welfare. Thus, we argue that the traditional Taylor rule is appropriate for managing interest rates in the presence of premia.
    Keywords: Inflation, Government Bonds, Liquidity, Spreads, Maturity, Balance Sheet.
    JEL: E40 E61 E62 H21
    Date: 2022–05
  14. By: Emilio Colombo; Davide Furceri; Pietro Pizzuto; Patrizio Tirelli
    Abstract: This paper investigates the role of informality in affecting the magnitude of the fiscal multiplier in a panel of 141 countries, using the local projections method. We find a strong negative relationship between the degree of informality and the size of the fiscal multiplier. This result holds irrespective of the levels of economic development and institutional quality and is robust to additional country characteristics such as trade, financial openness and exchange rate regime. In a two-sector new-Keynesian model, we rationalize this result by showing that fiscal shocks raise the relative price of official goods, shifting demand towards the informal sector. This reallocation effect increases with the level informality, because a larger informal sector is associated with a stronger appreciation of relative prices in response to fiscal shocks. Thus, informality raises the size of the unofficial multiplier. A higher degree of non-separability between public and private goods also contributes to rationalize the lower multipliers in high-informality countries.
    JEL: H30 H50 E26 C32
    Date: 2022
  15. By: Simon Hildebrandt (University of Kassel); Jochen Michaelis (University of Kassel)
    Abstract: Benigno and Fornaro (2014) show that an episode of low interest rates may harm an economy. Low interest rates trigger a consumption boom, labor shifts away from the tradable sector, learning spillovers from foreign technology decline and so do domestic total factor productivity, consumption and welfare. In this paper, we show that their conclusion of a financial resource curse does not hold in a world with capital as production factor. Low interest rates now trigger an investment boom, there is no shift of labor between sectors, total factor productivity remains unaffected. Our model confirms “textbook wisdom†, i.e., an episode of low interest rates enhances welfare in a small open economy.
    Keywords: capital accumulation, endogenous growth, macroeconomic integration
    JEL: E22 F36 F43
    Date: 2022
  16. By: Victor Hernandez Martinez; Kaixin Liu
    Abstract: This paper argues that the value of unemployment insurance (UI) can be decomposed into a liquidity component and an insurance component. While the liquidity component captures the value of relieving the cost to access liquidity during unemployment, the insurance component captures the value of protecting the worker against a potential permanent future income loss. We develop a novel sufficient statistics method to identify each component that requires only the labor supply responses to changes in the potential duration of UI and severance payment and implement it using Spanish administrative data. We find that the liquidity component represents half of the value of UI, while the insurance component captures the remaining half. However, the relevance of each component is highly heterogeneous across different groups of workers. Poorer and wealthier workers are both similarly liquidity-constrained, but poorer workers place a higher value on UI because the insurance component is significantly more important for them. On the other hand, wealthier workers and workers with more cash-on-hand value additional UI equally, but the wealthier value its liquidity, while those with more liquidity care about its insurance value. Finally, from a welfare perspective, we show that extending the potential duration of Spain’s UI would increase welfare. However, in our counterfactual case where UI is complemented with the provision of liquidity, the optimal potential duration of Spain's UI should be lower than its current level.
    Keywords: Unemployment Insurance; Liquidity Constraints; Consumption Smoothing
    JEL: H20 J64 J65
    Date: 2022–05–18
  17. By: Federico, Salvatore (Center for Mathematical Economics, Bielefeld University); Ferrari, Giorgio (Center for Mathematical Economics, Bielefeld University); Torrente, Maria-Laura (Center for Mathematical Economics, Bielefeld University)
    Abstract: We propose and solve an optimal vaccination problem within a deterministic compart-mental model of SIRS type: the immunized population can become susceptible again, e.g. because of a not complete immunization power of the vaccine. A social planner thus aims at reducing the number of susceptible individuals via a vaccination campaign, while minimizing the social and economic costs related to the infectious disease. As a theoretical contribution, we provide a technical non-smooth verification theorem, guaranteeing that a semiconcave viscosity solution to the Hamilton-Jacobi-Bellman equation identifies with the minimal cost function, provided that the colosed-loop equation admits a solution. Coditions under which the closed-loop equation is well-posed are then derived by borrowing results from the theory of Regular Lagrangian Flows. From the applied point of view, we provide a numerical implementation of the model in a case study with quadrativ instantaneous costs. Amongst other conclusions, we observe that in the long-run the optimal vaccination policy is able to keep the percentage of infected to zero, at least when the natural reproduction number and the reinfection rate are small.
    Keywords: SIRS model, optimal control, viscosity soltuion, nonsmooth verification theorem: epidemic, optimal vaccination
    Date: 2022–06–08

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