nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2022‒06‒20
24 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Commodity price shocks and macroeconomic dynamics By Ruthira Naraidoo; Juan Paez-Farrell
  2. Managing Inequality over Business Cycles: Optimal Policies with Heterogeneous Agents and Aggregate Shocks By François Le Grand; Xavier Ragot
  3. State-Contingent Forward Guidance By Julien Albertini; Valentin Jouvanceau; Stéphane Moyen
  4. A simple framework for analyzing the macroeconomic effects of inside money By Balázs Világi; Balázs Vonnák
  5. Short-time work policies during the COVID-19 pandemic By Julien Albertini; Xavier Fairise; Arthur Poirier; Anthony Terriau
  6. Optimal Taxation of Risky Entrepreneurial Capital By Corina Boar; Matthew Knowles
  7. How important are shocks to the elasticity of aggregate labor supply for business cycle fluctuations? By Aleksandar Vasilev
  8. State Dependent Government Spending Multipliers: Downward Nominal Wage Rigidity and Sources of Business Cycle Fluctuations By Yoon J. Jo; Sarah Zubairy
  9. Fiscal Policy and the Slowdown in Trend Growth in an Open Economy By Alexander Beames; Mariano Kulish; Nadine Yamout
  10. Exchange rate and inflation under weak monetary policy: Turkey verifies theory By Gürkaynak, Refet S.; Kısacıkoğlu, Burçin; Lee, Sang Seok
  11. Top Earners: a Labor Productivity Process By Campanale Claudio; Rocio Fernandez-Bastidas
  12. Financial crises and shadow banks: A quantitative analysis By Rottner, Matthias
  13. Accounting for Risk in a Linearized Solution: How to Approximate the Risky Steady State and Around It By Pierlauro Lopez; J. David López-Salido; Francisco Vazquez-Grande
  14. Uncertainty Shocks, Capital Flows, and International Risk Spillovers By Ozge Akinci; Sebnem Kalemli-Ozcan; Albert Queraltó
  15. Fertility and Family Labor Supply By Katrine Marie Jakobsen; Thomas H. Jørgensen; Hamish Low; Katrine Marie Jakobsen
  16. Firm Heterogeneity, Market Power and Macroeconomic Fragility By Alessandro Ferrari; Francisco Queir\'os
  17. Should wages be subsidized in a pandemic? By Brant Abbott; Nam Phan
  18. The Marginal Propensity to Consume in Heterogeneous Agent Models By Greg Kaplan; Giovanni L. Violante
  19. Fertility and migration By Arianna Garofalo
  20. Robot Adoption, Organizational Capital and the Productivity Paradox By Rodimiro Rodrigo
  21. Financial Crises and Expectation-driven Recessions By Juan Carlos Castro Fernández; Juan Carlos Castro Fernández
  22. Heterogeneous Paths to Stability By di Porto, Edoardo; Tealdi, Cristina
  23. Q-Monetary Transmission By Priit Jeenas; Ricardo Lagos
  24. The Geographic Effects of Monetary Policy By Juan Herreno; Mathieu Pedemonte

  1. By: Ruthira Naraidoo (University of Pretoria); Juan Paez-Farrell (Department of Economics, University of Sheffield, UK)
    Abstract: We analyse the transmission mechanism of commodity price shocks in emerging economies. Using a panel vector autoregression, we find that the shock leads to a real exchange rate appreciation, increases in output, inflation the nominal interest rate and the trade balance, and a fall in the unemployment rate. The transmission mechanism can be understood using a dynamic stochastic general equilibrium model of a small commodity-exporting open economy with nominal as well as search and matching frictions. We find that the conduct of monetary policy is key to both the variables’ dynamics as well as to the magnitude of Dutch disease effects.
    Keywords: Commodity prices, emerging markets, inflation, monetary policy, search and matching, unemployment, Dutch disease, DSGE modelling
    JEL: E31 E32 E44 E52 E61 F42 O11
    Date: 2022–05
  2. By: François Le Grand (EM - emlyon business school); Xavier Ragot (OFCE - Observatoire français des conjonctures économiques (Sciences Po) - Sciences Po - Sciences Po, ECON - Département d'économie (Sciences Po) - Sciences Po - Sciences Po - CNRS - Centre National de la Recherche Scientifique)
    Abstract: We present a truncation theory of idiosyncratic histories for heterogeneous agent models. This method allows us to derive optimal Ramsey policies in heterogeneous agent models with aggregate shocks, in general frameworks. We use this method to characterize the optimal level of unemployment insurance over the business cycle in a production economy, with occasionally binding credit constraints.
    Keywords: Incomplete markets,Optimal policies,Heterogeneous agent models
    Date: 2020–12–01
  3. By: Julien Albertini (Univ Lyon, Université Lumière Lyon 2, GATE UMR 5824, F-69130 Ecully, France, France); Valentin Jouvanceau (Lietuvos Bankas); Stéphane Moyen (Bundesbank)
    Abstract: This paper proposes a new strategy for modeling and solving state-dependent forward guidance policies (SCFG). We study its transmission channels using a DSGE model with search and matching frictions in which agents account for the fact that the SCFG is an endogenous regime-switching system. A fully credible SCFG causes a boom in inflation and output but no rapid exit from the ZLB. Thus, the transmission of its effects is primarily through the realization of additional ZLB periods more than through changes in expectations. We next consider the implications of imperfect credibility. In this case of uncertainty, an SCFG is less impactful. Finally, using counterfactual experiments on the December 2012 FOMC statement, we find that it led to about 1.5 pp gain in unemployment and 0.5 pp in inflation.
    Keywords: New Keynesian model, Search and matching, ZLB, Forward guidance
    JEL: E30 J60
    Date: 2022
  4. By: Balázs Világi (Magyar Nemzeti Bank (Central Bank of Hungary)); Balázs Vonnák (Magyar Nemzeti Bank (Central Bank of Hungary))
    Abstract: The majority of the New Keynesian DSGE literature assumes that the macroeconomic effects of monetary policy can be satisfactorily described by an interest rate rule without addressing the details of the money supply. We investigate whether this approach remains valid in the presence of inside money created by the banking system. To analyze this issue we present a framework based on the generalization of the IS and LM curves to dynamic general equilibrium models. We find that it is possible to implement a policy based on an interest rate rule even in the presence of inside money, although it requires a more complex toolkit of monetary policy implementation than it is assumed in models with only outside money. We also show that despite some current views, the existence of inside money does not invalidate the common macroeconomic wisdom that investments are linked to savings: both savings and financing matter in determining investments.
    Keywords: monetary policy, interest rate rule, inside money, liquidity, money multiplier.
    JEL: E51 E52 G21
    Date: 2022
  5. By: Julien Albertini (Univ Lyon, Université Lumière Lyon 2, GATE UMR 5824, F-69130 Ecully, France); Xavier Fairise (GAINS, University of Le Mans); Arthur Poirier (LED, Paris 8 University Vincennes-Saint-Denis); Anthony Terriau (GAINS, University of Le Mans)
    Abstract: In this paper, we analyze the impact of short-time work programs on the French labor market during the COVID-19 pandemic. We develop a dynamic model with incomplete markets, search frictions, human capital, and aggregate and idiosyncratic productivity shocks. We calibrate our model and simulate what the labor market response to a lockdown shock would have been under various STW programs. We show that STW succeeded in stabilizing employment and consumption but generated substantial windfall effects characterized by an excessive reduction in hours worked.
    Keywords: COVID-19, matching frictions, short-time work policies, incomplete markets.
    JEL: E21 E24 J24 J38 J63 J65
    Date: 2022
  6. By: Corina Boar (New York University); Matthew Knowles (University of Cologne)
    Abstract: We study optimal taxation in a model with endogenous financial frictions, risky investment and occupational choice, where the distribution of wealth across entrepreneurs affects how efficiently capital is used. The planner chooses linear taxes on wealth, capital and labor income to maximize the steady state utility of a newborn agent. Most agents in the model are poor, leading to a redistributive motive for taxation. Optimal tax rates can be written as a closed-form function of the size of the tax bases and their elasticities with respect to tax rates. We find that it is optimal to tax capital income because financial frictions reduce the elasticity of capital income with respect to taxes and because capital income taxes prevent excessive entry into entrepreneurship. Optimal wealth taxes are positive but close to zero, since they strongly discourage capital accumulation.
    Keywords: Entrepreneurship; Financial Frictions; Taxation
    JEL: E2 E6 H2
    Date: 2022–05
  7. By: Aleksandar Vasilev
    Abstract: Stochastic shocks to aggregate labor supply elasticity are introduced into a real-business-cycle setup augmented with a detailed government sector. The model is calibrated to Bulgarian data for the period following the introduction of the currency board arrange-ment (1999-2018). The quantitative importance of a stochastic aggregate labor supply elasticity parameter is investigated for the magnitude of the cyclical fluctuations in Bulgaria. The quantitative effect of such a stochasticity increases the variability of hours, and lowers the correlation between hours and wages, and thus is found to be quantitatively important for the labor market aspect of business cycles.
    Keywords: Business cycles, stochastic aggregate labor supply elasticity, Bulgaria
    JEL: E24 E32
    Date: 2022–03–08
  8. By: Yoon J. Jo; Sarah Zubairy
    Abstract: We consider a New Keynesian model with downward nominal wage rigidity (DNWR) and show that government spending is much more effective in stimulating output in a low-inflation recession relative to a high-inflation recession. The government spending multiplier is large when DNWR binds, but the nature of recession matters due to the opposing response of inflation. In a demand-driven recession, inflation falls, preventing real wages from falling, leading to unemployment, while inflation rises in a supply-driven recession limiting the consequences of DNWR on employment. We document supporting empirical evidence, using both historical time series data and cross-sectional data from U.S. states.
    JEL: E24 E32 E62
    Date: 2022–05
  9. By: Alexander Beames (Macroeconomic Group, The Treasury); Mariano Kulish (School of Economics, University of Sydney); Nadine Yamout (School of Economics, University of Sydney)
    Abstract: We study the impact that a permanent slowdown in trend growth has on fiscal policy with an estimated small open economy model. The magnitude and timing of the change in trend growth are estimated alongside the structural and fiscal policy rule parameters. Around 2003:Q3, trend growth in per capita output is estimated to have fallen from just over 2 per cent to 0.6 per cent annually. The slowdown sets off an endogenous response of the private sector which increases capital accumulation acting as an automatic stabilizer. The slowdown also brings about a lasting transition which in the short-run decreases consumption tax revenues but increases them in the long-run changing permanently the composition of tax revenues and temporarily increasing the government debt to output ratio.
    Keywords: Open economy, trend growth, fiscal policy, real business cycles, estimation, structural breaks.
    JEL: E30 F43 H30
    Date: 2022–05
  10. By: Gürkaynak, Refet S.; Kısacıkoğlu, Burçin; Lee, Sang Seok
    Abstract: For the academic audience, this paper presents the outcome of a well-identifted, large change in the monetary policy rule from the lens of a standard New Keynesian model and asks whether the model properly captures the effects. For policymakers, it presents a cautionary tale of the dismal effects of ignoring basic macroeconomics. The Turkish monetary policy experiment of the past decade, stemming from a belief of the government that higher interest rates cause higher inflation, provides an unfortunately clean exogenous variance in the policy rule. The mandate to keep rates low, and the frequent policymaker turnover orchestrated by the government to enforce this, led to the Taylor principle not being satisfted and eventually a negative coefficient on inflation in the policy rule. In such an environment, was the exchange rate still a random walk? Was inflation anchored? Does the "standard model" suffice to explain the broad contours of macroeconomic outcomes in an emerging economy with large identifying variance in the policy rule? There are no surprises for students of open-economy macroeconomics; the answers are no, no, and yes.
    JEL: E02 E31 E52 E58 F31 F41
    Date: 2022
  11. By: Campanale Claudio (Depatment of Economics and Statistics (ESOMAS) University of Torino, Italy); Rocio Fernandez-Bastidas (Departamento de Fundamentos del Analisis Economico (FAE), Universidad de Alicante, Spain)
    Abstract: In the present paper we confront standard wage processes used in the quantitative literature on the optimal tax progressivity and a process with heterogeneous life-cycle profiles that we propose against the data. We find that the former fail to capture several features of the earnings dynamics at the very top of the distribution while our proposed model improves along some of these dimensions.
    Keywords: Top earners, Earnings Dynamics, Heterogeneous Income Growth
    JEL: D31 E24 J24 J31
    Date: 2022–05
  12. By: Rottner, Matthias
    Abstract: Motivated by the build-up of shadow bank leverage prior to the financial crisis of 2007-2008, I develop a nonlinear macroeconomic model featuring excessive leverage accumulation and endogenous financial crises to capture the observed dynamics and to quantify the build-up of financial fragility. I use the model to illustrate that extensive leverage makes the shadow banking system runnable, thereby raising the vulnerability of the economy to future financial crises. The model is taken to U.S. data with the objective of estimating and analyzing the probability of a run in the years preceding the financial crisis of 2007-2008. According to the model, the estimated risk of a run was already considerable in 2005 and kept increasing due to the upsurge in leverage. Using counterfactual scenarios, I assess the impact of alternative monetary and macroprudential policy strategies on the estimated build-up of financial fragility.
    Keywords: Financial crises,leverage,credit boom,nonlinear estimation
    JEL: E32 E44 G23
    Date: 2022
  13. By: Pierlauro Lopez; J. David López-Salido; Francisco Vazquez-Grande
    Abstract: We propose a novel approximation of the risky steady state and construct first-order perturbations around it for a general class of dynamic equilibrium models with time-varying and non-Gaussian risk. We offer analytical formulas and conditions for their local existence and uniqueness. We apply this approximation technique to models featuring Campbell-Cochrane habits, recursive preferences, and time-varying disaster risk, and show how the proposed approximation represents the implications of the model similarly to global solution methods. We show that our approximation of the risky steady state cannot be generically replicated by higher-order perturbations around the deterministic steady state, which cannot account well for the effects of risk in our applications even up to third order. Finally, we argue that our perturbation can be viewed as a generalized version of the heuristic loglinear-lognormal approximations commonly used in the macro-finance literature.
    Keywords: Perturbation methods; Risky steady state; Macroeconomic uncertainty; Solving dynamic equilibrium models; Time-varying risk premia
    JEL: C63 G12 E32 E44
    Date: 2022–05–11
  14. 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
  15. By: Katrine Marie Jakobsen; Thomas H. Jørgensen; Hamish Low; Katrine Marie Jakobsen
    Abstract: We study the role of fertility adjustments for the labor market responsiveness of men and women. First, we use longitudinal Danish register data and tax reforms from 2009 to provide new empirical evidence on asymmetric fertility adjustments to tax changes of men and women. Second, we quantify the importance of these fertility adjustments for understanding the labor supply responsiveness of couples through a life-cycle model of family labor supply and fertility. Allowing fertility adjustments increases the labor supply responsiveness of women by 28%. These adjustments affect human capital accumulation and has permanent implications for the gender wage gap within couples.
    Keywords: fertility, labor supply, human capital accumulation, gender inequality, tax reform, life-cycle
    JEL: J22 J13 D15 H24
    Date: 2022
  16. By: Alessandro Ferrari; Francisco Queir\'os
    Abstract: We study how firm heterogeneity and market power affect macroeconomic fragility, defined as the probability of long-lasting recessions. We propose a theory in which the positive interaction between firm entry, competition and factor supply can give rise to multiple steady-states. We show that when firm heterogeneity is large, even small temporary shocks can trigger firm exit and make the economy spiral in a competition-driven poverty trap. Calibrating our model to incorporate the well-documented trends in increasing firm heterogeneity in the US economy, we find that, relative to 2007, an economy with the 1985 level of firm heterogeneity is 5 to 9 times less likely to experience a very persistent recession. We use our framework to study the 2008-09 recession and show that the model can rationalize the persistent deviation of output and most macroeconomic aggregates from trend, including the behavior of net entry, markups and the labor share. Post-crisis cross-industry data corroborates our proposed mechanism. We conclude by showing that firm subsidies can be powerful in preventing quasi-permanent recessions and can lead to up to a 21% increase in welfare.
    Date: 2022–05
  17. By: Brant Abbott; Nam Phan
    Abstract: We use a labor search model with heterogenous households and firms to study the efficacy of a wage subsidy during a pandemic, relative to enhancing unemployment benefits. A large proportion of the economy is forced to shut down, and firms in that sector choose whether to lay off workers or keep them on payroll. A wage subsidy encourages firms to keep workers on payroll, which speeds up labor market recovery after the pandemic ends. However, a wage subsidy can be costlier than enhancing unemployment benefits. If the shutdown is long or profit margins are low then a wage subsidy is preferable, and vice-versa. The optimal mixture of policies includes a wage subsidy that covers 90% the first $200/week of earnings, and expands unemployment benefits to cover all salary up to $275/week. Low income workers, as well as those in less productive jobs, benefit the most from a wage subsidy.
    Keywords: wage subsidy, unemployment insurance, search, pandemic, Covid-19
    JEL: E2 E32 J40
    Date: 2022–05
  18. By: Greg Kaplan; Giovanni L. Violante
    Abstract: What model features and calibration strategies yield a large average marginal propensity to consume (MPC) in heterogeneous agent models? Through a systematic investigation of models with different preferences, dimensions of ex-ante heterogeneity, income processes and asset structure, we show that the most important factor is the share and type of hand-to-mouth households. One-asset models either feature a trade-off between a high average MPC and a realistic level of aggregate wealth, or generate an excessively polarized wealth distribution that vastly understates the wealth held by households in the middle of the distribution. Two-asset models that include both liquid and illiquid assets can resolve this tension with a large enough gap between liquid and illiquid returns. We discuss how such return differential can be justified from the perspective of theory and data.
    JEL: D15 D31 D52 E21 E62 E71 G51
    Date: 2022–05
  19. By: Arianna Garofalo (Universitat de Barcelona)
    Abstract: Over the past three decades, the drop in fertility rates has been accompanied by high rates of migration in several developing countries. We argue that migration affects fertility negatively in the countries of origin. To analyze the effect of migration we build a fertility choice model, based on De La Croix (2014), with endogenous migration decisions. In this framework, when a member of the household migrates abroad, income increases due to remittances but at the same time, individuals left at home face a much higher opportunity cost time. This means that household members have less time to devote to taking care of the children and the consequence is a decrease in fertility. We calibrate the model to match the migration rates and to quantify the effect of migration on the fertility rate in those countries. To this end, we first show that the model can replicate the high rate of migrations in several developing countries. Then we perform two counterfactual exercises to address the effect of our mechanism. In the first exercise, we keep the migration constant as in the benchmark model while we give a higher value to the time cost of migration. The result is an increase in fertility. In the second exercise, we quantify how the differences in the time cost of migration affect the differences in fertility. We found that the time cost of migration accounts for 53% of the fall in the fertility of the developing countries in our sample between 1990 and 2017.
    Keywords: Fertility, migration, remittances.
    JEL: O11 J11 F22 F24
    Date: 2022
  20. By: Rodimiro Rodrigo (Department of Economics, Georgetown University)
    Abstract: Major technological changes have come with an adjustment period of stagnant productivity before the economy operates at its full potential. The mechanism of this adoption process is still not well understood. Using event studies, I document that productivity increases with a five-year lag after the adoption of industrial robots in Brazilian local labor markets. Combining employer-employee matched data with a novel measure of robot adoption, I provide first evidence of establishment-level labor reorganization and organizational capital depreciation induced by the automation process. During the five years after adoption, labor switching across occupations increases within firms, moving from production to support activities. I show that firms’ organizational capital measured by workers’ firm-occupation-specific experience depreciates and then slowly re-accumulates. When these processes stop, the productivity gains reach their maximum. I use these results to estimate a general equilibrium model with heterogeneous firms, endogenous robot adoption, and organizational capital accumulation. The model accounts for the productivity paradox, the diffusion of industrial robots, and the change in the aggregate skill demand. The model highlights the role of organizational costs accompanying the adoption of new technologies. I illustrate its usefulness by using it to characterize the implications of the “innovator’s dilemma.” Classification- E24, J62, L23, O32, O33
    Keywords: Labor Productivity, Occupational Mobility, Technological Change, Automation
    Date: 2022–02–27
  21. By: Juan Carlos Castro Fernández; Juan Carlos Castro Fernández
    Keywords: Financial crises, financial frictions, expectations, debt overhang, news shocks, boom– bust cycles.
    Date: 2022–05–26
  22. By: di Porto, Edoardo (University of Naples Federico II); Tealdi, Cristina (Heriot-Watt University, Edinburgh)
    Abstract: We investigate how the flexibility of temporary contracts affects the probability of young workers to be upgraded into permanent employment. Theoretically, we explore the workers' career development in response to the change in flexibility within a search and matching model; empirically, we exploit an Italian labour market reform which increased flexibility in a difference in differences framework. We find that new entrants in the labour market who have been affected by the reform experienced a decrease in the conversion rate of approximately 12.5 percentage points in the first months after the reform, and of 5.1 percentage points over a year, compared to unaffected peers. This effect is particularly strong among women and low-educated workers employed in low productive firms in the Center/South of Italy. Worryingly, the lower conversion rate leads to a 25% wage penalty even two years down the workers' career paths.
    Keywords: institutional reforms, flexibility, young workers, temporary contracts, employment protection legislation
    JEL: J41 J63 J64
    Date: 2022–04
  23. 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.
    JEL: D83 E22 E44 E52 G12 G31 G32
    Date: 2022–05
  24. By: Juan Herreno; Mathieu Pedemonte
    Abstract: We study the differential regional effects of monetary policy exploiting geographical heterogeneity in income across cities in the United States. We find that prices and employment in poorer cities react more to monetary policy shocks. The results for prices hold for a wide range of narrow consumer expenditure categories. The results are consistent with New Keynesian models that allow for a differential share of hand-to-mouth consumers across regions, but not with models in which regions have different slopes of the Phillips curve. We show that an increase in heterogeneity across cities amplifies the effect of monetary policy on prices and employment.
    Keywords: Heterogeneous Effects of Monetary Policy; Monetary Union; TANK
    JEL: E31 E24 E52 E58 F45
    Date: 2022–05–12

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