nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2022‒08‒29
seventeen papers chosen by

  1. Time-Varying Parameter Four-Equation DSGE Model By Rangan Gupta; Xiaojin Sun
  2. Monetary Union, Asymmetric Recession, and Exit By Keuschnigg, Christian
  3. The Great Moderation and the Financial Cycle By Friedrich Lucke
  4. Credit and Saving Constraints in General Equilibrium: A Quantitative Exploration By Granda-Carvajal, Catalina; Hamann, Franz; Tamayo, Cesar E.
  5. Labour market dynamics and growth By Jake Bradley; Axel Gottfries
  6. Market Incompleteness, Consumption Heterogeneity and Commodity Price Shocks By Damian Romero
  7. Mortgage securitization and information frictions in general equilibrium By Salomón García
  8. Financial Innovations in a World with Limited Commitment: Implications for Inequality and Welfare By Saroj Dhital; Pedro Gomis-Porqueras; Joseph H. Haslag
  9. Overborrowing and Systemic Externalities in the Business Cycle Under Imperfect Information By Juan Herreño; Carlos Rondón-Moreno
  10. General Equilibrium and Dynamic Inconsistency By Kirill Borissov; Mikhail Pakhnin; Ronald Wendner
  11. Temporary Super Depreciation Allowances for Green and Digital Investments By Michael Funke; Raphael Terasa
  12. Debt and Taxes: Optimal Fiscal Consolidation in the Small Open Economy By Carlos Rondón-Moreno
  13. A model for predicting Finnish household loan stocks By Nyholm, Juho; Silvo, Aino
  14. Adjustment costs and factor demand: new evidence from firms' real estate By Bergeaud, Antonin; Ray, Simon
  15. Digital Money as a Medium of Exchange and Monetary Policy in Open Economies By Daisuke Ikeda
  16. Climate Change Mitigation: How Effective is Green Quantitative Easing? By Raphael Abiry; Marien Ferdinandusse; Alexander Ludwig; Carolin Nerlich
  17. Evergreening By Miguel Faria-e-Castro; Jose E. Galdon Sanchez; Pascal Paul; Juan M. Sanchez

  1. By: Rangan Gupta (Department of Economics, University of Pretoria, Private Bag X20, Hatfield 0028, South Africa); Xiaojin Sun (Department of Economics and Finance, University of Texas at El Paso, USA)
    Abstract: We build in the time-varying parameter feature into the Sims et al. (2020) four-equation Dynamic Stochastic General Equilibrium (DSGE) model in this paper. We find that both parameters and impulse responses of the variables in the four-equation DSGE model exhibit significant variation over time. Allowing model parameters to vary over time also improves the model's forecasting performance.
    Keywords: Four-Equation DSGE, Time-Varying Parameter, Forecasting
    JEL: E32 C52 C53
    Date: 2022–08
  2. By: Keuschnigg, Christian
    Abstract: We propose a New Keynesian DSGE model of the Eurozone and analyze an asymmetric recession in a vulnerable member state characterized by a trilemma of high public debt, weak banks, and deteriorating competitiveness. We compare macroeconomic adjustment under continued membership with two exit scenarios that introduce flexible exchange rates and autonomous monetary policy. An exit with stable investor expectations could significantly dampen the short-run impact. Stabilization is achieved by a targeted monetary expansion combined with depreciation. However, investor panic may lead to escalation, aggravate the recession and delay the recovery.
    Keywords: Currency union, exchange rate flexibility, fiscal consolidation, sovereign debt, banks
    JEL: E42 E44 E60 F30 F36 F45 G15 G21
    Date: 2022–08
  3. By: Friedrich Lucke
    Abstract: We show that the defining features of the Great Moderation were a shift from output volatility to medium- term fluctuations and a shift in the origin of those fluctuations from the real to the financial sector. We discover a Granger-causal relationship by which financial cycles attenuate short-term business cycle fluc- tuations while they amplify longer-term fluctuations at the same time. As a result, financial shocks system- atically drive medium-term output fluctuations whereas real shocks drive short-term output fluctuations. We use these results to argue that the Great Moderation and Great Recession both result from the same eco- nomic forces. On the theoretical front, we show that long-run risk is a critical ingredient of DSGE models with financial sectors that seek to replicate these shifts. Finally, we used this DSGE model to refine “good luck” and “good policy” hypothesis of the Great Moderation.
    Keywords: Great Moderation,Business Cycle,Financial Cycle,Frequency-Domain
    JEL: E00 E32 E44 E50
    Date: 2022–07
  4. By: Granda-Carvajal, Catalina; Hamann, Franz; Tamayo, Cesar E.
    Abstract: In this paper we build an incomplete-markets model with heterogeneous households and firms to study the aggregate effects of saving constraints and credit constraints in general equilibrium. We calibrate the model using survey data from Colombia, a developing country in which informal saving and credit frictions are pervasive. Our quantitative results suggest that reducing savings costs increases selection into formal saving, but the effect on aggregate outcomes and welfare is dwarfed by that of a policy which ameliorates borrowing constraints. Such a policy improves resource allocation and increases returns to capital and labor, resulting in higher savings and welfare gains for both households and firms.
    Keywords: saving constraints; credit constraints; financial inclusion; misallocation; savings; formal and informal financial markets
    JEL: E21 E44 G21 O11 O16
    Date: 2022–08
  5. By: Jake Bradley; Axel Gottfries
    Abstract: We embody a technological diffusion process into the canonical search and matching model of the labor market. New matches imitate the production process of incumbents. The resulting model retains the features of a labor search model whilst also generating endogenous growth through creative destruction. The model is calibrated to standard moments from the US labor market and generates, consistent with data, an order of magnitude more amplification in unemployment than a similarly calibrated model without endogenous growth. The model provides a natural framework to decompose the sources of growth based on labor market flows. Using cross-country data for 32 countries across a broad range of development, we find that growth via creative destruction is quantitatively more important for developing countries.
    Keywords: labour market dynamics; growth
    Date: 2022
  6. By: Damian Romero
    Abstract: This paper studies how household heterogeneity shapes the response to commodity price shocks. Using data from Chile and other emerging economies, we document that (i) low/high-income households spend relatively more on food/services, and (ii) more than 40 percent of the population is financially constrained. We build a multi-sector New Keynesian model for a small open economy with household heterogeneity and non-homothetic preferences. Non-homothetic preferences dampen the effect of a commodity price shock by inducing a reallocation in the consumption basket towards more income-elastic goods: an economy with non-homothetic preferences generates aggregate responses 29 percent lower.
    Date: 2022–04
  7. By: Salomón García (Banco de España)
    Abstract: I develop a macro model of the U.S. housing finance system that delivers an equilibrium connection between the securitization and mortgage credit markets. An endogenous securitization market efficiently reallocates illiquid assets, increases liquidity to fund mortgage lending, and lowers interest rates for borrowers. However, its benefits are hindered by originators’ private information about loan quality which leads to adverse selection in securitization. Fluctuations in household credit risk induce expansion and contractions of mortgage credit through the securitization liquidity channel. Adverse selection generates a multiplier effect of household shocks. Applying the theory to the Great Financial Crisis, I quantify that information frictions amplified the observed mortgage credit contraction by a factor of 1.5. The multiplier is an endogenous function of the severity of information frictions. A subsidy policy in the securitization market can stabilize liquidity and credit cycles. However, the policy generates inefficiently high liquidity and fails to realize meaningful welfare gains for households.
    Keywords: securitization, banking, DSGE, private information, liquidity frictions
    JEL: D5 D82 G21 G28
    Date: 2022–06
  8. 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
  9. By: Juan Herreño; Carlos Rondón-Moreno
    Abstract: We study the interaction between imperfect information and financial frictions and its role in driving financial crises in small open economies. We use a model where households observe income growth but do not perceive whether the underlying shocks are permanent or transitory and borrowing is subject to a collateral constraint. The optimal macroprudential policy helps stabilize the economy by taxing debt procyclically. We show that the combination of imperfect information and borrowing constraints is a significant source of economic instability. The optimal tax under these conditions is six times larger than the tax in the perfect information limit.
    Date: 2022–03
  10. By: Kirill Borissov; Mikhail Pakhnin; Ronald Wendner
    Abstract: We study the role of expectations of naive agents in a general equilibrium version of the Ramsey model with quasi-hyperbolic discounting. When agents recognize others’ naivete, as strongly suggested by empirical evidence, they revise consumption paths, correctly anticipating prices in a resulting sliding equilibrium (perfect foresight). When agents are unaware of others’ naivete, as is typically assumed in the literature, they revise both consumption paths and price expectations (quasi-perfect foresight). We prove the existence of sliding equilibrium under perfect foresight for the class of isoelastic utility functions. We show that generically quasi-hyperbolic discounting matters for saving behavior: sliding equilibrium under perfect foresight is observationally equivalent to some optimal path in the standard Ramsey model if and only if utility is logarithmic. We compare sliding equilibria under different types of foresight and show that perfect foresight implies a higher saving rate, long-run capital stock, and consumption level than quasi-perfect foresight.
    Keywords: quasi-hyperbolic discounting, time inconsistency, naivete, sliding equilibrium, perfect foresight, observational equivalence
    JEL: D15 D84 D91 E21 O40
    Date: 2022
  11. By: Michael Funke; Raphael Terasa
    Abstract: As an incentive to increase high-impact investment and boost growth, the German Federal Government is planning to introduce a targeted temporary super depreciation allowance to support much-needed green and digital transitions. Using a calibrated multi-sector DSGE model, we find that the temporary super deduction could trigger an uplift of 10 percentage points for green and digital capital spending, turbo-charging green growth ambitions. However, with the temporary measure set to end after two years, there is a risk that business investment could tail off at a crucial time, when post-COVID-19 recovery is levelling out. Thus, additional longer-term climate policies are needed to drive the green transition, facilitated by broad policy packages.
    Keywords: climate economics, business taxation, firm investment, depreciation allowances, DSGE model, Germany
    JEL: E22 E60 H25 Q54 Q58
    Date: 2022
  12. By: Carlos Rondón-Moreno
    Abstract: In this paper, I argue that the optimal design of a fiscal consolidation plan must consider the transition dynamics of the economy and be chosen such that either welfare (or another given measure of prosperity) is maximized. In the context of a small open economy, I study the optimal design of a fiscal consolidation plan under different monetary policy regimes and, in particular, the implications of reducing debt under a currency peg. Two main lessons are derived from the results. First, consolidation is costly enough regarding welfare, so that the fiscal authority would like to implement it at a very slow pace. If the government is forced to do it by a certain deadline, the welfare maximizing path will reduce the losses but will not be able to offset them. Second, from the output perspective, the optimal consolidation path under an independent monetary regime leads to a positive response of aggregate demand. While, under the currency peg, the optimal path induces an economic recession. Devaluation seems to be a key factor in stabilizing output during fiscal consolidation.
    Date: 2022–03
  13. By: Nyholm, Juho; Silvo, Aino
    Abstract: We propose a new Bayesian VAR model for forecasting household loan stocks in Finland. The model is designed to work as a satellite model of a larger DSGE model for the Finnish economy, the Aino 2.0 model. The forecasts produced with the BVAR model can be conditioned on projections of several macro variables obtained from the Aino 2.0 model. We study several specifications for the set of variables and lags included in the BVAR, and evaluate their out-of-sample forecast accuracy with root mean squared forecasting errors (RMSFEs). We then select a preferred specification that performs best in predicting the loan stocks over forecast horizons ranging from one to twelve quarters ahead. The model adds to the existing toolkit of forecast models currently in use at the Bank of Finland and improves our understanding of household debt trends in Finland.
    Keywords: household debt,Bayesian estimation,conditional forecasting
    JEL: C11 C32 E37
    Date: 2022
  14. By: Bergeaud, Antonin; Ray, Simon
    Abstract: We study corporate real estate frictions and their effect on firm dynamics and labour demand. We build and simulate a general equilibrium model with heterogeneous firms that predicts the response of firms to a productivity shock in the presence of fixed adjustment costs on real estate. Using a large firm-level database merged with local real estate prices, we then exploit variations in the tax on capital gains to document a causal effect of adjustment costs on firms' labour demand and derive new results on the causes and implications of firms' local relocation.
    JEL: D21 H25 J21 O52
    Date: 2021–01–01
  15. By: Daisuke Ikeda (Director and Senior Economist, Institute for Monetary and Economic Studies (currently, Financial System and Bank Examination Department), Bank of Japan (E-mail:
    Abstract: The rise of digital money may bring about privately issued money that circulates across borders and coexists with public money. This paper uses an open-economy search model with multiple currencies to study the impact of such global money on monetary policy autonomy -- the capacity of central banks to set a policy instrument. I show that the circulation of global money can entail a loss of monetary policy autonomy, but it can be preserved if government policy that limits the amount or use of global money for transactions is introduced or if the global currency is subject to counterfeiting. The result suggests that global digital money and monetary policy autonomy can be compatible.
    Keywords: Cryptocurrency, Monetary policy autonomy, Currency counterfeiting, Government transaction policy
    JEL: D82 E4 E5 F31
    Date: 2022–07
  16. By: Raphael Abiry (Goethe University Frankfurt (E-mail:; Marien Ferdinandusse (European Central Bank (E-mail:; Alexander Ludwig (Goethe University Frankfurt, ICIR & CEPR (E-mail:; Carolin Nerlich (European Central Bank (E-mail:
    Abstract: We develop a two sector incomplete markets integrated assessment model to analyze the effectiveness of green quantitative easing (QE) in complementing fiscal policies for climate change mitigation. We model green QE through an outstanding stock of private assets held by a monetary authority and its portfolio allocation between a clean and a dirty sector of production. Green QE leads to a partial crowding out of private capital in the green sector and to a modest reduction of the global temperature by 0.04 degrees of Celsius until 2100. A moderate global carbon tax of 50 USD is 4 times more effective.
    Keywords: Climate Change, Integrated Assessment Model, 2-Sector Model, Green Quantitative Easing, Carbon Taxation
    JEL: E51 E62 Q54
    Date: 2022–07
  17. By: Miguel Faria-e-Castro; Jose E. Galdon Sanchez; Pascal Paul; Juan M. Sanchez
    Abstract: We develop a simple model of relationship lending where lenders have incentives for evergreening loans by offering better terms to less productive and more indebted firms. We detect such lending behavior using loan-level supervisory data for the United States. Low-capitalized banks systematically distort firms’ risk assessments to window-dress their balance sheets. To avoid further reductions in their capital ratios, such banks extend relatively more credit to underreported borrowers. We incorporate the theoretical mechanism into a dynamic heterogeneous-firm model to show that evergreening affects aggregate outcomes, resulting in lower interest rates, higher levels of debt, and lower productivity.
    Keywords: evergreening; zombie firms; bank lending; misallocation
    Date: 2022–07–31

General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.