nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2022‒09‒19
ten papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Idiosyncratic Income Risk and Aggregate Fluctuations By Davide Debortoli; Jordi Galí
  2. Search Frictions, Labor Supply, and the Asymmetric Business Cycle By Domenico Ferraro; Giuseppe Fiori
  3. Counter-cyclical fiscal rules and the zero lower bound By Hauptmeier, Sebastian; Kamps, Christophe; Radke, Lucas
  4. DSGE Models and Machine Learning: An Application to Monetary Policy in the Euro Area By Daniel Stempel; Johannes Zahner
  5. Policy Rules and Large Crises in Emerging Markets By Emilio Espino; Julian Kozlowski; Fernando M. Martin; Juan M. Sanchez
  6. Genetic Endowments, Income Dynamics, and Wealth Accumulation Over the Lifecycle By Daniel Barth; Nicholas W. Papageorge; Kevin Thom; Mateo Velásquez-Giraldo
  7. Democratic Climate Policies with Overlapping Generations By Arnaud Goussebaïle
  8. Lower for longer under endogenous technology growth By Elfsbacka Schmöller, Michaela; Spitzer, Martin
  9. Weather Shocks and Inflation Expectations in Semi-Structural Models By Jose Vicente Romero; Sara Naranjo Saldarriaga
  10. Spatial economic dynamics and transport project appraisal By James Lennox

  1. By: Davide Debortoli; Jordi Galí
    Abstract: We study the role of idiosyncratic income shocks for aggregate fluctuations within a simple heterogeneous household framework with no binding borrowing constraints. We show that the presence of idiosyncratic income shocks affects the economy's response to an aggregate shock in a way that can be captured by a consumption weighted average of the changes in uncertainty generated by the shock. We apply this framework to two example economies - an endowment economy and a New Keynesian economy - and show that under plausible calibrations the impact of idiosyncratic income shocks on aggregate fluctuations is quantitatively small, since most of the changes in uncertainty are concentrated among poorer (low consumption) households.
    Keywords: Heterogeneous agents, economic fluctuations, aggregate shocks, idiosyncratic shocks, monetary policy, HANK models
    JEL: E21 E32 E50
    Date: 2021–08
  2. By: Domenico Ferraro; Giuseppe Fiori
    Abstract: We develop a business cycle model with search frictions in the labor market and a labor supply decision along the extensive margin that yields cyclical asymmetry between peaks and troughs of the unemployment rate and symmetric fluctuations of the labor force participation rate as in the U.S. data. We calibrate the model and find that cyclical changes in the extent of search frictions are solely responsible for the peak-trough asymmetry. Participation decisions do not generate asymmetry but contribute to the fluctuations in search frictions by changing the size and composition of the pool of job seekers, which in turn affects the tightness ratio and thereby slack in the labor market. The participation rate would be counterfactually asymmetric absent labor supply responses to shocks.
    Keywords: Asymmetric business cycles; Labor supply; Search frictions; Employment; Unemployment rate; Labor force participation rate
    JEL: E24 E32 J63 J64
    Date: 2022–08–16
  3. By: Hauptmeier, Sebastian; Kamps, Christophe; Radke, Lucas
    Abstract: We analyse the effectiveness of optimal simple and implementable monetary and fiscal policy rules in stabilising economic activity, inflation and government debt in face of an occasionally binding lower bound on the nominal interest rate in a New Keynesian model. We show that, within the traditional assignment of active monetary policy and passive fiscal policy, the optimal fiscal policy rule features a strong counter-cyclical response to the deviation of inflation from the central bank’s target - providing significant macroeconomic stabilisation especially at the lower bound - while also featuring a strong response to government debt. Our quantitative results show that the optimal counter-cyclical fiscal feedback to inflation significantly improves welfare and reduces the lower-bound frequency. In addition, the optimal simple monetary and fiscal rules almost completely resolve the deflationary bias associated with the lower bound. JEL Classification: E31, E52, E61, E62
    Keywords: deflationary bias, fiscal rules, inflation targeting, zero lower bound
    Date: 2022–08
  4. By: Daniel Stempel (University of Duesseldorf); Johannes Zahner (University of Marburg)
    Abstract: In the euro area, monetary policy is conducted by a single central bank for 19 member countries. However, countries are heterogeneous in their economic development, including their inflation rates. This paper combines a New Keynesian model and a neural network to assess whether the European Central Bank (ECB) conducted monetary policy between 2002 and 2022 according to the weighted average of the inflation rates within the European Monetary Union (EMU) or reacted more strongly to the inflation rate developments of certain EMU countries. The New Keynesian model first generates data which is used to train and evaluate several machine learning algorithms. We find that a neural network performs best out-of-sample. Thus, we use this algorithm to classify historical EMU data. Our findings suggest disproportional emphasis on the inflation rates experienced by southern EMU members for the vast majority of the time frame considered (80%). We argue that this result stems from a tendency of the ECB to react more strongly to countries whose inflation rates exhibit greater deviations from their long-term trend.
    Keywords: New Keynesian Models, Monetary Policy, European Monetary Union, Neural Networks, Transfer Learning
    JEL: C45 C53 E58
    Date: 2022
  5. By: Emilio Espino; Julian Kozlowski; Fernando M. Martin; Juan M. Sanchez
    Abstract: In response to the COVID-19 pandemic, Latin American countries temporarily suspended rules limiting debt, fiscal and monetary policies. Despite this increase in flexibility, the crisis implied a substantial deterioration of macroeconomic variables (e.g., real GDP declined by 9.5%) and high welfare costs (which we estimate as equivalent to a 13% one-time reduction in non-tradable consumption). This paper studies a sovereign default model with fiscal and monetary policies to assess the policy response and evaluate the gains from flexibility in times of severe distress.
    Keywords: COVID-19; crises; default; Sovereign debt; Exchange rate; inflation; fiscal policy; emerging markets; Markov equilibrium
    JEL: E52 E62 F34 F41 G15
    Date: 2022–08–31
  6. By: Daniel Barth; Nicholas W. Papageorge; Kevin Thom; Mateo Velásquez-Giraldo
    Abstract: We develop and estimate a life-cycle consumption savings model in which observed genetic variation is allowed to affect wealth accumulation through several distinct channels. We focus on genetic markers that predict educational attainment, aggregated into a predictive index called a polygenic score. Based on substantial descriptive evidence, we allow variation in these endowments to affect earnings, the disutility of labor, stock market participation costs, and idiosyncratic rates of return on risky investments. The model also incorporates endogenous retirement and a realistic social security system. Parameter estimates suggest that, in addition to earnings, genetic differences are significantly associated with risky asset returns, both of which contribute to wealth inequality. Counterfactual policy exercises indicate that two ways to lower costs of an aging population (extending the age of retirement or cutting social security benefits) have similar magnitudes and distributions of welfare costs even though the latter policy appears to reduce wealth differences between agents with different genetic endowments. This illustrates the importance of welfare calculations when evaluating how genes interact with policy, which is possible to do if we incorporate genetic data into structural models.
    JEL: D14 D15 D31 D63 G50 H31 H55 I38 J24 J26
    Date: 2022–08
  7. By: Arnaud Goussebaïle (CER-ETH – Center of Economic Research at ETH Zurich, Zuerichbergstrasse 18 8092 Zurich, Switzerland)
    Abstract: An extensive climate policy literature provides various recommendations, but they are not supported democratically since the models employed consider either infinitely-lived individuals or normative social objectives (or both). In contrast, the present paper provides policy recommendations that are able to go through democratic processes. I develop an overlapping generation model with political process micro-foundations. I analyze how democratic policies, which are directly and indirectly related to climate change, differ from standard recommended policies. The novel politico-economic formula derived for the interest rate highlights that individual pure time preference, individual altruism toward descendants, and young generation political power are key determinants of democratic climate policy ambition.
    Keywords: Climate change; Discounting; Externality; Overlapping generations; Political economy
    JEL: D6 D7 E6 Q5
    Date: 2022–08
  8. By: Elfsbacka Schmöller, Michaela; Spitzer, Martin
    Abstract: This paper studies monetary policy strategies under endogenous technology dynamics and low r*. Endogenous growth strengthens the gains from make-up strategies relative to inflation targeting, especially if policy space is reduced. This result is due to the long-run non-neutrality of money and the hysteresis effects in TFP through which ELB episodes generate permanent scars on long-run aggregate supply. Make-up strategies not only foster the alignment of inflation with target but also support productivity-improving investment in R&D and technology adoption and hence the long-run trend path, provided that the inherent make-up element is sufficiently pronounced. Inflation is less responsive to monetary policy due to the interaction with productivity dynamics. As a result, additional stimulus is required at the ELB and the degree of subsequent overshooting is alleviated. Endogenous growth also generates novel monetary policy trade-offs, most notably credibility challenges, which can be mitigated by confining make-up elements to ELB episodes. JEL Classification: E24, E31, E32, E52, O30
    Keywords: cycle-trend interaction, endogenous TFP, hysteresis, make-up strategies, ZLB
    Date: 2022–08
  9. By: Jose Vicente Romero (Banco de la Republica); Sara Naranjo Saldarriaga (Banco de la Republica)
    Abstract: Colombia is particularly affected by the El Nino Southern Oscillation (ENSO) weather fluctuations. In this context, this study explores how the adverse weather events linked to ENSO affect the inflation expectations in Colombia and how to incorporate these second-round effects into a small open economy New Keynesian model. Using BVARx models we provide evidence that the inflation expectations obtained from surveys and break-even inflation measures are affected by weather supply shocks. Later, using this stylised fact, we modify one of the core forecasting models of the Banco de la Republica by incorporating the mechanisms in which weather-related shocks affect marginal costs and inflation expectations. We find that ENSO shocks had an important role in both inflation and the dynamics of inflation expectations, and that policymakers should consider this fact.
    Keywords: Inflation; inflation expectations; inflation expectations anchoring; weather shocks
    JEL: D84 E31 E52 Q54
    Date: 2022–08–15
  10. By: James Lennox
    Abstract: Transport infrastructure is costly to build and very long-lived. Major projects are expected to enhance accessibility, which over time, is likely to a ect the distribution of population and employment. In a Dynamic Spatial Equilibrium (DSE) model, the timing and location of a project's direct costs and benefits can be explicitly represented. Effects of both construction and operational phases are captured in a forward-looking spatial general equilibrium with costly adjustment. Not only are dynamic responses of direct interest to policymakers, but they have crucial implications for welfare analysis. In this paper, we present a flexible DSE model incorporating dynamics of internal migration and occupation choice, and intra- period spatial linkages via commuting and trade flows. We calibrate the framework to Australian data and illustrate its application by modelling a hypothetical fast express rail service in South-East Queensland. In analysing the results, we highlight the roles of general equilibrium effects within and between periods. These are important both to overall welfare benefits and to their distribution. Transport cost changes are exogenous inputs to our simulation. However, we also discuss the potential to link a DSE model to a four-step strategic transport model to enable fully dynamic Land Use-Transport Interactions (LUTI) simulations.
    Keywords: dynamic spatial equilibrium, project appraisal
    JEL: R12 R23 R42
    Date: 2022–08

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