nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2022‒10‒03
sixteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Heterogeneous Expectations and the Business Cycle at the Effective Lower Bound By Tolga Özden
  2. Neoclassical Growth with Long-Term One-Sided Commitment Contracts By Dirk Krueger; Harald Uhlig
  3. On the Empirical Relevance of the Exchange Rate as a Shock Absorber at the Zero Lower Bound By David Finck; Mathias Hoffmann; Patrick Huertgen
  4. “Green†fiscal policy measures and non-standard monetary policy in the euro area By Anna Bartocci; Alessandro Notarpietro; Massimiliano Pisani
  5. The Effects of Fiscal Policy when Planning Horizons are Finite By Joep Lustenhouwer; Kostas Mavromatis
  6. Quarterly Projection Model for the Bank of Ghana By Shalva Mkhatrishvili; Valeriu Nalban; Philip Abradu-Otoo; Ivy Acquaye; Abubakar Addy; Nana Kwame Akosah; James Attuquaye; Simon Harvey; Zakari Mumuni
  7. Effective Fiscal-Monetary Interactions in Severe Recessions By Mr. Raphael A Espinoza; Jesper Lindé; Mr. Jiaqian Chen; Zoltan Jakab; Carlos Goncalves; Tryggvi Gudmundsson; Martina Hengge
  8. Markups, Taxes, and Rising Inequality By Stéphane Auray; Aurélien Eyquem; Bertrand Garbinti; Jonathan Goupille-Lebret
  9. Temporary Replacement Workers in a Matching Model with Employment at Will By Garibaldi, Pietro; Gomes, Pedro Maia
  10. DEMUR, a regional semi-structural model of the Ural Macroregion By Oleg Kryzhanovsky; Alexander Zykov
  11. Optimal growth with labour market frictions By Guerrazzi, Marco
  12. Brazilian economy in the 2000’s: A tale of two recessions By Matheus Cardoso Leal; Marcio Issao Nakane
  13. LINVER: The Linear Version of FRB/US By Flint Brayton; David L. Reifschneider
  14. Boomerang College Kids: Unemployment, Job Mismatch and Coresidence By Albanesi, Stefania; Gihleb, Rania; Zhang, Ning
  15. Central Bank Policy Mix: Policy Perspectives and Modeling Issues By Juhro, Solikin M.; Sahminan, Sahminan; Wijoseno, Atet; Waluyo, Jati; Bathaluddin, M. Barik
  16. Constrained portfolios in incomplete markets: a dynamic programming approach to Heston's model By Marcos Escobar-Anel; Yevhen Havrylenko; Rudi Zagst

  1. By: Tolga Özden
    Abstract: We analyze the empirical relevance of heterogeneous expectations at the effective lower bound (ELB) in the canonical New Keynesian model. Agents are allowed switch between an anchored Rational Expectations (RE) rule and an adaptive learning rule, where the latter may generate a de-anchoring of expectations. The structural change in monetary policy during ELB episodes, and the heterogeneity of private sector expectations are both captured in a unifled framework of endogenous regime switching. An application to the US economy over the period 1982Q1-2019Q4 shows that expectations are characterized as a mixture of RE and learning over the pre-GFC period, while a larger fraction of expectations remain anchored at the RE during the ELB period after 2008Q4. Model projections over both post-GFC and post-pandemic periods show that, a larger fraction of learning agents and a higher intensity of learning can both generate deflationary spirals and prolonged periods of recession, which highlights the importance of keeping expectations anchored during periods of uncertainty.
    Keywords: Adaptive Learning; Heterogeneous Expectations; Endogenous-Switching Models; Bayesian Estimation of DSGE Models; Effective Lower Bound.
    JEL: E37 E65 C11 C32
    Date: 2021–05
  2. By: Dirk Krueger (University of Pennsylvania CEPR and NBER); Harald Uhlig (University of Chicago CEPR and NBER)
    Abstract: This paper characterizes the stationary equilibrium of a continuous-time neoclassical production economy with capital accumulation in which households can insure against idiosyncratic income risk through long-term insurance contracts. Insurance companies operating in perfectly competitive markets can commit to future contractual obligations, whereas households cannot. For the case in which household labor productivity takes two values, one of which is zero, and where households have logutility we provide a complete analytical characterization of the optimal consumption insurance contract, the stationary consumption distribution and the equilibrium aggregate capital stock and interest rate. Under parameter restrictions, there is a unique stationary equilibrium with partial consumption insurance and a stationary consumption distribution that takes a truncated Pareto form. The unique equilibrium interest rate (capital stock) is strictly decreasing (increasing) in income risk. The paper provides an analytically tractable alternative to the standard incomplete markets general equilibrium model developed in Aiyagari (1994) by retaining its physical structure, but substituting the assumed incomplete asset markets structure with one in which limits to consumption insurance emerge endogenously, as in Krueger and Uhlig (2006).
    Keywords: Idiosyncratic Risk, Limited Commitment, Stationary Equilibrium
    JEL: E21 D11 D91 G22
    Date: 2022–09–09
  3. By: David Finck (University of Giessen); Mathias Hoffmann (Deutsche Bundesbank); Patrick Huertgen (Deutsche Bundesbank)
    Abstract: The open economy New Keynesian model with flexible exchange rates postulates that the real exchange rate appreciates in response to an asymmetric negative demand shock in a zero lower bound (ZLB) scenario and exacerbates the adverse macroeconomic effects. However, when monetary policy is able to accommodate the adverse effects of the negative demand shock via unconventional measures, the model can generate a real depreciation at the ZLB. This paper examines these counteracting exchange rate channels empirically. We estimate the effect of a negative asymmetric demand shock on the real exchange rate and inflation expectations as well as output and prices by employing state-dependent and sign-restricted local projection methods for the euro area vis-Ã -vis the United States, Canada, and Japan. We find that the real exchange rate depreciates when interest rates are not at the ZLB but also when they are. Furthermore, our empirical results show that the real exchange rate can absor considerable variations in output, confirming its shock-absorbing capacity before but also during the ZLB episode. The stabilizing role of the exchange rate is accompanied by a significant expansion of the ECBs balance sheet in the ZLB period, while it remained unaffected in the pre-ZLB period. Overall, our empirical results favor the open economy New Keynesian model with unconventional measures when interest rates are at the ZLB.
    Keywords: Zero Lower Bound, Exchange Rate, Local Projections, State-dependent Effects
    JEL: F31 E31 E37 C54
    Date: 2022
  4. By: Anna Bartocci (Bank of Italy); Alessandro Notarpietro (Bank of Italy); Massimiliano Pisani (Bank of Italy)
    Abstract: This paper evaluates the macroeconomic effects of increasing taxes on fossil fuels (“carbon tax†) and subsidies for renewable energy and reducing labor income tax in the euro area, and the interaction of these effects with domestic monetary policy. The tax increase is announced, gradually implemented and fully anticipated by agents (thus it is conceptually different from a sudden and unexpected positive shock affecting the international prices of fossil fuels). The analysis makes use of a New Keynesian two-country model with an energy sector, calibrated to the euro area and the rest of the world. The main results are the following. First, an increase in the carbon tax generates recessionary effects. Second, higher subsidies for green energy and a lower labor tax can limit the macroeconomic cost of increasing the carbon tax. Third, if the monetary policy rate is at its effective lower bound, the fiscal policy mix generates short-run recessionary effects, which can be offset if the central bank, for monetary policy purposes, purchases long-term sovereign bonds in the secondary market, thus keeping long-term interest rates low.
    Keywords: environmental policy, energy policies, dynamic general equilibrium model, fiscal policy, monetary policy, euro area
    JEL: D58 E52 E62 Q43
    Date: 2022–07
  5. By: Joep Lustenhouwer; Kostas Mavromatis
    Abstract: How important is the planning horizon of households for the effects of fiscal plans? We address this question through the lens of a New-Keynesian model where households are boundedly rational and plan over a finite number of periods. We show that the planning horizon affects the medium-run cumulative multipliers significantly. Government spending cumulative multipliers increase with the horizon while labor tax cumulative multipliers drop, in absolute terms. In light of the recent debt crisis in the Euro Area, we look at spending cuts and labor income tax hikes. In line with the empirical literature, we find in our benchmark calibration that spending cuts are less recessionary than tax hikes. Looking at the interaction between the planning horizon and the persistence of the fiscal plans, we find that spending cuts become less recessionary while tax hikes more recessionary when the persistence of fiscal plans rise, and that this effect is amplified by shorter planning horizons. Introducing wage stickiness, we show that for very sticky wages, tax hikes become less recessionary than spending cuts, but that intermediate levels of wage stickiness have the opposite effect on fiscal multipliers when planning horizons are finite.
    Keywords: Fiscal policy; Finite planning horizons; Bounded rationality
    JEL: E60 E62 E63 H63
    Date: 2021–06
  6. By: Shalva Mkhatrishvili; Valeriu Nalban; Philip Abradu-Otoo; Ivy Acquaye; Abubakar Addy; Nana Kwame Akosah; James Attuquaye; Simon Harvey; Zakari Mumuni
    Abstract: The paper describes the Quarterly Projection Model (QPM) that underlies the Bank of Ghana Forecasting and Policy Analysis System (FPAS). The New Keynesian semi-structural model incorporates the main features of the Ghanaian economy, transmission channels and policy framework, including an inflation targeting central bank and aggregate demand effects of fiscal policy. The shock propagation mechanisms embedded in the calibrated QPM demonstrate its theoretical consistency, while out-of-sample forecasting accuracy validates its empirical robustness. Another important part of the QPM is endogenous policy credibility, which may aggravate policy trade-offs in the model and make it more realistic for developing economies. Historical track record of real time policy analysis and medium-term forecasting conducted with the QPM – as a component of the broader FPAS analytical organization – establishes its critical role in supporting the Bank’s forward-looking monetary policy framework.
    Keywords: Ghana; Forecasting and Policy Analysis; Quarterly Projection Model; Monetary Policy; Transmission Mechanism
    Date: 2022–09–02
  7. By: Mr. Raphael A Espinoza; Jesper Lindé; Mr. Jiaqian Chen; Zoltan Jakab; Carlos Goncalves; Tryggvi Gudmundsson; Martina Hengge
    Abstract: The COVID-19 pandemic and the subsequent need for policy support have called the traditional separation between fiscal and monetary policies into question. Based on simulations of an open economy DSGE model calibrated to emerging and advance economies and case study evidence, the analysis shows when constraints are binding a more integrated approach of looking at policies can lead to a better policy mix and ultimately better macroeconomic outcomes under certain circumstances. Nonetheless, such an approach entails risks, necessitating a clear assessment of each country’s circumstances as well as safeguards to protect the credibility of the existing institutional framework.
    Date: 2022–09–02
  8. By: Stéphane Auray (CREST-ENSAI, Bruz, France); Aurélien Eyquem (University of Lausanne, Switzerland); Bertrand Garbinti (CREST-ENSAE-Institut Polytechnique Paris, France); Jonathan Goupille-Lebret (Univ Lyon, CNRS Ecully and ENS de Lyon, France)
    Abstract: How to explain rising income and wealth inequality? We build an original heterogeneousagent model with three key features: (i) an explicit link between firm’s market power and top income shares, (ii) a granular representation of the tax and transfer system, and (iii) three assets with endogenous portfolio decisions. Using France as an illustration, we look at how changes in markups, taxes, factor productivity, and asset prices affect inequality dynamics over the 1984-2018 period. Rising markups account for the bulk of rising income inequality. Wealth inequality dynamics result mostly from changes in saving rate inequality but only in response to the exogenous changes in taxation and markups. Our results point to the critical importance of endogenous saving decisions in response to exogenous shocks as a key driver of wealth inequality.
    Keywords: Heterogeneous Agents, Taxes, Market Power, Income Inequality, Wealth Inequality.
    JEL: D4 E2 H2 O4 O52
    Date: 2022–09–19
  9. By: Garibaldi, Pietro (University of Turin); Gomes, Pedro Maia (Birkbeck, University of London)
    Abstract: In the US almost 3 per cent of employees are absent from their job for reasons other than vacation, but are still technically employed. We argue that firms may find optimal to use temporary replacement workers to fill these vacant positions. We set up a matching model with directed search and double-sided heterogeneity. When a workers is temporarily forced out of the labour market, firms can freely destroy the job, put it in "mothball", or look for a temporary worker to "keep the seat warm". When the latter option is optimal, a market for temporary replacement workers emerges in equilibrium. In a quantitative application to the US labor market, replacement workers represent 2.7 per cent of total employment.
    Keywords: replacement workers, short-duration jobs, temporary jobs, worker heterogeneity, firm heterogeneity, employment at will
    JEL: J22 J40 J15 J60
    Date: 2022–08
  10. By: Oleg Kryzhanovsky (Bank of Russia, Russian Federation); Alexander Zykov (Bank of Russia, Russian Federation)
    Abstract: This paper offers an introduction into a new macroeconomic model of the Ural Macroregion named DEMUR (the Dynamic Equilibrium Model of the Ural Region). DEMUR is a regional semi-structural model that includes some key characteristics of the Ural economy for analysing the implications of monetary policy measures and forecasting. DEMUR is built in the logic of neo-Keynesian models with real and nominal rigidity. It also takes into account the structure of a small open economy, external (relative to the region) monetary conditions and other factors that drive changes of the Ural economy. The model is estimated by Bayesian methods based on international OECD, EAI, FRED and FAO statistical data, federal and regional statistical data by Rosstat and the Bank of Russia for 2009 Q1–2020 Q4. While describing DEMUR’s properties, we demonstrate the model’s capabilities by decomposing historical and forecast data. The model enables the analysis of changes in economic indicators on both Russian and macroregional levels in response to domestic or external macroeconomic shocks, and quantifies the macroregion’s contribution to changes in countrywide indicators, making it a valuable tool for macroeconomic analysis.
    Keywords: gross regional product, forecasting models, QPM, quarterly projection models, semi-structural models, monetary policy models, inflation targeting.
    JEL: C11 C13 E30
    Date: 2021–11
  11. By: Guerrazzi, Marco
    Abstract: In this paper, I develop an optimal growth model with labour market frictions in which recruiting efforts are measured in terms of labour instead of output. Specifically, I build an intertemporal framework à la Ramsey in which labour has to be alternatively employed in the production of goods or in the recruitment of workers. Within this setting, assuming that capital is paid according to its marginal productivity, I show that (i) capital measured along its intensive margin may converge towards its stationary value in a non-monotonic manner; (ii) Pareto optimal allocations typical of a centralized economy can also be achieved in a decentralized environment in which the prevailing wage is indexed to the labour market tightness indicator; (iii) the consistency of the wage that implements efficient allocations with the competitiveness of the market for goods relies on vanishing values of the discount rate.
    Keywords: Capital accumulation; Searching-and-matching frictions; Efficiency; Capitalization effects; Zero discounting
    JEL: E22 E24 J64
    Date: 2022–09–02
  12. By: Matheus Cardoso Leal; Marcio Issao Nakane
    Abstract: With the implementation of counter-cyclical economic policies, Brazil was less affected by the 2008 Great Recession than the average for the rest of the world, with an average annual growth of 4.11% between 2008 and 2011, compared to 3.25% for this group for the same period. This meant that the country ended the 2000s with an average annual growth of 3.91% between 2002 and 2010, above the 2.69% seen in the average of its Latin American peers. Despite this, the worsening of Brazil’s debt led to a significant deterioration of the macroeconomic scenario as of 2014, which resulted in a reduction in private investment, an increase in unemployment and negative growth rates for several quarters. In this sense, this paper aims to analyze the macroeconomic fluctuations experienced by the Brazilian economy using the analytical framework developed by Business Cycle Accounting (BCA) for quarterly data from 2002 to 2019. Among the main results found, the efficiency wedge was the main responsible for reproducing the output movements observed in both recessions, followed by labor wedge.
    Keywords: Business Cycle Accounting; Brazilian recessions; DSGE
    JEL: E32
    Date: 2022–09–20
  13. By: Flint Brayton; David L. Reifschneider
    Abstract: FRB/US, a large-scale, nonlinear macroeconomic model of the U.S., has been in use at the Federal Reserve Board for 25 years. For nearly as long, the FRB/US “project” has included a linear version of the model known as LINVER. A key reason that LINVER exists is the vast reduction in the computational costs that linearity confers when running experiments requiring large numbers of simulations under the assumption that expectations are model-consistent (MC). The public has been able to download FRB/US simulation code, documentation, and data from the Federal Reserve Board’s website since 2014. To further expand access to and understanding of the FRB/US project, a package devoted to LINVER is now available on the website. In this paper, we provide both a general introduction to LINVER and an overview of the contents and capabilities of its package. We review the ways that LINVER has been used in past research to study key policy issues; describe the package’s comprehensive set of programs for running simulations with MC expectations, with or without imposing the effective lower bound (ELB) on the federal funds rate and other nonlinear constraints; and illustrate how LINVER deterministic and stochastic simulations can be used to gauge the implications of the ELB for macroeconomic performance and to assess different strategies for mitigating its adverse effects.
    Keywords: Interest rates; Simulation; Econometric modeling; Monetary policy; Effective lower bound
    JEL: E52 E37 E58 E32
    Date: 2022–08–16
  14. By: Albanesi, Stefania (Federal Reserve Bank of New York); Gihleb, Rania (University of Pittsburgh); Zhang, Ning (University of Pittsburgh)
    Abstract: Labor market outcomes for young college graduates have deteriorated substantially in the last twenty five years, and more of them are residing with their parents. The unemployment rate at 23-27 years old for the 1996 college graduation cohort was 9%, whereas it rose to 12% for the 2013 graduation cohort. While only 25% of the 1996 cohort lived with their parents, 31% for the 2013 cohort chose this option. Our hypothesis is that the declining availability of 'matched jobs' that require a college degree is a key factor behind these developments. Using a structurally estimated model of child-parent decisions, in which coresidence improves college graduates' quality of job matches, we find that lower matched job arrival rates explain two thirds of the rise in unemployment and coresidence between the 2013 and 1996 graduation cohorts. Rising wage dispersion is also important for the increase in unemployment, while declining parental income, rising student loan balances and higher rental costs only play a marginal role.
    Keywords: coresidence, job mismatch, unemployment, student loans
    JEL: E24 J24 J12 E21
    Date: 2022–08
  15. By: Juhro, Solikin M.; Sahminan, Sahminan; Wijoseno, Atet; Waluyo, Jati; Bathaluddin, M. Barik
    Abstract: This paper discusses the core model of Bank Indonesia policy mix (BIPOLMIX), a macroeconomic modeling breakthrough designed for economic and financial projections and policy simulations. The BIPOLMIX model captures the integrated central bank policy responses, e.g. monetary, macroprudential, and payment system policies, and considers the role of fiscal policy. The strategy of developing the model is flexible, dynamic, and forward-looking to make the model relevant as the basis for Bank Indonesia policy transformation in coping with challenges in a rapidly changing environment. In this regard, the model takes into account various economic dynamics and policy instrument mix in optimizing the achievement of macroeconomic and financial system stability. Amid main issues related to the model parameter consistency, in line with theoretical and technical considerations, the modeling framework is believed to be useful as a pivotal reference by the central banks in EMEs in developing core models to support optimal policy responses.
    Keywords: Central Bank Policy Mix, Policy Modeling, Projections and Simulations, Bank Indonesia.
    JEL: C51 E37 E58
    Date: 2022–09
  16. By: Marcos Escobar-Anel; Yevhen Havrylenko; Rudi Zagst
    Abstract: We solve an expected utility-maximization problem with terminal-wealth constraints via dynamic programming in a setting of incomplete markets due to stochastic volatility. We demonstrate that the value function in the constrained problem can be represented as an expected modified utility of a vega-neutral financial derivative on the optimal unconstrained wealth. The optimal wealth and the optimal investment strategy in the constrained problem follow similarly. The case of a power utility and a Value-at-Risk constraint is treated theoretically in details. In numerical studies, we substantiate the impact of risk aversion levels, and investment horizons on the optimal investment strategy. We find a 20% relative difference between constrained and unconstrained allocations for average parameters in a low risk-aversion, short-horizon setting.
    Date: 2022–08

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