nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2022‒10‒31
twenty papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Impact of Technological Shock on the Sierra Leone Economy: A Dynamic Stochastic General Equilibrium (DSGE) Approach By Barrie, Mohamed Samba; Jackson, Emerson Abraham
  2. Optimal carbon pricing with fluctuating energy prices - emission targeting vs. price targeting By Alkis Blanz; Ulrich Eydam; Maik Heinemann; Matthias Kalkuhl
  3. Neoclassical Growth with Long-Term One-Sided Commitment Contracts By Dirk Krueger; Harald Uhlig
  4. The risk premium in New Keynesian DSGE models: the cost of inflation channel By Iania, Leonardo; Tretiakov, Pavel; Wouters, Rafael
  5. Monetary Policy and Endogenous Financial Crises By F Boissay; F Collard; J Galí; C Manea
  6. Foreign currency exposure and the financial channel of exchange rates By Longaric, Pablo Anaya
  7. TFP, Capital Deepening, and Gains from trade By B. Ravikumar; Ana Maria Santacreu; Michael Sposi
  8. Sraffian indeterminacy of steady-state equilibria in the Walrasian general equilibrium framework By Yoshihara, Naoki; Kwak, Se Ho
  9. The Impact of Racial Segregation on College Attainment in Spatial Equilibrium By Victoria Gregory; Julian Kozlowski; Hannah Rubinton
  10. Efficiency and Welfare Effects of Fiscal Policy in Emerging Economies: The Case of Morocco By El-Khalifi, Ahmed; Ouakil, Hicham; Torres, José L.
  11. Fintech Entry, Firm Financial Inclusion, and Macroeconomic Dynamics in Emerging Economies By Federico S. Mandelman; Victoria Nuguer; Alan Finkelstein Shapiro
  12. Spatial Development and Mobility Frictions in Latin America : Theory-Based Empirical Evidence By Conte,Bruno; Ianchovichina,Elena
  13. Computing Longitudinal Moments for Heterogeneous Agent Models By Sergio Ocampo; Baxter Robinson
  14. Technical Change, Task Allocation, and Labor Unions By Marczak, Martyna; Beissinger, Thomas; Brall, Franziska
  15. A Quantitative Theory of Relationship Lending By Kyle Dempsey; Miguel Faria-e-Castro
  16. Housing Dynamics: Theory Behind Empirics By Ping Wang; Danyang Xie
  17. An Elementary Model of VC Financing and Growth By Jeremy Greenwood; Pengfei Han; Hiroshi Inokuma; Juan M. Sanchez
  18. The general equilibrium effects of localised technological progress : A Classical approach By Yoshihara, Naoki; Veneziani, Roberto
  19. Bribery, Plant Size and Size Dependent Distortions By Tamkoc,Mehmet Nazim
  20. Smooth Value Function for a Consumption-Wealth Preference and Leverage Constraint By Weidong Tian; Zimu Zhu

  1. By: Barrie, Mohamed Samba; Jackson, Emerson Abraham
    Abstract: The neoclassical growth model has emphasised the importance of technology shocks, which supposedly affect macroeconomic variables’ heterogeneously in a small open economy like Sierra Leone. Using a Bayesian DSGE methodology for a non-linear model, we found that investment-specific technological shock partly explains business cycle fluctuations in Sierra Leone. Moreover, the analysis indicates that technology shock on output, capital, and consumption is more persistent than that of interest rate. The key implication is that technological innovation is crucial for long-term steady-state growth in Sierra Leone. The results also partly confirm the neoclassical growth model prediction – that is, in the long run, productivity growth is driven only by technological progress. The model specified for this research is largely inward-looking, with a minimal role for the Bank of Sierra Leone to influence investment in technology-related investment directly. Despite this limitation and more so given the fact that the DSGE modelling concept is quite a new venture at the BSL, thoughts have been given to enhance the model’s future capabilities to incorporate both the monetary bloc and external blocs to fully assess the impact of technological shock’s transmission in the entire economy in future research.
    Keywords: Neoclassical growth model, Bayesian DSGE, Technological Shock, Impulse Response, Sierra Leone
    JEL: C11 E30 E32 E37
    Date: 2022–05–28
  2. By: Alkis Blanz (University of Potsdam, Mercator Research Institute on Global Commons and Climate Change); Ulrich Eydam (University of Potsdam); Maik Heinemann (University of Potsdam); Matthias Kalkuhl (University of Potsdam, Mercator Research Institute on Global Commons and Climate Change)
    Abstract: Prices of primary energy commodities display marked fluctuations over time. Market-based climate policy instruments (e.g., emissions pricing) create incentives to reduce energy consumption by increasing the user cost of fossil energy. This raises the question of whether climate policy should respond to fluctuations in fossil energy prices? We study this question within an environmental dynamic stochastic general equilibrium (E-DSGE) model calibrated on the German economy. Our results indicate that the welfare implications of dynamic emissions pricing crucially depend on how the revenues are used. When revenues are fully absorbed, a reduction in emissions prices stabilizes the economy in response to energy price shocks. However, when revenues are at least partially recycled, a stable emissions price improves overall welfare. This result is robust to different modeling assumptions.
    Keywords: energy prices, E-DSGE, climate policy, welfare
    JEL: E62 E64 Q43 Q52
    Date: 2022–09
  3. By: Dirk Krueger; Harald Uhlig
    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 log-utility 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).
    JEL: E10 E21
    Date: 2022–09
  4. By: Iania, Leonardo (Université catholique de Louvain, LIDAM/LFIN, Belgium); Tretiakov, Pavel (Université catholique de Louvain, LIDAM/LFIN, Belgium); Wouters, Rafael (National Bank of Belgium)
    Abstract: We study the role of the cost of inflation channel in determining the risk premium in a (nonlinear) New Keynesian DSGE model. Relying on a Calvo (or Rotemberg) price setting, we show that while the cost of inflation channel generates the desired term premium moments, it suffers from nontrivial, counterintuitive approximation errors in the price dispersion function. In addition to documenting the issues, we propose ways to alleviate them, including a quasikinked demand function as a risk-generating mechanism.
    Date: 2022–08–24
  5. By: F Boissay (BIS - Bank for International Settlements); F Collard (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); J Galí (Pompeu Fabra University, Departament de Traducció i Ciències del Llenguatge); C Manea (Bundesbank - Bundesbank)
    Abstract: We study whether a central bank should deviate from its objective of price stability to promote financial stability. We tackle this question within a textbook New Keynesian model augmented with capital accumulation and microfounded endogenous financial crises. We compare several interest rate rules, under which the central bank responds more or less forcefully to inflation and aggregate output. Our main findings are threefold. First, monetary policy affects the probability of a crisis both in the short run (through aggregate demand) and in the medium run (through savings and capital accumulation). Second, a central bank can both reduce the probability of a crisis and increase welfare by departing from strict inflation targeting and responding systematically to fluctuations in output. Third, financial crises may occur after a long period of unexpectedly loose monetary policy as the central bank abruptly reverses course.
    Keywords: Financial crisis,Monetary policy
    Date: 2022–08–29
  6. By: Longaric, Pablo Anaya
    Abstract: Exchange rate movements affect the economy through changes in net exports, i.e. the trade channel, and through valuation changes in assets and liabilities denominated in foreign currencies, i.e. the financial channel. In this paper, I investigate the macroeconomic and financial effects of U.S. dollar (USD) exchange rate fluctuations in small open economies. Specifically, I examine how the financial channel affects the overall impact of exchange rate fluctuations and assess to what extent foreign currency exposure determines the financial channel’s strength. My empirical analysis indicates that, if foreign currency exposure is high, an appreciation of the domestic currency against the USD is expansionary and loosens financial conditions, which is consistent with the financial channel of exchange rates. Moreover, I estimate a small open economy New Keynesian model, in which a fraction of the domestic banks’ liabilities is denominated in USD. In line with the empirical results, the model shows that an appreciation against the USD can be expansionary depending on the strength of the financial channel, which is linked to the level of foreign currency exposure. Finally, the model indicates that the financial channel amplifies the effects of foreign monetary policy shocks. JEL Classification: E44, F31, F41
    Keywords: exchange rates, financial and trade channels, local projections - instrumental variable, open economy DSGE model
    Date: 2022–10
  7. By: B. Ravikumar; Ana Maria Santacreu; Michael Sposi
    Abstract: We study welfare gains from trade in a dynamic, multicountry model with capital accumulation. We compute the exact transition paths for 93 countries following a permanent, uniform, unanticipated trade liberalization. We find that while the dynamic gains are different across countries, consumption transition paths look similar except for scale. In addition, dynamic gains accrue gradually and are about 60 percent of steady-state gains for every country. Finally, the contribution of capital accumulation to dynamic gains is four times that of TFP.
    Keywords: dynamic gains from trade; capital deepening; total factor productivity
    JEL: E22 F11 O11
    Date: 2022–09–27
  8. By: Yoshihara, Naoki; Kwak, Se Ho
    Abstract: In contrast to Mandler’s (1999a; Theorem 6) generic determinacy of the steady-state equilibrium, we first show that any regular Sraffian steady-state equilibrium is indeterminate in terms of Sraffa (1960) under a simple overlapping generation economy with a fixed Leontief technique. We also check that this indeterminacy is generic. These results are obtained by explicitly introducing a simple model of every generation’s utility function and individual optimization program to the overlapping generation economy, which also explains the main source of the difference between our results and Mandler (1999a; section 6). We also argue the distinctiveness of our results in comparison with the standard literature, like Calvo (1978), of overlapping generations indeterminacy.
    Keywords: Sraffian indeterminacy, factor income distribution, general equilibrium framework
    JEL: B51 D33 D50
    Date: 2022–09
  9. By: Victoria Gregory; Julian Kozlowski; Hannah Rubinton
    Abstract: We incorporate race into an overlapping-generations spatial-equilibrium model with neighborhood spillovers. Race matters in two ways: (i) the Black-White wage gap and (ii) homophily—the preferences of individuals over the racial composition of their neighborhood. We find that these two forces generate a Black-White college gap of 22 percentage points, explaining about 80% of the college gap in the data for the St. Louis metro area. Counterfactual exercises show that the wage gap and homophily explain 7 and 18 percentage points of the college gap, respectively. A policy of equalizing school funding across neighborhoods reduces the college gap by almost 10 percentage points and generates large welfare gains.
    Keywords: racial disparities; neighborhood segregation; education; income inequality
    JEL: J15 J24 O18
    Date: 2022–10–12
  10. By: El-Khalifi, Ahmed; Ouakil, Hicham; Torres, José L.
    Abstract: The welfare cost of fiscal policy does not only depend on distortions by taxation, but also on how public revenues are spent in the economy, and on wealth inequality. Many of the government's spending activities are related to the provision of consumption goods and services, and the provision of public inputs. Hence, optimal taxation policy is not independent of how fiscal revenues are spent. This paper uses a model with two types of agents: Active households (who behave as Ricardian agents) and non-active government-dependent households (who behave as hand-to-mouth agents). The model economy considers a detailed government for both fiscal revenues and public spending. We compute welfare changes of different tax rates and alternative spending policies and quantify the trade-off of fiscal policy across the two groups of agents. The main results can be presented as follows: i) Distortions from some taxes on economic activity can be positive due to the presence of public inputs. ii) Output efficiency can be gained by changing the tax mix while keeping constant fiscal revenues. iii) Total welfare gains can be obtained by increasing tax rates, except the capital income tax, at the cost of reducing the welfare of active households.
    Keywords: Fiscal policy; Active households; Government spending-dependent households; Taxes; Government Spending, Laffer curves; Welfare.
    JEL: H21 H3 H42
    Date: 2022–10–07
  11. By: Federico S. Mandelman; Victoria Nuguer; Alan Finkelstein Shapiro
    Abstract: We build a model with a traditional banking system, endogenous entry of firms and fintech intermediaries, and firm heterogeneity in credit access and usage to study the credit-market, macroeconomic, and business cycle implications of the recent sizable growth in the number of fintech intermediaries in emerging economies. Our analysis delivers three findings. First, the impact of greater fintech entry on firm financial inclusion depends on whether greater entry is driven by lower entry costs for fintech intermediaries or lower barriers to fintech credit for unbanked firms. Second, greater fintech entry can have positive long-term macroeconomic effects. Third, greater fintech entry leads to a reduction in output volatility but results in greater relative volatility in bank credit and consumption. The effects of fintech entry on macro outcomes and volatility hinge critically on the interaction between domestic financial shocks and the reduction in fintech lending rates stemming from greater fintech entry. Unless greater fintech entry leads to lower fintech credit costs for firms, greater fintech entry will have no meaningful credit-market or business-cycle consequences.
    Keywords: financial access and participation; endogenous firm entry; banking sector; fintech entry; emerging economy business cycles
    JEL: E24 E32 E44 F41 G21
    Date: 2022–01–31
  12. By: Conte,Bruno; Ianchovichina,Elena
    Abstract: Using fine-grained spatial data and a dynamic spatial general equilibrium model, this paperassesses the magnitude of mobility frictions in Latin America as well as the effects of their reduction on spatialdevelopment in the region. The results suggest that in most Latin American countries, migration frictions calibratedbased on spatially differentiated initial utility are on average smaller and less dispersed than those obtainedassuming uniform within-country initial utility. A reduction in trade costs due to optimal investments in roadinfrastructure in most Latin American countries increases the present discounted value of real per capita income onaverage in the region by 15.1 percent. This effect is larger than the effects obtained with static quantitative trademodels because of substantial dynamic gains. By contrast, a reduction in migration entry costs in the most productiveand more populous locations in the Latin American countries has a negligible effect on the present discounted value ofthe region’s real per capita income, reflecting the relatively small dispersion in domestic migration frictionsand their relatively low levels in top locations. In both counterfactuals, the welfare increases are significantlylarger than the increases in real per capita output because the reductions in mobility frictions allow people torelocate to areas with better amenities and therefore derive higher utility. These results suggest that trade costs, notmigration barriers, represent a major constraint to theefficient spatial distribution of economic activity and growth in Latin America.
    Date: 2022–05–31
  13. By: Sergio Ocampo (University of Western Ontario); Baxter Robinson (University of Western Ontario)
    Abstract: Computing population moments for heterogeneous agent models is a necessary step for their estimation and evaluation. Computation based on Monte Carlo methods is usually time- and resource-consuming because it involves simulating a large sample of agents and potentially tracking them over time. We argue in favor of an alternative method for computing both cross-sectional and longitudinal moments that exploits the endogenous Markov transition function that defines the stationary distribution of agents in the model. The method relies on following the distribution of populations of interest by iterating forward the Markov transition function rather than focusing on a simulated sample of agents. Approximations of this function are readily available from standard solution methods of dynamic programming problems. The method provides precise estimates of moments like top-wealth shares, auto-correlations, transition rates, age-profiles, or coefficients of population regressions at lower time- and resource-costs compared to Monte Carlo based methods.
    Keywords: Computational Methods, Heterogeneous Agents, Simulation.
    JEL: C6 E2
    Date: 2022
  14. By: Marczak, Martyna; Beissinger, Thomas; Brall, Franziska
    Abstract: We propose a novel framework that integrates the "task approach" for a more precise production modeling into the search-and-matching model with low- and high-skilled workers, and wage setting by labor unions. We establish the relationship between task reallocation and changes in wage pressure, and examine how skill- biased technical change (SBTC) affects the task composition, wages of both skill groups, and unemployment. In contrast to the canonical model with a fixed task allocation, low-skilled workers may be harmed in terms of either lower wages or higher unemployment depending on the relative task-related productivity profile of both worker types. We calibrate the model to the US and German data for the periods 1995-2005 and 2010-2017. The simulated effects of SBTC on low-skilled unemployment are largely consistent with observed developments. For example, US low-skilled unemployment increases due to SBTC in the earlier period and decreases after 2010.
    Keywords: task approach,search and matching,labor unions,skill-biased technical change,labor demand,wage setting
    JEL: J64 J51 E23 E24 O33
    Date: 2022
  15. By: Kyle Dempsey; Miguel Faria-e-Castro
    Abstract: Banks' loan pricing decisions reflect the fact that borrowers tend to have long-lasting relationships with lenders. Therefore, pricing decisions have an inherently dynamic component: high interest rates may yield higher static profits per loan, but in the long run they erode a banks' customer base and reduce future profitability. We study this tradeoff using a dynamic banking model which embeds lending relationships using deep habits (“customer capital”) and costs of adjusting loan portfolio composition. High customer capital raises the level and decreases the interest rate elasticity of loan demand. When faced with an adverse shock to net worth, banks with high customer capital recapitalize quickly by charging high interest rates and eroding customer capital in the short term, while banks with low customer capital face persistent financial distress. Using Call Report data to measure the franchise value of banks' loan portfolios, we find that this effect has strong implications for how individual banks and the financial sector as a whole recover from shocks.
    Keywords: banks; Customer Capital; relationship lending; interest rates; financial crises
    JEL: E4 G2
    Date: 2022–09–23
  16. By: Ping Wang; Danyang Xie
    Abstract: To fill the knowledge gap that previous studies ignore either housing or internal urban structure and to enable better fit with important stylized facts, we construct a two-sector optimal growth model of housing where housing is produced by land and housing structure/household durables. We explicitly model within-city locational choice. Housing services derive positive utility but are decayed away from the city center. Our model enables a full characterization of the dynamic paths of housing and housing and land prices. The model is then calibrated to fit part of the stylized facts: faster growth of housing structure/household durables than housing, faster growth of land prices than housing prices, and downward housing price and land rent gradients within a city. The calibrated model can then be used to predict the remaining untargeted part of stylized facts: a locationally steeper land rent gradient than the housing price gradient, relatively flatter housing quantity and price gradients in larger cities with flatter population gradients and moderate rise in the housing expenditure share. The calibrated model can be further used to yield additional insights on housing dynamics and spatial distribution. We find nonhomotheticities in housing preference and housing production are crucial for realistic model predictions.
    JEL: E20 O41 R13
    Date: 2022–09
  17. By: Jeremy Greenwood; Pengfei Han; Hiroshi Inokuma; Juan M. Sanchez
    Abstract: This article uses an endogenous growth model to study how the improvements in financing for innovative start-ups brought by venture capital (VC) affect firm innovation and growth. Partial equilibrium results show how lending contracts change as financing efficiency improves, while general equilibrium results demonstrate that better screening and development of projects by VC investors leads to higher aggregate productivity growth.
    Keywords: endogenous growth; financial development; innovation; IPO; screening; research and development; startups; venture capital
    JEL: E13 E22 G24 L26 O16 O31 O40
    Date: 2022–08–03
  18. By: Yoshihara, Naoki; Veneziani, Roberto
    Abstract: We study the general equilibrium effects of localised technical progress à la Atkinson-Stiglitz on income distribution in economies in which capital is a vector of reproducible and heterogeneous goods. We show that there is no obvious relation between ex-ante profitable innovations and the income distribution that actually emerges in equilibrium. Unlike in the standard macroeconomic literature, localised technical progress may lead to indeterminacy in equilibrium factor prices, and individually rational choices of technique do not necessarily lead to optimal outcomes. Innovations may even cause the disappearance of all equilibria.
    Keywords: localised technical progress, income distribution, equilibrium framework
    JEL: O33 D33 D51
    Date: 2022–09
  19. By: Tamkoc,Mehmet Nazim
    Abstract: This paper studies the relationship between distortions, plant size, and bribery possibilities.In a distorted economy, bribery is a transfer from a private party to government officials to ‘get things done’.Enterprise Surveys data shows that small plants spend a higher fraction of their output on bribery than big plants.In this paper, a one-sector growth model is developed in which size-dependent distortions, bribery opportunities, anddifferent plant sizes coexist. In the model, bribery is endogenous in the sense that managers decide to use it as away to deal with distortions. Two sets of exercises are conducted to quantify the interplay of size-dependentdistortions and bribery. First, the model parameters are calibrated to generate the plant size distribution of theU.S., by assuming the U.S. is free of distortions. Then, size-dependent distortions are introduced to the undistortedeconomy, and their effects with and without bribery opportunities are compared. Counterfactual exercises showthat size-dependent distortions become less distortionary in the presence of bribery opportunities since plants are ableto avoid distortions by paying larger bribes. Second, the model is calibrated with distortions and briberyopportunities using Turkish data. The choice of this country for analysis does not imply that bribery or size-dependentdistortions are particularly large in Türkiye relative to countries of comparable development. The choice is driven bythe availability of data on both the plant size distribution and spending on bribery in the country. The results indicatethat the inferred level of distortions is sizable for all plants. The removal of distortions, which would eliminatethe incentive for paying bribes, can have a substantial effect on both the output and the mean plant size whichcould increase by 63.6 and 82.5 percent, respectively.
    Date: 2022–09–02
  20. By: Weidong Tian; Zimu Zhu
    Abstract: This paper considers an optimal consumption-investment problem for an investor whose instantaneous utility depends on consumption and wealth (as luxury goods or social status). The investor faces a general leverage constraint that the investment amount in the risky asset does not exceed an exogenous function of the wealth. We prove that the value function is second-order smooth, and the optimal consumption-investment policy are provided in a feedback form. Moreover, when the risky investment amount is bounded by a fixed constant, we show that under certain conditions, the leverage constraint is binding if and only if an endogenous threshold bounds the portfolio wealth. Our results encompass many well-developed portfolio choice models and imply new applications.
    Date: 2022–10

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