nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2022‒12‒19
eighteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Beliefs, Aggregate Risk, and the U.S. Housing Boom By Margaret M. Jacobson
  2. The “Matthew Effect” and Market Concentration: Search Complementarities and Monopsony Power By Jesus Fernandez-Villaverde; Federico Mandelman; Yang Yu; Francesco Zanetti
  3. Housing Prices and Credit Constraints in Competitive Search By Antonia Díaz; Belén Jerez; Juan P. Rincón-Zapatero
  4. Taxing Consumption in Unequal Economies By Patrick Macnamara; Myroslav Pidkuyko; Raffaele Rossi
  5. LTV regulation and housing bubbles By Claire Océane Chevallier; Sarah El Joueidi
  6. A Ramsey Theory of Financial Distortions By Marco Bassetto; Wei Cui
  7. Financial development cycles and income inequality in a model with good and bad projects. By Spiros Bougheas; Pasquale Commendatore; Laura Gardini; Ingrid Kubin
  8. The Great Lockdown: information, noise and macroeconomic fluctuations By Michał Brzoza-Brzezina; Grzegorz Wesołowski
  9. Gender Equality, Economic Growth and Poverty in Côte d’Ivoire: A Quantitative Analysis By Franck M. Adobo; Barış Alpaslan
  10. Why Aging Induces Deflation and Secular Stagnation By R. Anton Braun; Daisuke Ikeda
  11. The Bribe Rate and Long Run Differences in Sovereign Borrowing Costs By Farzana Alamgir; Johnny Cotoc; Alok Johri
  12. The Puzzle of Educated Unemployment in West Africa By Girsberger, Esther Mirjam; Meango, Romuald
  13. Public Employment Agency Reform, Matching Efficiency, and German Unemployment By Merkl, Christian; Sauerbier, Timo
  14. Renewable resource and harvesting cost in a simple monetary overlapping generation economy. By David DESMARCHELIER; Rémi GIRARD
  15. Technology Adoption and Late Industrialization By Choi, Jaedo; Shim, Younghun
  16. Macroeconomic and policy implications of eurobonds By Cristina Badarau; F. Huart; I. Sangaré
  17. An ergodic theory of sovereign default By Pierri, Damian Rene; Seoane, Hernán
  18. A review of macroeconomic models for the WEFE nexus assessment By Castelli, Chiara; Castellini, Marta; Ciola, Emanuele; Gusperti, Camilla; Romani, Ilenia Gaia; Vergalli, Sergio

  1. By: Margaret M. Jacobson
    Abstract: Endogenously optimistic beliefs about future house prices can account for the path and standard deviation of house prices in the U.S. housing boom of the 2000s. In a general equilibrium model with incomplete markets and aggregate risk, agents form beliefs about future house prices in response to shocks to fundamentals. In an income expansion with looser credit conditions, agents are more likely to underpredict house prices and revise up their beliefs. Matching the standard deviation and steady rise in house prices results in homeownership becoming less affordable later in the boom as well as consumption dynamics that match the data.
    Keywords: Housing boom; Aggregate risk; Heterogeneous agents; Incomplete information
    JEL: E20 E30 C68 R21
    Date: 2022–09–23
  2. By: Jesus Fernandez-Villaverde (University of Pennsylvania); Federico Mandelman (Federal Reserve Bank of Atlanta); Yang Yu (Shanghai University of Finance and Economics); Francesco Zanetti (University of Oxford)
    Abstract: This paper develops a dynamic general equilibrium model with heterogeneous firms that face search complementarities in the formation of vendor contracts. Search complementarities amplify small differences in productivity among firms. Market concentration fosters monopsony power in the labor market, magnifying profits and further enhancing high-productivity firms’ output share. Firms want to get bigger and hire more workers, in stark contrast with the classic monopsony model, where a firm aims to reduce the amount of labor it hires. The combination of search complementarities and monopsony power induces a strong “Matthew effect” that endogenously generates superstar firms out of uniform idiosyncratic productivity distributions. Reductions in search costs increase market concentration, lower the labor income share, and increase wage inequality.
    Keywords: Market concentration, superstar firms, search complementarities, monopsony power in the labor market
    JEL: C63 C68 E32 E37 E44 G12
    Date: 2021–02
  3. By: Antonia Díaz (Instituto Complutense de Análisis Económico (ICAE), Universidad Complutense de Madrid (Spain).); Belén Jerez (Universidad Carlos III de Madrid (Spain).); Juan P. Rincón-Zapatero (Universidad Carlos III de Madrid (Spain).)
    Abstract: This paper shows that, when utility is imperfectly transferable and the search process is competitive (or directed), wealthier buyers pay higher prices to speed up transactions. This result is established in a dynamic model of the housing market where households save both to smooth consumption and to build a down payment. “Block recursivity” is ensured by the existence of risk-neutral housing intermediaries. The calibrated version of our benchmark economy features greater indebtedness and higher housing prices in the long run compared to a Walrasian model, especially when the elasticity of new housing supply is low. We also show that the long-run effect of greater credit availability on housing prices depends crucially on whether or not rental and real estate housing stocks are segmented. Under full segmentation, price effects are much larger, with and without search frictions. But, even if there is no segmentation, these effects are substantial in our search model when supply elasticity is low, being larger than in the Walrasian version of the model. The last result is reversed with full segmentation, when search frictions dampen the price effect of the credit expansion.
    Keywords: Competitive search; Wealth effects; Housing prices; Credit constraints; Housing supply elasticity; Rental market.
    JEL: D31 D83 E21 R21 R30
    Date: 2022
  4. By: Patrick Macnamara; Myroslav Pidkuyko; Raffaele Rossi
    Abstract: This paper shows that linear consumption taxes are a powerful tool to implement efficient redistribution. We derive this result in an estimated life-cycle economy with labor and capital income risk that reproduces the distribution of income and wealth in the United States. Optimal policy calls for raising all fiscal revenues from consumption, and providing social insurance via a highly progressive wage tax schedule. Capital income and wealth should not be taxed. This policy reduces inequality and increases productivity, and brings large welfare gains both relative to the status-quo and to the case where consumption is not taxed. More than two-thirds of these gains are due to redistribution. Considering transitional dynamics, we show that our reform also generates large welfare gains in the short run.
    Keywords: optimal policy; inequality; consumption taxation; life-cycle; entrepreneurs
    JEL: E62 H21 H24
    Date: 2022–11
  5. By: Claire Océane Chevallier (Université du Luxembourg (Extramural Research Fellow)); Sarah El Joueidi (American University of Beirut and Université du Luxembourg (Extramural Research Fellow))
    Abstract: This paper develops a dynamic general equilibrium model in innite ho- rizon, with an endogenous banking sector, market sensitive regulatory con- straints, and in which deterministic rational housing bubbles may emerge. We are interested in the conditions under which housing bubbles may emerge and their impact on the economy. We show that 1) when agents face a LTV regulation, two dierent equilibria may emerge and coexist: a bubbleless and a housing bubble equilibria; 2) housing bubbles increase banks' size; 3) when banks face operational costs, housing bubbles reduce welfare. In an extension of the model we introduce a stochastic banking bubble and show that the combination of two market sensitive macroprudential regu- lations, LTV and VaR regulations, allows housing and banking bubbles to arise simultaneously. Their interaction amplies banks' balance sheet size. The welfare impact is positive.
    Keywords: "Banking bubble; Dynamic general equilibrium; Housing bubbles; Innitely lived agents; Loan-to-Value; Market sensitive regulations."
    JEL: E44 E60 G1 G21 G21
    Date: 2022
  6. By: Marco Bassetto (Federal Reserve Bank of Minneapolis); Wei Cui (University College London; Centre for Macroeconomics (CFM))
    Abstract: We study optimal taxation in an economy with financial frictions, in which the government cannot directly redistribute towards the agents in need of liquidity but otherwise has access to a complete set of linear tax instruments. We establish a stark result. Provided this is feasible, optimal policy calls for the government to increase its debt, up to the point at which it provides sufficient liquidity to avoid financial constraints. In this case, capital-income taxes are zero in the long run, and the returns on government debt and capital are equalized. However, if the fiscal space is insufficient, a wedge opens between the rates of return on government debt and capital. In this case, optimal long-run tax policy is driven by a trade-off between the desire to mitigate financial frictions by subsidizing capital and the incentive to exploit the quasi-rents accruing to producers of capital by taxing capital instead. This latter incentive magnifies the wedge between rates of return on government debt and capital. It also makes it optimal to distort downward the interest rate on government debt in periods of high government spending.
    Keywords: Financing Constraints; Asset Directed Search; Capital Tax; Low Interest Rates; Optimal Level of Government Debt
    JEL: E22 E44 E62
    Date: 2021–02
  7. By: Spiros Bougheas; Pasquale Commendatore; Laura Gardini; Ingrid Kubin
    Abstract: We introduce a banking sector and heterogeneous agents in the Matsuyama et al. (2016) dynamic over-lapping generations neoclassical model with good and bad projects. The model captures the benefits and costs of an advanced banking system which can facilitate economic development when allocates resources to productive activities but can also hamper progress when invests in projects that do not contribute to capital formation. When the economy achieves higher stages of development it becomes prone to cycles. We show how the disparity of incomes across agents depends on changes in both the prices of the factors of production and the reallocation of agents across occupations.
    Keywords: banks; financial innovation; economic development; business cycles; income inequality
    Date: 2022
  8. By: Michał Brzoza-Brzezina (SGH Warsaw School of Economics); Grzegorz Wesołowski (University of Warsaw, Faculty of Economic Sciences)
    Abstract: This paper argues that not only actual lockdowns can affect economies, but also noisy information about them. We construct a New Keynesian model with imperfect information about how long the lockdown would last. On the one hand, a false signal about the lockdown lowers consumption, investment, employment and output and this effect can be quantitatively sizable. On the other hand, a true information about a lockdown being introduced can also be misinterpreted and hence cause an impact on agents' decisions being quantitatively different from the one desired by the authorities. To the extent that the latter have less noisy information about future lockdowns than the private sector, they can reduce these undesired fluctuations by precisely communicating the lockdown policy. Importantly, under some circumstances only radical improvements in information precision are successful.
    Keywords: Covid-19, lockdown, imperfect information, communication
    JEL: D83 E32 E61 E65 I18 J21
    Date: 2021
  9. By: Franck M. Adobo; Barış Alpaslan
    Abstract: In this paper, we develop a three-period gender-based Overlapping Generations (OLG) model of economic growth for Côte d’Ivoire by endogenizing life expectancy and linking growth and poverty. We then calibrate the model using the country-specific data to illustrate the role of public policies in the model, and its implications for long-term growth, gender equality, and poverty in Côte d’Ivoire. To this end, we discuss three sets of quantitative experiments: broad-based development policies (increase in education spending and infrastructure investment, and governance reform), gender-based policies (reduction in gender bias in the market place, increase in women’s bargaining power, and reduction in family bias against girls’ education), and a composite reform program (combination of pro-growth, pro-gender policies). Overall, our findings suggest that Côte d’Ivoire could achieve better growth and poverty outcomes if the country could implement a composite reform program that includes comprehensive development and gender-based policies.
    Keywords: Three-period gender-based OLG model, life expectancy, poverty, Côte d’Ivoire
    JEL: I25 J16 O41
    Date: 2022–11
  10. By: R. Anton Braun; Daisuke Ikeda
    Abstract: We provide a quantitative theory of deflation and secular stagnation. In our lifecycle framework, an aging population puts persistent downward pressure on the price level, real interest rates, and output. A novel feature of our theory is that it also recognizes the reactions of government policy. The central bank responds to falling prices by reducing its policy nominal interest rate, and the fiscal authority responds by allowing the public debt–gross domestic product ratio to rise.
    Keywords: monetary policy; lifecycle; portfolio choice; secular stagnation; nominal government debt; aging; Tobin effect; fiscal policy; deflation
    JEL: E52 E62 G51 D15
    Date: 2022–09–29
  11. By: Farzana Alamgir; Johnny Cotoc; Alok Johri
    Abstract: Sovereign spreads and the level of bureaucratic diversion of government spending vary widely across emerging economies and are correlated with each other. We build a sovereign default model where the government is constrained to use corrupt bureaucrats to deliver public goods and services in order to explain these facts. The diversion policy parameters are estimated using data on public resources and monitoring efficiency and used to calibrate the model. We use data on the average gift needed to be given to win public contracts in a country as a measure of bureaucratic diversion because it allows us to quantify diversion of public resources whereas tax evasion is hard to measure. We tie down the efficiency level to the Rule of Law index. We show that economies with low monitoring efficiency display higher diversion levels and higher default risk (and spreads) than those with higher efficiency. These results emerge because defaults reduce diversion levels and this benefit from default is higher for low monitoring efficiency economies, which encourages default.
    Keywords: sovereign default; country spreads; bureaucratic corruption; bribes; provision of public goods
    JEL: D73 F34 F41 G15 H63
    Date: 2022–11
  12. By: Girsberger, Esther Mirjam (University of Technology, Sydney); Meango, Romuald (University of Oxford)
    Abstract: Many developing countries exhibit a puzzling pattern given their scarce human capital: unemployment rates increase with education. We develop and estimate a model where educated unemployment arises from heterogeneous workers participating in a frictional labour market with three sectors (public, private and self-employment). We estimate that public sector distortions explain around two-thirds of educated unemployment in urban Burkina Faso and one-quarter in Senegal. We then simulate three equally costly policies. In contrast with public job creation and subsidies to self-employment income, subsidies for private sector vacancy creation effectively reduce educated unemployment and improve aggregate workers' welfare.
    Keywords: unemployment, education, search and matching model, urban West Africa
    JEL: J24 J64 E24
    Date: 2022–11
  13. By: Merkl, Christian (University of Erlangen-Nuremberg); Sauerbier, Timo (FAU, Erlangen Nuremberg)
    Abstract: Our paper analyzes the role of public employment agencies in job matching, in particular the effects of the restructuring of the Federal Employment Agency in Germany (Hartz III labor market reform) for aggregate matching and unemployment. Based on two microeconomic datasets, we show that the market share of the Federal Employment Agency as job intermediary declined after the Hartz-reforms. We propose a macroeconomic model of the labor market with a private and a public search channel and fit the model to various dimensions of the data. We show that direct intermediation activities of the Federal Employment Agency did not contribute to the decline of unemployment in Germany. By contrast, improved activation of unemployed workers reduced unemployed by 0.8 percentage points. Through the lens of an aggregate matching function, more activation is associated with a larger matching efficiency.
    Keywords: Hartz reforms, search and matching, reform of employment agency
    JEL: E24 E00 E60
    Date: 2022–11
    Abstract: The literature has pointed out that renewable resource preservation in the long run is ensured in two situations: (1) when resource can serve as a store of value and (2) when households are altruistic. The following paper shows that a third situation also implies resource preservation, that is, when harvesting is costly. To do so, a simple monetary overlapping generation economy is developed in which a renewable resource is privately owned by a representative household who lives for two periods. During her youth, she inherits the resource from her parents and decides how much to harvest. Income obtained from the resource selling is fully saved in fiat money to finance old age consumption. Harvesting is assumed to take time (harvesting cost) and then, the young household has to arbitrate between leisure or harvesting. In this simple context, we show that the resource level can be non zero in the long run (resource preservation). In particular, we observe that two steady states can coexist: one with a low resource level (overexploitation) and the other with a high resource level (underexploitation). Moreover, under a sufficiently productive harvesting technology, two-period cycles can emerge around each steady state through a flip bifurcation as well as local indeterminacy around the higher steady state. In this sense, costly harvesting appears to be both a source of resource preservation and a source of resource fluctuations.
    Keywords: Flip bifurcation, local indeterminacy, overlapping generation model, renewable resource.
    JEL: E32 O44 Q20
    Date: 2022
  15. By: Choi, Jaedo; Shim, Younghun
    Abstract: We study how the adoption of foreign technology and local spillovers from such adoption contributed to late industrialization in a developing country during the postwar period. Using novel historical firm-level data for South Korea, we provide three empirical findings: direct productivity gains to adopters, local productivity spillovers of the adoption, and complementarity in firms' adoption decisions. Based on these findings, we develop a dynamic spatial model with firms' technology adoption decisions and local spillovers. The spillovers induce dynamic complementarity in firms' technology adoption decisions. Because of this complementarity, the model potentially features multiple steady states. Temporary adoption subsidies can have permanent effects by moving an economy to a new transition path that converges to a higher-productivity steady state. We calibrate our model to the microdata and econometric estimates. We evaluate the effects of the South Korean government policy that temporarily provided adoption subsidies to heavy manufacturing firms in the 1970s. Had no adoption subsidies been provided, South Korea would have converged to a less industrialized steady state in which the heavy manufacturing sector’s share of GDP would have been 15 percentage points lower and aggregate welfare would have been 10% lower compared to the steady state with successful industrialization. Thus, temporary subsidies for technology adoption had permanent effects.
    Keywords: Technology adoption, industrialization, knowledge spillover, path dependence, big push
    JEL: O14 O33 O53 R12
    Date: 2022
  16. By: Cristina Badarau (Larefi - Laboratoire d'analyse et de recherche en économie et finance internationales - UB - Université de Bordeaux); F. Huart; I. Sangaré
    Abstract: This article explores the controversial subject of Eurobonds, by analyzing their economic consequences in an asymmetric monetary union like the Eurozone, where countries differ in size and policy preferences. We thus build a two-country monetary union DSGE model to compare three scenarios of government debt issuance: i) countries issue their own sovereign bonds (the baseline scenario is given the label "National bonds"); ii) countries issue common sovereign bonds without any limitations on the amount they can borrow (this scenario is labelled "Eurobonds"); and iii) there is a cap on the issuance of Eurobonds by each country so that the joint liability is limited (we call this scenario "Limited Eurobonds"). Assuming that a country decides to increase public spending and cares little about debt stabilization, we find that the spending multiplier would be the highest with Eurobonds and the lowest with Limited Eurobonds. The spillover effects on output in the rest of the union would be negative with Eurobonds but positive with Limited Eurobonds. The positive trade channel of the spillover effects is reinforced while the negative financial channel is reduced in the latter scenario. From the perspective of the monetary union as a whole, Limited Eurobonds could bring about higher overall output and produce larger benefits for aggregate household welfare depending upon country size. Altogether, our findings support the case for limited joint liability, especially when the public spending shock originates from a country which is smaller than the rest of the union, but not too small. © 2020 Elsevier Inc.
    Date: 2021
  17. By: Pierri, Damian Rene; Seoane, Hernán
    Abstract: We present the conditions under which the dynamics of a sovereign default model of private external debt are stationary, ergodic and globally stable. As our results are constructive, the model can be used for the accurate computation of global long run stylized facts. We show that default can be used to derive a stable unconditional distribution (i.e., a stable stochastic steady state), one for each possible event, which in turn allows us to characterize globally positive probability paths. We show that the stable and the ergodic distribution are actually the same object. We found that there are 3 type of paths: non-sustainable and sustainable; among this last category trajectories can be either stable or unstable. In the absence of default, non-sustainable and unstable paths generate explosive trajectories for debt. By deriving the notion of stable state space, we show that the government can use the default of private external debt as a stabilization policy.
    Keywords: Default; Private External Debt; Ergodicity; Stability
    JEL: F41 E61 E10
    Date: 2022–12–05
  18. By: Castelli, Chiara; Castellini, Marta; Ciola, Emanuele; Gusperti, Camilla; Romani, Ilenia Gaia; Vergalli, Sergio
    Abstract: The Water, Energy, Food and Ecosystems (WEFE) nexus refers to the system of complex and highly non-linear interconnections between these four elements. It now represents the basic framework to assess and design policies characterized by an holistic environmental end economical perspective. In this work, we provide a systematic review of the macroeconomic models investigating its components as well as combinations of them and their interlinkages with the economic system. We focus on four different types of macroeconomic models: Computable General Equilibrium (CGE) models, Integrated Assessment Models (IAMs), Agent-based Models (ABMs), and Dynamic Stochastic General Equilibrium (DSGE) models. On the basis of our review, we find that the structure of IAMs is currently the most used to represent the nexus complexity, while DSGE models focus only on single components but appear to be better suited to account for the randomization of exogenous shocks. CGE models and ABMs could be more effective on the side of the policy perspective. Indeed, the former can account for interlinkages across sectors and countries, while the latter can define theoretical frameworks that better approximate reality.
    Keywords: Environmental Economics and Policy, Land Economics/Use, Research Methods/ Statistical Methods, Resource /Energy Economics and Policy
    Date: 2022–11–28

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