nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2023‒01‒16
nineteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Commodity Exports, Financial Frictions and International Spillovers By Romain Houssa; Jolan Mohimont; Christopher Otrok
  2. Inequality and Business Cycles By Bilbiie, F.; Primiceri, G. E.; Tambalotti, A.
  3. How Quantitatively Important are Shocks to Consumption and Income Tax Rates for Business Cycle Fluctuations? Lessons from Bulgaria (1999-2020) By Aleksandar Vasilev
  4. Optimal climate policy as if the transition matters By Campiglio, Emanuele; Dietz, Simon; Venmans, Frank
  5. Public redistributive policies in general equilibrium: an application to Greece By Angelopoulos, Angelos; Economides, George; Liontos, George; Philippopoulos, Apostolis; Sakkas, Stelios
  6. Government Procurement and Access to Credit: Firm Dynamics and Aggregate Implications By Julian di Giovanni; Manuel García-Santana; Priit Jeenas; Enrique Moral-Benito; Josep Pijoan-Mas
  7. Rational Inattention and the Business Cycle Effects of Productivity and News Shocks By Bartosz Maćkowiak; Mirko Wiederholt
  8. Job Ladder, Human Capital, and the Cost of Job Loss By Richard Audoly; Federica De Pace; Giulio Fella
  9. On the long-run fluctuations of inheritance in two-sector OLG models By Florian Pelgrin; Alain Venditti
  10. Equilibrium Effects of Payroll Tax Reductions and Optimal Policy Design By Breda, Thomas; Haywood, Luke; Wang, Haomin
  11. Firm Entry and Exit during Recessions By Ayres, JoaÞo; Raveendranathan, Gajendran
  12. Welfare Effects of Capital Controls By Andreasen, Eugenia; Bauducco, Sofía; Dardati, Evangelina
  13. Consumer Bankrupcty, Mortgage Default and Labor Supply By Wenli Li; Costas Meghir; Florian Oswald
  14. Reallocation and Productivity during Commodity Cycles By Heresi, Rodrigo
  15. Working and Saving Informally: The Link between Labor Market Informality and Financial Exclusion By Luca Flabbi; Mauricio Tejada
  16. Income, Employment and Health Risks of Older Workers By Siqi Wei
  17. Sovereign Default and Liquidity: The Case for a World Safe Asset By François Le Grand; Xavier Ragot
  18. Employment Effects of Restricting Fixed-Term Contracts: Theory and Evidence By Pierre Cahuc; Pauline Carry; Franck Malherbet; Pedro S Martins
  19. Local containment policies and country-wide spread of Covid-19 in the United States: an epidemiological analysis By Jacek Rothert; Alexander McQuoid; Katherine Smith

  1. By: Romain Houssa; Jolan Mohimont; Christopher Otrok
    Abstract: This paper offers a solution to the international co-movement puzzle found in open-economy macroeconomic models. We develop a small open-economy (SOE) dynamic stochastic general equilibrium (DSGE) model describing three endogenous channels that capture spillovers from the world to a commodity exporter: a world commodity price channel, a domestic commodity supply channel and a financial channel. We estimate our model with Bayesian methods on two commodity-exporting SOEs, namely Canada and South Africa. In addition to explaining international business cycle synchronization, the new model attributes an important fraction of business cycle fluctuations to foreign shocks in the SOEs.
    Keywords: international spillovers; commodities; financial frictions; small open economy; DSGE; Bayesian; monetary policy
    JEL: E3 E43 E52 C51 C33
    Date: 2022–12–17
  2. By: Bilbiie, F.; Primiceri, G. E.; Tambalotti, A.
    Abstract: We quantify the connection between inequality and business cycles in a medium-scale New Keynesian model with tractable household heterogeneity, estimated with aggregate and cross-sectional data. We find that inequality substantially amplifies cyclical fluctuations. The primary source of this amplification is cyclical precautionary saving behavior. Savers reduce their consumption to insure themselves against the idiosyncratic risk of large income drops, which rises in recessions.
    Date: 2022–12–16
  3. By: Aleksandar Vasilev (Lincoln International Business School, UK)
    Abstract: This paper analyzes the macroeconomic effects of fluctuations in the marginal tax rates of consumption and income. To this end, stochastic tax rates are introduced as in Braun (1992), into a real-business-cycle setup augmented with a detailed government sector. The model is calibrated to Bulgarian data for the period following the introduction of the currency board arrangement (1999-2020). The quantitative importance of the presence of stochastic taxation is investigated for the stabilization of cyclical fluctuations in Bulgaria. The quantitative effect of such shocks to the marginal tax rates is found to be very small, and thus not important for either business cycle stabilization, or public finance issues.
    Keywords: business cycles, stochastic consumption and income taxes, Bulgaria
    JEL: E24 E32
    Date: 2023–01
  4. By: Campiglio, Emanuele; Dietz, Simon; Venmans, Frank
    Abstract: The optimal transition to a low-carbon economy must account for adjustment costs in switching from dirty to clean capital, technological progress, and economic and climatic shocks. We study the low-carbon transition using a dynamic stochastic general equilibrium model with emissions abatement costs calibrated on a large energy modelling database, solved with recursive methods. We show how capital inertia puts upward pressure on emissions and temperatures in the short run, but that nonetheless it is optimal to actively disinvest from – to ‘strand’ – a significant share of the dirty capital stock. Conversely, clean technological progress, as well as uncertainty about climatic and economic factors, lead to lower emissions and temperatures in the long run. Putting these factors together, we estimate a net premium of 33% on the optimal carbon price today relative to a ‘straw man’ model with perfect capital mobility, fixed abatement costs and no uncertainty.
    Keywords: adjustment costs; carbon price; climate change; low-carbon transition; stranded assets; technological progress; uncertainty
    JEL: C61 E22 H23 Q54 Q55
    Date: 2022–12–14
  5. By: Angelopoulos, Angelos; Economides, George; Liontos, George; Philippopoulos, Apostolis; Sakkas, Stelios
    Abstract: We develop a general equilibrium OLG model of a small open economy to quantify the aggregate and distributional implications of a wide menu of public redistributive policies in a unified context. Inequality is driven by unequal parental conditions in financial and human capital. The model is calibrated and solved using fiscal data from Greece. Our aim is to search for public policies, targeted and non-targeted, that can reduce income inequality without damaging the macroeconomy and without worsening the public finances. Pareto-improving reforms that also reduce inequality include an increase in public education spending provided to all and an increase in the inheritance tax rate on financial wealth. At the other end, we identify reforms that may reduce inequality but make everybody worse o§. Regarding cases in between, a switch to a fully funded public pension system is good for everybody although it is the rich-born that benefit more by moving to a more efficient macroeconomy.
    Keywords: inequality; efficiency; public policy
    JEL: D30 H30 H50
    Date: 2022–11
  6. By: Julian di Giovanni (Federal Reserve Bank of New York); Manuel García-Santana (Universitat Pompeu Fabra); Priit Jeenas (Universitat Pompeu Fabra); Enrique Moral-Benito (Bank of Spain); Josep Pijoan-Mas (CEMFI, Centro de Estudios Monetarios y Financieros)
    Abstract: We provide a framework to study how different allocation systems of public procurement contracts affect firm dynamics and long-run macroeconomic outcomes. We start by using a newly created panel dataset of administrative data that merges Spanish credit register loan data, quasicensus firm-level data, and public procurement projects to study firm selection into procurement and the effects of procurement on credit growth and firm growth. We show evidence consistent with the hypotheses that there is selection of large firms into procurement, that procurement contracts provide useful collateral for firms -more so than sales to the private sector- and that procurement contracts facilitate firm growth beyond the contract duration. We next build a model of firm dynamics with both asset-based and earnings-based borrowing constraints and a government that buys goods and services from private sector firms. We use the calibrated model to quantify the long-run macroeconomic consequences of alternative procurement allocation systems. We find that granting procurement contracts to small firms, either by directly targeting them or by slicing large contracts into smaller ones, helps these firms grow and overcome financial constraints in the long run. However, we also find that reducing the average size of contracts |or making it less likely for large firms to access them| removes saving incentives for large firms, whose negative effects on capital accumulation can overcome the expansionary consequences for small firms and hence generate a drop in aggregate output.
    Keywords: Government procurement, financial frictions, capital accumulation, aggregate productivity.
    JEL: E22 E23 E62 G32
    Date: 2022–02
  7. By: Bartosz Maćkowiak (CEPR - Center for Economic Policy Research - CEPR); Mirko Wiederholt (ECON - Département d'économie (Sciences Po) - Sciences Po - Sciences Po - CNRS - Centre National de la Recherche Scientifique, CEPR - Center for Economic Policy Research - CEPR, LMU - Ludwig Maximilian University [Munich])
    Abstract: We solve a real business cycle model with rational inattention (an RI-RBC model). In the standard model, anticipated fluctuations in productivity fail to cause business cycle comovement. In response to news about higher future productivity, consumption rises but employment and investment fall. Introducing rational inattention helps produce comovement. Agents choose an optimal signal about the state of the economy. The optimal signal turns out to confound current with expected future productivity. Labor and investment demand rise after a news shock, causing an output expansion. Rational inattention also improves the propagation of a standard productivity shock, by inducing persistence.
    Keywords: Information choice, Rational inattention, Real business cycle model, News shocks, Productivity shocks
    Date: 2021–12
  8. By: Richard Audoly; Federica De Pace; Giulio Fella
    Abstract: High-tenure workers losing their job experience a large and prolonged fall in wages and earnings. The aim of this paper is to understand and quantify the forces behind this empirical regularity. We propose a structural model of the labor market with (i) on-the-job search, (ii) general human capital, and (iii) firmspecific human capital. Jobs are destroyed at an endogenous rate due to idiosyncratic productivity shocks and the skills of workers depreciate during periods of non-employment. The model is estimated on German Social Security data. By jointly matching moments related to workers’ mobility and wages, the model can replicate the size and persistence of the losses in earnings and wages observed in the data. We find that the loss of a job with a more productive employer is the primary driver of the cumulative wage losses following displacement (about 50 percent), followed by the loss of firm-specific human capital (about 30 percent).
    Keywords: job loss; on-the-job search; human capital
    JEL: J0 J3 J6
    Date: 2022–12–01
  9. By: Florian Pelgrin (EDHEC - EDHEC Business School - UCL - Université catholique de Lille); Alain Venditti (AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique, EDHEC - EDHEC Business School - UCL - Université catholique de Lille)
    Abstract: This paper provides a long-run cycle perspective to explain the behavior of the annual flow of inheritance. Based on the low- and medium frequency properties of long time bequests series in Sweden, France, UK, and Germany, we explore the extent to which a two-sector Barro-type OLG model is consistent with such empirical regularities. As long as agents are sufficiently impatient and preferences are non-separable, we show that endogenous fluctuations are likely to occur through two mechanisms, which can generate independently or together either period-2 cycles or Hopf bifurcations. The first mechanism relies on the elasticity of intertemporal substitution or equivalently the sign of the cross-derivative of the utility function whereas the second rests on sectoral technologies through the sign of the capital intensity difference across two sectors. Furthermore, building on the quasi-palindromic nature of the degree-4 characteristic equation, we derive some meaningful sufficient conditions associated to the occurrence of complex roots and a Hopf bifurcation in a two-sector OLG model.
    Keywords: Two-sector overlapping generations model,Altruism,Bequest,Endogenous fluctuations,Quasi-palindromic polynomial,Periodic and quasi-periodic cycles
    Date: 2022–08
  10. By: Breda, Thomas (Paris School of Economics); Haywood, Luke (Mercator Research Institute on Global Commons and Climate Change (MCC)); Wang, Haomin (University of Konstanz)
    Abstract: Recent empirical literature documents that targeted tax reductions or minimum wages can have unintended reallocation and spillover effects on workers not directly targeted by these policies. We quantify these effects using an equilibrium search-and-matching model estimated on French data before a low-wage payroll tax reduction in 1995; the model features heterogeneous workers and firms, labor taxation, and a minimum wage. Based on our model, the tax reduction led to changes in the vacancy distribution such that it becomes harder for workers to move up the job ladder in terms of firm productivity. We refer to this as the negative reallocation effect. The tax reduction also increased labor force participation of low-productivity workers, leading to a negative spillover effect because these workers create congestion in the labor market, lowering the job-finding rate for all workers. Given these unintended effects, low-wage tax reduction should cover jobs in a broad wage range. Finally, we find that the efficiency-maximizing policy mix involves moderately regressive payroll taxation and a low but binding minimum wage.
    Keywords: payroll tax, minimum wage, equilibrium job search, worker and firm heterogeneity
    JEL: J64 E24 H24 J38
    Date: 2022–12
  11. By: Ayres, JoaÞo; Raveendranathan, Gajendran
    Abstract: We analyze shocks to productivity, collateral constraint (credit shock), firm operation, and labor disutility in a model of firm dynamics with entry and exit. Shocks to firm operation and labor disutility capture COVID-19 lockdowns. Compared to the productivity shock, the credit and the lockdown shocks generate larger changes in firm entry and exit. The credit shock accounts for lower entry, higher exit, and concentration of exit among young firms during the Great Recession. The lockdown shocks predict a large fall in entry and rise in exit followed by a sharp rebound. In both recessions, changes in entry and exit account for 10-20 percent of the fall in output and hours. Finally, we discuss how the modeling of potential entrants matters for the quantitative results.
    Keywords: firm dynamics;general equilibrium model;COVID-19;recession;lockdown;COVID-19;COVID-19;COVID-19;COVID-19;Creditshock
    JEL: E24 E32 D22 D21
    Date: 2021–06
  12. By: Andreasen, Eugenia; Bauducco, Sofía; Dardati, Evangelina
    Abstract: This paper studies the effect of capital controls on misallocation and welfare in an economy with financial constraints. We build a general equilibrium model with heterogeneous firms, financial constraints and international trade and calibrate it to the Chilean economy. Since high-productivity and exporting firms need to borrow more to reach their optimal scale, capital controls that tax international borrowing hit them harder. As a result, misallocation increases relatively more for this group of firms, and for young firms that are still trying to reach their optimal scale. In terms of welfare, the model predicts a sizable aggregate loss of 2.39 percent when capital controls are introduced, with welfare decreasing twice as much for high-productivity firms. We empirically corroborate the main insights in terms of misallocation obtained from the model using Chilean manufacturing firm data from 1990 to 2007.
    Keywords: International trade;Financial Frictions;welfare;Capital controls;Misallocation
    JEL: F41 O47 F12
    Date: 2021–06
  13. By: Wenli Li (Federal Reserve Bank Philadelphia); Costas Meghir (Yale University [New Haven], CEPR - Center for Economic Policy Research - CEPR); Florian Oswald (ECON - Département d'économie (Sciences Po) - Sciences Po - Sciences Po - CNRS - Centre National de la Recherche Scientifique)
    Abstract: We specify and estimate a lifecycle model of consumption, housing demand and labor supply in an environment where individuals may file for bankruptcy or default on their mortgage. Uncertainty in the model is driven by house price shocks, {education specific} productivity shocks, and catastrophic consumption events, while bankruptcy is governed by the basic institutional framework in the US as implied by Chapter 7 and Chapter 13. The model is estimated using micro data on credit reports and mortgages combined with data from the American Community Survey. We use the model to understand the relative importance of the two chapters (7 and 13) for each of our two education groups that differ in both preferences and wage profiles. We also provide an evaluation of the BACPCA reform. Our paper demonstrates importance of distributional effects of Bankruptcy policy.
    Keywords: Lifecycle, Bankruptcy, Mortgage Default, Housing, Labor Supply, Consumption, Education, Insurance, Moral hazard
    Date: 2022–03–17
  14. By: Heresi, Rodrigo
    Abstract: I study the firm-level dynamic response of a commodity-exporting economy to global cycles in commodity prices. To do so, I develop a heterogeneous-firms model that endogenizes declines in aggregate productivity through reallocation towards less productive firms. Within a given sector, commodity booms reallocate market share away from exporters because of currency appreciation and away from capital-intensive firms because of the increase in capital cost. I provide empirical evidence for these channels using microdata for Chile, the worlds largest copper producer. When fed with the commodity super-cycle of 2003-2012, the calibrated model generates about 50% of the observed productivity decline.
    Keywords: Productivity;Resource booms;Open economy macroeconomics
    JEL: F41 D24 Q33
    Date: 2021–04
  15. By: Luca Flabbi; Mauricio Tejada
    Abstract: The high level of informality and the low level of savings observed in developing countries are fundamentally linked because informal workers have limited access to formal financial institutions. We study this link by developing and estimating a labor market model where workers can be employed both formally and informally and agents can save through both formal and informal financial institutions. We estimate the model on nationally representative data for Colombia and use the estimated model to simulate counterfactual experiments. Results show that reaching full financial inclusion of informal workers would increase savings by 3% a month and formal assets by 21%. The same policy would strongly decrease inequality in assets and mildly decrease inequality in consumption.
    Keywords: Informality, financial inclusion, savings, labor market search, structural estimation
    Date: 2022
  16. By: Siqi Wei (CEMFI, Centro de Estudios Monetarios y Financieros)
    Abstract: This paper begins with the observation that many olderworkers move to "bridge" jobs with lower wages and fewer working hours before exiting the labor force for good. To explain this gradual transition to full retirement, I propose a nonlinear agingrelated shock — mismatch shock, which mismatches workers with their existing job and triggers job leaves. I develop an empirical framework of employment and job transitions jointly with stochastic wage and hour processes to separate health risks, individual-specific productivity risks, firm-specific mismatch risks, quality of outside offers, and job destruction risks faced by older workers. The model is estimated with a sample of male individuals aged 51 to 70 in the US Health and Retirement Study applying a novel parameter-expanded stochastic EM algorithm. The paper finds that mismatch shocks play an important role in explaining the reduction in wages and hours for movers. Furthermore, I calculate the welfare cost of risks and quantify how much individuals value the possibility of a flexible transition to full retirement by constructing a utility-based structural model of consumption, employment and job movements where agents face the same risks as in the empirical model. The model is estimated using a novel simulation-based algorithm that exploits the connection to the empirical model and the estimates from the empirical model. The results show that the median cost of mismatch risks amounts to a reduction in consumption flow by 5?3%-7?1% depending on the education group. Banning job changes and re-entry causes a welfare loss equivalent to a consumption drop of 12% 4%.
    Keywords: Income risks, health risks, mismatch, bridge jobs, latent variables.
    JEL: J26 J24 J22 C51 I14
    Date: 2022–07
  17. By: François Le Grand (EM - emlyon business school, ETH Zürich - Eidgenössische Technische Hochschule - Swiss Federal Institute of Technology [Zürich]); Xavier Ragot (ECON - Département d'économie (Sciences Po) - Sciences Po - Sciences Po - CNRS - Centre National de la Recherche Scientifique, CNRS - Centre National de la Recherche Scientifique, OFCE - Observatoire français des conjonctures économiques (Sciences Po) - Sciences Po - Sciences Po)
    Abstract: This paper presents a positive and normative study of a world financial market when sovereign countries can default on their debt. We construct a tractable model that enables us to study sovereign default in general equilibrium. The amount of safe assets is thus endogenous and determined by international risk-sharing. We characterize the equilibrium structure and we show that the market equilibrium can generate multiple equilibria. In addition, the market equilibrium is not constrained-efficient because countries do not fully internalize the value of their debt being used as liquidity. We prove that a world fund issuing a safe asset increases aggregate welfare. The fund's relationship with the IMF's Special Drawing Rights is discussed.
    Keywords: Sovereign Default,Safe Asset,International Liquidity
    Date: 2021–07
  18. By: Pierre Cahuc (ECON - Département d'économie (Sciences Po) - Sciences Po - Sciences Po - CNRS - Centre National de la Recherche Scientifique, IZA - Forschungsinstitut zur Zukunft der Arbeit - Institute of Labor Economics, CEPR - Center for Economic Policy Research - CEPR); Pauline Carry (CREST - Centre de Recherche en Économie et Statistique - ENSAI - Ecole Nationale de la Statistique et de l'Analyse de l'Information [Bruz] - X - École polytechnique - ENSAE Paris - École Nationale de la Statistique et de l'Administration Économique - CNRS - Centre National de la Recherche Scientifique); Franck Malherbet (CREST - Centre de Recherche en Économie et Statistique - ENSAI - Ecole Nationale de la Statistique et de l'Analyse de l'Information [Bruz] - X - École polytechnique - ENSAE Paris - École Nationale de la Statistique et de l'Administration Économique - CNRS - Centre National de la Recherche Scientifique, IZA - Forschungsinstitut zur Zukunft der Arbeit - Institute of Labor Economics); Pedro S Martins (NOVA SBE - NOVA - School of Business and Economics - NOVA - Universidade Nova de Lisboa = NOVA University Lisbon, IZA - Forschungsinstitut zur Zukunft der Arbeit - Institute of Labor Economics)
    Abstract: This paper examines a labor law reform implemented in Portugal in 2009 which restricted the use of fixed-term contracts to reduce labor market segmentation. The reform targeted establishments created by large firms above a specific size threshold, covering about 15% of total employment. Drawing on linked employer-employee longitudinal data and regression discontinuity methods, we find that, while the reform was successful in reducing the number of fixed-term jobs, it did not increase the number of permanent contracts and decreased employment in large firms. However, we find evidence of positive spillovers to small firms that may bias reduced form estimates. To evaluate general equilibrium effects, we build and estimate a directed search and matching model with endogenous number of establishments and jobs. We find spillover effects that induce small biases on reduced form estimates but that significantly change the evaluation of the overall impact of the reform because they diffuse to the whole economy. We estimate that the reform slightly reduced aggregate employment and had negative effects on the welfare of employees and unemployed workers.
    Keywords: Directed search and matching, Labour market segmentation, Regression discontinuity
    Date: 2022–01
  19. By: Jacek Rothert (United States Naval Academy; Group for Research in Applied Economics (GRAPE)); Alexander McQuoid (United States Naval Academy); Katherine Smith (United States Naval Academy)
    Abstract: Among the G7 economies gross foreign direct investment (FDI) positions are very large, averaging 100% of GDP and dwarfing the absolute values of net FDI positions in most countries. Additionally, inward and outward FDI flows exhibit robust, positive correlation over the business cycle. In the standard international business cycle (IBC) model gross FDI stocks and flows are not well defined, and only net flows matter. We extend the standard model by allowing domestic and foreign ownership of physical capital in the aggregate production function to be imperfect substitutes. We estimate that elasticity of substitution using the co-movement of gross FDI flows, and find it to be less than 2.5 – a value much smaller than the implicitly assumed infinity in the IBC literature. Our results uncover a new source of welfare gains from openness to FDI among otherwise identical, developed economies – a capital diversity channel, akin to product variety in trade models. The channel is quantitatively important – openness to FDI yields steady-state welfare gains equivalent to at least a 4-5% increase in life-time consumption.
    Keywords: FDI, risk-sharing, international financial integration, international business cycles, BKK puzzle, Feldstein-Horioka puzzle
    JEL: R15 H77 I19
    Date: 2022

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