nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2023‒02‒06
twenty papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Repeated Transition Method and the Nonlinear Business Cycle with the Corporate Saving Glut By Lee, Hanbaek
  2. Managing Inequality over Business Cycles: Optimal Policies with Heterogeneous Agents and Aggregate Shocks By François Le Grand; Xavier Ragot
  3. Technology Choice, Externalities in Production, and a Chaotic Middle-Income Trap By Takao Asano; Akihisa Shibata; Masanori Yokoo
  4. Income Distribution by Age Group and Productive Bubbles By Xavier Raurich; Thomas Seegmuller
  5. Environment, public debt and epidemics By Marion Davin; Mouez Fodha; Thomas Seegmuller
  6. Equilibrium Yield Curves with Imperfect Information By Hiroatsu Tanaka
  7. Controlling Chaotic Fluctuations through Monetary Policy By Takao Asano; Akihisa Shibata; Masanori Yokoo
  8. Make-up strategies and exchange rate pass-through in a low-interest-rate environment By Alessandro Cantelmo; Pietro Cova; Alessandro Notarpietro; Massimiliano Pisani
  9. The preferential treatment of green bonds By Giovanardi, Francesco; Kaldorf, Matthias; Radke, Lucas; Wicknig, Florian
  10. Striking While the Iron Is Cold: Fragility after a Surge of Lumpy Investments By Lee, Hanbaek
  11. Aggregate Implications of Heterogeneous Inflation Expectations: The Role of Individual Experience By Mathieu Pedemonte; Hiroshi Toma; Estaban Verdugo
  12. The Regional Keynesian Cross By Marco Bellifemine; Adrien Couturier; Rustam Jamilov
  13. Equilibrium Determinacy With Behavioral Expectations By Jonathan J Adams
  14. Symbolic Stationarization of Dynamic Equilibrium Models By Fabio Canova; Kenneth Sæterhagen Paulsen
  15. Ensemble MCMC sampling for robust Bayesian inference By Böhl, Gregor
  16. The real effects of financial disruptions in a monetary economy By Miroslav Gabrovski; Athanasios Geromichalos; Lucas Herrenbrueck; Ioannis Kospentaris; Sukjoon Lee
  17. Debt-Ridden Borrowers and Persistent Stagnation By Keiichiro KOBAYASHI; Daichi SHIRAI
  18. Stock Price Wealth Effects and Monetary Policy under Imperfect Knowledge By Ifrim, Adrian
  19. Gazing at r-star: A Hysteresis Perspective By Paul Beaudry; Katya Kartashova; Césaire Meh
  20. Education inequality By Blanden, Jo; Doepke, Matthias; Stuhler, Jan

  1. By: Lee, Hanbaek
    Abstract: This paper develops a novel methodology to globally solve nonlinear dynamic stochastic general equilibrium models with high accuracy. The algorithm is based on the ergodic theorem: if a simulated path of the aggregate shock is long enough, all the possible equilibrium allocations are realized, enabling a complete characterization of the rationally expected future outcomes at each point on the path. The algorithm is applied to a heterogeneous-firm business cycle model where firms hoard cash as a buffer stock. Using the model, I analyze the state-dependent shock sensitivity of consumption over corporate cash stocks and provide empirical evidence.
    Keywords: Nonlinear business cycle, heterogeneous agents, stochastic dynamic programming, monotone function, state dependence.
    JEL: C63 D21 E32
    Date: 2022–12
  2. 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: We present a truncation theory of idiosyncratic histories for heterogeneous-agent models. This method allows us to solve for optimal Ramsey policies in such models with aggregate shocks. The method can be applied to a large variety of settings, with occasionally binding credit constraints. We use this theory to characterize the optimal level of unemployment insurance over the business cycle in a production economy. We find that the optimal policy is countercyclical.
    Keywords: Incomplete Markets, Optimal Policies, Heterogeneous Agent Models
    Date: 2021
  3. By: Takao Asano (Okayama University); Akihisa Shibata (Kyoto University); Masanori Yokoo (Okayama University)
    Abstract: We incorporate the external effects of capital in production and endogenous technology choice into the standard overlapping generations model. We demonstrate that our model can exhibit a poverty trap, a middle-income trap, and perpetual growth paths. We also show that, under some economic conditions, an economy exhibits all three of these phenomena, depending on its initial capital level, and that the economy caught in the middle-income trap can exhibit chaotic fluctuations in the long run. In obtaining these results in the standard overlapping generations model, the combination of technology choice and externalities in production plays a crucial role.
    Keywords: External effect; Technology choice; Overlapping generations model, Middle-income trap; Chaos
    Date: 2023–01
  4. By: Xavier Raurich (University of Barcelona); Thomas Seegmuller (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)
    Abstract: The aim of this paper is to study the role of the distribution of income by age group on the existence of speculative bubbles. A crucial question is whether this distribution may promote a bubble associated to a larger level of capital, that is a productive bubble. We address these issues in an overlapping generations model where agents live three periods and productive investment done in the first period of life is an illiquid investment whose return occurs in the following two periods. A bubble is a liquid speculative investment that facilitates intertemporal consumption smoothing. We show that the distribution of income by age group determines both the existence and the effect of bubbles on aggregate production. We also show that fiscal policy, by changing the distribution of income, may facilitate or prevent the existence of bubbles and may also modify the effect that bubbles have on aggregate production.
    Keywords: Bubble, Efficiency, Income Distribution, Overlapping Generations
    Date: 2022–04
  5. By: Marion Davin (CEE-M - Centre d'Economie de l'Environnement - Montpellier - UM - Université de Montpellier - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement - Institut Agro - Montpellier SupAgro - Institut Agro - Institut national d'enseignement supérieur pour l'agriculture, l'alimentation et l'environnement); Mouez Fodha (PSE - Paris School of Economics - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement); Thomas Seegmuller (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)
    Abstract: We study whether fiscal policies, especially public debt, can help to curb the macroeconomic and health consequences of epidemics. Our approach is based on three main features: we introduce the dynamics of epidemics in an overlapping generations model to take into account that old people are more vulnerable; people are more easily infected when pollution is high; public spending and public debt can be used to tackle the effects of epidemics. We show that fiscal policies can promote the convergence to a stable steady state with no epidemics. When public policies are not able to permanently eradicate the epidemic, public debt and income transfers could reduce the number of infected people and increase capital and GDP per capita. As a prerequisite, pollution intensity should not be too high. Finally, we define a household subsidy policy which eliminates income and welfare inequalities between healthy and infected individuals.
    Keywords: public debt, epidemics, pollution, overlapping generations
    Date: 2021–05–07
  6. By: Hiroatsu Tanaka
    Abstract: I study the dynamics of default-free bond yields and term premia using a novel equilibrium term structure model with a New-Keynesian core and imperfect information about productivity. The model generates term premia that are on average positive with sizable countercyclical variation that arises endogenously. Importantly, demand shocks, in addition to supply shocks, play a key role in the dynamics of term premia. This is in sharp contrast to existing DSGE term structure models with perfect information, which tend to rely on large supply shocks to generate timevariation in yields and term premia. With imperfect information, a shock to productivity is a supply shock, while a shock to signals about productivity that do not lead to actual changes in productivity acts as a demand shock. Nevertheless, an increase in economic activity generates more information about productivity, regardless of which type of shock it arises from. Moreover, a decrease in economic uncertainty leads to a decline in term premia as longer-term bonds are risky on average. This feature helps reconcile the empirical evidence that term premia have been on average positive and countercyclical, with numerous studies pointing to demand shocks as being an important driver of business cycles over the last few decades.
    Keywords: Term Premium; Term Structure of Interest Rates; Yield Curve; DSGE Model; Imperfect Information; Learning
    JEL: D83 E12 E32 E43 E44 E52 G12
    Date: 2022–12
  7. By: Takao Asano (Okayama University); Akihisa Shibata (Kyoto University); Masanori Yokoo (Okayama University)
    Abstract: This paper applies the chaos control method (the OGY method) proposed by Ott et al. (1990, Physical Review Letters) to policy making in macroeconomics. This paper demonstrates that the monetary equilibrium paths in a discrete-time, two-dimensional overlapping generations model exhibit chaotic fluctuations depending on the money supply rate and the elasticity of substitution between capital and labor under the assumption of the constant elasticity of substitution (CES) production function. We also show that the chaotic fluctuations can be stabilized by controlling the money supply rate by using the OGY method.
    Keywords: Macroeconomy; Chaos Control; OGY method; Monetary Policy; OLG model; Chaos
    Date: 2023–01
  8. By: Alessandro Cantelmo (Bank of Italy); Pietro Cova (Bank of Italy); Alessandro Notarpietro (Bank of Italy); Massimiliano Pisani (Bank of Italy)
    Abstract: We evaluate the macroeconomic stabilization properties, with particular reference to the exchange rate pass-through, of price level targeting (PLT), average inflation targeting (AIT) and inflation targeting (IT) strategies when the effective lower bound on the monetary policy rate can be binding. The results of simulating the canonical open-economy New Keynesian model -- in which the assumption of local currency pricing holds and which is calibrated without loss of generality to the euro area -- are as follows. First, make-up strategies (PLT and AIT) stabilize inflation better than IT, by favoring a smaller appreciation (larger depreciation) of the nominal exchange rate in the event of disinflationary demand (supply) shocks. Second, and in connection with this, the exchange rate pass-through to import prices is more limited under make-up strategies than under IT, as the former stabilize the inflation rate of imports to a greater extent. Third, the results are robust to alternative values of import price stickiness and elasticity of substitution between domestic and imported goods. Fourth, the stabilization properties of make-up strategies are qualitatively preserved under partially backward-looking inflation expectations, although the relative gains of make-up strategies with respect to IT are smaller than under model-consistent inflation expectations.
    Keywords: effective lower bound, exchange rate pass-through, local currency pricing, make-up strategies, monetary policy
    JEL: E31 E52 F31 F41
    Date: 2022–12
  9. By: Giovanardi, Francesco; Kaldorf, Matthias; Radke, Lucas; Wicknig, Florian
    Abstract: We study the preferential treatment of green bonds in the central bank collateral framework as an environmental policy instrument within a DSGE model with environmental and financial frictions. In the model, green and carbon-emitting conventional firms issue defaultable corporate bonds to banks that use them as collateral. The collateral premium associated to a relaxation in collateral policy induces firms to increase bond issuance, investment, leverage, and default risk. Collateral policy solves a trade-off between increasing collateral supply, adverse effects on firm risk-taking, and subsidizing green investment. Optimal collateral policy is characterized by modest preferential treatment, which increases the green investment share and reduces emissions. However, welfare gains fall well short of what can be achieved with optimal emission taxes. Moreover, due to elevated risk-taking of green firms, preferential treatment is a qualitatively imperfect substitute of Pigouvian taxation on emissions: if and only if the optimal emission tax can not be implemented, optimal collateral policy features preferential treatment of green bonds.
    Keywords: Green Investment, Collateral Framework, Environmental Policy
    JEL: E44 E58 E63 Q58
    Date: 2022
  10. By: Lee, Hanbaek
    Abstract: This paper studies the endogenous state dependence of the aggregate investment dynamics stemming from synchronized lumpy investments at the firm level. I develop a heterogeneous-firm real business cycle model where the semi-elasticities of large and small firms’ investments are matched with the empirical estimates. In the model, following a negative TFP shock, the timings of large firms’ lumpy investments are persistently synchronized due to the low sensitivity to the general equilibrium effect, leading to a surge of lumpy investments. After the surge, TFP-induced recessions are especially severe, and the semi-elasticity of the aggregate investment drops significantly.
    Keywords: Business cycle, state dependence, lumpy investment, interest-elasticity.
    JEL: D21 E22 E32
    Date: 2022–11
  11. By: Mathieu Pedemonte; Hiroshi Toma; Estaban Verdugo
    Abstract: We show that inflation expectations are heterogeneous and depend on past individual experiences. We propose a diagnostic expectations-augmented Kalman filter to represent consumers’ heterogeneous inflation expectations-formation process, where heterogeneity comes from an anchoring-to-the-past mechanism. We estimate the diagnosticity parameter that governs the inflation expectations-formation process and show that the model can replicate systematic differences in inflation expectations across cohorts in the US. We introduce this mechanism into a New Keynesian model and find that heterogeneous expectations anchor aggregate responses to the agents’ memory, making shocks more persistent. Central banks should be more active to prevent agents from remembering current shocks far into the future.
    Keywords: Expectations; Survey Data; Belief Formation; Heterogeneous Expectations
    JEL: D84 E31 E58 E71
    Date: 2023–01–10
  12. By: Marco Bellifemine; Adrien Couturier; Rustam Jamilov
    Abstract: We study monetary policy transmission across space. Empirically, we show that two channels explain a sizable portion of the variation in the regional effects of identified U.S. monetary policy shocks: local marginal propensities to consume (MPCs), as captured by household wealth, and industry composition, as measured by the local share of non-tradable employment. Theoretically, we develop a heterogeneous agents New Keynesian (HANK) model of a monetary union with two-layered regional heterogeneity in household and industry composition. We provide a sequence-space characterization of the response of local employment to unexpected changes in interest rates as a function of intertemporal MPCs and industry composition: the regional Keynesian cross. Central to our theory is an equilibrium complementarity between these two sources of regional heterogeneity. We provide direct empirical evidence of this household industry complementarity, thus validating our key model mechanism. Quantitatively, reactions from fiscal authorities and the rest of the nation are key determining factors of the aggregate regional economic response.
    Date: 2022–12–24
  13. By: Jonathan J Adams (Department of Economics, University of Florida)
    Abstract: When do dynamic models with behavioral expectations have unique solutions? I derive a Blanchard-Kahn-style condition that ensures a unique solution exists in a broad class of models: the number of non-predetermined variables must match the number of the model's unstable eigenvalues. With behavioral expectations, an eigenvalue is unstable if it is larger in magnitude than the spectral radius of the expectation operator. The condition is always sufficient, but only necessary for some forms of expectations: many behavioral expectations do not admit sunspot equilibria in some types of models. Next, I illustrate the determinacy conditions in several examples, including the canonical New Keynesian model, which has a unique equilibrium under an interest rate peg when expectations are given by a variety of common heuristics. Finally, I characterize the spectral radii and other properties of a variety of popular behavioral expectations.
    JEL: C62 D84 E70
    Date: 2023–01
  14. By: Fabio Canova; Kenneth Sæterhagen Paulsen
    Abstract: Dynamic equilibrium models are specified to track time series with unit root-like behavior. Thus, unit roots are typically introduced and the optimality conditions adjusted. This step requires tedious algebra and often leads to algebraic mistakes, especially in models with several unit roots. We propose a symbolic algorithm that simplies the step of rendering non-stationary models stationary. It is easy to implement and works when trends are stochastic or deterministic, exogenous or endogenous. Three examples illustrate the mechanics and the properties of the approach. A comparison with existing methods is provided.
    Keywords: DSGE models, unit roots, endogenous growth, symbolic computation
    Date: 2021–12–20
  15. By: Böhl, Gregor
    Abstract: This paper proposes a Differential-Independence Mixture Ensemble (DIME) sampler for the Bayesian estimation of macroeconomic models. It allows sampling from particularly challenging, high-dimensional black-box posterior distributions which may also be computationally expensive to evaluate. DIME is a "Swiss Army knife", combining the advantages of a broad class of gradient-free global multi-start optimizers with the properties of a Monte Carlo Markov chain. This includes (i) fast burn-in and convergence absent any prior numerical optimization or initial guesses, (ii) good performance for multimodal distributions, (iii) a large number of chains (the "ensemble") running in parallel, (iv) an endogenous proposal density generated from the state of the full ensemble, which (v) respects the bounds of the prior distribution. I show that the number of parallel chains scales well with the number of necessary ensemble iterations. DIME is used to estimate the medium-scale heterogeneous agent New Keynesian ("HANK") model with liquid and illiquid assets, thereby for the first time allowing to also include the households' preference parameters. The results mildly point towards a less accentuated role of household heterogeneity for the empirical macroeconomic dynamics.
    Keywords: Bayesian Estimation, Monte Carlo Methods, Heterogeneous Agents, Global Optimization, Swiss Army Knife
    JEL: C11 C13 C15 E10
    Date: 2022
  16. By: Miroslav Gabrovski (Department of Economics, University of Hawaii); Athanasios Geromichalos (Department of Economics, University of California, Davis); Lucas Herrenbrueck (Department of Economics, Simon Fraser University); Ioannis Kospentaris (Department of Economics, VCU School of Business); Sukjoon Lee (Department of Economics, New York University Shanghai)
    Abstract: A large literature in macroeconomics reaches the conclusion that disruptions in financial markets have large negative effects on output and (un)employment. Although seemingly diverse, papers in this literature share a common characteristic: they employ frameworks where money is not explicitly modeled. This paper argues that the omission of money may hinder a model’s ability to evaluate the real effects of financial disruptions, since it deprives agents of a payment instrument that they could have used to cope with the resulting liquidity disruption. In a carefully calibrated New-Monetarist model with frictional labor, product, and financial markets we show that output and unemployment respond very modestly to shocks in the ability of agents to trade in the financial market. Explicitly modeling money enables us to show that the size of the transmission mechanism between the financial market shock and the real economy is disciplined by the inflation level.
    Keywords: search frictions; unemployment; corporate bonds; money; liquidity; inflation
    JEL: E24 E31 E41 E44
    Date: 2023–01
  17. By: Keiichiro KOBAYASHI; Daichi SHIRAI
    Abstract: Persistent stagnation often follows a financial crisis. We construct a model in which a debt buildup in the corporate sector can persistently depress the economy, even when there are no structural changes. We consider endogenous borrowing constraints on short-term and long-term debt. A firm is referred to as debt-ridden when its long-term debt is so large that it can never decrease even though the firm pays all income in each period to the lender. A debt-ridden firm continues inefficient production permanently, and the emergence of a substantial number of debt-ridden firms causes a persistent recession. Further, if the initial debt exceeds a certain threshold, the firm intentionally chooses to increase borrowing and, thus, becomes debt-ridden. We numerically show successive productivity shocks or a large wealth shock can generate debt-ridden firms. The relief of debt-ridden borrowers from excessive debt may be effective for economic recovery.
    Date: 2023–01
  18. By: Ifrim, Adrian
    Abstract: Departures from full-information rational expectation models give rise to stock price wealth effects which introduce inefficient cyclical fluctuations in the economy. Waves of optimism/pessimism affect beliefs and asset prices which influence aggregate demand through expectation-driven wealth effects. Monetary policy can play an important role in eliminating the non-fundamental effects of belief-driven asset price cycle: reacting symmetrically and transparently to stock prices increases welfare significantly compared to flexible inflation targeting strategies. A quantitative model estimated on US data shows that increasing interest rates by 12 basis points for every 100% rise in stock prices accomplish this goal. Moreover, a nonlinear reaction to stock prices only when capital gains exceed 7% delivers similar efficiency gains.
    Keywords: monetary policy, wealth effects, learning, survey expectations, stock prices, animal spirits
    JEL: D84 E32 E44 E52
    Date: 2023
  19. By: Paul Beaudry; Katya Kartashova; Césaire Meh
    Abstract: Many explanations for the decline in real interest rates over the last 30 years point to the role that population aging or rising income inequality plays in increasing the long-run aggregate demand for assets. Notwithstanding the importance of such factors, the starting point of this paper is to show that the major change driving household asset demand over this period is instead an increased desire—for a given age and income level—to hold assets. We begin by presenting a simple explanation for this pattern that relies on integrating retirement and inter-temporal substitution motives in saving decisions. We then show how the interaction of these two saving motives can have profound implications in terms of the shape of asset demands, the possibility of multiple steady state real interest rates, and a potential role for monetary policy to influence the long-run evolution of real rates. The framework highlights how an inflationary episode followed by a strong monetary response, as we are currently witnessing, can have long-term implications for real interest rates.
    Keywords: Economic models; Fiscal policy; Inflation and prices; Inflation targets; Interest rates; Monetary policy; Monetary policy framework
    JEL: E21 E52 E31 E43 E58 E62 G51 H6
    Date: 2023–01
  20. By: Blanden, Jo; Doepke, Matthias; Stuhler, Jan
    Abstract: This paper provides new evidence on educational inequality and reviews the literature on the causes and consequences of unequal education. We document large achievement gaps between children from different socio-economic backgrounds, show how patterns of educational inequality vary across countries, time, and generations, and establish a link between educational inequality and social mobility. We interpret this evidence from the perspective of economic models of skill acquisition and investment in human capital. The models account for different channels underlying unequal education and highlight how endogenous responses in parents' and children's educational investments generate a close link between economic inequality and educational inequality. Given concerns over the extended school closures during the Covid-19 pandemic, we also summarize early evidence on the impact of the pandemic on children's education and on possible long-run repercussions for educational inequality.
    Keywords: educational inequality; education finance; children
    JEL: J1
    Date: 2022–04–28

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