nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2023‒03‒27
eighteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Schumpeterian Growth, Price Rigidities, and the Business Cycles By Adil Mahroug; Alain Paquet
  2. Optimal Monetary Policy with Heterogeneous Agents: Discretion, Commitment, and Timeless Policy By Eduardo Dávila; Andreas Schaab
  3. Heterogeneity and the Equitable Rate of Interest. By Riccardo Masolo
  4. Rethinking the Welfare State By Nezih Guner; Remzi Kaygusuz; Gustavo Ventura
  5. Means Testing and Social Security in the U.S. By Shantanu Bagchi
  6. Fat Tailed DSGE Models: A Survey and New Results By Dave, Chetan; Sorge, Marco
  7. Expectation Shocks and Business Cycles By Sonan Memon
  8. The optimal quantity of CBDC in a bank-based economy By Lorenzo Burlon; Carlos Montes-Galdón; Manuel A. Muñoz; Frank Smets
  9. The Fiscal and Welfare Effects of Policy Responses to the Covid-19 School Closures By Nicola Fuchs-Schundeln; Dirk Krueger; Andre Kurmann; Etienne Lale; Alexander Ludwig; Irina Popova
  10. Beware the Side Effects: Capital Controls, Trade, Misallocation and Welfare By Eugenia Andreasen; Sofía Bauducco; Evangelina Dardati; Enrique G. Mendoza
  11. Search and Multiple Jobholding By Etienne Lale
  12. On the determination of the real exchange rate in free markets: do consumer risk-pooling and uncovered interest parity differ and fit? By Minford, Patrick; Ou, Zhirong; Zhu, Zheyi
  13. Bounded Rational Expectation: How It Can Affect the Effectiveness of Monetary Rules in the Open Economy By Dong, Xue; Minford, Patrick; Meenagh, David; Yang, Xiaoliang
  14. Did the Fed Remain at the ZLB Long Enough? Lessons from the 2008-2019 Period By Joshua Brault; Hashmat Khan; Louis Phaneuf; Jean Gardy Victor
  15. Is there international risk-sharing between developed economies? New evidence from indirect inference By Minford, Patrick; Ou, Zhirong; Zhu, Zheyi
  16. Financial Development and Minimum Capital Requirements in Macroeconomic Analysis By Miho Sunaga
  17. Financing Innovation with Innovation By Zhiyuan Chen; Minjie Deng; Min Fang
  18. The Future of Global Economic Power By Zubarev Andrey; Nesterova Kristina; Kazakova Maria; Benzell Seth; Kotlikoff Laurence; LaGarda Guillermo; Yifan Ye Victor

  1. By: Adil Mahroug (University of Quebec in Montreal); Alain Paquet (University of Quebec in Montreal)
    Abstract: Embedding Schumpeterian innovation within a New Keynesian DSGE model matters for the likelihood of innovating when making endogenous decisions about investments in R&D and the path of the technological frontier. This feature brings new challenges at the modeling and simulation stages with implications for the interactions between Schumpeterian innovation and price rigidities, and between business cycle and growth. The interplay of innovation with optimal price setting in the intermediate sector spells out how the technological frontier advances, and how more innovation leads to more price flexibility despite the existence of nominal rigidities. With a reasonable calibration, key moments and comovements of macroeconomic variables are consistent with their observed counterparts. The Schumpeterian features of the model play a role on the cyclical impacts of various standard shocks and that of a knowledge-spillover shock. Moreover, different combinations of steady-state innovation probability and extent of knowledge spillovers, for the same steady-state growth rate of the economy, have important welfare implications in consumption equivalent terms.
    Keywords: Schumpeterian endogenous growth, Innovation, Business cycles, New Keynesian dynamic stochastic general equilibrium (DSGE) model, nominal price rigidity and flexibility.
    JEL: E32 E52 O31 O33 O42
    Date: 2021–11
  2. By: Eduardo Dávila; Andreas Schaab
    Abstract: This paper characterizes optimal monetary policy in a canonical heterogeneous-agent New Keynesian (HANK) model with wage rigidity. Under discretion, a utilitarian planner faces the incentive to redistribute towards indebted, high marginal utility households, which is a new source of inflationary bias. With commitment, i) zero inflation is the optimal long-run policy, ii) time-consistent policy requires both inflation and distributional penalties, and iii) the planner trades off aggregate stabilization against distributional considerations, so Divine Coincidence fails. We compute optimal stabilization policy in response to productivity, demand, and cost-push shocks using sequence-space methods, which we extend to Ramsey problems and welfare analysis.
    JEL: E52 E61
    Date: 2023–02
  3. By: Riccardo Masolo (Università Cattolica del Sacro Cuore; Dipartimento di Economia e Finanza, Università Cattolica del Sacro Cuore)
    Abstract: The equitable rate of interest represents a benchmark to evaluate the cross-sectional effects of monetary policy. I define it as the real rate of interest that minimizes the welfare losses associated to cross-sectional heterogeneity, under flexible prices. In a large class of models, it can be expressed as the payoff of a suitably chosen portfolio. In a Two-Agent New Keynesian model the deviations of the optimal policy prescription, relative to a Representative-Agent benchmark, can be traced back to the equitable rate gap: the difference between prevailing real rates and the equitable rate. This parallels the way in which the natural rate is the reference stick to evaluate the stance of monetary policy with regards to aggregate stabilization. Indeed, the difference between the natural rate and the equitable rate marks the tradeoff between aggregate and cross-sectional stabilization, faced by a welfare-maximizing policymaker.
    Keywords: Monetary Policy, Heterogeneous Agents, Optimal Policy.
    JEL: E31 E52
    Date: 2023–02
  4. By: Nezih Guner; Remzi Kaygusuz; Gustavo Ventura
    Abstract: The U.S. spends non trivially on non-medical transfers for its working-age population in a wide range of programs that support low and middle-income households. How valuable are these programs for U.S. households? Are there simpler, welfare-improving ways to transfer resources that are supported by a majority? What are the macroeconomic effects of such alternatives? We answer these questions in an equilibrium, life-cycle model with single and married households who face idiosyncratic productivity risk, in the presence of costly children and potential skill losses of females associated with non-participation. Our findings show that a potential revenue-neutral elimination of the welfare state generates large welfare losses in the aggregate, although most households support the move as losses are concentrated among a small group. We find that a Universal Basic Income program does not improve upon the current system. If instead per-person transfers are implemented alongside a proportional tax, a Negative Income Tax experiment, it becomes feasible to improve upon the current system. Providing per-person transfers to all households is costly, and reducing tax distortions helps providing for resources to expand redistribution.
    Keywords: taxes and transfers, universal basic income, household labor supply, income risk, Social Insurance
    JEL: E62 H24 H31
    Date: 2023–03
  5. By: Shantanu Bagchi (Department of Economics, Towson University)
    Abstract: This paper uses a heterogeneous-agent overlapping-generations model to examine the fiscal and distributional consequences of introducing a means test in U.S. Social Security. I find that a means test, i.e. conditioning benefit payments on a household’s earnings and/or assets, leads to a higher implicit tax on old-age resources, but has desirable distributional effects. A 75% cut in the benefits to households with earnings more than 200% of the median leads to a 2.3% reduction in the overall size of Social Security, but has almost no effect on the average benefit level. A fiscally comparable payroll tax cut, on the other hand, leads to an across-the-board decline of 2% decline in the benefits. Finally, an asset-based means test causes a decline of 1% in average benefits, but has a large negative effect on the accidental bequests left behind by deceased households.
    Keywords: Health risk, Social Security, benefit-earnings rule, consumption smoothing, general equilibrium.
    JEL: E21 E62 H55
    Date: 2023–03
  6. By: Dave, Chetan (University of Alberta, Department of Economics); Sorge, Marco (University of Salerno)
    Abstract: We review recent advances in dynamic stochastic general equilibrium theory concerned with the emergence of fat tailed time series distributions. Focusing on mechanisms that are firmly grounded in structural equilibrium models, we provide a common reference framework to organize existing contributions according to whether they entail extreme business cycle swings as an endogenous response to small and short-lived shocks ('thin in, fat out'), or rather as an automatic consequence of large and/or heteroskedastic exogenous impulses ('fat in, fat out'). Within the former class, non-Gaussian features of equilibrium patterns can endogenously emerge in fully rational, Gaussian environments. Using an empirically plausible real business cycle framework, we also report novel simulation-based evidence that helps reconcile theoretical predictions with the documented higher-order properties of time-series data for output measures.
    Keywords: non-Gaussian distributions; fat tails; DSGE models; minimum distance estimation
    JEL: E30 E40 E70
    Date: 2023–02–28
  7. By: Sonan Memon (Pakistan Institute of Development Economics)
    Abstract: I study a smorgasbord of different expectation shocks in two kinds of macroeconomic models. As a baseline, I use a simple aggregate demand and supply framework with adaptive expectations. I present impulse response results for exogenous, temporary expectation shocks lasting for one period only or four periods, expectation shock with output gap-centered Taylor rule as opposed to inflation targeting and permanent exogenous shocks (long-run shock) to expectations. Later, I extend my results using a New Keynesian model, allowing for a richer analysis. In this New Keynesian setting, I study the impact of anticipated and unanticipated preference shocks with backward- and forward-looking expectations. My results indicate the centrality of the expectation formation process in driving the shock reactions and propagation 1. Policymakers in Pakistan should design policies which manoeuvre market sentiments more effectively through press releases and frequent information sharing with the market to make business cycle fluctuations more docile.
    Keywords: AD and AS Model, Expectation Shocks in New Keynesian Models, Monetary Policy and Inflation Expectations, Permanent and Sequence of Temporary Expectation Shocks, Smorgasbord of Inflation Expectation Shocks, Temporary
    JEL: D84 E00 E12 E30 E32 E40 E50 E52 E70 E71
    Date: 2023
  8. By: Lorenzo Burlon; Carlos Montes-Galdón; Manuel A. Muñoz; Frank Smets (-)
    Abstract: We provide evidence on the estimated effects of news about the introduction of a digital euro on bank valuations and lending and find that the effects depend on the reliance on deposit funding and design features aimed at calibrating the quantity of the central bank digital currency (CBDC). Then, we develop a quantitative DSGE model that replicates such evidence and incorporates key selected mechanisms through which CBDC issuance could affect bank intermediation and the economy. Under empirically-relevant assumptions (i.e. imperfect substitutability across CBDC, cash and deposits and a number of financial constraints such as a collateral requirement for central bank funding), the issuance of CBDC yields non-trivial welfare trade-offs between, on one side, the positive expansion of liquidity services and the improved stabilization of deposit funding and lending and, on the other side, a negative bank disintermediation effect. Welfare-maximizing CBDC policy rules are effective in mitigating the risk of bank disintermediation and induce significant welfare gains. The optimal amount of CBDC in circulation for the case of the euro area lies between 15% and 45% of quarterly GDP in equilibrium.
    JEL: E42 E58 G21
    Date: 2023–02
  9. By: Nicola Fuchs-Schundeln (Goethe Universität Frankfurt and CEPR); Dirk Krueger (University of Pennsylvania, CEPR and NBER); Andre Kurmann (Drexel University); Etienne Lale (University of Quebec in Montreal); Alexander Ludwig (Goethe Universität Frankfurt, ICIR and CEPR); Irina Popova (Goethe Universität Frankfurt)
    Abstract: Using a structural life-cycle model and data on school visits from Safegraph and school closures from Burbio, we quantify the heterogeneous impact of school closures during the Corona crisis on children affected at different ages and coming from households with different parental characteristics. Our data suggests that secondary schools were closed for in-person learning for longer periods than elementary schools (implying that younger children experienced less school closures than older children), and that private schools experienced shorter closures than public schools, and schools in poorer U.S. counties experienced shorter school closures. We then extend the structural life cycle model of private and public schooling investments studied in Fuchs-Schündeln, Krueger, Ludwig, and Popova (2021) to include the choice of parents whether to send their children to private schools, empirically discipline it with data on parental investments from the PSID, and then feed into the model the school closure measures from our empirical analysis to quantify the long run consequences of the Covid-19 school closures on the cohorts of children currently in school. Future earnings- and welfare losses are largest for children that started public secondary schools at the onset of the Covid-19 crisis. Comparing children from the topto children from the bottom quartile of the income distribution, welfare losses are ca. 0.8 percentage points larger for the poorer children if school closures were unrelated to income. Accounting for the longer school closures in richer counties reduces this gap by about 1/3. A policy intervention that extends schools by 3 months (6 weeks in the next two summers) generates significant welfare gains for the children and raises future tax revenues approximately sufficient to pay for the cost of this schooling expansion.
    Keywords: Covid-19, school closures, inequality, intergenerational persistence.
    JEL: D15 D31 E24 I24
    Date: 2021–11
  10. By: Eugenia Andreasen; Sofía Bauducco; Evangelina Dardati; Enrique G. Mendoza
    Abstract: We show that capital controls have large adverse effects on misallocation, exports and welfare using a dynamic Melitz-OLG model with heterogeneous firms, monopolistic competition, endogenous trade participation and collateral constraints. Static effects increase misallocation by reducing capital-labor ratios and rising firm prices, dynamic effects reduce it by incentivizing saving and delaying entry into export markets, and general equilibrium effects are ambiguous. Firms at the collateral constraint or at their optimal scale are barely affected but those in between are severely affected. Calibrated to the 1990s Chilean encaje, the model yields higher aggregate misallocation with larger effects on exporters and high-productivity firms. Social welfare falls and welfare of exporters falls significantly more. LTV regulation cuts credit by the same amount at sharply lower costs, because it spreads the burden of the cut more evenly. A panel data analysis of Chilean manufacturing firms yields strong evidence supporting the model's predictions.
    JEL: F12 F38 F41 O47
    Date: 2023–02
  11. By: Etienne Lale (University of Quebec in Montreal, CIRANO and IZA)
    Abstract: This paper develops an equilibrium model of the labor market with hours worked, off-and on-the-job search, and single as well as multiple jobholders. The model quantitatively accounts for the incidence of and worker flows in and out of multiple jobholding. Central to the model’s mechanism is that holding a second job ties the worker to her primary employer, at the benefits of having a stronger outside option to bargain with the outside employer. The model is also informative of how multiple jobholding shapes the outcomes that are typically the focus of search models. Multiple jobholding has opposing effects on job-to-job transitions that mostly offset each other. At the same time, since the option of having second jobs makes the main job survive longer, it reduces job separations and increases the employment rate. These findings have material implications for the calibration of standard models which ignore multiple jobholding.
    Keywords: Multiple jobholding, Employment, Hours worked, Job search
    JEL: E24 J21 J62
    Date: 2022–11
  12. By: Minford, Patrick (Cardiff Business School); Ou, Zhirong (Cardiff Business School); Zhu, Zheyi (Cardiff Business School)
    Abstract: We revisit the ‘puzzle’ in open economy studies that evidence of international risk-sharing is hardly seen despite the completeness of the financial market. We reassess both risk-pooling via state-contingent bonds, and uncovered interest parity – both were believed to be different, and spuriously rejected, in previous work – in the context of a full DSGE model. We prove that the two models are identical, both analytically and numerically. When tested as part of the full DSGE model by indirect inference which circumvents the bias of single-equation tests, we find strong and wide evidence of international risk-sharing.
    Keywords: consumer risk-pooling; UIP; two-country DSGE model; indirect inference test
    JEL: C12 E12 F41
    Date: 2023–02
  13. By: Dong, Xue (Zhejiang University of Finance and Economics, China); Minford, Patrick (Cardiff Business School); Meenagh, David (Cardiff Business School); Yang, Xiaoliang (Cardiff Business School)
    Abstract: Since the channel for agents’ expectations matters for the effectiveness of monetary policies, it is crucial for policy-makers to assess the degree to which economic agents are boundedly rational and understand how the bounded rationality affects the monetary rules in stabilising the economy. We investigate the empirical evidence for the bounded rationality in a small open economy model of the UK, and compare the results with those for the conventional rational expectations model. Overall, comparing the estimated models favours the bounded rationality framework. The results show that bounded rationality model helps to explain the hump-shaped dynamics of real exchange rate following monetary shocks, while the rational expectations model cannot. Also, we find that the exchange rate channel in the bounded rationality enlarges the effects of foreign mark-up shock, policymakers should send stronger signals over its target to the economics agents to combat the inflation. So the bounded rationality that can be found in the data still leaves scope for the forward guidance channel to work strongly enough to be exploited by policymakers.
    Keywords: bounded rationality, monetary policy, small open economy, exchange rate channel
    JEL: E52 E70 F41 C51 F31
    Date: 2023–02
  14. By: Joshua Brault (Carleton University); Hashmat Khan (Carleton University); Louis Phaneuf (University of Quebec in Montreal); Jean Gardy Victor (Desjardins Group)
    Abstract: We present evidence suggesting the Fed can learn useful lessons by looking at the effectiveness of its policy over the 2008-2019 time period. Using a medium-scale New Keynesian model estimated with Bayesian techniques, we find that by raising the nominal interest rate above the ZLB from 2015:4 to 2019:4 and gradually limiting recourse to quantitative easing, the Fed undid most of the stimulus it gave the economy during the 2008-2014 time segment. We estimate that during the two years prior to lift-off, the per quarter average deviation of inflation from target was negative so that potential fears of rising inflation were unwarranted. Investment growth was most adversely affected by the Fed’s policy during the 2015-2019 time segment. Total hours worked had not yet returned to their pre-recession level of 2008 by the end of 2019. We conclude that faced with exceptional events such as the Great Recession and the pandemic, the monetary and fiscal authorities in the future could combine their efforts to provide stimulus over a longer period of time than they did after the Great Recession.
    Keywords: Unconventional Monetary Policy, Great Recession, Recovery Years, New Keynesian Model, Shadow Rate, Bayesian Estimation.
    JEL: E31 E32 E37
    Date: 2021–11
  15. By: Minford, Patrick (Cardiff Business School); Ou, Zhirong (Cardiff Business School); Zhu, Zheyi (Cardiff Business School)
    Abstract: It has been an `empirical consensus' that data from developed economies generally do not support the hypothesis of international risk-sharing, either in the form of full risk-pooling via state-contingent assets or in the form of uncovered interest parity enforced by trading non-contingent assets. We reassess these hypotheses in the context of a full DSGE model, as opposed to testing them as single regressions in previous work. We prove that the two model versions behave identically, suggesting that consumers would receive the same scope of protection against risks whether bonds are state-contingent. We further find that the model, when tested appropriately as a whole embracing risk-pooling/UIP, fits the data well and universally through the lens of indirect inference; hence, we provide new evidence of the hypotheses' empirical validity spuriously rejected by single regressions.
    Keywords: consumer risk-pooling; UIP; two-country DSGE model; indirect inference test
    JEL: C12 E12 F41
    Date: 2023–02
  16. By: Miho Sunaga
    Abstract: We develop a macroeconomic model with a moral hazard problem between financial intermediaries and households, which causes inefficient resource allocation, to make us reconsider the financial regulation according to financial development, and individual and aggregate economic activities in the short and long runs. First, we show that in an economy where financial market has not developed, raising minimum capital requirements improves resource allocation and welfare in the long run, while it reduces welfare in an economy where financial market has developed. Second, our study reveals that an economy with a minimum capital adequacy ratio of 8% has a larger drop in aggregate net worth, consumption, and output when a negative capital quality shock occurs. However, during the financial crisis, the economy recovers faster than an economy with a higher minimum capital ratio (about 10%).These results indicate that tighter bank requirements temporally mitigate crises in economies with a developed financial market; however, they do not promote their activity in the long run.
    Date: 2023–02
  17. By: Zhiyuan Chen; Minjie Deng; Min Fang
    Abstract: This paper documents that firms are increasingly financing innovation using their stock of innovation, measured as patents. We refer to this behavior as financing innovation with innovation. Drawing on patent collateral data from both the US and China, we first show that (1) in both countries, the total number and share of patents pledged as collateral have been rising steadily, (2) Chinese firms employ patents as collateral on a smaller scale and with a lower intensity than US firms, (3) firms increase their borrowing and innovation after they start to use patent collateral. We then construct a heterogeneous firm general equilibrium model featuring idiosyncratic productivity risk, innovation capital investment, and borrow- ing constrained by patent collateral. The model emphasizes two barriers that hinder the use of patent collateral: high inspection costs and low liquidation values of patent assets. We parameterize the model to firm-level panel data in the US and China and find that both barriers are significantly more severe in China than in the US. Finally, counterfactual analyses show that the gains in innovation, output, and welfare from reducing the inspection costs in China to the US level are substantial, moreso than enhancing the liquidation value of patent assets.
    Keywords: Patent collateral; innovation investment; financial frictions; firm dynamics;
    JEL: E22 G32 O31 O33
    Date: 2023–03–02
  18. By: Zubarev Andrey (RANEPA); Nesterova Kristina (RANEPA); Kazakova Maria (Gaidar Institute for Economic Policy); Benzell Seth (Gaidar Institute for Economic Policy); Kotlikoff Laurence (Gaidar Institute for Economic Policy); LaGarda Guillermo (Gaidar Institute for Economic Policy); Yifan Ye Victor (Gaidar Institute for Economic Policy)
    Abstract: The global economy’s enormous region-specific demographic, technological, and fiscal changes raise five major questions. First, which regions will come to dominate the world economy? Second, will regional levels of per capita GDP converge? Third, will high saving rates in fast growing regions lead to a global capital glut? Fourth, does aging augur far higher tax rates in particular regions? Fifth, will automation materially influence development? This paper develops the Global Gaidar Model, a 17-region, 2-skills, 100-period, OLG model, to address these questions. The model is carefully calibrated to 2017 UN demographic and IMF fiscal data. Productivity growth and its interaction with demographic change are the main drivers of future economic power. Fiscal conditions and automation matter are secondary factors. Our baseline simulation, which sets future productivity based on each region’s long-term record, predicts China and India becoming the world’s top two economies with 27.0 percent and 16.2 percent of 2100 world GDP, respectively. The respective US and Western Europe shares are just 12.3 percent and 11.9 percent. Our baseline also features an evolving global savings glut, major reductions in the world interest rate, substantial aging-related increases in tax rates, and permanent differences in regional living standards. Automation makes little difference to these results. But assumed productivity growth does. If recent productivity continues and demographic projections prove accurate, India will account for one third of world output in 2100 and China for over one fifth. The US output share will grow slightly while other developed countries shrink dramatically. Under more sophisticated, if seemingly less plausible projections, productivity growth in China and India dramatically slows leaving China’s plus India’s 2100 output share at only 16 percent, but, remarkably, Africa’s at an astounding 17 percent.
    Keywords: Global economy, Global Gaidar Model, OLG model, GDP
    JEL: E0 J0 O1
    Date: 2022

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