nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2023‒04‒17
twelve papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Labor Market Institutions, Productivity, and the Business Cycle: An Application to Italy By Josué Diwambuena; Raquel Fonseca; Stefan Schubert
  2. Monetary policy strategies for the euro area: optimal rules in the presence of the ELB By Mazelis, Falk; Motto, Roberto; Ristiniemi, Annukka
  3. Firm Heterogeneity and the Transmission of Central Bank Credit Policy By Konrad Kuhmann
  4. Beware the Side Effects: Capital Controls, Trade, Misallocation andWelfare By Eugenia Andreasen; Sofia Bauducco; Evangelina Dardati; Enrique G. Mendoza
  5. A Theory of Rational Housing Bubbles with Phase Transitions By Tomohiro Hirano; Alexis Akira Toda
  6. Budget-Neutral Capital Tax Cuts By Frédéric Dufourt; Lisa Kerdelhué; Océane Piétri
  7. Policy Distortions and Aggregate Productivity with Endogenous Establishment-Level Productivity By Jose-Maria Da-Rocha; Diego Restuccia; Marina M. Tavares
  8. Money velocity, digital currency, and inflation dynamics By Danny Hermawan; Denny Lie; Aryo Sasongko; Richard I. Yusan
  9. On the Role of Product Quality in Product Reallocation and Macroeconomic Dynamics. By Ako Viou Bahun-Wilson
  10. A Two Country Model of Trade with International Borrowing and Lending By Kazumichi Iwasa; Kazuo Nishimura
  11. Natural Resources and Sovereign Risk in Emerging Economies: A Curse and a Blessing By Franz Hamann; Juan Camilo Mendez-Vizcaino; Enrique G. Mendoza; Paulina Restrepo-Echavarria
  12. Longevity, Health and Housing Risks Management in Retirement By Pierre-Carl Michaud; Pascal St. Amour

  1. By: Josué Diwambuena; Raquel Fonseca; Stefan Schubert
    Abstract: This paper studies the effect of labor market institutions on the cyclicality of labor productivity and aggregate fluctuations in Italy. It uses a New Keynesian model with labor market frictions and labor effort when two wage bargaining settings (efficient Nash and right-to-manage) interact with three types of hiring costs. We focus on three sets of labor market deregulation modeled as a fall in wage rigidity, hiring costs, and the bargaining power of workers. We show that, when labor effort varies, reforms trigger procyclical productivity under efficient bargaining, and countercyclical productivity under right-to-manage bargaining. Reforms also have different effects on cyclical moments. Second, we estimate the model with Bayesian techniques and find that productivity is mainly driven by technology shocks.
    Keywords: Labor market institutions, labor productivity, business cycles, hiring costs, effort.
    JEL: E24 E32 C51 C52
    Date: 2023
  2. By: Mazelis, Falk; Motto, Roberto; Ristiniemi, Annukka
    Abstract: We study alternative monetary policy strategies in the presence of the lower bound on nominal interest rates and a low equilibrium real rate using an estimated DSGE model for the euro area. We find that simple feedback rules that implement inflation targeting result in a binding lower bound one-fourth of the time as well as inflation and output exhibiting large downward biases and heightened volatility. Rule-based asset purchases that are activated once the policy rate reaches the lower bound are not able to fully offset the destabilizing effects of the lower bound if we assume plausible limits on the size of purchases. Makeup strategies, especially average inflation targeting with a long averaging window, perform better than inflation targeting. However, differences in performance across strategies become small if the response coefficients of the feedback rules are optimized. In addition, we find that the benefits of makeup strategies tend to vanish if agents exhibit a degree of inattention to central bank policies as estimated in the data. JEL Classification: E31, E32, E37, E52, E58, E61, E71
    Keywords: asset purchases, effective lower bound, forward guidance, makeup strategies, monetary policy, optimal policy
    Date: 2023–03
  3. By: Konrad Kuhmann
    Abstract: I study the role of firm heterogeneity for the transmission of unconventional monetary policy in the form of “credit policy†à la Gertler and Karadi (2011). To this end, I lay out a Two-Agent New-Keynesian model with financially constrained and unconstrained firms and a financial intermediary with an endogenous leverage constraint. I find that, when firms are heterogeneous, aggregate investment is substantially less responsive to credit policy compared to an identical firm setting. Moreover, when debt markets are segmented, credit policy directed exclusively at financially unconstrained firms is most effective. My paper provides a tractable framework to illustrate mechanisms through which firm heterogeneity affects the transmission of credit policy. According to my findings, the presence of firm heterogeneity can be expected to make credit policy less effective than predicted by a representative agent framework.
    Keywords: Credit Policy, Firm Heterogeneity, Investment, Financial Frictions
    JEL: E50 E52 E58
    Date: 2023–03–23
  4. By: Eugenia Andreasen (University of Chile); Sofia Bauducco (University of Chile); Evangelina Dardati (Universidad Diego Portales); Enrique G. Mendoza (University of Pennsylvania and NBER)
    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 firmprices, 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
    Keywords: Capital controls, welfare, misallocation, financial frictions, international trade
    JEL: F12 F38 F41 O47
    Date: 2023–02–07
  5. By: Tomohiro Hirano; Alexis Akira Toda
    Abstract: Empirically observed rent-price ratios suggest a disconnection between fundamentals and prices. We analyze equilibrium housing prices in an overlapping generations model with perfect housing and rental markets. We prove that the economy exhibits a two-stage phase transition: as the income of home buyers rises, the equilibrium regime changes from fundamental only to coexistence of fundamental and bubbly equilibria. With even higher incomes, fundamental equilibria disappear and housing bubbles become inevitable. Expectation-driven housing booms containing a bubble and their collapse can occur. Contrary to widely-held beliefs, fundamental equilibria in the coexistence region are inefficient despite housing being a productive non-reproducible asset.
    Date: 2023–03
  6. By: Frédéric Dufourt (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); Lisa Kerdelhué (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, Centre de recherche de la Banque de France - Banque de France); Océane Piétri (University of Konstanz)
    Abstract: We revisit the canonical policy of eliminating capital taxation by increasing labor taxation in a endogenous-labor, heterogeneous-agent model with income and wealth heterogeneity, when the government is subject to a strict (per-period) balanced-budget constraint. By contrast with its non-budget neutral equivalent-associated with a constant tax rate over time and a permanent increase in the level of public debt-we show that the obtained endogenous path for the labor tax rate is sharply increasing in the initial period and decreasing over time. The policy then generates a deeper recession in the short-run and a greater expansion in the long-run, as well as a smaller decline in wealth inequality associated with a reduced incentive to save for precautionary motives. Overall, the policy still generates significant losses in average welfare.
    Keywords: Fiscal Policy, Capital Tax Cut, Tax Composition, Heterogeneous Agents, Wealth Redistribution
    Date: 2022–06
  7. By: Jose-Maria Da-Rocha; Diego Restuccia; Marina M. Tavares
    Abstract: What accounts for income per capita and total factor productivity (TFP) differences across countries? We study resource misallocation across heterogeneous production units in a general equilibrium model where establishment productivity and size are affected by policy distortions. We solve the model in closed form and show that policy distortions have a substantial negative effect on establishment productivity growth, average establishment size, and aggregate productivity. Calibrating a distorted benchmark economy to U.S. data, we find that empirically reasonable variations in distortions generate reductions in aggregate TFP of more than 24 percent while slightly increasing concentration in the establishment size distribution. If distortions in addition lower the exit rate of incumbent establishments, as supported by some empirical evidence, the aggregate TFP loss doubles to 48 percent.
    Keywords: distortions, misallocation, investment, productivity, establishment size.
    JEL: O11 O3 O41 O43 O5 E0 E13 C02 C61
    Date: 2023–03–31
  8. By: Danny Hermawan; Denny Lie; Aryo Sasongko; Richard I. Yusan
    Abstract: This paper empirically investigates the impact of transaction cost-induced variations in the velocity of money on inflation dynamics, based on a structural New Keynesian Phillips curve (NKPC) with an explicit money velocity term. The money velocity effect arises from the role of money, both in physical and digital forms, in reducing the aggregate transaction costs and facilitating purchases of goods and services. We find a non-trivial aggregate impact in the context of the Indonesian economy: our benchmark estimates suggest that a 10% decrease in money velocity, which might be facilitated by a new digital currency (e.g. CBDC) issuance, would reduce the inflation rate by 0:6-1:7%, all else equal. Using the estimates and within a small-scale New Keynesian DSGE model, we analyze the potential implications of a CBDC issuance on aggregate fluctuations. A CBDC issuance that conservatively lowers the velocity of money by 5% is predicted to permanently raise the GDP level by 0:8% and lower the inflation rate by 0:8%. Both nominal and real interest rates are also permanently lower. Our findings imply that central banks could potentially use CBDCs as an additional stabilization policy tool by influencing the velocity.
    Keywords: inflation dynamics; transaction cost; velocity of money; digital money; digital currency; central bank digital currency (CBDC); aggregate fluctuations;
    Date: 2023–03
  9. By: Ako Viou Bahun-Wilson (Université de Sherbrooke)
    Abstract: Recent empirical investigations by Argente et al. (2018) reveal that product reallocation, i.e. creation and destruction of products, happens through two leading margins: entry and exit of production modules within firms, the so-called "extensions", and changes in the characteristics of products within incumbent production modules, the so-called "improvements". This paper develops a DSGE model in which product reallocation involves these two margins and examines the impact on macroeconomic dynamics. I show that relative to the standard model that only accounts for extensions, the model augmented with product improvements does a better job at explaining the dynamics of production modules within firms and the firm-level TFP. A recession facilitates the production of low-quality/low-cost products, which allows the survival of low-productivity modules that would not survive in a fixed quality environment. As the recessionary shock dissipates, the share of high-quality products increases, eliminating low-productivity and low-quality modules and increasing the firm-level TFP. My results illustrate the importance of recognizing the dynamics of product characteristics within firms’ production lines in addition to the dynamics of production lines per se to understand business cycles.
    Keywords: product creation and destruction, multi-line firm, quality switching, business cycles.
    JEL: D24 E23 E32 L15 L60
    Date: 2022–03
  10. By: Kazumichi Iwasa (Research Institute for Economics and Business Administration, Kobe University, JAPAN); Kazuo Nishimura (Research Institute for Economics and Business Administration and Center for Computational Social Science, Kobe University, JAPAN)
    Abstract: We investigate the properties of a two-country dynamic Heckscher-Ohlin model that allows international borrowing and lending. As is well known, international trade patterns become undecidable when international borrowing and lending is allowed. To avoid this, we assume a consumable capital good to be nontradable. A key feature of our model is the existence of a continuum of steady state levels of capital stocks, which enables us to examine how the initial amount of physical capital and assets in each country affects the amount of capital and assets in the steady state.
    Keywords: Two-country model; International borrowing and lending; Continuum of steady states
    JEL: E13 E21 F11
    Date: 2023–03
  11. By: Franz Hamann (Banco de la Republica); Juan Camilo Mendez-Vizcaino (Banco de la Republica); Enrique G. Mendoza (University of Pennsylvania and NBER); Paulina Restrepo-Echavarria (Federal Reserve Bank of St. Louis)
    Abstract: Emerging economies that are large oil producers have sizable external debt, their country risk rises when oil prices fall, and several of them have defaulted at least once since 1979. Moreover, while oil and non-oil output reduce country risk on impact and in the long-run, oil reserves reduce it marginally on impact but increase it in the long-run. We propose a model of sovereign default and oil extraction consistent with these observations. The sovereign manages oil reserves strategically to make default less painful by altering the value of autarky, and hence its sustainable debt falls. All else equal, default is less likely in states in which reserves or oil prices are higher, or non-oil GDP is lower, but the equilibrium dynamics of reserves and country risk in response to oil-price shocks switch from negatively correlated on impact to positively correlated for several years.
    Keywords: Country Risk, Oil Prices, Oil Reserves, Sovereign Debt.
    JEL: E44 F4 F34 G12 H63 L72
    Date: 2023–03–17
  12. By: Pierre-Carl Michaud; Pascal St. Amour
    Abstract: Annuities, long-term care insurance and reverse mortgages remain unpopular to manage longevity, medical and housing price risks after retirement. We analyze low demand using a life-cycle model structurally estimated with a unique stated-preference survey experiment of Canadian households. Low risk aversion, substitution between housing and consumption and low marginal utility when in poor health explain most of the reduced demand. Bequests motives are found to be a luxury good and play a limited role. The remaining disinterest is explained by information frictions and behavioural status-quo biases. We find evidence of strong spousal co-insurance motives motivating LTCI and of responsiveness to bundling with a near doubling of demand for annuities when reverse mortgages can be used to annuitize, instead of consuming home equity.
    JEL: G51 G53 I13 J14
    Date: 2023–03

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