nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2023‒05‒29
twenty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Robot tax and endogenous fertility in an Overlapping Generations Model By Minoru Watanabe
  2. Mortgage Borrowing Caps: Leverage, Default, and Welfare By Leonor Queiró; João G. Oliveira
  3. Are the Liquidity and Collateral Roles of Asset Bubbles Different? By Lise Clain‐chamosset‐yvrard; Xavier Raurich; Thomas Seegmuller
  4. Sectoral shocks, reallocation, and labor market policies By Joaquín García-Cabo; Joaquín Anna Lipińska; Gastón Navarro
  5. The forgotten lender: the role of multilateral lenders in sovereign debt and default By María Bru Muñoz
  6. Interest Rate Liberalization, Permanent Technology Shocks, and Macroeconomic Volatility in China By Qiaoyu Liang; Yihao Xue; Bing Tong
  7. Tax policies, informality, and real wage rigidities By Andres García-Suaza; Fernando Jaramillo; Marlon Salazar
  8. Public Employment Agency Reform, Matching Efficiency, and German Unemployment By Christian Merkl; Timo Sauerbier
  9. Richer earnings dynamics, consumption and portfolio choice over the life cycle By Julio Gálvez; Gonzalo Paz-Pardo
  10. It’s Baaack: The Surge in Inflation in the 2020s and the Return of the Non-Linear Phillips Curve By Pierpaolo Benigno; Gauti B. Eggertsson
  11. Trend Inflation and Exchange Rate Dynamics : A New Keynesian Approach By KANO, Takashi
  12. Does nominal wage stickiness affect fiscal multiplier in a two-agent new Keynesian model? By Ida, Daisuke; Okano, Mitsuhiro
  13. Demographic Transition, Industrial Policies, and Chinese Economic Growth By Michael Dotsey; Wenli Li; Fang Yang
  14. A Simple Model of a Central Bank Digital Currency By Bineet Mishra; Eswar S. Prasad
  15. Bank capitalization heterogeneity and monetary policy By Peter Paz
  16. Self-Fulfilling Debt Crises with Long Stagnations By Joao Ayres; Gaston Navarro; Juan Pablo Nicolini; Pedro Teles
  17. Inefficient Bank Recapitalization, Bailout and Post-Crisis Recoveries By Andrea Modena
  18. A Theory of Net Capital Flows over the Global Financial Cycle By J. Scott Davis; Eric Van Wincoop
  19. Heterogeneity in Macroeconomics and the Minimal Econometric Interpretation for Model Comparison By Marco Cozzi
  20. Search Theory of Imperfect Competition with Decreasing Returns to Scale By Guido Menzio
  21. Diamond-Dybvig and Beyond: On the Instability of Banking By Chao Gu; Cyril Monnet; Ed Nosal; Randall Wright

  1. By: Minoru Watanabe (Hokusei Gakuen University)
    Abstract: This brief study constructs a simple Overlapping Generations Model incorporating endogenous fertility and automation capital, which can be used as a replacement for labor inputs Further more, this study introduces a robot tax on automation capital.In the long run, robot tax promote s not only fertility but also per capita income.
    Keywords: Automation capital, Robot tax, Endogenous fertility, Income growth
    JEL: E10 H50 J11
    Date: 2023–04
  2. By: Leonor Queiró; João G. Oliveira
    Abstract: We explore the transmission channels of macroprudential policy in the form of caps on household mortgage borrowing. We employ an overlapping generations model with uninsurable labor income risk, housing, and long-term defaultable loans to measure the long-run economic impact of loan-to-value (LTV) and debt payment-to-income (PTI) caps on mortgage contracts in an economy without aggregate risk. We calibrate the model to Portugal, which implemented a 90 percent LTV cap and a 50 percent PTI cap. We find that the leverage cap can lower mortgage debt to output by one-third and eliminate the default rate. However, this comes at the cost of a 2 percent reduction in household welfare, chiefly among income and wealthpoor agents. PTI limits reduce default by limiting debt service but increase indebtedness and household leverage. This mechanism stems from the interaction between labor market risk and the payment-to-income cap: Households fear future adverse income shocks may constrain their access to credit markets and borrow earlier with lower down payments. Finally, we find that the policymaker can achieve similar cuts in default relative to the policy with a smaller welfare cost by setting a less stringent LTV cap or a more restrictive PTI cap.
    JEL: D60 E21 E44
    Date: 2023
  3. By: Lise Clain‐chamosset‐yvrard (GATE Lyon Saint-Étienne - Groupe d'Analyse et de Théorie Economique Lyon - Saint-Etienne - ENS Lyon - École normale supérieure - Lyon - UL2 - Université Lumière - Lyon 2 - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon - UJM - Université Jean Monnet - Saint-Étienne - CNRS - Centre National de la Recherche Scientifique); 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: Several papers explain why asset bubbles are observed when growth is large. These papers differ in the role of the bubble, used to provide liquidities or as collateral in a borrowing constraint. We compare the liquidity and collateral roles of bubbles in an overlapping generations model. When the bubble is deterministic, the equilibrium is identical under these two roles, implying that the same mechanism explains the crowding-in effect of the bubble on growth. With stochastic bubbles, growth is larger when bubbles play the liquidity role, because the burst of a bubble used for liquidity is less damaging to capital investors.
    Keywords: bubble, liquidity, collateral, crowding-in effect, growth
    Date: 2023–03–23
  4. By: Joaquín García-Cabo; Joaquín Anna Lipińska; Gastón Navarro
    Abstract: Unemployment insurance and wage subsidies are key tools to support labor markets in recessions. We develop a multi-sector search and matching model with on-the-job human capital accumulation to study labor market policy responses to sector-specific shocks. Our calibration accounts for structural differences in labor markets between the United States and the euro area, including a lower job-finding rate in the latter. We use the model to evaluate unemployment insurance and wage subsidy policies in recessions of different duration. After a temporary sector-specific shock, unemployment insurance improves reallocation toward productive sectors at the cost of initially higher unemployment and, thus, human capital destruction. By contrast, wage subsidies reduce unemployment and preserve human capital at the cost of limiting reallocation. In the United States, unemployment insurance is preferred to wage subsidies when it does not distort job creation for too long. In the euro area, wage subsidies are preferred, given the lower job-finding rate and reallocation.
    Keywords: labor market policies, search and matching frictions, reallocation
    JEL: E24 J64 J68
    Date: 2023–04
  5. By: María Bru Muñoz (Banco de España)
    Abstract: The role of multilateral lenders in sovereign default has been traditionally overlooked by the literature. However, these creditors represent a significant share of lending to emerging markets and feature very distinct characteristics, such as lower interest rates and seniority. By including these creditors in a traditional DSGE model of sovereign default, I reproduce the high debt levels found in the data while maintaining default probabilities within realistic values. Additionally, I am able to analyze the role of multilateral debt in emerging economies. Multilateral loans complement private financing and reduce the incompleteness of international financial markets. Also, multilateral funding acts as an insurance mechanism in bad times, providing countries with some degree of consumption smoothing, opposite to the role of front-loading consumption fulfilled by private financing.
    Keywords: sovereign debt and default, IFIs, multilateral institutions, seniority, consumption smoothing, emerging markets
    JEL: F34 F35 G15
    Date: 2023–01
  6. By: Qiaoyu Liang (School of Economics at Henan University, Kaifeng, Henan); Yihao Xue (School of Economics at Henan University, Kaifeng, Henan); Bing Tong (Center for Financial Development and Stability at Henan University, and School of Economics at Henan University, Kaifeng, Henan)
    Abstract: Are technology shocks contractionary or expansionary when interest rates are inflexible? This paper studies this issue based on Chinese data during the interest rate reform. We decompose the technology shock into permanent and transitory components and investigate their macroeconomic effects based on the New Keynesian model and the local projection method. Our empirical results show that interest rate fixation amplifies the effects of permanent technology shocks: a positive shock generates higher output and inflation during the period of fixed interest rates. This result is consistent with the New Keynesian model's prediction for permanent technology shocks. However, the empirical results for transitory technology shocks are insignificant.
    Keywords: Technology Shock, Interest rate liberalization, Total factor productivity (TFP), Macroeconomic Volatility
    JEL: E31 E42 E43 E52 E58
    Date: 2023–04
  7. By: Andres García-Suaza; Fernando Jaramillo; Marlon Salazar
    Abstract: Developing countries have a vast informal sector generally associated with low productivity levels. The response of informal employment to tax policies might depend on labor market rigidities. This paper proposes a theoretical framework consisting of a search and matching model with segmentation in the labor market to understand how tax policies and enforcement interact to determine the size of the formal sector. The analytical results show that decreasing payroll taxes increases formal employment demand, and enforcement expenditure decreases informal employment offers. The model suggests that a tax policy combination leads to a significant impact on informality reduction. Moreover, the magnitude of the effect of tax policies depends on real wage rigidities, i.e., when the economy faces high real wage rigidities, the tax policies have a higher effect on informality reduction
    Keywords: Informality, payroll taxes, fiscal policy, enforcement, search frictions, shirking, developing countries.
    JEL: E26 E62 J21 J46 J31 O17 K42
    Date: 2023–04–28
  8. By: Christian Merkl; Timo Sauerbier
    Abstract: Our paper analyzes the role of public employment agencies in job matching, in particular the effects of the restructuring of the Federal Employment Agency in Germany (Hartz III labor market reform) for aggregate matching and unemployment. Based on two microeconomic datasets, we show that the market share of the Federal Employment Agency as job intermediary declined after the Hartz reforms. We propose a macroeconomic model of the labor market with a private and a public search channel and fit the model to various dimensions of the data. We show that direct intermediation activities of the Federal Employment Agency did not contribute to the decline in unemployment in Germany. By contrast, improved activation of unemployed workers reduced unemployed by 0.8 percentage points. Through the lens of an aggregate matching function, more activation is associated with a larger matching efficiency.
    Keywords: Hartz reforms, search and matching, reform of employment agency
    JEL: E24 E00 E60
    Date: 2023
  9. By: Julio Gálvez (Banco de España); Gonzalo Paz-Pardo (European Central Bank)
    Abstract: Households face earnings risk which is non-normal and varies by age and over the income distribution. We show that, in the context of a structurally estimated life-cycle portfolio choice model, allowing for these rich features of earnings dynamics helps to better understand the limited participation of households in the stock market and their low holdings of risky assets. Because households are subject to more background risk than previously considered, the estimated model implies a substantially lower coefficient of risk aversion and a lower optimal risky asset share for older workers with low wealth and high earnings.
    Keywords: portfolio choice, life cycle, earnings dynamics, household ?nance, simulated method of moments
    JEL: G11 G12 D14 D91 J24
    Date: 2022–11
  10. By: Pierpaolo Benigno; Gauti B. Eggertsson
    Abstract: This paper proposes a non-linear New Keynesian Phillips curve (Inv-L NK Phillips Curve) to explain the surge of inflation in the 2020s. Economic slack is measured as firms' job vacancies over the number of unemployed workers. After showing empirical evidence of statistically significant nonlinearities, we propose a New Keynesian model with search and matching frictions, complemented by a form of wage rigidity, in the spirit of Phillips (1958), that generates strong nonlinearities. Policy implications include the thesis that appropriate monetary policy can bring inflation down without a significant recession and that the recent inflationary surge was mostly generated by a labor shortage -- i.e. an exceptionally tight labor market.
    JEL: E12 E3 E30 E40 E50 E60
    Date: 2023–04
  11. By: KANO, Takashi
    Abstract: This study examines the exchange rate implications of trend inflation within a two-country New Keynesian (NK) model. An NK Phillips curve generalized by trend inflation makes the inflation differential smoother, more persistent, and less sensitive to the real exchange rate. A Bayesian analysis with post-Bretton Woods data for Canada and the U.S. shows that the model’s equilibrium, which relies on Taylor rules with a persistent trend inflation shock and strong policy inertia, mimics empirical regularities in exchange rates that are difficult to reconcile within a standard NK model. Trend inflation helps explain the empirical puzzles of the exchange rate dynamics.
    Keywords: Real and Nominal Exchange Rates, Trend Inflation, New Keynesian Model, Bayesian analysis
    JEL: E31 E52 F31 F41
    Date: 2023–04
  12. By: Ida, Daisuke; Okano, Mitsuhiro
    Abstract: This study examines the effect of nominal wage stickiness on the fiscal multiplier in a two-agent new Keynesian model. We find that under fully flexible nominal wages, an increased share of liquidity-constrained (LC) consumers amplifies the fiscal multiplier in the cases of money-financed (MF) and debt-financed (DF) regimes. In the case of sticky nominal wages, an increase in the share of LC consumers drastically decreases the MF fiscal multiplier. We also demonstrate that even in the presence of nominal wage stickiness and LC consumers, the fiscal multiplier under an MF regime outperforms that under a DF regime. Furthermore, this paper shows that under the fiscal stimulus via a tax cut, an increased share of LC consumers magnifies the fiscal multiplier in the cases of MF and DF regimes. Finally, the degree of nominal price stickiness and the size of government spending are crucial in assessing the effect of fiscal stimulus on output.
    Keywords: Money-financed regime; Debt-financed regime; Nominal wage stickiness; Liquidity-constrained consumers; Two-agent new Keynesian model;
    JEL: E52 E58
    Date: 2023–05–08
  13. By: Michael Dotsey; Wenli Li; Fang Yang
    Abstract: We build a unified framework to quantitatively examine the demographic transition and industrial policies in contributing to China’s economic growth between 1976 and 2015. We find that the demographic transition and industrial policy changes by themselves account for a large fraction of the rise in household and corporate savings relative to total output and the rise in the country’s per capita output growth. Importantly, their interactions also lead to a sizable fraction of the increases in savings since the late 1980s and reduce growth after 2010. A novel and important factor that drives these dynamics is endogenous human capital accumulation, which depresses household savings between 1985 and 2010 but leads to substantial gains in per capita output growth after 2005.
    Keywords: Aging; Credit policy; Household saving; Output growth; China
    JEL: E21 J11 J13 L52
    Date: 2022–06–27
  14. By: Bineet Mishra; Eswar S. Prasad
    Abstract: We develop a general equilibrium model that highlights the trade-offs between physical and digital forms of retail central bank money. The key differences between cash and central bank digital currency (CBDC) include transaction efficiency, possibilities for tax evasion, and, potentially, nominal rates of return. We establish conditions under which cash and CBDC can co-exist and show how government policies can influence relative holdings of cash, CBDC, and other assets. We illustrate how a CBDC can facilitate negative nominal interest rates and helicopter drops, and also how a CBDC can be structured to prevent capital flight from other assets.
    JEL: E4 E5 E61
    Date: 2023–04
  15. By: Peter Paz (Banco de España)
    Abstract: This paper shows that heterogeneity in bank capitalization ratios plays a crucial role in the transmission of monetary policy to bank lending. First, I offer new empirical evidence on how banks’ lending responses to monetary policy shocks depend on their capitalization ratios. Highly capitalized banks reduce their lending more after a monetary tightening, even after controlling for bank liquidity, size and market power in the deposit market. I also document how highly capitalized banks have a riskier portfolio, as measured by loan charge-off rates, and default rates on their loans increase relatively more after a tightening in monetary policy. I then construct a dynamic macroeconomic model that rationalizes the empirical evidence through the interaction of the heterogeneous recovery technologies of banks facing a risk-weighted capital constraint. In particular, after an increase in the policy rate, the model predicts that loan rates and default probabilities increase in both sectors. Highly capitalized banks with a riskier portfolio are more sensitive because the risk-weighted capital constraint affects them more, so they contract lending more. In a counterfactual analysis, I find higher capital requirements amplify the effects of monetary policy.
    Keywords: monetary policy, banks, heterogeneity
    JEL: E43 E52 E58 E60 G21
    Date: 2022–10
  16. By: Joao Ayres; Gaston Navarro; Juan Pablo Nicolini; Pedro Teles
    Abstract: We assess the quantitative relevance of expectations-driven sovereign debt crises, focusing on the Southern European crisis of the early 2010’s and the Argentine default of 2001. The source of multiplicity is the one in Calvo (1988). Key for multiplicity is an output process featuring long periods of either high growth or stagnation that we estimate using data for those countries. We find that expectations-driven debt crises are quantitatively relevant but state dependent, as they only occur during stagnations. Expectations are a major driver explaining default rates and credit spread differences between Spain and Argentina.
    Keywords: Self-fulfilling debt crises; Sovereign default; Multiplicity; Stagnations
    JEL: E44 F34
    Date: 2023–02–14
  17. By: Andrea Modena
    Abstract: We study bailouts in a macroeconomic model where banks provide services that facilitate firms’ investments but limit their own leverage to prevent costly recapitalizations. This precautionary motive can generate financial crises, in which banks’ limited intermediation capacity discourages investments and dampens growth. Bank recapitalizations are constrained-inefficient because they do not internalize that, in the aggregate, higher equity buffers allow for more intermediation, favouring investments and accelerating recoveries. System-wide bailouts can mitigate this inefficiency and improve long-run welfare as long as their positive effect on banks’ equity value outweighs their negative impact on risk-taking incentives.
    Keywords: bailout, efficiency, financial crisis, general equilibrium, recovery, welfare
    JEL: D51 G21
    Date: 2023–04
  18. By: J. Scott Davis; Eric Van Wincoop
    Abstract: We develop a theory to account for changes in net capital flows of safe and risky assets over the global financial cycle. We show empirically that countries that have a net debt of safe assets experience a rise in net outflows of safe assets (reduced accumulation of safe debt) during a downturn in the global financial cycle. This is accomplished through a rise in total net outflows and a drop in net outflows of risky assets. We develop a multi-country portfolio choice model that can account for these facts. The theory relies on cross-country heterogeneity in the share of an investor's portfolio invested in risky assets. A global drop in risky asset prices changes relative wealth across countries due to this heterogeneity, which leads to changes in net flows of safe and risky assets. The model is applied to 20 advanced countries and calibrated to reflect observed cross-country heterogeneity of net foreign asset positions of safe and risky assets. The implications of the calibrated model for net capital flows are quantitatively consistent with the data.
    Keywords: global financial cycle; capital flows; current account; Portfolio Heterogeneity
    JEL: F30 F40
    Date: 2023–05–06
  19. By: Marco Cozzi (Department of Economics, University of Victoria)
    Abstract: I formally compare the fit of various versions of the incomplete markets model with aggregate uncertainty relying on the Minimal Econometric Interpretation, which is a computationally tractable Bayesian empirical framework. The models differ in the degree of household heterogeneity, with a focus on the role of preferences. For every specification, empirically motivated priors for the parameters are postulated to obtain the models' predictive distributions, which are interpreted as being distributions of population moments. These are in turn compared to the posterior distributions of the same moments obtained from an atheoretical Bayesian econometric model. I show that aggregate data on consumption and income contain valuable information to determine which models are more likely to have generated the data. The two models featuring risk aversion heterogeneity have the highest marginal likelihoods, showing that this element is quantitatively important also for the study of aggregate outcomes. I also extend the framework to include the fit of the wealth Gini index, but the ranking of the models is only marginally affected.
    Date: 2022–10–31
  20. By: Guido Menzio
    Abstract: I study a version of the search-theoretic model of imperfect competition by Burdett and Judd (1983) in which sellers face a strictly increasing rather than a constant marginal cost of production. The equilibrium exists and is unique, and its structure depends on the extent of search frictions. If search frictions are large enough, the price distribution is non-degenerate and atomless. If search frictions are neither too large nor too small, the price distribution is non-degenerate with an atom at the lowest price. If search frictions are small enough, the price distribution is degenerate. The equilibrium is efficient if and only if the price distribution is degenerate and, hence, if and only if search frictions are small enough. In contrast, in Burdett and Judd (1983), the equilibrium price distribution is always non-degenerate and atomless and the equilibrium is always efficient. As in Burdett and Judd (1983), the equilibrium goes from monopolistic to competitive as search frictions decline.
    JEL: D43 D83 J31
    Date: 2023–04
  21. By: Chao Gu; Cyril Monnet; Ed Nosal; Randall Wright
    Abstract: Are financial intermediaries—in particular, banks—inherently unstable or fragile, and if so, why? We address this question theoretically by analyzing whether model economies with financial intermediation are more prone than those without it to multiple, cyclic, or stochastic equilibria. We consider several formalizations: insurance-based banking, models with reputational considerations, those with fixed costs and delegated investment, and those where bank liabilities serve as payment instruments. Importantly for the issue at hand, in each case banking arrangements arise endogenously. While the economics and mathematics differ across specifications, they all predict that financial intermediation engenders instability in a precise sense.
    Keywords: banking; financial intermediation; instability; volatility
    JEL: D02 E02 E44 G21
    Date: 2023–02–13

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