nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2023‒06‒26
eighteen papers chosen by

  1. Solving linear DSGE models with Bernoulli iterations By Meyer-Gohde, Alexander
  3. A role for confidence: volition regimes and news By Saccal, Alessandro
  4. Macroeconomic Effects of Dividend Taxation with Investment Credit Limits By Matteo Ghilardi; Roy Zilberman
  5. The Heterogeneous Effects of Social Assistance and Unemployment Insurance: Evidence from a Life-Cycle Model of Family Labor Supply and Savings By Peter Haan; Victoria Prowse
  6. Should inequality factor into central banks’ decisions? By Niels-Jakob H. Hansen; Alessandro Lin; Rui C. Mano
  7. Employment and Reallocation Effects of Higher Minimum Wages By Moritz Drechsel-Grau
  8. A User Manual for the DIGNAD Toolkit By Mr. Zamid Aligishiev; Cian Ruane; Azar Sultanov
  9. Consumption categories, household attention, and inflation expectations: Implications for optimal monetary policy By Dietrich, Alexander M.
  10. Time Averaging Meets Labor Supplies of Heckman, Lochner, and Taber By Sebastian Graves; Victoria Gregory; Lars Ljungqvist; Thomas J. Sargent
  11. Debt crises, fast and slow Giancarlo By Giancarlo Corsetti
  12. Big news: Climate change and the business cycle By Dietrich, Alexander M.; Müller, Gernot J.; Schoenle, Raphael
  13. At Home versus in a Nursing Home: Long-term Care Settings and Marginal Utility By Bertrand Achou; Philippe De Donder; Franca Glenzer; Minjoon Lee; Marie-Louise Leroux
  14. Do Economic Crises in Europe Affect the U.S.? Some Lessons from the Past Three Decades By Ozge Akinci; Paolo Pesenti
  15. A Monetary Equilibrium with the Lender of Last Resort By Tarishi Matsuoka; Makoto Watanabe
  16. Targeted Reserve Requirements for Macroeconomic Stabilization By Zheng Liu; Mark M. Spiegel; Jingyi Zhang
  17. The Macroeconomic Stabilization of Tariff Shocks: What is the Optimal Monetary Response? By Giancarlo Corsetti; Paul Bergin
  18. Exchange Rate Misalignment and External Imbalances: What is the Optimal Monetary Policy Response? By Giancarlo Corsetti; Luca Dedola; Sylvain Leduc

  1. By: Meyer-Gohde, Alexander
    Abstract: This paper presents and compares Bernoulli iterative approaches for solving linear DSGE models. The methods are compared using nearly 100 different models from the Macroeconomic Model Data Base (MMB) and different parameterizations of the monetary policy rule in the medium-scale New Keynesian model of Smets and Wouters (2007) iteratively. I find that Bernoulli methods compare favorably in solving DSGE models to the QZ, providing similar accuracy as measured by the forward error of the solution at a comparable computation burden. The method can guarantee convergence to a particular, e.g., unique stable, solution and can be combined with other iterative methods, such as the Newton method, lending themselves especially to refining solutions.
    Keywords: Numerical accuracy, DSGE, Solution methods
    JEL: C61 C63 E17
    Date: 2023
  2. By: Solikin M. Juhro (Bank Indonesia); Denny Lie (University of Sydney); Atet Rizki Wijoseno (University of North Carolina); Mohammad Aly Fikry (Bank Indonesia)
    Abstract: This paper seeks to answer the following policy-relevant questions: (i) does the complementarity between monetary and macroprudential policies depend on the monetary and fiscal policy stances, and (ii) what is the likely aggregate effect of a central bank digital currency (CBDC) issuance on the existing central bank policy mix (CBPM) framework. We analyze these questions within a medium-scale Dynamic Stochastic General Equilibrium (DSGE) model for Indonesia with a non-trivial fiscal policy and a parsimonious CBDC effect. On the first question, we find that monetaryfiscal policy stances do matter for whether a macroprudential policy rule stabilizes business cycle fluctuations and is welfare-improving. It is still the case, however, a passive monetary, active fiscal regime (PMAF) is sub-optimal compared to the active monetary, passive fiscal (AMPF) regime counterpart. On the second question, we find that a CBDC issuance lowers the transaction costs and its effects on aggregate economic variables are similar to the effects of a permanent technological progress.
    Keywords: integrated policy framework, central bank policy mix, DSGE model for Indonesia, monetary-fiscal policy coordination, macroprudential-fiscal policy coordination, central bank digital currency (CBDC)
    JEL: E12 E32 E58 E61 E63 F41
    Date: 2022
  3. By: Saccal, Alessandro
    Abstract: Economic literature exhibits a variety of empirical structural impulse response function (SIRF) patterns in real consumption and real output due to changes in confidence or sentiment, with particular regard to the USA and the EA. This work replicates them in the orbit of a neo-Keynesian dynamic stochastic general equilibrium (NK-DSGE) model especially characterised by macroeconomic agents and derived from start to end. Confidence is specifically modelled as an endogenous variable characterised by a coalescence of three processes regulated by a degree of volition, the processes being permanent technology, transitory technology and noise technology. The first two processes affect real production technology with a delay of one lag, while the third does not at all. Short run responses to changes in confidence are displayed whenever the degree of volition allow confidence to shift real consumption and aggregate labour, thereby being non-negligible. Whenever the degree of volition were by contrast negligible exogenous shocks in noise technology would cause no fluctuations in real consumption and real output whatsoever.
    Keywords: aggregate labour; confidence; volition; permanent technology; transitory technology; noise technology; real economic activity; real consumption; real output.
    JEL: C22 C60 E12 E13 E32 E37
    Date: 2023–05–31
  4. By: Matteo Ghilardi; Roy Zilberman
    Abstract: A dynamic general equilibrium model augmented for an occasionally-binding investment borrowing limit reconciles competing views on the macroeconomic effects of dividend taxation. Permanent tax reforms are distortionary in the credit-constrained long-run equilibrium but are neutral otherwise. Temporary tax cuts may be expansionary or contractionary in the short-term depending on their scale and on the firm's initial and interim credit position. Interactions between payout tax shocks and the financial constraint tightness produce state-contingent, non-linear, and asymmetrical macroeconomic dynamics. These findings are consistent with the varied responses in investment rates and asset prices observed in the data following historical dividend tax changes.
    Keywords: Dividend Taxation, Occasionally-Binding Borrowing Constraints, Investment, Tobin's q, Business Activity
    JEL: E22 E32 E44 E62 H25 H30 H32
    Date: 2023
  5. By: Peter Haan; Victoria Prowse
    Abstract: We empirically analyze the heterogeneous welfare effects of unemployment insurance and social assistance. We estimate a structural life-cycle model of singles’ and married couples’ labor supply and savings decisions. The model includes heterogeneity by age, education, wealth, sex and household composition. In aggregate, social assistance dominates unemployment insurance; however, the opposite holds true for married men, whose leisure time declines more than that of their spouses when unemployment insurance is reduced. A revenue-neutral rebalancing of social support away from unemployment insurance and toward social assistance increases aggregate welfare. Income pooling in married households decreases the welfare value of social assistance.
    Keywords: Life-cycle labor supply, Family labor supply, Unemployment insurance, Social assistance, Household savings, Employment risk, Added worker effect, Intra-household insurance
    JEL: J18 J68 H21 I38
    Date: 2023–06–07
  6. By: Niels-Jakob H. Hansen (International Monetary Fund); Alessandro Lin (Bank of Italy); Rui C. Mano (International Monetary Fund)
    Abstract: Inequality is increasingly a policy concern. It is well known that fiscal and structural policies can mitigate inequality. However, less is known about the potential role of monetary policy. This paper investigates how inequality matters for the conduct of monetary policy within a tractable Two-Agent New Keynesian model. We find some support for making consumption inequality an explicit target for monetary policy, particularly if central banks follow standard Taylor rules. Given the importance of labor income at the lower end of the income distribution, we also consider augmented Taylor rules targeting the labor share. We find that such a rule is preferable to targeting consumption inequality directly. However, under optimal monetary policy the gains from targeting inequality are smaller.
    Keywords: inequality, optimal monetary policy, Taylor rules
    JEL: E21 E32 E52
    Date: 2023–04
  7. By: Moritz Drechsel-Grau
    Abstract: This paper studies the employment and reallocation effects of minimum wages in Germany in a search-and-matching model with endogenous job search effort and vacancy posting, multiple employment levels, a progressive tax-transfer system, and worker and firm heterogeneity. I find that minimum wages up to 70% of the median wage significantly increase productivity, hours worked and output without reducing employment. In frictional labor markets, however, reallocation takes time whenever the minimum wage cuts deep into the wage distribution. I show that gradually implementing a high minimum wage is necessary to avoid elevated unemployment rates during the transition.
    Keywords: minimum wage, reallocation, employment, job search, worker and firm heterogeneity, hours worked, equilibrium search-and-matching model, transition dynamics
    JEL: E24 E25 E64 J20 J31 J38
    Date: 2023
  8. By: Mr. Zamid Aligishiev; Cian Ruane; Azar Sultanov
    Abstract: This note is a user’s manual for the DIGNAD toolkit, an application aimed at facilitating the use of the DIGNAD model (Debt-Investment-Growth and Natural Disasters) by economists with no to little knowledge of MATLAB and Dynare via a user-friendly Excel-based interface. DIGNAD is a dynamic general equilibrium model of a small open economy developed at the International Monetary Fund. The model can help economists and policymakers with quantitative assessments and policy scenario analysis of the macrofiscal effects of natural disasters and adaptation infrastructure investments in low-income developing countries and emerging markets. DIGNAD is tailored to disaster-prone countries, which typically are small countries or low-income countries that are particularly exposed to large climate shocks—countries where shocks that can disrupt the entire economy are frequent. However, DIGNAD can be relevant also for larger countries that may potentially be exposed to extreme climatic disasters in the future.
    Keywords: natural disasters; adaptation; resilient infrastructure; public investment; public investment efficiency; debt sustainability
    Date: 2023–06–05
  9. By: Dietrich, Alexander M.
    Abstract: What inflation measure should central banks target? This paper shows optimal monetary policy targets headline inflation if households pay limited attention to different consumption categories when forming inflation expectations. This result stands in contrast to standard rational expectations models, where optimal policy targets core inflation. The core inflation rate excludes volatile energy and food prices (non-core) from headline inflation. Using novel survey data on inflation expectations for disaggregated consumption categories, I find household expectations are disproportionately driven by beliefs about future non-core prices. I develop a sparsity-based rational inattention model to account for the empirical evidence. While forming inflation expectations, households pay attention to the volatile non-core components; the stable core inflation component receives little attention. Finally, I embed this framework into a multi-sector New Keynesian model to derive the optimal inflation target. In the model, targeting headline inflation is optimal, whereas a core inflation target would fail to stabilize the economy sufficiently.
    Keywords: Households expectations, Survey, Monetary policy, Behavioral macroeconomics
    JEL: C83 E31 E52 E70
    Date: 2023
  10. By: Sebastian Graves; Victoria Gregory; Lars Ljungqvist; Thomas J. Sargent
    Abstract: We incorporate time-averaging into the canonical model of Heckman, Lochner, and Taber (1998) (HLT) to study retirement decisions, government policies, and their interaction with the aggregate labor supply elasticity. The HLT model forced all agents to retire at age 65, while our model allows them to choose career lengths. A benchmark social security system puts all of our workers at corner solutions of their career-length choice problems and lets our model reproduce HLT model outcomes. But alternative tax and social security arrangements dislodge some agents from those corners, bringing associated changes in equilibrium prices and human capital accumulation decisions. A reform that links social security benefits to age but not to employment status eliminates the implicit tax on working beyond 65. High taxes with revenues returned lump-sum keep agents off corner solutions, raising the aggregate labor supply elasticity and threatening to bring about a “dual labor market” in which many people decide not to supply labor.
    Keywords: time averaging; labor supply elasticity; retirement; taxation; Laffer curve; social security reform
    JEL: E24 E60 J22 J26
    Date: 2023–05–29
  11. By: Giancarlo Corsetti
    Abstract: We build a dynamic model where the economy is vulnerable to belief-driven slowmoving debt crisesat intermediate debt level, and rollover crises at both low and high debt levels. Vis-à-vis the threatof slow-moving crises, countercyclical deficits generally welfare-dominate debt reduction policies.In a recession, optimizing governments only deleverage if debt is close to the threshold below whichbelief-driven slow-moving crises can no longer occur. The welfare benefits from deleveraging insteaddominate if governments are concerned with losing market access even at low debt levels. Longbond maturities may fully eliminate belief-driven rollover crises but not slow-moving ones.
    Keywords: Sovereign default, Self-fulfilling crises, Expectations, Debt sustainability
    Date: 2023–02
  12. By: Dietrich, Alexander M.; Müller, Gernot J.; Schoenle, Raphael
    Abstract: News drive expectations about the economy's future fundamentals. Climate change is big news: it will impact the economy profoundly but the effect will take some time to materialize in full. Climate-change expectations thus offer a unique opportunity to study the impact of news on the business cycle. We measure these expectations in a representative survey of US consumers. Respondents expect not much of an impact on GDP growth, but perceive a high probability of costly, rare disasters-suggesting they are salient of climate change. Furthermore, expectations vary systematically with socioeconomic characteristics, media consumption, various information treatments and over time. We calibrate a New Keynesian model with rare disasters to key results of the survey and find that shifts in climate change expectations operate like demand shocks and cause sizeable business cycle fluctuations.
    Keywords: Climate change, Disasters, Expectations, Survey, Monetary policy, Business Cycle, Natural rate of interest
    JEL: E43 E52 E58
    Date: 2023
  13. By: Bertrand Achou; Philippe De Donder; Franca Glenzer; Minjoon Lee; Marie-Louise Leroux
    Abstract: Marginal utility of financial resources when needing long-term care, and the related incentives for precautionary savings and insurance, may vary significantly by whether one receives care at home or in a nursing home. In this paper, we develop strategic survey questions to estimate those differences. All else equal, we find that the marginal utility is significantly higher when receiving care at home rather than in a nursing home. We then use these estimates within a quantitative life cycle model to evaluate the impact of the expected choice of care setting (home versus nursing home) on precautionary savings and insurance valuation. The estimated marginal utility differences imply a significant increase in the incentives to save when expecting to receive care at home. Larger incentives to self-insure also translate to a higher valuation of additional subsidies for home care than for nursing homes, shedding light on an efficient way to expand public long-term care subsidies. We also examine how the magnitude of our results quantitatively vary with the existing public long-term care subsidies.
    Keywords: Long-term Care, Marginal Utility, Home Care, Nursing Home, Savings.
    JEL: D14 E21 G51 I10
    Date: 2023
  14. By: Ozge Akinci; Paolo Pesenti
    Abstract: In this post we summarize the main results of our contribution to a recent e-book, “The Making of the European Monetary Union: 30 years since the ERM crisis, ” on the economic and financial crises in Europe since 1992-93, and focus on the spillovers of those crises onto the United States and the global economy. We find that the answer to the question in the title of this post is a (moderate) yes.
    Keywords: Cross-County; spillovers; Dynamic Stochastic General Equilibrium (DSGE) models; euro area; sovereign debt crises
    JEL: F0 E2 E51 G01
    Date: 2023–05–31
  15. By: Tarishi Matsuoka; Makoto Watanabe
    Abstract: This paper studies the role of a lender of last resort (LLR) in a monetary model where a shortage of a bank’s monetary reserves (a liquidity crisis) occurs endogenously. We show that discount window lending by the LLR is welfare-improving but reduces banks’ ex-ante incentive to hold monetary reserves, which increases the probability of a liquidity crisis, and can cause moral hazard in capital investment. We also analyze the combined effects of monetary and extensive LLR policies, such as a nominal interest rate, a lending rate, and a haircut.
    Keywords: monetary equilibrium, liquidity crisis, lender of last resort, moral hazard
    JEL: E40
    Date: 2023
  16. By: Zheng Liu; Mark M. Spiegel; Jingyi Zhang
    Abstract: We study the effectiveness of targeted reserve requirements (RR) as a policy tool for macroeconomic stabilization. Targeted RR adjustments were implemented in China during both the 2008-09 global financial crisis and the recent COVID-19 pandemic. We develop a model in which firms with idiosyncratic productivity can borrow from two types of banks---local or national---to finance working capital. National banks provide liquidity services, while local banks have superior monitoring technologies, such that both types coexist. Relationship banking is modeled in terms of a fixed cost of switching lenders, and banks choose to switch only under sufficiently large shocks. Reducing RR on local banks boosts leverage and aggregate output, whereas reducing RR on national banks has an ambiguous output effect. Following a large recessionary shock, a targeted RR policy that reduces RR for local banks relative to national banks can lower costs of switching lenders, stabilizing macroeconomic fluctuations. However, targeting RR in that manner also boosts local bank leverage, increasing risks of default and related liquidation losses. Our model's mechanism is supported by bank-level empirical evidence.
    Keywords: reserve requirements; macroeconomic stabilization; bank sizes
    JEL: E32 E52 E21
    Date: 2023–05–08
  17. By: Giancarlo Corsetti; Paul Bergin
    Abstract: In the wake of Brexit and Trump trade war, central banks face the need to reconsider the role ofmonetary policy in managing the inflationary-recessionary effects of hikes in tariffs. Using a NewKeynesian model enriched with global value chains and firm dynamics, we show that the optimalmonetary response is expansionary. It supports activity and producer prices at the expense ofaggravating short-run headline inflation---contrary to the prescription of the standard Taylor rule. Thisholds all the more when the home currency is dominant in pricing of international trade.
    Keywords: Tariff shock, tariff war, optimal monetary policy, production chains
    Date: 2023–03
  18. By: Giancarlo Corsetti; Luca Dedola; Sylvain Leduc
    Abstract: How should monetary policy respond to excessive capital inflows that appreciate the currency, widen the external deficit and cause overheating? Using the workhorse open-macro model, we derive a quadratic approximation of the utility-based global loss function in incomplete market economies, and solve for the optimal targeting rules under cooperation. The optimal monetary stance is expansionary if the exchange rate pass-through (ERPT) on import prices is complete, contractionary if nominal rigidities reduce the ERPT. Excessive capital inflows, however, may lead to currency undervaluation instead of overvaluation for some parameter values. The optimal stance is then invariably expansionary to support domestic demand.
    Keywords: Currency misalignments, trade imbalances, asset markets and risk sharing, optimal targeting rules, international policy cooperation, exchange rate pass-through
    Date: 2022–11

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