nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2023‒07‒17
23 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Inequality and the Zero Lower Bound By Jesús Fernández-Villaverde; Joël Marbet; Galo Nuño; Omar Rachedi
  2. Corporate taxes, productivity, and business dynamism By Andrea Colciago; Vivien Lewis; Branka Matyska
  3. Pareto Improving Fiscal and Monetary Policies: Samuelson in the New Keynesian Model By Mark A. Aguiar; Manuel Amador; Cristina Arellano
  4. Public Education and Intergenerational Housing Wealth Effects By Michael Gilraine; James Graham; Angela Zheng
  5. Intergeneration Human Capital Transmission and Poverty Traps By Carmen Camacho; Fernanda Estevan
  6. Ricardian Business Cycles By Lorenzo Bretscher; Jesús Fernández-Villaverde; Simon Scheidegger
  7. Comparing different features of a fiscal stimulus in the euro area By Caroline Bozou; Jérôme Creel
  8. A Simple Model of a Central Bank Digital Currency By Mishra, Bineet; Prasad, Eswar
  9. Residential Land Use and Utilities of Multiple Generations with Lifespan Perspectives and Demographic Dynamics By Kono, Tatsuhito; Tsutaki, Keisuke
  10. Do this or do that? A model to prioritize reforms By Carmen Camacho; Hannes Tepper
  11. Unequal Transition: The Widening Wealth Gap amidst China’s Rapid Growth By Yangtian Jiang; Yu Zheng; Lijun Zhu
  12. Child-rearing, Social Security and Married Women’s Labor Supply over the Life Cycle By Das, Debasmita
  13. On the Instability of Fractional Reserve Banking By Heon Lee
  14. The Empirical Distribution of Firm Dynamics and Its Macro Implications By Nir Jaimovich; Stephen J. Terry; Nicolas Vincent
  15. House Prices and the Distribution of Wealth Around the Great Recession By Cóndor Richard; Oviedo Moguel Rodolfo
  16. Global models for a global pandemic: the impact of COVID-19 on small euro area economies By Pablo Garcia; Pascal Jacquinot; ÄŒrt LenarÄ iÄ; Matija Lozej; Kostas Mavromatis
  17. At Home versus in a Nursing Home: Long-term Care Settings and Marginal Utility By De Donder, Philippe; Achou, Bertrand; Glenzer, Franca; Lee, Minjoon; Leroux, Marie-Louise
  18. Quantifying the Impact of Red Tape on Investment: A Survey Data Approach By Bruno Pellegrino; Geoffery Zheng
  19. Stimulus through Insurance: The Marginal Propensity to Repay Debt By Koşar, Gizem; Melcangi, Davide; Pilossoph, Laura; Wiczer, David
  20. Estimation of a Macroeconomic Model for the Israeli Economy By Yaakov Chen Zion
  21. Shadow Economy in Sri Lanka: A Review and New Estimates By K K C Sineth Kannangara; Yanrui Wu
  22. Analysis of the Amplification Mechanisms in the Process of Debt Deleveraging By Nimrod Cohen
  23. Dynamic Programming on a Quantum Annealer: Solving the RBC Model By Jesús Fernández-Villaverde; Isaiah J. Hull

  1. By: Jesús Fernández-Villaverde; Joël Marbet; Galo Nuño; Omar Rachedi
    Abstract: This paper studies how household inequality shapes the effects of the zero lower bound (ZLB) on nominal interest rates on aggregate dynamics. To do so, we consider a heterogeneous agent New Keynesian (HANK) model with an occasionally binding ZLB and solve for its fully nonlinear stochastic equilibrium using a novel neural network algorithm. In this setting, changes in the monetary policy stance influence households’ precautionary savings by altering the frequency of ZLB events. As a result, the model features monetary policy non-neutrality in the long run. The degree of long-run non-neutrality, i.e., by how much monetary policy shifts real rates in the ergodic distribution of the model, can be substantial when we combine low inflation targets and high levels of wealth inequality.
    Keywords: heterogeneous agents, HANK models, neural networks, non-linear dynamics
    JEL: D31 E12 E21 E31 E43 E52 E58
    Date: 2023
  2. By: Andrea Colciago; Vivien Lewis; Branka Matyska
    Abstract: We identify the effects of corporate income tax shocks on key US macroeconomic aggregates. In response to a corporate income tax cut, we find that: (i) labor productivity increases; (ii) entry increases with delay; (iii) exit increases; (iv) total labor increases by more than production labor. To rationalize these empirical findings, we build a New Keynesian model with idiosyncratic firm productivity, and entry and exit. Our model features productivity gains due to selection and cleansing along the entry and exit margins. Models with homogeneous firms fail to account for the selection and cleansing process and produce counterfactual results.
    Keywords: corporate taxation; productivity; firm entry and exit
    JEL: E62 E32 H25
    Date: 2023–06
  3. By: Mark A. Aguiar; Manuel Amador; Cristina Arellano
    Abstract: This paper explores the positive and normative consequences of government bond issuances in a New Keynesian model with heterogeneous agents, focusing on how the stock of government bonds affects the cross-sectional allocation of resources in the spirit of Samuelson (1958). We characterize the Pareto optimal levels of government bonds and the associated monetary policy adjustments that should accompany Pareto-improving bond issuances. The paper introduces a simple phase diagram to analyze the global equilibrium dynamics of inflation, interest rates, and labor earnings in response to changes in the stock of government debt. The framework also provides a tractable tool to explore the use of fiscal policy to escape the Effective Lower Bound (ELB) on nominal interest rates and the resolution of the “forward guidance puzzle.” A common theme throughout is that following the monetary policy guidance from the standard Ricardian framework leads to excess fluctuations in income and inflation.
    JEL: E4 E60
    Date: 2023–06
  4. By: Michael Gilraine; James Graham; Angela Zheng
    Abstract: While rising house prices benefit existing homeowners, we document a new channel through which price shocks have intergenerational wealth effects. Using panel data from school zones within a large U.S. school district, we find that higher local house prices lead to improvements in local school quality, thereby increasing child human capital and future incomes. We quantify this housing wealth channel using an overlapping generations model with neighborhood choice, spatial equilibrium, and endogenous school quality. Housing market shocks in the model generate large intra- and intergenerational wealth effects, with the latter accounting for over half of total wealth effects.
    JEL: E21 E24 I24 J62 R21 R23
    Date: 2023–06
  5. By: Carmen Camacho (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); Fernanda Estevan (EESP - Sao Paulo School of Economics - FGV - Fundacao Getulio Vargas [Rio de Janeiro])
    Abstract: We use an overlapping generations model to investigate the role of parental health investment and children's schooling on the aggregate level of human capital and inequality. In our model, parental longevity affects children's human capital since it impacts human capital transmission. When poor parents cannot afford to invest in health, poverty traps may arise as human capital levels remain low in the long run. Both health costs and public school quality are crucial in determining whether households fall into the poverty trap. We demonstrate that high-quality schools ensure that successive generations become more educated, eventually attaining a higher human capital steady state. However, public health investments are particularly effective, as they affect household income and schooling and allow for human capital transmission through generations. We calibrate our model for Brazil and Chile and show that our model predicts that a poverty trap will arise in Brazil but not in Chile.
    Keywords: Poverty trap, Human capital, School quality, Intergenerational transmission, Longevity
    Date: 2023–04
  6. By: Lorenzo Bretscher (University of Lausanne; Swiss Finance Institute, and CEPR); Jesús Fernández-Villaverde (University of Pennsylvania; National Bureau of Economic Research (NBER)); Simon Scheidegger (University of Lausanne)
    Abstract: This paper presents a dynamic stochastic general equilibrium model of Ricardian business cycles. Our model is Ricardian because countries (or, equivalently, regions) trade to take advantage of their comparative advantages. Their relative efficiencies, however, change over time stochastically. Similarly, country-specific shocks to demand, supply, and investment efficiency induce countries to engage in intra- and intertemporal substitutions in non-durable consumption, investment, services, and trade, generating business cycles. Finally, all agents have rational expectations about the stochastic components of the model. We solve the model globally using deep neural networks and calibrate it to the U.S., Europe, and China. Our quantitative results highlight the role of trading costs in shaping the responses of the economy to different shocks.
    Keywords: International Trade, Business Cycles, General Equilibrium, Comparative Advantage, Deep Learning
    JEL: C45 C63 F10 F40
    Date: 2023–01
  7. By: Caroline Bozou (UP1 - Université Paris 1 Panthéon-Sorbonne); Jérôme Creel (OFCE - Observatoire français des conjonctures économiques (Sciences Po) - Sciences Po - Sciences Po)
    Abstract: We build a two-country DSGE model where we distinguish the core from the periphery of a monetary union. First, we highlight the spillovers of fiscal shocks across countries. Then, we evaluate and compare the macroeconomic effects of the European recovery plan NGEU with national plans. In all settings, we distinguish public consumption shocks from public investment ones, and funding via loans or grants. We also generate a post-Covid situation where we add a zero-lower bound and demand shocks and compare the outcomes to the former scenarios. We find that the stimulus is more effective when it is financed by grants, interestingly enough especially for public consumption, that public investment spending has a higher multiplier effect in the long run and that a European fiscal stimulus has always more impact per country than a national stimulus plan. A side-result permits to assess the opportunity cost of accepting loans.
    Keywords: fiscal policy, open economy, euro area, spillovers, DSGE, NGEU, RRF
    Date: 2023–02–08
  8. By: Mishra, Bineet (Cornell University); Prasad, Eswar (Cornell University)
    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 in uence 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.
    Keywords: central bank digital currency, cash, medium of exchange, store of value, transaction efficiency
    JEL: E4 E5 E61
    Date: 2023–05
  9. By: Kono, Tatsuhito; Tsutaki, Keisuke
    Abstract: Demographic dynamics and spatial distribution of urban amenities bring about spatially different benefits to young, middle-aged, and elderly people, thereby affecting residential location patterns. Using an overlapping generations model in a closed city with two zones with different amenity levels, we demonstrate how young, middle-aged, and elderly generations with lifespan perspectives reside in the two zones with their interplay across periods and locations and analyze the residents’ welfare levels. We find that, unlike a static situation, there is no steady residential pattern in which middle-aged or elderly households live in both of the two zones when they optimize their residential locations throughout their life. Our numerical simulation reveals two findings useful for policy making: first, urban amenities should be unevenly distributed across the city from a perspective of lifetime utility; second, different demographic changes lead to different desirable residential patterns in terms of utility. Finally, we check the robustness of these findings for the case of the expansion of remote work.
    Keywords: Urban land use, Overlapping generations model, Urban amenities, Demographic dynamics
    JEL: H4 R0 R28
    Date: 2023–06
  10. By: Carmen Camacho (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); Hannes Tepper (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)
    Abstract: This paper aims to fill the methodological gap in development economics that until now there exists no quantitative tool that allows to prioritize reforms in a systematic nor optimal way. Following the recent debate on the issues Randomized Control Trials (RCTs) have with establishing external validity and general equilibrium effects, this paper proposes a micro-founded Growth Diagnostics framework to consider general equilibrium effects and prioritize policy prescriptions. Contrarily to Hausmann et al. (2005), we set up two continous-time Overlapping Generations (OLG) models to account for the different net-marginal valuations of various economic activities rigorously. We solve the household and planner problem to respectively obtain the private and social net-marginal valuations of economic activities via the corresponding Lagrange multipliers. With these in hand, we define the wedges in the net-marginal private and social valuations to set up a new planner problem (we call super policy maker problem), where the planner minimizes the sum of wedges. This final wrapping optimization problem allows to prioritize optimally economic reforms in a second-best framework, thus, to put it in the words of Rodrik (2010), to first diagnose before one prescribes the remedy.
    Keywords: Reform, Economic policy, Structural change, General equilibrium reform
    Date: 2023–02–27
  11. By: Yangtian Jiang (Institute of New Structural Economics, Peking University, Beijing, China.); Yu Zheng (School of Economics and Finance, Queen Mary University of Lon-don. Mile End Road, E1 4NS London, UK.); Lijun Zhu (Institute of New Structural Economics, Peking University, Beijing, China.)
    Abstract: We propose a quantitative theory of wealth creation and distribution during China’s transitional growth from the early 1990s, when barriers to setting up private businesses, trading housing, and migrating from rural to urban areas are struck down. In response to the changing economic environment, a small entrepreneurial class emerges and accumulates substantial wealth, whereas the majority working class, partly due to limited investment available from an underdeveloped financial sector, uses housing as the main vehicle of wealth accumulation over the course of a long-time housing boom. Our heterogeneous-agent dynamic equilibrium framework determines growth and equity jointly. We show a reasonably calibrated version of the model matches the rise in urban China’s wealth inequality since 1995 almost exactly. We further quantify the relative contribution of different reform measures to the rising inequality and discuss the welfare implications taking into account possible growth-equity trade-offs.
    Keywords: Wealth inequality, Capital accumulation, Entrepreneurship, Housing, Migration
    JEL: E21 O11 O16 O18
  12. By: Das, Debasmita
    Abstract: This paper studies how career interruptions during child-rearing years affect the labor market trajectory, lifetime earnings, and Social Security benefits of married women in the United States. To this end, I develop a dynamic structural life-cycle model of female labor supply, savings, and Social Security benefit claiming and estimate the model using the Method of Simulated Moments for the 1943-1954 birth cohort. Utilizing the estimated model, I evalu- ate the effects of revenue-neutral introduction of the Social Security Caregiver Credits that cover lost earnings during early child-rearing years through change in retirement benefits. The model predicts that introducing the provision of earning credits for child care in the Social Security system would lead to a sizeable reduction in gender gap in average career earnings at the Social Security Early Retirement Age. The findings suggest that instituting caregiver credits for child-rearing in the absence of the marriage-based Social Security ben- efits would offset a substantial portion of the motherhood penalty in lifetime labor earnings of married women and increase their retirement benefit adequacy.
    Keywords: Caregiver Credit, Female Labor Supply, Life-cycle Model, Social Security
    JEL: D14 E21 H55 I38 J13 J21 J26
    Date: 2022–08–04
  13. By: Heon Lee
    Abstract: This paper develops a dynamic monetary model to study the (in)stability of the fractional reserve banking system. The model shows that the fractional reserve banking system can endanger stability in that equilibrium is more prone to exhibit endogenous cyclic, chaotic, and stochastic dynamics under lower reserve requirements, although it can increase consumption in the steady-state. Introducing endogenous unsecured credit to the baseline model does not change the main results. This paper also provides empirical evidence that is consistent with the prediction of the model. The calibrated exercise suggests that this channel could be another source of economic fluctuations.
    Date: 2023–05
  14. By: Nir Jaimovich; Stephen J. Terry; Nicolas Vincent
    Abstract: Heterogeneous firm models are ubiquitous in modern macroeconomics. We revisit a central feature of these models: the idiosyncratic shock process faced by firms. Using a large representative firm-level dataset, we document nonparametrically that the common assumption, a Gaussian AR(1) shock process, is at odds in important ways with observed fat-tailed firm dynamics. We embed these findings within a standard quantitative general equilibrium heterogeneous firm dynamics model and show that the nature of firm-level shocks has a sizable quantitative effect on the economy’s responsiveness to aggregate shifts.
    JEL: E0
    Date: 2023–06
  15. By: Cóndor Richard; Oviedo Moguel Rodolfo
    Abstract: This paper employs a calibrated model of the US economy to analyze the boom and bust in house prices as well as the shifts in the distribution of wealth during the years around the Great Recession. We replicate the dynamics of the housing market using shocks to aggregate income, the distribution of income, credit conditions, and expectations of future housing demand driven by irrational exuberance. We find that irrational exuberance was the primary driver behind the dynamics of house prices and that the relaxation and subsequent tightening of credit conditions are crucial to explain the behavior of mortgage debt, default rates, and housing holdings by households at the bottom of the wealth distribution. The boom in house prices led to a temporary decrease in wealth concentration, which was subsequently reversed during the bust.
    Keywords: Credit Conditions;Expectations;Irrational Exuberance;Great Recession;House Prices
    JEL: E21 E32 G01 R31 D31 D84
    Date: 2023–06
  16. By: Pablo Garcia; Pascal Jacquinot; ÄŒrt LenarÄ iÄ; Matija Lozej; Kostas Mavromatis
    Abstract: We analyse the COVID-19 pandemic shock on small open economies (SOEs) in the euro area in a unified modelling framework: the Euro Area and the Global Economy model. We find strong negative international spillovers affecting each of the modelled SOEs, stemming not only from the rest of the euro area, but also from the United States and the rest of the world. A lower bound on nominal interest rates in the euro area amplifies these spillovers, especially within the euro area. Furthermore, we find some positive spillovers from the fiscal measures implemented in the Euro area to combat the pandemic, including the new Next Generation EU instrument.
    Keywords: DSGE Modelling, International Spillovers; Monetary Union; Euro Area; COVID-19
    JEL: C53 E32 E52 F45
    Date: 2023–06
  17. By: De Donder, Philippe; Achou, Bertrand; Glenzer, Franca; Lee, Minjoon; Leroux, Marie-Louise
    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 varies with the existing public long-term care subsidies
    Keywords: Long-term Care; Marginal Utility; Home Care; Nursing Home; Savings
    JEL: D14 E21 G51 I0
    Date: 2023–06–06
  18. By: Bruno Pellegrino; Geoffery Zheng
    Abstract: An important strand of research in macro-finance investigates which factors impede enterprise investment, and quantifies their aggregate cost. In this paper, we make two contributions to this literature. The first contribution is methodological: we introduce a novel framework to calibrate macroeconomic models with firm-level distortions using enterprise survey micro-data. The core of our innovation is to explicitly model the firms’ decisions to report the distortions they face in the survey. Our second contribution is to apply our method across seven countries to characterize the distribution of these distortions and estimate the GDP loss induced by distortionary red tape. Our estimates are based on a dynamic general equilibrium model with heterogeneous firms whose capital investment decisions are distorted by red tape. We find that the aggregate cost of red tape varies widely across the countries in our dataset, with an average cost of of 0.8% of annual GDP. Our framework opens up a new range of applications for enterprise surveys in macro-financial modeling and policy analysis.
    Keywords: bureaucracy, growth, investment, legislation, misallocation, red tape, regulations, survey
    JEL: C83 E20 E60 G38 H10 H20 K20 O10 O40
    Date: 2023
  19. By: Koşar, Gizem (Federal Reserve Bank of New York); Melcangi, Davide (Federal Reserve Bank of New York); Pilossoph, Laura (Duke University); Wiczer, David (Federal Reserve Bank of Atlanta)
    Abstract: Using detailed micro data, we document that households often use "stimulus" checks to pay down debt, especially those with low net wealth-to-income ratios. To rationalize these patterns, we introduce a borrowing price schedule into an otherwise standard incomplete markets model. Because interest rates rise with debt, borrowers have increasingly larger incentives to use an additional dollar to reduce debt service payments rather than consume. Using our calibrated model, we then study whether and how this marginal propensity to repay debt (MPRD) alters the aggregate implications of fiscal transfers. We uncover a trade-off between stimulus and insurance, as high–debt individuals gain considerably from transfers, but consume relatively little immediately. We show how this mechanism can lower short-run fiscal multipliers, but sustain aggregate consumption for longer.
    Keywords: marginal propensity to consume, consumption, debt, fiscal transfers
    JEL: E21 E62
    Date: 2023–06
  20. By: Yaakov Chen Zion (Bank of Israel)
    Abstract: This paper presents a formulation and an estimation of a small macroeconomic model for a small and open economy, as well as for the effect of the global economy on it. This DSGE type model allows for the overall assessment and analysis of the state of the economy throughout the business cycle, as well as of its long-term trends. The model is estimated by using a combination of Bayesian estimation together with calibration. The results of the estimation reveal that the last decade in the Israeli economy has been characterized by positive supply shocks, which are reflected in the combination of elevated activity, side by side with below-target inflation and an expansionary monetary policy. The appreciation in the real exchange rate, which has characterized the last 15 years, stems mainly, according to the model, from long-term structural processes. The development of the implied inflation target was analyzed - which reflects the way the central bank's inflation target is perceived by the public. As part of the analysis, it has been found that a significant part of the development of the inflation cannot be attributed to changes in the target over the course of the past five years. By using this model, we discuss the impact of a major shock over the interpretation of historical developments, and present a proposal for judgmental intervention (discretion), which is based on information which exist outside of the model, and allows for an historical analysis while avoiding the amplified influence of surprises. Such an analysis demonstrates that with the outbreak of the Covid-19 epidemic in the beginning of 2020, the natural rate of interest and the growth rate of the potential output decreased sharply.
    Date: 2021–12
  21. By: K K C Sineth Kannangara (Business School, The University of Western Australia and Central Bank of Sri Lanka); Yanrui Wu (Business School, The University of Western Australia)
    Abstract: Using a country-specific data set to reflect employment in the official sector, the dynamic general equilibrium modelling results in this paper demonstrate that Sri Lanka's shadow economy has not behaved in line with the general literature finding of a shrinking shadow economy over time. Since 2012, especially, Sri Lanka has been experiencing a rapid surge in its shadow economy, which now accounts for about half of its publicly reported GDP. Therefore, this paper emphasises the significance of paying due attention to the performance of the economy and how to minimise the further worsening of the ability of the economy to receive expected outcomes of the policies implemented.
    Date: 2023
  22. By: Nimrod Cohen (Bank of Israel)
    Abstract: This research examines a model of an economic-financial crisis caused by a sudden debt deleveraging in the economy. In this type of a crisis, demand is contracted, and the monetary interest rate may drop to its effective lower bound – a phenomenon called the "liquidity trap" – in such a way, that the monetary policy is restricted in its response (Eggertsson and Woodford, 2003). At the same time, there are other mechanisms that may intensify the crisis, such as the mechanism of the "financial accelerator" (Bernanke et al., 1999), and the mechanism of the "debt deflation" (Eggertsson and Krugman, 2012). Therefore, we are induced to question, what is the "contribution" of those various mechanisms to this crisis, and in particular - what is the interaction between those mechanisms. For this purpose, a general equilibrium model has been built in a Neo- Keynesian framework with two types of representative agents – a borrower and a saver – where the financial spread of the borrower depends on his or her level of leverage (the ratio of debt to the value of assets). The model is solved without linearization, emphasizing the monetary policy rule, which includes an effective lower bound on the interest rate. This is to enable an analysis of the interactions between the various mechanisms. From the analysis of the reaction of the economy to the debt deleveraging in the various situations, it was found that the interaction of the various mechanisms is extremely significant. For example, when the economy enters the "liquidity trap", the effect of the "financial accelerator" is intensifying the crisis to a great extent, much more than it occurs in a situation where the interest rate is not subject to the effective lower bound. In fact, the analysis illustrates the importance of an effective monetary policy in the course of a financial crisis, because monetary expansion is critical in this situation and prevents a crisis which is much more acute.
    Keywords: liquidity trap; the effective lower bound (ELB); financial friction; monetary policy; financial crisis; financial crisis; debt deleveraging; credit market; financial accelerator, debt deflation
    Date: 2022–09
  23. By: Jesús Fernández-Villaverde; Isaiah J. Hull
    Abstract: We introduce a novel approach to solving dynamic programming problems, such as those in many economic models, on a quantum annealer, a specialized device that performs combinatorial optimization. Quantum annealers attempt to solve an NP-hard problem by starting in a quantum superposition of all states and generating candidate global solutions in milliseconds, irrespective of problem size. Using existing quantum hardware, we achieve an order-of-magnitude speed-up in solving the real business cycle model over benchmarks in the literature. We also provide a detailed introduction to quantum annealing and discuss its potential use for more challenging economic problems.
    JEL: C63 C78 E37
    Date: 2023–06

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