nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2023‒09‒11
twelve papers chosen by
Christian Zimmermann, Federal Reserve Bank of St. Louis

  1. Unemployment Insurance when the Wealth Distribution Matters By Facundo Piguillem; Hernan Ruffo; Nicholas Trachter
  2. A HANK² Model of Monetary Unions By Christian Bayer; Alexander Kriwoluzky; Gernot J. Müller; Fabian Seyrich
  3. A Behavioral New Keynesian Model of a Small Open Economy Under Limited Foresight By Seunghoon Na; Yinxi Xie
  4. Firm heterogeneity, capital misallocation and optimal monetary policy By Beatriz González; Galo Nuño; Dominik Thaler; Silvia Albrizio
  5. On the Unimportance of Commitment for Monetary Policy By Juan Paez-Farrell
  6. State Reduction and Second-order Perturbations of Heterogeneous Agent Models By Reiter, Michael
  7. Climate Defaults and Financial Adaptation By Toan Phan; Felipe Schwartzman
  8. Trade Liberalization versus Protectionism: Dynamic Welfare Asymmetries By B. Ravikumar; Ana Maria Santacreu; Michael Sposi
  9. Occupational Reallocation Within and Across Firms: Implications for labor-market polarization By MUKOYAMA Toshihiko; TAKAYAMA Naoki; TANAKA Satoshi
  10. Coping with Climate Shocks: Food Security in a Spatial Framework By Diogo Baptista; John A Spray; Ms. Filiz D Unsal
  11. Accessing U.S. Dollar Swap Lines: Macroeconomic Implications for a Small Open Economy By Dominguez, Begona; Gomis-Porqueras, Pedro
  12. Sovereign Debt and Credit Default Swaps By Gaston Chaumont; Grey Gordon; Bruno Sultanum; Elliot Tobin

  1. By: Facundo Piguillem; Hernan Ruffo; Nicholas Trachter
    Abstract: This paper analyzes the welfare effects of unemployment insurance in a life-cycle model, focusing on partial vs. general equilibrium effects. We study an OLG economy with learning-by-doing human capital accumulation. Agents can be employed or unemployed. While unemployed agents costly search for new jobs. We calibrate the model to the U.S. economy, and find that replacement ratio and potential duration are close to the current one. But, in contrast with the previous literature, we find that the optimal policies under general and partial equilibrium are almost the same. Through a series of exercises we conclude that the life-cycle model provides two key components, crucial for welfare evaluation: it emphasizes workers' insurance needs by accurately reproducing the left tail of the wealth distribution, and generates a realistic response of precautionary savings to transfers.
    Keywords: wealth distribution; unemployment insurance
    Date: 2023–06
  2. By: Christian Bayer; Alexander Kriwoluzky; Gernot J. Müller; Fabian Seyrich
    Abstract: How does a monetary union alter the impact of business cycle shocks at the household level? We develop a Heterogeneous Agent New Keynesian model of two countries (HANK2) and show in closed form that a monetary union shifts the adjustment to a shock horizontally—across countries—within the brackets of the union-wide wealth distribution rather than vertically—that is, across the brackets of the union-wide wealth distribution. Calibrating the model to the euro area reveals that a monetary union alters the impact of shocks most strongly in the tails of the wealth distribution but leaves the middle class almost unaffected.
    Keywords: HANK2, OCA theory, Two-country model, monetary union, spillovers, monetary policy, heterogeneity, inequality, households
    JEL: F45 E52 D31
    Date: 2023–08
  3. By: Seunghoon Na; Yinxi Xie
    Abstract: This paper investigates exchange rate dynamics in open economies by incorporating bounded rationality. We develop a small open-economy New Keynesian model with an incomplete asset market, wherein decision-makers possess limited foresight and can plan for only a finite distance into the future. The equilibrium dynamics depend on the degree of foresight and the decision-makers’ belief-updating behaviors that approximate continuation values at the end of their planning horizons. This limited foresight leads to persistent, non-monotonic forecast errors in the real exchange rate across time horizons and distinguishes between short- and long-term expectations. This framework hence provides a micro-foundation for understanding time-horizon variability in uncovered interest parity puzzles.
    Keywords: Exchange rates; Monetary policy transmission; International topics; Business fluctuations and cycles
    JEL: E43 E70 F31 F41
    Date: 2023–08
  4. By: Beatriz González (Banco de España); Galo Nuño (Banco de España); Dominik Thaler (European central bank); Silvia Albrizio (International monetary fund)
    Abstract: We analyze monetary policy in a New Keynesian model with heterogeneous firms and financial frictions. Firms differ in their productivity and net worth and face collateral constraints that cause capital misallocation. TFP endogenously depends on the time-varying distribution of firms. Although a reduction in real rates increases misallocation in partial equilibrium, general-equilibrium effects overturn this result: a monetary expansion increases the investment of high-productivity firms relatively more than that of low-productivity ones, crowding out the latter and increasing TFP. We provide empirical evidence based on Spanish granular data supporting this mechanism. This has important implications for optimal monetary policy. We show how a central bank without pre-commitments engineers an unexpected monetary expansion to increase TFP in the medium run. In the event of a cost-push shock, the central bank leans with the wind to increase demand and reduce misallocation.
    Keywords: Monetary policy, firm heterogeneity, financial frictions, misallocation
    JEL: E12 E22 E43 E52 L11
    Date: 2021–12
  5. By: Juan Paez-Farrell (Department of Economics, University of Sheffield, Sheffield S1 4DT, UK)
    Abstract: In a New Keynesian model where the trade-off between stabilising the aggregate inflation rate and the output gap arises from sectoral asymmetries, the gains from commitment are either zero or negligible. Thus, to the extent that economic fluctu- ations are caused by sectoral shocks, policies designed to overcome the stabilisation bias are aiming to correct an unimportant problem.
    Keywords: optimal monetary policy, stabilization bias, discretion, commitment, inflation target
    JEL: E52 E58
    Date: 2023–08
  6. By: Reiter, Michael (Institut für Höhere Studien - Institute for Advanced Studies (IHS))
    Keywords: heterogeneous agents, model reduction, perturbation methods
    JEL: C63 C68 E21
    Date: 2023–08
  7. By: Toan Phan; Felipe Schwartzman
    Abstract: We analyze the relationship between climate-related disasters and sovereign debt crises using a model with capital accumulation, sovereign default, and disaster risk. We find that disaster risk and default risk together lead to slow post-disaster recovery and heightened borrowing costs. Calibrating the model to Mexico, we find that the increase in cyclone risk due to climate change leads to a welfare loss equivalent to a permanent 1% consumption drop. However, financial adaptation via catastrophe bonds and disaster insurance can reduce these losses by about 25%. Our study highlights the importance of financial frictions in analyzing climate change impacts.
    Keywords: climate change; disasters; sovereign default; emerging markets; growth
    JEL: Q54 F41 F44 H63 H87
    Date: 2023–03
  8. By: B. Ravikumar; Ana Maria Santacreu; Michael Sposi
    Abstract: We investigate whether the losses from an increase in trade costs (protectionism) are equal to the gains from a symmetric decrease in trade costs (liberalization). We incorporate dynamics through capital accumulation into a standard Armington trade model and show that the welfare changes are asymmetric: Losses from protectionism are smaller than the gains from liberalization. In contrast, standard static trade models imply that the losses equal the gains. The intuition for asymmetry in our model is that, following protectionism, the economy can coast off of previously accumulated capital stock, so higher trade costs do not imply large losses immediately. We develop an accounting device to decompose the source of welfare asymmetries into three time-varying contributions: share of income allocated to consumption, measured productivity, and capital stock. Asymmetry in capital accumulation is the largest contributing factor, and measured productivity is the smallest.
    Keywords: dynamic gains; asymmetry; capital; protectionism; liberalization
    JEL: F13 F11 E22
    Date: 2023–08–20
  9. By: MUKOYAMA Toshihiko; TAKAYAMA Naoki; TANAKA Satoshi
    Abstract: This study analyzes how labor-market frictions interact with firms' decisions to reallocate workers across different occupations during labor-market polarization. We compare the patterns of occupational reallocation within and across firms in the United States and Germany in recent years. We find that within-firm reallocation contributes significantly to the decline in employment in routine occupations in Germany, but much less in the United States. We construct a general equilibrium model of firm dynamics and find that the model with different firing taxes can replicate the difference in firm-level adjustment patterns across these countries. We conduct two counterfactual experiments, highlighting the different roles played by the within-firm cost of reorganizing occupational mix and across-firm frictions created by firing taxes.
    Date: 2023–07
  10. By: Diogo Baptista; John A Spray; Ms. Filiz D Unsal
    Abstract: We develop a quantitative spatial general equilibrium model with heterogeneous house-holds and multiple locations to study households’ vulnerability to food insecurity from cli-mate shocks. In the model, households endogenously respond to negative climate shocks by drawing-down assets, importing food and temporarily migrating to earn additional income to ensure sufficient calories. Because these coping strategies are most effective when trade and migration costs are low, remote households are more vulnerable to climate shocks. Food insecure households are also more vulnerable, as their proximity to a subsistence requirement causes them to hold a smaller capital buffer and more aggressively dissave in response to shocks, at the expense of future consumption. We calibrate the model to 51 districts in Nepal and estimate the impact of historical climate shocks on food consumption and welfare. We estimate that, on an annual basis, floods, landslides, droughts and storms combined generated GDP losses of 2.3 percent, welfare losses of 3.3 percent for the average household and increased the rate of undernourishment by 2.8 percent. Undernourished households experience roughly 50 percent larger welfare losses and those in remote locations suffer welfare losses that are roughly two times larger than in less remote locations (5.9 vs 2.9 percent). In counterfactual simulations, we show the role of better access to migration and trade in building resilience to climate shocks.
    Keywords: Agriculture; Food Security; Trade, Migration; Climate change; Climate shocks
    Date: 2023–08–11
  11. By: Dominguez, Begona; Gomis-Porqueras, Pedro
    Abstract: This paper proposes a framework to examine the macroeconomic impact of having U.S. dollar swap arrangements, where domestic and foreign currencies are valued and where agents also have access to domestic short and long-term bonds that have differential pledgeability. Within this environment, we investigate how U.S. dollar swap lines affect inflation and debt dynamics in the small open economy when domestic quantitative easing and standard interest rate management policies are also enacted. We show different combinations of U.S. dollar swap lines, and domestic quantitative easing as well as interest rate management policies can deliver the same steady state. We also find that such policies imply different short-run dynamics. Moreover, we find that traditional stabilization policies are not operative when agents do not consume the first best. When calibrated to Australia during the pandemic and under some conditions, we find that a more favorable swap line (agents in the small open economy can obtain U.S. dollar cheaper than in the forex market) would have allowed to cut back on long-term bond purchases from 35% to 24% of GDP. We also show that swaps and quantitative easing dampen the fiscal eigenvalue, changing the speed of adjustment towards the long run equilibria. Moreover, we find that the region of indeterminacy is enlarged when more liquid quantitative easing policies and more favorable swaps are pursued. Finally, we show that swap lines have a differential impact on domestic and foreign consumption.
    Keywords: swaps, quantitative easing, repos, interest rate management
    JEL: E4 E40 E44 F4 F42
    Date: 2023–08
  12. By: Gaston Chaumont; Grey Gordon; Bruno Sultanum; Elliot Tobin
    Abstract: ow do credit default swaps (CDS) affect sovereign debt markets? The answer depends crucially on trading frictions, risk-sharing, arbitrage violations, and spillovers from secondary to primary markets. We propose a sovereign default model where investors trade bonds and CDS over the counter via directed search. CDS affect bond prices through several channels. First, CDS act as a synthetic bond. Second, CDS reduce bond-investing risks, allowing exposure to be unwound. Third, CDS availability increases trading profitability, which induces entry and reduces trading costs. Last, these direct effects feedback into default decisions. Our novel identification strategy exploits confidential microdata to quantify the extent of trading frictions and risk-sharing. The model generates realistic CDS-bond basis deviations, bid/ask spreads, and CDS volumes and positions. Our baseline specification predicts large effects of frictions generally but small spillovers from a naked CDS ban. These predictions hinge crucially on the identified parameters.
    Keywords: sovereign debt; CDS; Directed search; Over-the-counter
    JEL: F34 G12
    Date: 2023–03–14

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