nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2023‒09‒18
23 papers chosen by
Christian Zimmermann, Federal Reserve Bank of St. Louis

  1. The Macroeconomic Effects of Debt Relief Policies During Recessions By Soyoung Lee
  2. UK Monetary Policy in An Estimated DSGE Model with State-Dependent Price and Wage Contracts By Chen, Haixia; Le, Vo Phuong Mai; Meenagh, David; Minford, Patrick
  3. The Cambridge capital controversies (CCC) as market and firm structure controversies: modern neoclassical interpretation By Review, Blind
  4. On the unimportance of commitment for monetary policy By Juan Paez-Farrell
  5. A single monetary policy for heterogeneous labour markets: the case of the euro area By Gomes, Sandra; Jacquinot, Pascal; Lozej, Matija
  6. Incorporating Diagnostic Expectations into the New Keynesian Framework By Jean-Paul L’Huillier; Sanjay R. Singh; Donghoon Yoo
  7. Estimating HANK for Central Banks By Sushant Acharya; William Chen; Marco Del Negro; Keshav Dogra; Aidan Gleich; Shlok Goyal; Donggyu Lee; Ethan Matlin; Reca Sarfati; Sikata Sengupta
  8. Can Central Banks Do the Unpleasant Job That Governments Should Do? By Vasiliki Dimakopoulou; George Economides; Apostolis Philippopoulos; Vanghelis Vassilatos
  9. Micro MPCs and Macro Counterfactuals: The Case of the 2008 Rebates By Jacob Orchard; Valerie A. Ramey; Johannes F. Wieland
  10. House Price Expectations and Inflation Expectations: Evidence from Survey Data By Vedanta Dhamija; Ricardo Nunes; Roshni Tara
  11. Managing an Energy Shock: Fiscal and Monetary Policy By Adrien Auclert; Hugo Monnery; Matthew Rognlie; Ludwig Straub
  12. Marriage and Work Among Prime-Age Men By Adam Blandin; John Bailey Jones; Fang Yang
  13. Labour Supply and Firm Size By Lin Shao; Faisal Sohail; Emircan Yurdagul
  14. Trade Liberalization versus Protectionism: Dynamic Welfare Asymmetries By B. Ravikumar; Ana Maria Santacreu; Michael Sposi
  15. Exchange rate misalignment and external imbalances: what is the optimal monetary policy response? By Corsetti, Giancarlo; Dedola, Luca; Leduc, Sylvain
  16. Capital Management and Wealth Inequality By James Best; Keshav Dogra
  17. Macroeconomic Effects of UI Extensions at Short and Long Durations By Acosta, Miguel; Mueller, Andreas I.; Nakamura, Emi; Steinsson, Jón
  18. Dynare replication of "A Model of Secular Stagnation: Theory and Quantitative Evaluation" by Eggertsson et al. (2019) By Crescentini, Alex; Giri, Federico
  19. Evaluating Fiscal Policy Reforms using the Fiscal Frontier By CHEN Xiaoshan; LEITH Campbell; RICCI Mattia
  20. Leverage, Endogenous Unbalanced Growth, and Asset Price Bubbles By Tomohiro Hirano; Ryo Jinnai; Alexis Akira Toda
  21. The origins of monetary policy disagreement: the role of supply and demand shocks By Carlos Madeira; João Madeira; Paulo Santos Monteiro
  22. The macroeconomic effects of global supply chain reorientation By Clancy, Daragh; Valenta, Vilém; Smith, Donal
  23. A Comment on Monetary Policy and Rational Asset Price Bubbles By Franklin Allen; Gadi Barlevy; Douglas Gale

  1. By: Soyoung Lee
    Abstract: I study debt relief as a stimulus policy using a dynamic stochastic general equilibrium model that captures the rich heterogeneity in households’ balance sheets. In this environment, a large-scale mortgage principal reduction can amplify a recovery, support house prices and lower foreclosures. The nature of the intervention, in terms of its eligibility, liquidity and financing, shapes its macroeconomic impact. This impact rests on how resources are redistributed across households that vary in their marginal propensities to consume. The availability of bankruptcy on unsecured debt quantitatively changes the macroeconomic response to large-scale mortgage relief by reducing precautionary savings.
    Keywords: Business fluctuations and cycles; Credit and credit aggregates; Debt management; Housing
    JEL: E21 E32 E6
    Date: 2023–08
  2. By: Chen, Haixia (Cardiff Business School); Le, Vo Phuong Mai (Cardiff Business School); Meenagh, David (Cardiff Business School); Minford, Patrick (Cardiff Business School)
    Abstract: Considerable micro-level evidence suggests that price/wage contract durations fluctuate with the state of the economy, particularly inflation; nonetheless, macro-level evidence for this is scarce. We incorporate state-dependent price/wage setting into an open economy DSGE model to investigate the evidence of state-dependence in the UK economy’s postwar behaviour. The model is estimated and tested using the Indirect Inference method and is found to fit the dynamic behaviour of key variables very well over a long sample period 1955-2021. In the state-dependent scenario, apart from the direct responses to shocks, monetary policy affects the degree to which the economy is close to the NK world, which in turn indirectly affects the response to these shocks; it also potentially pushes interest rates to the Zero Lower Bound, ZLB. Under the interaction of state-dependence and the ZLB, monetary-fiscal coordination is needed to stabilise the economy, as monetary policy alone cannot achieve economic stability during ZLB scenarios, where it must use bond purchases (Quantitative Easing, QE). Our findings suggest that a coordinated monetary-fiscal policy framework, i.e., an interest rate policy that targets nominal GDP complemented by a ZLB-suppressing fiscal policy, decreases the frequency of economic crises and enhances price/output stability and household welfare compared to the baseline Taylor Rule and QE framework.
    Keywords: State-dependence, DSGE, QE, ZLB, Monetary Policy, Nominal GDP Targeting, Fiscal Policy, Indirect Inference.
    Date: 2023–08
  3. By: Review, Blind
    Abstract: How dynamic stochastic general equilibrium (DSGE) models, widely used in mainstream macroeconomics, revive neoclassical capital theory parables and the uniform rate of interest is analyzed. While Arrow-Debreu-McKenzie (ADM) general equilibrium models disallow such a revival, DSGE has agents re-optimizing at each period, along with separate intra-period budget constraints, which then result in first-order conditions that lead to the resurrection of capital aggregation and the traditional neoclassical capital theory. Despite these initially positive results for neoclassicals, the Cambridge capital controversies (CCC) can be re-cast in form of market and firm structure: quasi-complete contract versus incomplete contract and ADM-style complete market versus DSGE-style incomplete market. In both a theory of the firm and 'ADM versus DSGE, ' the question is: why do agents choose the inferior market structure (incomplete contract and DSGE-style incomplete market) that leads to lower expected time-discounted utility? In this sense, CCC is alive even in neoclassical macroeconomics.
    Date: 2023–08–09
  4. By: Juan Paez-Farrell
    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 fluctuations are caused by sectoral shocks, policies designed to overcome the stabilisation bias are aiming to correct an unimportant problem.
    Date: 2023–08
  5. By: Gomes, Sandra (Bank of Portugal, UECE/REM); Jacquinot, Pascal (European Central Bank); Lozej, Matija (Central Bank of Ireland)
    Abstract: Differences in labour market institutions and regulations between countries of the monetary union can cause divergent responses even to a common shock. We augment a multi-country model of the euro area with search and matching framework that differs across Ricardian and hand-to-mouth households. In this setting, we investigate the implications of cross-country heterogeneity in labour market institutions for the conduct of monetary policy in a monetary union. We compute responses to an expansionary demand shock and to an inflationary supply shock under the Taylor rule, asymmetric unemployment targeting, and average inflation targeting. For each rule we distinguish between cases with zero weight on the unemployment gap and a negative response to rising unemployment. Across all rules, responding to unemployment leads to lower losses of employment and higher inflation. Responding to unemployment reduces cross-country differences within the monetary union and the differences in consumption levels of rich and poor households.
    Keywords: DSGE Modelling, Business cycles, Search and matching, Monetary Union.
    JEL: E24 E32 E43 E52 F45
    Date: 2023–04
  6. By: Jean-Paul L’Huillier; Sanjay R. Singh; Donghoon Yoo
    Abstract: Diagnostic expectations constitute a realistic behavioral model of inference. This paper shows that this approach to expectation formation can be productively integrated into the New Keynesian framework. Diagnostic expectations generate endogenous extrapolation in general equilibrium. We show that diagnostic expectations generate extra amplification in the presence of nominal frictions; a fall in aggregate supply generates a Keynesian recession; fiscal policy is more effective at stimulating the economy. We perform Bayesian estimation of a rich medium-scale model that incorporates consensus forecast data. Our estimate of the diagnosticity parameter is in line with previous studies. Moreover, we find empirical evidence in favor of the diagnostic model. Diagnostic expectations offer new propagation mechanisms to explain fluctuations.
    Keywords: heuristics; general equilibrium; shocks; volatility
    JEL: E12 E32 E71
    Date: 2023–03–01
  7. By: Sushant Acharya; William Chen; Marco Del Negro; Keshav Dogra; Aidan Gleich; Shlok Goyal; Donggyu Lee; Ethan Matlin; Reca Sarfati; Sikata Sengupta
    Abstract: We provide a toolkit for efficient online estimation of heterogeneous agent (HA) New Keynesian (NK) models based on Sequential Monte Carlo methods. We use this toolkit to compare the out-of-sample forecasting accuracy of a prominent HANK model, Bayer et al. (2022), to that of the representative agent (RA) NK model of Smets and Wouters (2007, SW). We find that HANK’s accuracy for real activity variables is notably inferior to that of SW. The results for consumption in particular are disappointing since the main difference between RANK and HANK is the replacement of the RA Euler equation with the aggregation of individual households’ consumption policy functions, which reflects inequality.
    Keywords: HANK model; Heterogeneous-agent New Keynesian (HANK) model; Bayesian inference; sequential Monte Carlo methods
    JEL: C11 C32 D31 E32 E37 E52
    Date: 2023–08–01
  8. By: Vasiliki Dimakopoulou; George Economides; Apostolis Philippopoulos; Vanghelis Vassilatos
    Abstract: We investigate what happens when the fiscal authorities do not react to rising public debt so that the unpleasant task of fiscal sustainability falls upon the Central Bank (CB). In particular, we explore whether the CB’s bond purchases in the secondary market can restore stability and determinacy in an otherwise unstable model. This is investigated in a DSGE model calibrated to the Euro Area (EA) and where monetary policy is conducted subject to the numerical rules of the Eurosystem (ES). We show that given the recent situation in the ES, and to the extent that a relatively big shock hits the economy and fiscal policy remains active, there is no room left for further quasi-fiscal actions by the ECB; there will be room only if the ES’ rules are violated. We then search for policy mixes that can respect the ES’s rules and show that debt-contingent fiscal and quantitative monetary policies can reinforce each other; this confirms the importance of policy complementarities. On the negative side, bond purchases by the CB worsen income inequality and the unavoidable reversal, in the form of QT, will come at a real cost.
    Keywords: central banking, fiscal policy, debt stabilization, Euro Area
    JEL: E50 E60 O50
    Date: 2023
  9. By: Jacob Orchard; Valerie A. Ramey; Johannes F. Wieland
    Abstract: We present evidence that the high estimated MPCs from the leading household studies result in implausible macroeconomic counterfactuals. Using the 2008 tax rebate as a case study, we calibrate a standard medium-scale New Keynesian model with the estimated micro MPCs to construct counterfactual macroeconomic consumption paths in the absence of a rebate. The counterfactual paths imply that consumption expenditures would have plummeted in spring and summer 2008 and then recovered when Lehman Brothers failed in September 2008. We use narratives and forecasts to argue that these paths are implausible. We then show that standard two-way fixed effect estimates of the micro MPCs are upward biased. When we correct for the biases, we estimate smaller micro MPCs than the previous literature. We also show that reasonable modifications of the model result in general equilibrium forces that dampen rather than amplify micro MPCs. The combination of smaller micro MPCs and dampening general equilibrium forces implies general equilibrium consumption multipliers that are below 0.2.
    JEL: E21 E27 E62
    Date: 2023–08
  10. By: Vedanta Dhamija (University of Surrey); Ricardo Nunes (University of Surrey); Roshni Tara (University of Surrey)
    Abstract: We find that households tend to overweight house price expectations when forming their inflation expectations. The finding is robust across several specifications and two survey data sets for the United States. We also find that there is a significant effect of the cognitive abilities of households as more sophisticated households don’t overweight house price inflation as much. We model this household behaviour in a two-sector New Keynesian model with an overweighted and a non-overweighted sector and analytically derive a welfare loss function consistent with the micro-foundations of the model. In this setup, we show that to gauge the correct interest rate response, the central bank needs to be aware that some sectors are overweighted and that movements in expected inflation in such sectors are important for monetary policy.
    JEL: D10 E12 E31 E52 E58
    Date: 2023–07
  11. By: Adrien Auclert; Hugo Monnery; Matthew Rognlie; Ludwig Straub
    Abstract: This paper studies the macroeconomic effects of energy price shocks in energy-importing economies using a heterogeneous-agent New Keynesian model. When MPCs are realistically large and the elasticity of substitution between energy and domestic goods is realistically low, increases in energy prices depress real incomes and cause a recession, even if the central bank does not tighten monetary policy. Imported energy inflation can spill over to wage inflation through a wage-price spiral, but this does not mitigate the decline in real wages. Monetary tightening has limited effect on imported inflation when done in isolation, but can be powerful when done in coordination with other energy importers by lowering world energy demand. Fiscal policy, especially energy price subsidies, can isolate individual energy importers from the shock, but it has large negative externalities on other economies.
    JEL: E52 F42 Q43
    Date: 2023–08
  12. By: Adam Blandin; John Bailey Jones; Fang Yang
    Abstract: Married men work substantially more hours than men who have never been married, even after controlling for observables. Panel data reveal that much of this gap is attributable to an increase in work in the years leading up to marriage. Two potential explanations for this increase are: (i) men hit by positive labor market shocks are more likely to marry; and (ii) the prospect of marriage increases men’s labor supply. We quantify the relative importance of these two channels using a structural life-cycle model of marriage and labor supply. Our calibration implies that marriage substantially increases male labor supply. Counterfactual simulations suggest that if men were unable to marry, prime-age male work hours would fall by 7%, and if marriage rates fell to the extent observed, men born around 1980 would work 2% fewer hours than men born around 1960.
    Keywords: labor supply; family structure; marriage; marital wage premium
    JEL: D15 J1 J22 J31
    Date: 2023–08–29
  13. By: Lin Shao; Faisal Sohail; Emircan Yurdagul
    Abstract: Larger firms feature i) longer hours worked, ii) higher wages, and iii) smaller (larger) wage penalties for working long (short) hours. We reconcile these patterns in a general equilibrium model, which features the endogenous interaction of hours, wages, and firm size. In the model, workers willing to work longer hours sort into larger firms that offer a wage premium. Complementarities in hours worked generate wage penalties that increase with the distance from the average firm hours. We use the model to argue about the importance of the interaction between hours, wages, and firm size on inequality.
    Keywords: Firm dynamics; Labour markets
    JEL: E24 J2 J31
    Date: 2023–08
  14. By: B. Ravikumar (Federal Reserve Bank of St. Louis); Ana Maria Santacreu (Federal Reserve Bank of St. Louis); Michael Sposi (Southern Methodist University)
    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
  15. By: Corsetti, Giancarlo; Dedola, Luca; Leduc, Sylvain
    Abstract: How should monetary policy respond to excessive capital in•ows that appreciate the currency and widen the external de•cit? Using the workhorse two-country 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 attenuate ERPT. Excessive capital in•ows, however, may lead to currency undervaluation instead of overvaluation for some parameter values. The optimal stance is then invariably expansionary to support domestic demand. JEL Classification: E44, E52, E61, F41, F42
    Keywords: asset markets and risk sharing, currency misalignment, exchange rate pass-through, international policy cooperation, optimal targeting rules, trade imbalances
    Date: 2023–08
  16. By: James Best; Keshav Dogra
    Abstract: Wealthier individuals have stronger incentives to seek higher returns. We investigate the effect that this has on long-run wealth inequality. Incorporating capital management into a standard Ramsey-Cass-Koopmans model generates substantial long-run inequality: the majority of the population works and holds no capital, while a small minority holds a large amount of capital and manages it full time. Counterintuitively, financial innovations or policies that reduce return differentials increase long-run wealth inequality. Egalitarian steady states may exist but are inefficient and unstable: a small concentration in capital ownership causes a transition to an unequal steady state. Capital management introduces a novel equity-efficiency tradeoff: scale economies make it efficient for a few individuals to manage capital full-time, but under laissez-faire this generates substantial inequality. A utilitarian planner would instead instruct a few individuals to manage capital on behalf of society and transfer most of their income to the workers.
    Keywords: wealth inequality; capital; returns; management; information; Financial innovation
    JEL: D31 D83 E21 E22 G51
    Date: 2023–09–01
  17. By: Acosta, Miguel (Federal Reserve Board); Mueller, Andreas I. (University of Texas at Austin); Nakamura, Emi (University of California, Berkeley); Steinsson, Jón (UC Berkeley)
    Abstract: We study the macroeconomic effects of unemployment insurance (UI) benefit extensions in the United States at short and long durations. To do this, we develop a new state level dataset on trigger variables for UI extensions and a "UI benefit calculator" based on detailed legislative and administrative sources spanning five decades. Our identification approach exploits variation across states in the options governing the Extended Benefits program. We find that UI extensions during time periods when UI benefit durations are already long—such as in the Great Recession—have minimal effects. However, UI extensions when initial durations are shorter have substantial effects on the unemployment rate and the number of people receiving UI. Through the lens of a search-and-matching model, we show that our estimates are consistent with microeconomic estimates of the duration elasticity to UI, implying small general equilibrium effects of UI extensions.
    Keywords: unemployment insurance, unemployment, general equilibrium
    JEL: E2 J6
    Date: 2023–08
  18. By: Crescentini, Alex; Giri, Federico
    Abstract: This paper replicates the study "A Model of Secular Stagnation: Theory and Quantitative Evaluation" by Eggertsson et al. (2019) using the Dynare toolkit. Replication is important as it confirms the results of the original article, provides a user-friendly version using Dynare (Adjemian et al., 2022), and shows how to deal with large-scale models with occasionally binding constraints. The results show that the original Matlab code was fully replicated, but minor discrepancies were found between the paper's equations and the code. The two models produce similar dynamics but with small differences, particularly at the beginning of the simulation.
    Keywords: Dynare, Secular Stagnation, Occasionally Binding Constraints
    JEL: E0 E43 C62
    Date: 2023
  19. By: CHEN Xiaoshan; LEITH Campbell; RICCI Mattia (European Commission - JRC)
    Abstract: We develop a Fiscal Frontier which traces out the maximum government debt level that can be sustained at a given welfare cost. Through duality, the intertemporal policy mix underpinning the Frontier mirrors standard Ramsey policy and defines an upper limit on the welfare gains that can be achieved by any fiscal reform. The Frontier is then used to evaluate a variety of fiscal reforms: (1) one-off changes in tax instruments considered in Laffer curve calculations, (2) a gradual reduction in capital taxation proposed by Lucas (1990), and (3) fiscal consolidation strategies akin to those considered by the Congressional Budget Office. Conventional Laffer curve calculations significantly under-estimate the sustainable debt of the US. The desirable pace of capital tax abolition has slowed since the 1970s, but the reform remains close to the Frontier. Achieving debt reduction targets considered by the Congressional Budget Office is typically very costly, especially when the fiscal consolidation is large and must be achieved quickly, but a simultaneous capital tax reform can more than offset those costs in all cases we consider.
    Keywords: Laffer Curve, Optimal Policy, Debt Sustainability, Fiscal Limit, Duality
    JEL: E62 H30 H60
    Date: 2023–07
  20. By: Tomohiro Hirano; Ryo Jinnai; Alexis Akira Toda
    Abstract: We present a new theoretical framework to think about asset price bubbles in dividend-paying assets. We study a general equilibrium microfinance model with a positive feedback loop between capital investment and land price, whose magnitude is affected by financial leverage. As leverage is relaxed beyond a critical value, a phase transition occurs from balanced growth of a stationary nature where land prices reflect fundamentals (present value of rents) to unbalanced growth of a nonstationary nature where land prices grow faster than rents, generating a land price bubble. Unbalanced growth dynamics and bubbles are associated with financial deregulation and technological progress. Keywords : land bubble, leverage, nonstationarity, phase transition, unbalanced growth. JEL codes : D52, D53, E44, G12.
    Date: 2023–08
  21. By: Carlos Madeira; João Madeira; Paulo Santos Monteiro
    Abstract: We investigate how dissent in the FOMC is affected by structural macroeconomic shocks obtained using a medium-scale DSGE model. We find that dissent is less (more) frequent when demand (supply) shocks are the predominant source of inflation fluctuations. In addition, supply shocks are found to raise private sector forecasting uncertainty about the path of interest rates. Since supply shocks impose a trade-off between inflation and output stabilisation while demand shocks do not, our findings are consistent with heterogeneous preferences over the dual mandate among FOMC members as a driver of policy disagreement.
    Keywords: FOMC, committees, monetary policy, structural shocks, dissent
    JEL: E52 E58 D78
    Date: 2023–08
  22. By: Clancy, Daragh (Central Bank of Ireland and University of Limerick); Valenta, Vilém (European Central Bank); Smith, Donal (Organisation for Economic Cooperation & Development)
    Abstract: Policymakers around the world are (re)considering the trade-off between efficiency and resilience inherent in global supply chains. Many have introduced legislation seeking to encourage the local production of key inputs to reduce risks from excessive dependencies on external suppliers. We analyse the macroeconomic effects of localisation policies, such as reshoring and friend-shoring production, using a novel non-tariff mechanism in a global dynamic general equilibrium model. We find that localisation policies imply transition costs and their long-term impact on aggregate domestic output are generally negative. The size (and sign) of the impact depends on whether these policies are implemented unilaterally or as part of a global shift and, most importantly, the extent to which they lead to a reduction in domestic competition and productivity. Untargeted localisation policies are also unlikely to achieve their goal of improving macroeconomic resilience, as sensitivity to regional shocks increases, while resilience to global shocks improves only marginally. Based on these findings, we provide some tentative recommendations for policymakers considering implementing a localisation agenda.
    Keywords: Euro area; Friendshoring; Reshoring; Strategic autonomy.
    JEL: F13 F41 F45 F62
    Date: 2023–06
  23. By: Franklin Allen; Gadi Barlevy; Douglas Gale
    Abstract: Galí (2014) showed that a monetary policy rule that raises interest rates in response to bubbles can paradoxically lead to larger bubbles. This comment shows that a central bank that wants to dampen bubbles can always do so by raising interest rates aggressively enough. This result is different from the Miao, Shen and Wang (2019) comment on Galí’s paper. They argue Galí’s model contains additional equilibria in which more aggressive rules dampen bubbles. We show that for these equilibria, more aggressive rules involve threats to raise interest rates more than actual rate increases.
    Date: 2023–07–23

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