nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2023‒09‒25
sixteen papers chosen by
Christian Zimmermann, Federal Reserve Bank of St. Louis

  1. Macroeconomic Uncertainty and Capital-Skill Complementarity By Anna Belianska
  2. Consumption Commitments and Unemployment Insurance By Javier López Segovia
  3. Monetary Policy with Racial Inequality By Makoto Nakajima
  4. A Structural Approach to Combining External and DSGE Model Forecasts By Thorsten Drautzburg
  5. Rethinking the Welfare State By Nezih Guner; Remzi Kaygusuz; Gustavo Ventura
  6. Why Global and Local Solutions of Open-Economy Models with Incomplete Markets Differ and Why it Matters By Oliver de Groot; Ceyhun Bora Durdu; Enrique G. Mendoza
  7. Dynamic Tax Evasion and Capital Misallocation in General Equilibrium By Francesco Menoncin; Andrea Modena; Luca Regis
  8. Capital Risk, Fiscal Policy, and the Distribution of Wealth By Andrea Modena; Luca Regis
  9. The Gender Pay Gap: Micro Sources and Macro Consequences By Morchio, Iacopo; Moser, Christian
  10. Unveiling the Interplay between Central Bank Digital Currency and Bank Deposits By Hanfeng Chen; Maria Elena Filippin
  11. The Inflation Attention Threshold and Inflation Surges By Oliver Pf\"auti
  12. Do firing costs change wages of low- and high-educated workers differently? By Jhon Jair Gonzalez Pulgarin
  13. News Shocks under Financial Frictions: A comment on Görtz et al. (2022) By Ash, Thomas; Nikolaishvili, Giorgi; Struby, Ethan
  14. Discretionary Extensions to Unemployment-Insurance Compensation and Some Potential Costs for a McCall Worker By Rich Ryan
  15. Why Hours Worked Decline Less after Technology Shocks? By Olivier Cardi; Romain Restout
  16. General Constrained Dynamic Models in Economics - General Dynamic Theory of Economic Variables - Beyond Walras and Keynes By Glötzl, Erhard; Glötzl, Florentin; Richters, Oliver; Binter, Lucas

  1. By: Anna Belianska
    Abstract: I examine the impact of macroeconomic uncertainty on labor market outcomes for skilled and unskilled workers and propose a new channel to improve our understanding of the underlying propagation mechanisms. I find that uncertainty shocks are recessionary with the unskilled experiencing a steeper fall in employment. To rationalize these findings, I build a New Keynesian DSGE model with skill heterogeneity and wage rigidities, which, coupled with precautionary labor supply, significantly amplify contractionary effects of uncertainty on the real economy.
    Keywords: Stochastic volatility; Capital-skill complementarity; Relative wages; Skill premium.
    Date: 2023–08–04
  2. By: Javier López Segovia
    Abstract: Households allocate around 40% of their budget to goods and services that are difficult to adjust, such as rents, mortgages, or mobile plans, which are called “commitments”. Only about 11% of households adjust the consumption of these goods every quarter. Commitments imply monthly payments that are hard to avoid and make employment and income fluctuations more costly. This paper analyzes the role of unemployment insurance in the presence of commitments using a heterogeneous agents search model with incomplete markets and unemployment shocks. The model is calibrated to the US data and matches key features of the US labor market. Using this framework, we show that the existence of commitment goods amplifies the effects of unemployment insurance on search effort and unemployment duration. Commitments also induce households to build larger precautionary savings. Morover, we show that welfare gains from elimating UI increase from 3.4% to 4.2% when commitments are considered. The optimal replacement rate is 57% in the benchmark economy, higher than the current US policy (50%).
    Keywords: unemployment, consumption commitments, precautionary savings, optimal unemployment insurance
    JEL: E2 H2 I38 J64
    Date: 2023–08
  3. By: Makoto Nakajima
    Abstract: I develop a heterogeneous-agent New-Keynesian model featuring racial inequality in income and wealth, and studies interactions between racial inequality and monetary policy. Black and Hispanic workers gain more from accommodative monetary policy than White workers mainly due to higher labor market risks. Their gains are larger also because of a larger proportion of them are hand-to-mouth, while wealthy White workers gain more from asset price appreciation. Monetary and fiscal policies are substitutes in providing insurance against cyclical labor market risks. Racial minorities gain even more from an accommodative monetary policy in the absence of income-dependent fiscal transfers.
    Keywords: monetary policy; racial inequality; labor market; unemployment; wealth distribution; hand-to-mouth; marginal propensity to consume; business cycle; heterogeneous agents
    JEL: E21 E52 J15 J64
    Date: 2023–05–30
  4. By: Thorsten Drautzburg
    Abstract: This note shows that combining external forecasts such as the Survey of Professional Fore casters can significantly increase DSGE forecast accuracy while preserving the interpretability in terms of structural shocks. Applied to pseudo real-time from 1997q2 onward, the canonical Smets and Wouters (2007) model has significantly smaller forecast errors when giving a high weight to the SPF forecasts. Incorporating the SPF forecast gives a larger role to risk premium shocks during the global financial crisis. A model with financial frictions favors a larger weight on the DSGE model forecast.
    Keywords: Forecasting; model averaging; DSGE model; judgmental forecasts
    JEL: C32 C53
    Date: 2023–06–01
  5. By: Nezih Guner (CEMFI, Centro de Estudios Monetarios y Financieros); Remzi Kaygusuz (Durham University & Sabanci University); Gustavo Ventura (Arizona State University)
    Abstract: The U.S. spends signifficant amounts on non-medical transfers for its working-age population in a wide range of programs that support low and middle-income households. How valuable are these programs for U.S. households? Are there simpler, welfare improving ways to transfer resources that are supported by a majority? What are the macroeconomic effects of such alternatives? We answer these questions in an equilibrium, life-cycle model with single and married households who face idiosyncratic productivity risk, in the presence of costly children and potential skill losses of females associated with non-participation. Our findings show that a potential revenue-neutral elimination of the welfare state generates large welfare losses in the aggregate, although most households support the move as losses are concentrated among a small group. We find that a Universal Basic Income program does not improve upon the current system. If instead per-person transfers are implemented alongside a proportional tax, a Negative Income Tax experiment, it becomes feasible to improve upon the current system. Providing per-person transfers to all households is costly, and reducing tax distortions helps to provide for resources to expand redistribution.
    Keywords: Taxes and transfers, universal basic income, household labor supply, income risk, social insurance.
    JEL: E62 H24 H31
    Date: 2023–08
  6. By: Oliver de Groot; Ceyhun Bora Durdu; Enrique G. Mendoza
    Abstract: Global and local methods used to study open-economy incomplete-markets models yield different cyclical moments, impulse responses, spectral densities and precautionary savings. Endowment and RBC model solutions obtained with first-order, higher-order, and risky-steady-state local methods are compared with fixed-point-iteration global solutions. Analytic and numerical results show that the differences are due to the near-unit-root nature of net foreign assets under incomplete markets and inaccuracies of local methods in computing their autocorrelation. In a Sudden Stops model, quasi-linear methods that handle occasionally binding constraints understate the size of credit constraint multipliers, financial premia and macroeconomic responses.
    JEL: F41 F44 G01 G15
    Date: 2023–08
  7. By: Francesco Menoncin; Andrea Modena; Luca Regis
    Abstract: We study tax evasion in a dynamic macroeconomic model where utility-maximizing entrepreneurs use capital to produce or buy bonds, depending on their firm’s stochastic productivity. The government provides productivity-enhancing public goods financed through taxes and bond issuance. Entrepreneurs can increase their income by evading taxes at the risk of being audited and fined. Lower productivity boosts evasion incentives, exacerbating capital misallocation because unproductive entrepreneurs accumulate wealth at their peers’ expense. Consistently with OECD data, the model predicts a negative relation between tax evasion and productivity in the aggregate but heterogeneous signs and magnitudes across productivities. Public goods provision affects these outcomes ambiguously.
    Keywords: dynamic tax evasion, financial frictions, general equilibrium, misallocation
    JEL: E25 E26 H23 H26
    Date: 2023–08
  8. By: Andrea Modena; Luca Regis
    Abstract: We develop a continuous-time model of a production economy where households face leverage constraints, uninsurable labour income shocks, and capital depreciation risk. We derive a numerical approximation of the model’s competitive equilibrium and compare it with a benchmark economy with no capital risk. Introducing capital risk generates a positive risk premium while fostering aggregate capital accumulation and safe asset demand. At the same time, it exacerbates wealth inequality by making poor households’ net worth more volatile than their wealthier peers. In this framework, we investigate the impact of fiscal policy on households’ wealth distribution and welfare. Fiscal policy influences the equilibrium wealth distribution by changing the risk premium. This channel unevenly impacts households’ consumption and asset allocation decisions, depending on their wage and net worth levels. Tax cuts on risky capital may benefit wealthy or poor households, depending on whether they are financed by raising taxes on safe assets or labour.
    Keywords: fiscal policy, incomplete market, portfolio choices, wealth distribution
    JEL: C61 E21 E62 G11
    Date: 2023–08
  9. By: Morchio, Iacopo (University of Bristol); Moser, Christian (Columbia University)
    Abstract: Using linked employer-employee data from Brazil, we document a large gender pay gap due to women working at lower-paying employers with better nonpay attributes. To interpret these facts, we develop an equilibrium search model with endogenous firm pay, amenities, and hiring. We provide a constructive proof of identification of all model parameters. The estimated model suggests that amenities are important for both men and women, that compensating differentials explain half of the gender pay gap, and that there are significant output and welfare gains from eliminating gender differences. However, equal-treatment policies fail to achieve those gains.
    Keywords: wage inequality, amenities, equilibrium search model, linked employer-employee data, compensating differentials, taste-based discrimination, monopsony power
    JEL: E24 J16 J31 J32
    Date: 2023–08
  10. By: Hanfeng Chen; Maria Elena Filippin
    Abstract: We extend the Real Business Cycle model in Niepelt (2022) to analyze the risk to financial stability following the introduction of a central bank digital currency (CBDC). CBDC competes with commercial bank deposits as households' source of liquidity. We consider different degrees of substitutability between payment instruments and review the equivalence result in Niepelt (2022) by introducing a collateral constraint banks must respect when borrowing from the central bank. When CBDC and deposits are perfect substitutes, the central bank can offer loans to banks that render the introduction of CBDC neutral to the real economy. We show that the optimal level of the central bank's lending rate depends on the restrictiveness of the collateral constraint: the tighter it is, the lower the loan rate the central bank needs to post. However, when CBDC and deposits are imperfect substitutes, the central bank cannot make banks indifferent to the competition from CBDC. It follows that the introduction of CBDC has real effects on the economy.
    Date: 2023–08
  11. By: Oliver Pf\"auti
    Abstract: At the outbreak of the recent inflation surge, the public's attention to inflation was low but increased rapidly once inflation started to rise. In this paper, I develop a general equilibrium monetary model where it is optimal for agents to pay little attention to inflation when inflation is low and stable, but in which they increase their attention once inflation exceeds a certain threshold. Using survey inflation expectations, I estimate the attention threshold to be at an inflation rate of 4%, with attention in the high-attention regime being twice as high as in the low-attention regime. When calibrated to match these findings, the model generates inflation and inflation expectation dynamics consistent with the recent inflation surge in the US. The attention threshold induces a state dependency: cost-push shocks become more inflationary in times of loose monetary policy. These state-dependent effects are absent in the model with constant attention or under rational expectations. Following simple Taylor rules triggers frequent and prolonged episodes of heightened attention, thereby increasing the volatility of inflation, and-due to the asymmetry of the attention threshold-also the average level of inflation, which leads to substantial welfare losses.
    Date: 2023–08
  12. By: Jhon Jair Gonzalez Pulgarin (Université du Maine)
    Abstract: Wages of highly educated workers are affected differently by firing taxes compared with wages of less educated workers. Using a variety of data sources, I evaluate the effects of increasing firing taxes across the United States on wages of high- and low-educated workers. In particular, I analyze how changes in the regulation of the employment-at-will across states affected the wages between 1970–1995. Application of quasiexperimental methods yields results suggesting a negative effect for low-educated workers and no significant effects for the highly educated. The standard search and matching model with endogenous search extended to account for two types of agents points as well to a negative effect of the firing costs on wages, with a more pronounced effect for low-educated workers.
    Date: 2023–08–11
  13. By: Ash, Thomas; Nikolaishvili, Giorgi; Struby, Ethan
    Abstract: Görtz et al. (2022) estimate the effects of innovations to future total factor productivity (TFP) on financial markets. In a Bayesian vector autoregression, they identify a TFP news shock as one that explains the largest share of 40- quarter ahead forecast error variance (FEV) of TFP. Their estimated impulse responses functions show that a positive news shock significantly decreases credit market spreads and increases credit market supply. They also find that a shock that explains the maximum of the FEV of the "excess bond premium" (EBP) (Gilchrist and Zakrajsek 2012) causes similar responses. These results are consistent with an estimated DSGE model with financial frictions. We estimate the main IRFs of the study using the original data and a frequentist estimation approach. We obtain similar point estimates for the dynamic responses to TFP news and EBP max-share shocks. We also update their macroeconomic and financial time series, as some of the data has been revised substantially since their original estimate. We use the updated data to re-estimate the above-mentioned IRFs, and we find that the results are robust to this change in the data. Finally, we investigate the computational reproducibility of their DSGE results, and find that their provided code (consistent with warnings in their README file) does not execute in the most recent version of Dynare or Matlab. Using the version indicated in their replication files, we encounter issues estimating the posterior mode.
    Keywords: Replication, News Shocks, Financial Frictions, Excess Bond Premium
    JEL: E12 E31 E32 E44 G12 G21
    Date: 2023
  14. By: Rich Ryan
    Abstract: Unemployment insurance provides temporary cash benefits to eligible unemployed workers. Benefits are sometimes extended by discretion during economic slumps. In a model that features temporary benefits and sequential job opportunities, a worker's reservation wages are studied when policymakers can make discretionary extensions to benefits. A worker's optimal labor-supply choice is characterized by a sequence of reservation wages that increases with weeks of remaining benefits. The possibility of an extension raises the entire sequence of reservation wages, meaning a worker is more selective when accepting job offers throughout their spell of unemployment. The welfare consequences of misperceiving the probability and length of an extension are investigated. In a numerical example, the costs of misperception are small, which has implications for policymakers considering economic slumps, virus pandemics, extreme heat, and natural disasters.
    Date: 2023–08
  15. By: Olivier Cardi; Romain Restout
    Abstract: The contractionary effect of aggregate technology shocks on hours worked has shrunk over time in OECD countries. Our estimates suggest that this finding can be attributed to the increasing share of the variance of technology improvements driven by asymmetric technology shocks across sectors. While technology improvements uniformly distributed across sectors are found empirically to give rise to a dramatic decline in total hours worked, asymmetric technology shocks do the opposite. By depreciating non-traded prices, symmetric technology shocks generate a contractionary effect on non-traded labor and thus on total hours. In contrast, by appreciating non-traded prices, technological change concentrated toward traded industries puts upward pressure on wages which has a strong expansionary effect on total hours worked. A two-sector open economy model with frictions into the movements of inputs can reproduce the time-increasing response of both total and sectoral hours worked we estimate empirically once we allow for factor-biased technological change and we let the share of asymmetric technology shocks increase over time. A model with endogenous technology decisions reveals that two-third of the progression of asymmetric technology shocks is driven by greater exposition of traded industries to the international stock of knowledge.
    Keywords: ector-biased technology shocks, Endogenous technological change, Factor-augmenting efficiency, Open economy, Labor reallocation, CES production function, Labor income share
    JEL: E25 E62 F11 F41 O33
    Date: 2023
  16. By: Glötzl, Erhard; Glötzl, Florentin; Richters, Oliver; Binter, Lucas
    Abstract: For more than 100 years economists have tried to describe economics in analogy to physics, more precisely to classical Newtonian mechanics. The development of the Neoclassical General Equilibrium Theory has to be understood as the result of these efforts. But there are many reasons why General Equilibrium Theory is inadequate: 1. No genuine dynamics. 2. The assumption of the existence of utility functions and the possibility to aggregate them to one “master” utility function. 3. The impossibility to describe situations as in “Prisoners Dilemma”, where individual optimization does not lead to a collective optimum. This book aims at overcoming these problems. It illustrates how not only equilibria of economic systems, but also the general dynamics of these systems can be described in close analogy to classical mechanics. To this end, this book makes the case for an approach based on the concept of constrained dynamics, analyzing the economy from the perspective of “economic forces” and “economic power” based on the concept of physical forces and the reciprocal value of mass. Realizing that accounting identities constitute constraints in the economy, the concept of constrained dynamics, which is part of the standard models of classical mechanics, can be applied to economics. Therefore, it is reasonable to denote such models as General Constraint Dynamic Models (GCD-Models) Such a framework allows understanding both Keynesian and neoclassical models as special cases of GCD-Models in which the power relationships with respect to certain variables are one-sided. As mixed power relationships occur more frequently in reality than purely one-sided power constellations, GCD-models are better suited to describe the economy than standard Keynesian or Neoclassic models. A GCD-model can be understood as “Continuous Time”, “Stock Flow Consistent”, “Microfounded”, where the behaviour of the agents is described with a general differential equation for every agent. In the special case where the differential equations can be described with utility functions, the behaviour of every agent can be understood as an individual optimization strategy. He thus seeks to maximize his utility. However, while the core assumption of neoclassical models is that due to the “invisible hand” such egoistic individual behaviour leads to an optimal result for all agents, reality is often defined by “Prisoners Dilemma” situations, in which individual optimization leads to the worst outcome for all. One advantage of GCD-models over standard models is that they are able to describe also such situations, where an individual optimization strategy does not lead to an optimum result for all agents. In conclusion, the big merit and effort of Newton was, to formalize the right terms (physical force, inertial mass, change of velocity) and to set them into the right relation. Analogously the appropriate terms of economics are economic force, economic power and change of variables. GCD-Models allow formalizing them and setting them into the right relation to each other.
    Keywords: Stephen Smale, Problem 8, macroeconomic models, constraint dynamics, GCD, DSGE, out-of-equilibrium dynamics, Lagrangian mechanics, stock flow consistent, SFC, demand shock, supply shock, price shock, intertemporal utility function
    JEL: A12 B13 B41 B59 C02 C30 C54 C60 E10
    Date: 2023–06–01

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