nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2023‒10‒02
nineteen papers chosen by
Christian Zimmermann, Federal Reserve Bank of St. Louis

  1. A HANK2 Model of Monetary Unions By Christian Bayer; Alexander Kriwoluzky; Gernot J. Müller; Fabian Seyrich
  2. Optimal Monetary Policy and Rational Asset Bubbles By Jacopo Bonchi; Salvatore Nisticò
  3. Entrepreneurship and the Efficiency Effects of Migration By Gustavo González
  4. Population Aging and Income Inequality in a Semi-Endogenous Growth Model By Kazuo Mino; Hiroaki Sasaki
  5. Liquidity and Exchange Rates: An Empirical Investigation By Engel, Charles; Wu, Steve Pak Yeung
  6. At the Right Time:Ramsey-Cass-Koopmans Model with Declining Population By Ichiroh DAITOH; Hiroaki SASAKI
  7. Sticky Leverage: Comment By Andrea Ajello; Ander Pérez-Orive; Bálint Szőke
  8. Global Drivers and Macroeconomic Volatility in EMEs: a Dynamic Factor, General Equilibrium Perspective By Gent Bajraj; Andrés Fernández; Miguel Fuentes; Benjamín García; Jorge Lorca; Manuel Paillacar; Juan Marcos Wlasiuk
  9. Financial and real effects of pandemic credit policies: an application to Chile By Felipe Garcés; Juan Francisco Martínez; M. Udara Peiris; Dimitrios P. Tsomocos
  10. Monetary Policy in Small Open Economies and the International Zero Lower Bound By Marco Rojas
  11. Overborrowing, Underborrowing, and Macroprudential Policy By Fernando Arce; Julien Bengui; Javier Bianchi
  12. Energy shocks as Keynesian supply shocks: implications for fiscal policy By Enisse Kharroubi; Frank Smets
  13. International Welfare Gains from Sharing Climate-Risk By Felix Kubler
  14. An Experiment on a Dynamic Beauty Contest Game By Nobuyuki Hanaki; Yuta Takahashi
  15. Greed? Profits, Inflation, and Aggregate Demand By Florin O. Bilbiie; Diego R. Känzig
  16. The Impact of Bretton Woods International Capital Controls on the Global Economy and the Value of Geopolitical Stability: A General Equilibrium Analysis By Lee E. Ohanian; Paulina Restrepo-Echavarria; Diana Van Patten; Mark L.J. Wright
  17. Behavioral Finance through the Lens of Evolution: "Survival of the Fittest" for Portfolio Rules By Igor V. Evstigneev; Thorsten Hens; Mohammad Javad Vanaei; Mohammad Mikhail Zhitlukhin
  18. Occupational Choice, Human Capital, and Financial Constraints By Rui Castro; Pavel Sevcik
  19. Disentangling Demand and Supply Inflation Shocks from Chilean Electronic Payment Data By Guillermo Carlomagno; Nicolas Eterovic; L. G. Hernández-Román

  1. 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
  2. By: Jacopo Bonchi; Salvatore Nisticò
    Abstract: Using a New Keynesian model with stochastic asset market participation, we analyze the normative implications of bubbly fluctuations for monetary policy. We show that stochastic asset-market participation allows rational bubbles to emerge in equilibrium despite the fact that households are infinitely lived. A central bank concerned with social welfare faces an additional tradeoff implied by the effect of bubbly fluctuations on consumption dispersion across market participants, which makes, in general, strict inflation targeting a suboptimal monetary-policy regime. Deviations from inflation targeting are welfare improving in particular when the economy fluctuates around a balanced-growth path where equilibrium bubbles are small or absent, and the endogenous tradeoff is more stringent, requiring larger deviations of inflation/output gap to mitigate bubbly fluctuations in wealth and thus consumption inequality. The specific optimal monetary-policy response to bubbly fluctuations depends however on the intrinsic features of latter, and the associated effects on wealth inequality.
    Keywords: Rational bubbles, Optimal monetary policy, Stochastic Asset Market Participation, Consumption dispersion
    JEL: E21 E32 E44 E58
    Date: 2023–08
  3. By: Gustavo González
    Abstract: This paper constructs and calibrates a parsimonious two-country dynamic general equilibrium model of entrepreneurship and migration. Countries differ in their TFP and degree of financial frictions. The model is calibrated to replicate the economic and migratory situation of the United States and the rest of the world. I evaluate the impact of changing migration barriers on GDP per capita, average firms productivity, business ownership rates, and consumption on both regions. I find that migration barriers have a non-monotone impact on the average productivity of the host coun-try, depending this on the entrepreneurial skill and mass of people that move in and are displaced by entrants. A migration policy that favors the entry of foreign people with a higher entrepreneurial drive would reduce profits of native entrepreneurs, but would make the economy more efficient and would lift the welfare of workers of the host economy.
    Date: 2023–07
  4. By: Kazuo Mino (Institute of Economic Research, Kyoto University); Hiroaki Sasaki (Graduate School of Economics, Kyoto University)
    Abstract: Using a continuous-time overlapping generations model with semi-endogenous growth, this study examines the impact of population aging on inequality. We characterize the stationary distribution of income and wealth among households and investigate how an increase in life expectancy and a decrease in birth rate affect the distributional profile. The numerical experiments revealed that an increase in life expectancy lowers inequality, whereas a decrease in birth rate increases inequality. We also consider extended models with exogenous productivity growth, agents' retirement from labor participation, and endogenous labor supply.
    Keywords: population aging, semi-endogenous growth, overlapping generations model, income and wealth inequality, Pareto distribution
    JEL: E2 O4
    Date: 2023–09
  5. By: Engel, Charles; Wu, Steve Pak Yeung
    Abstract: Abstract: We find strong empirical evidence that the liquidity yield on government bonds in combination with standard economic fundamentals can well account for nominal exchange rate movements. We find impressive evidence that changes in the liquidity yield are significant in explaining exchange rate changes for all the G10 countries, and we stress that the US dollar is not special in this relationship. We show how these relationships arise out of a canonical two-country New Keynesian model with liquidity returns. Additionally, we find a role for sovereign default risk and currency swap market frictions.
    Keywords: Economics, Applied Economics, Econometrics, Applied economics, Economic theory
    Date: 2023–09–05
  6. By: Ichiroh DAITOH; Hiroaki SASAKI
    Abstract: This paper investigates how population decline may affect the optimal path in two types of Ramsey-Cass- Koopmans (RCK) model with child rearing costs. An optimal path exists in both models under economically plausible conditions and a new type of optimal path exists in the model where the discount rate is only the time preference rate. Under population decline, the existence and properties of an optimal path depend on the range of the rates of population change, regardless of the child rearing costs. First, when population decline is mild, the optimal path is a saddle-point path converging to a finite steady state, as in the standard RCK model with increasing population. Second, when population decline is faster, the optimal path is a saddle-point path converging, by reversible investment, to a finite steady state (i.e., a balanced growth path (BGP)), at which per capita consumption is larger than per capita income. Third, when population decline is even faster, the optimal path can be an asymptotically BGP, along which both per capita consumption and income keep increasing permanently. We show empirical relevance of these optimal paths by Japanese data and World Population Prospects 2019.
    Keywords: Microcredit; Population decline; dynamic optimization; long-run per capita growth; child rearing cost
    JEL: E21 J11 O11 O41
    Date: 2023–09
  7. By: Andrea Ajello; Ander Pérez-Orive; Bálint Szőke
    Abstract: We revisit the role of long-term nominal corporate debt for the transmission of inflation shocks in the general equilibrium model of Gomes, Jermann, and Schmid (2016, henceforth GJS). We show that inaccuracies in the model solution and calibration strategy lead GJS to a model equilibrium in which nominal long-term debt is systematically mispriced. As a result, the quantitative importance of corporate leverage in the transmission of inflation shocks to real activity in their framework is 6 times larger than what arises under the rational expectations equilibrium.
    Keywords: corporate leverage; nominal long-term debt; debt overhang; generalized Euler equation
    JEL: E12 E31 E44 E52 G01 G32 G35
    Date: 2023–07–26
  8. By: Gent Bajraj; Andrés Fernández; Miguel Fuentes; Benjamín García; Jorge Lorca; Manuel Paillacar; Juan Marcos Wlasiuk
    Abstract: We study the role of global drivers in emerging market economies (EMEs)’ business cycles. Using a dynamic factor model, we first pin down the global drivers that are relevant to a sample of twelve EMEs. Our identification assumption allows for the well-known global financial cycle to coexist with additional global factors of different nature, i.e. commodities, growth/productivity. Next, to better understand how these global forces are transmitted into EMEs we zoom in on Chile—one of the EMEs in the sample—and augment a large-scale DSGE regularly used for policy analysis with the estimated global dynamic factor structure. This allows us to document the general equilibrium channels through which shocks in these global factors are transmitted into the business cycle of Chile and, in turn, the policy challenges that they entail. Our findings indicate a preponderant role of global drivers for EMEs’ business cycles, with a third of their macro variability being traced back to shocks in global dynamic factors. While the global financial cycle is a relevant force, a factor associated to global prices and commodities appears equally important, with a relatively modest role played by pure growth/productivity forces. The general equilibrium analysis for Chile reveals that while some of the ensuing effects of shocks to the financial cycle offset each other, the opposite occurs when a shock to global prices materializes, calling for a more active monetary policy response.
    Date: 2022–09
  9. By: Felipe Garcés; Juan Francisco Martínez; M. Udara Peiris; Dimitrios P. Tsomocos
    Abstract: The economic disruption of the COVID-19 pandemic triggered the deployment of a plethora of conventional and unconventional policies. Whilst the policies, in general, are believed to have prevented a more calamatous economic decline, it has been difficult to disentangle the effects of policies from the counterfactual path of the economy. In this paper we estimate a medium scale DSGE model, with a banking sector, and use observed policy responses to extract the underlying shocks characterising the economic effects of the COVID-19 pandemic in Chile. We find that GDP contracted by 10% less because of the pandemic policies while credit policies helped to boost the commercial portfolio by an additional 14% and 12% of accumulated annual growth, for big and small banks respectively, with a limited increase in non-performing loans in the first group of banks. We argue that this and other findings relative to heterogeneity are useful when designing policies transmitted through the banking sector.
    Date: 2023–08
  10. By: Marco Rojas
    Abstract: How does the zero lower bound (ZLB) on the international interest rate affect monetary policy in small open economies (SOE)? When the Fed’s rate was at the ZLB (2008-2015), data for several SOE show a significantly lower correlation between interest rates and inflation, which is at odds with the empirical regularity. This is explained in a model where the distribution of shocks that affect SOE changes when the international interest rate hits the ZLB. Two opposing channels affect the exchange rate. At the ZLB, the depreciating channel is amplified, while the appreciating channel is attenuated. Then, the SOE currency depreciates more than in a scenario without ZLB. This passes through to inflation, which affects SOE’s ability to stabilize the economy as it cannot lower its interest rate as much. In an estimated model, this mechanism by itself can explain 26 percent of the lower correlation observed in the data.
    Date: 2022–12
  11. By: Fernando Arce; Julien Bengui; Javier Bianchi
    Abstract: In this paper, we revisit the scope for macroprudential policy in production economies with pecuniary externalities and collateral constraints. We study competitive equilibria and constrained-efficient equilibria and examine the extent to which the gap between the two depends on the production structure and the policy instruments available to the planner. We argue that macroprudential policy is desirable regardless of whether the competitive equilibrium features more or less borrowing than the constrained-efficient equilibrium. In our quantitative analysis, macroprudential taxes on borrowing turn out to be larger when the government has access to ex-post stabilization policies.
    Keywords: Macroprudential policy; Under-borrowing; Over-borrowing
    JEL: E58 F32 F34 F31
    Date: 2023–05–31
  12. By: Enisse Kharroubi; Frank Smets
    Abstract: This paper analyses the economic impact of and the optimal policy response to energy supply shocks in a flexible price model with heterogeneous households. We introduce energy as a consumption good on the demand side and as an input to production on the supply side. A distinguishing feature is that, in line with empirical evidence, we allow households' energy demand to be non-homothetic. The model provides three main insights. First, (negative) energy supply shocks act as a (negative) demand shock, or Keynesian supply shock, when three conditions are met: (i) household income heterogeneity is intermediate, neither too high nor too low; (ii) the fraction of poor and credit-constrained households is high and (iii) competition between firms is strong enough. Second, implementing the first-best allocation requires subsidising the poor and taxing the rich, and more so when the economy faces a negative energy shock. Last, issuing public debt can be part of the optimal policy response to a negative energy shock, if the shock is large and the economy's overall energy intensity is low.
    Keywords: energy shocks, non-homothetic demand, heterogeneous households, fiscal policy, public debt
    JEL: D31 E21 E32 E62 H3
    Date: 2023–09
  13. By: Felix Kubler (University of Zurich; Swiss Finance Institute)
    Abstract: In this paper, we consider a heterogeneous agents model of a production economy with uncertain climate change and evaluate the welfare gains from the introduction of securities that pay contingent on average surface temperature and total yearly emissions. Since different regions will be affected dramatically differently by climate change, potential welfare gains from sharing climate risk are large. In our benchmark calibration, the region most affected by climate change gains almost 10 percent in wealth equivalent welfare. This takes into account price effects and assumes no transfers. With transfers, the completion can be Pareto-improving, with the poorest region gaining more than 15 percent. We conduct a global sensitivity analysis where we consider a range of parameter values that are considerably more conservative than in the benchmark. We find that the result of significant welfare gains is robust, although they are, on average, much smaller than in our benchmark. By computing first-order Sobol’ indices, we demonstrate that the main driver of uncertainty is the standard deviation of the equilibrium climate sensitivity.
    Keywords: climate change, financial innovations, heterogeneous agents, risk-sharing, environmental policy
    JEL: C61 D52 D62 Q51 Q54
    Date: 2023–09
  14. By: Nobuyuki Hanaki; Yuta Takahashi
    Abstract: We present and conduct a novel experiment on a dynamic beauty contest game motivated by the canonical New-Keynesian model. Participants continuously provide forecasts for prices spanning multiple future periods. These forecasts determine the price for the current period and participants’ payoffs. Our findings are threefold. First, the observed prices in the experiment deviate more from the rational expectations equilibrium prices under strategic complementarity than under strategic substitution. Second, participants’ expectations respond to announcements of future shocks on average. Finally, participants employ heuristics in their forecasting; however, the choice of heuristic varies with the degree of strategic complementarity.
    Date: 2023–09
  15. By: Florin O. Bilbiie; Diego R. Känzig
    Abstract: Amidst the recent resurgence of inflation, this paper investigates the interplay of corporate profits and income distribution in shaping inflation and aggregate demand within the New Keynesian framework. We derive a novel analytical condition for profits to be procyclical and inflationary. Furthermore, we show that the cyclicality of profits is a key determinant of the propagation properties of these models under household heterogeneity, but there is a catch: for aggregate-demand fluctuations and inflation to be amplified by heterogeneity, profits have to be countercyclical—an implication that is at odds with the data. Adding physical capital investment to the model can resolve this conundrum, generating aggregate-demand amplification even under procyclical profits. However, the amplification works through an investment channel and not through profits, inconsistent with the narrative attributing elevated inflation to corporate greed.
    JEL: D11 E32 E52 E62
    Date: 2023–08
  16. By: Lee E. Ohanian; Paulina Restrepo-Echavarria; Diana Van Patten; Mark L.J. Wright
    Abstract: This paper quantifies the positive and normative impact of Bretton Woods capital controls on global and regional economic activity. A three-region DSGE capital flows accounting framework consisting of the U.S., Western Europe, and the Rest of the World (ROW) is developed to quantify capital controls and evaluate their impact on the world economy. We find these controls had large effects. Counterfactual analysis show world output would have been 0:5 percent higher had there been perfect capital mobility, with substantial capital flowing from the ROW to the U.S. Bretton Woods capital controls raised welfare substantially in the ROW, but at the expense of much lower U.S. welfare. Given the U.S.’s goal of keeping capital within these countries to preserve their stability during this period, we interpret lower U.S. welfare due to Bretton Woods as the implicit value the U.S. placed on preserving geopolitical stability in ally countries during the Cold War.
    JEL: E0 F30 P0
    Date: 2023–08
  17. By: Igor V. Evstigneev (University of Manchester); Thorsten Hens (University of Zurich, Norwegian School of Economics and Business Administration, University of Lucerne, and Swiss Finance Institute); Mohammad Javad Vanaei (University of Manchester); Mohammad Mikhail Zhitlukhin (Steklov Mathematical Institute)
    Abstract: This paper analyzes a dynamic stochastic equilibrium model of an asset market based on behavioral and evolutionary principles. The core of the model is a non-traditional game-theoretic framework combining elements of stochastic dynamic games and evolutionary game theory. Its key characteristic feature is that it relies only on objectively observable market data and does not use hidden individual agents' characteristics (such as their utilities and beliefs). A central goal of the study is to identify an investment strategy that allows an investor to survive in the market selection process, i.e., to keep with probability one a strictly positive, bounded away from zero share of market wealth over an infinite time horizon, irrespective of the strategies used by the other players. The main results show that under very general assumptions, such a strategy exists, is asymptotically unique and easily computable. Most of the related models currently considered in this field assume that asset payoffs are exogenous and depend only on the underlying stochastic process of states of the world. The present work develops a modeling framework where the payoffs are endogenous: they depend on the share of total market wealth invested in the asset.
    Keywords: Evolutionary Finance, Behavioral Finance, Stochastic dynamic games, DSGE, Survival portfolio rules
    JEL: C73 D53 D58 G11 G02
    Date: 2023–08
  18. By: Rui Castro (McGill University); Pavel Sevcik (University of Quebec in Montreal)
    Abstract: We study the aggregate productivity effects of firm-level financial frictions. Credit constraints affect not only production decisions, but also household level schooling decisions. In turn, entrepreneurial schooling decisions impact firm-level productivities, whose cross-sectional distribution becomes endogenous. In anticipation of future constraints, entrepreneurs under-invest in schooling early in life. Frictions lower aggregate productivity because talent is misallocated across occupations, and capital misallocated across firms. Firm level productivities are also lower due to schooling distortions. These effects combined account for between 36 and 68 percent of the U.S.-India aggregate productivity difference. Schooling distortions are the major source of aggregate productivity differences.
    Keywords: Aggregate Productivity, Financial Frictions, Entrepreneurship, Human Capital, Misallocation
    JEL: E24 I25 J24 O11 O15 O16 O47
    Date: 2023–08
  19. By: Guillermo Carlomagno; Nicolas Eterovic; L. G. Hernández-Román
    Abstract: We propose a novel methodology to track inflation dynamics in Chile by identifying supply and demand shocks at a highly disaggregated level using prices and quantities information from elec-tronic payments data. We estimate SVAR models where supply and demand shocks are identified with sign restrictions. These estimates are then used to group products into categories of CPI inflation. As opposed to similar studies using categorical-level regressions (e.g., Shapiro, 2022), supply and demand shocks may coexist at a given point in time for a particular category, providing a much richer environment for the policymaker. For the Chilean case, our decomposition provides a reasonable narrative to explain the dynamics of inflation since the start of the COVID-19 pandemic and thereafter. The decomposition of headline inflation obtained by adding up the disaggregates is consistent with that coming from a large DSGE model of the Chilean economy. Keywords: Emerging Economy, Electronic Payment Data, COVID-19, inflation, supply and demand shocks, SVAR.
    Date: 2023–07

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