nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2023‒10‒16
seventeen papers chosen by
Christian Zimmermann, Federal Reserve Bank of St. Louis

  1. Climate policies, macroprudential regulation, and the welfare cost of business cycles By Annicchiarico, Barbara; Carli, Marco; Diluiso, Francesca
  2. Assessing the macroeconomic impact of weather shocks in Colombia By Jose Vicente Romero; Sara Naranjo-Saldarriaga; Jonathan Alexander Munoz
  3. Homeownership rates, housing policies, and co-residence decisions By Grevenbrock, Nils; Ludwig, Alexander; Siassi, Nawid
  4. Sovereign Defaults and Public Investment (Capital) By Tamon Asonuma; Hyungseok Joo
  5. The Pro-Competitive Consequences of Trade in Frictional Labor Markets By Hamid Firooz
  6. Health Heterogeneity, Portfolio Choice and Wealth Inequality By Juergen Jung; Chung Tran
  7. A Bayesian DSGE Approach to Modelling Cryptocurrency By Stylianos Asimakopoulos; Marco Lorusso; Francesco Ravazzolo
  8. Financial Integration, Excess Consumption Volatility, and the World Real Interest Rate By YAMADA, Haruna
  9. Preventive vs. Curative Medicine: A Macroeconomic Analysis of Health Care over the Life Cycle By Serdar Ozkan
  10. Permanent and Transitory Monetary Shocks around the World By Javier Garcia Cicco; Patricio Goldstein; Federico Sturzenegger
  11. A Tale of Two Countries: Two Stories of Job Polarization By Albertini, Julien; Langot, François; Sopraseuth, Thepthida
  12. Ambiguous Business Cycles, Recessions and Uncertainty: A Quantitative Analysis By Giulia Piccillo; Poramapa Poonpakdee
  13. Monetary policy rules: model uncertainty meets design limits By Dück, Alexander; Verona, Fabio
  14. Financial Exclusion and Inflation Costs By Diogo Baerlocher
  15. Employer vs Government Parental Leave: Labour Market Effects By Elena Del Rey; Maria Racionero; Jose I. Silva
  16. Unbalanced Financial Globalization By Damien Capelle; Bruno Pellegrino
  17. Parenting with Patience: Parental Incentives and Child Development By Del Boca, Daniela; Flinn, Christopher; Verriest, Ewout; Wiswall, Matthew

  1. By: Annicchiarico, Barbara (University of Rome ‘Tor Vergata’); Carli, Marco (University of Rome ‘Tor Vergata’); Diluiso, Francesca (Bank of England)
    Abstract: We compare the performance of a carbon tax and a cap-and-trade scheme in a dynamic stochastic general equilibrium model that includes an environmental externality and agency problems associated with financial intermediation. Heterogeneous polluting firms purchase capital by combining their resources with loans from banks and are hit by idiosyncratic shocks that can lead them to default. We find that financial market distortions strongly affect the performance of climate policy throughout the business cycle. The welfare cost of business cycles is substantially lower under a cap-and-trade system than under a carbon tax if financial frictions are stringent, firm leverage is high, and agents are sufficiently risk-averse. The difference in welfare costs shrinks significantly in the presence of simple macroprudential policy rules that weaken the strength of financial market distortions. These policies can go a long way in smoothing business-cycle fluctuations and aligning the performance of price and quantity pollution policies, reducing the uncertainty inherent to the Government’s chosen climate policy tool.
    Keywords: Business cycle; cap-and-trade; carbon tax; E-DSGE
    JEL: E32 E44 Q58
    Date: 2023–08–11
  2. By: Jose Vicente Romero (Banco de la Republica); Sara Naranjo-Saldarriaga (Banco de la Republica); Jonathan Alexander Munoz (Banco de la Republica)
    Abstract: In this paper, we investigate the impact of adverse weather shocks on Colombian economic activity, with a particular emphasis on the effects on agricultural output, food and headline inflation. Existing literature and empirical evidence suggest that adverse weather shocks, such as those related to the El Nino event in 2015-2016, lead to decreases in agricultural output and increases in inflation without significantly affecting total GDP growth. To further assess this result, we evaluate the impact of ENSO fluctuations using a BVAR-X model. Based on these findings, we propose a small open economy New Keynesian model that introduces a novel channel through which relative prices (agricultural vs. non-agricultural) are affected by weather shocks, allowing us to incorporate this empirical evidence into a structural model for Colombia.
    Keywords: Weather shocks; El Nino Southern Oscillation (ENSO); Small Open Economy New Keynesian Models
    JEL: Q54 E52 E31
    Date: 2023–09–14
  3. By: Grevenbrock, Nils; Ludwig, Alexander; Siassi, Nawid
    Abstract: Homeownership rates differ widely across European countries. We document that part of this variation is driven by differences in the fraction of adults co-residing with their parents. Comparing Germany and Italy, we show that in contrast to homeownership rates per household, homeownership rates per individual are very similar during the first part of the life cycle. To understand these patterns, we build an overlapping-generations model where individuals face uninsurable income risk and make consumption-saving and housing tenure decisions. We embed an explicit intergenerational link between children and parents to capture the three-way trade-off between owning, renting, and co-residing. Calibrating the model to Germany we explore the role of income profiles, housing policies, and the taste for independence and show that a combination of these factors goes a long way in explaining the differential life-cycle patterns of living arrangements between the two countries.
    Keywords: Homeownership, Co-residence, Overlapping generations
    JEL: D15 E21 H31 R21
    Date: 2023
  4. By: Tamon Asonuma (International Monetary Fund); Hyungseok Joo (University of Surrey)
    Abstract: Sovereigns' public investment (capital) influences sovereign debt crises and resolution. We compile a dataset on public expenditure composition in 1975{2020 for 75 countries. We show that during sovereign debt restructurings with private external creditors, public investment (i) experiences a severe decline and a slow recovery, (ii) differs from public consumption and transfers, and (iii) relates with restructuring delays. We develop a theoretical model of defaultable debt that embeds endogenous public capital accumulation, expenditure composition, production and multi-round debt renegotiations. The model quantitatively shows public investment dynamics delay debt settlement (i.e., \capital accumulation delays"). Data support theoretical predictions.
    JEL: F34 F41 H63
    Date: 2023–08
  5. By: Hamid Firooz
    Abstract: What are the pro-competitive consequences of trade in frictional labor markets? This paper develops and estimates a dynamic general equilibrium trade model to show that the interplay between endogenously variable markups in product markets and frictions in labor markets has important implications for aggregate as well as distributional consequences of trade. In particular, I show that once markups are allowed to respond to trade liberalization, unemployment and residual wage inequality rise almost three times more than in a model with constant markups (in the steady state). The presence of labor market frictions makes the pro-competitive gains from trade liberalization negative.
    Keywords: international trade, variable markups, pro-competitive gains, labor elasticity of revenue, unemployment, residual wage inequality, firm size distribution
    JEL: F12 F16 E24 J64 L11
    Date: 2023
  6. By: Juergen Jung (Department of Economics, Towson University); Chung Tran (Research School of Economics, The Australian National University)
    Abstract: We investigate implications of health heterogeneity for savings, portfolio choice, wealth accumulation and inequality over the lifecycle. We first use the Health and Retirement Study 1992–2018 and document the effects of exposure to poor health during the peak earnings period between age 45 and 55 on the lifecycle patterns of savings and the composition of the wealth portfolio at retirement. We then quantify these dynamic effects using a structural lifecycle model with elastic labor supply, asset portfolio choice, and household heterogeneity in health status, health expenditure, health insurance, and earnings ability. We find that the presence of both safe and risky assets with heterogeneous returns introduces a new health-wealth portfolio channel that amplifies the effects of health on wealth accumulation over the lifecycle. We demonstrate that in the absence of the health-wealth portfolio channel, the wealth gap is significantly lower at retirement. Finally, we study the importance of health insurance in reducing wealth inequality by mitigating exposure to health expenditure shocks and encouraging riskier investment choices with higher returns. Our new insights imply that health insurance reforms can have large impacts on wealth inequality reduction in the US.
    Keywords: Health and income risks, Health insurance, Heterogeneity, Lifecycle savings, Risky and safe assets, Asset portfolio, Inequality.
    JEL: G41 G51 G52 E21 H21 I13 I14
    Date: 2023–09
  7. By: Stylianos Asimakopoulos; Marco Lorusso; Francesco Ravazzolo
    Abstract: We develop and estimate a DSGE model to evaluate the economic repercussions of cryptocurrency. In our model, cryptocurrency offers an alternative currency option to government currency, with endogenous supply and demand. We uncover a substitution effect between the real balances of government currency and cryptocurrency in response to technology, preferences and monetary policy shocks. We find that an increase in cryptocurrency productivity induces a rise in the relative price of government currency with respect to cryptocurrency. Since cryptocurrency and government currency are highly substitutable, the demand for the former increases whereas it drops for the latter. Our historical decomposition analysis shows that fluctuations in the cryptocurrency price are mainly driven by shocks in cryptocurrency demand, whereas changes in the real balances for government currency are mainly attributed to government currency and cryptocurrency demand shocks.
    Date: 2023–09
  8. By: YAMADA, Haruna
    Abstract: Contrary to classical macroeconomic theory, the volatility of consumption relative to income has risen in emerging markets despite the international financial integration. This study presents a theoretical mechanism of this phenomenon by developing a small open economy model with an occasionally binding borrowing constraint, named the Interest Coverage Ratio-based borrowing constraint. Calibration exercises show that financial integration improves consumption smoothing and mitigates income shocks. Meanwhile, the foreign debt limit is more sensitive to changes in the world real interest rate. An increase in the world real interest rate tightens the borrowing constraint and decreases consumption significantly for the repayment. Financial integration would make consumption more vulnerable to the world real interest rate changes, resulting the higher volatility in emerging markets.
    Keywords: Financial Integration, Excess Consumption Volatility, Emerging Market Economy, World Real Interest Rate, Occasionally Binding Borrowing Constraint
    JEL: E21 E41 E44 F62
    Date: 2023–09
  9. By: Serdar Ozkan
    Abstract: This paper studies differences in health care usage and health outcomes between low- and high-income individuals. Using data from the Medical Expenditure Panel Survey (MEPS) I find that early in life the rich spend significantly more on health care, whereas from midway through life until very old age the medical spending of the poor dramatically exceeds that of the rich. In addition, low-income individuals are less likely to incur any medical expenditures in a given year, yet, when they do incur medical expenditures, the amounts are more likely to be extreme. To account for these facts, I develop and estimate a life-cycle model of two distinct types of health capital: preventive and physical. Physical health capital determines survival probabilities, whereas preventive health capital governs the endogenous distribution of shocks to physical health capital, thereby controlling the life expectancy. Moreover, I incorporate important features of the U.S. health care system such as private health insurance, Medicaid, and Medicare. In the model, optimal expected life span is longer for the rich, which can only be achieved by greater investment in preventive health capital. Therefore, as they age, their health shocks grow milder compared to those of the poor, and in turn they incur lower curative medical expenditures. Public insurance for the elderly amplifies this mechanism by hampering the incentives of the poor to invest in preventive health capital. I use the model to examine a counterfactual economy with universal health insurance in which 75% of preventive medical spending is reimbursed on top of existing coverage in the benchmark economy. My results suggest that policies encouraging the use of health care by the poor early in life produce significant welfare gains, even when fully accounting for the increase in taxes required to pay for them.
    Keywords: health production; health inequality; health reform; social insurance
    JEL: D52 D91 E21 E61 E65 I12 I14
    Date: 2023–09–19
  10. By: Javier Garcia Cicco (Universidad de San Andrés); Patricio Goldstein (Columbia University); Federico Sturzenegger (Universidad de San Andrés)
    Abstract: The effects of monetary policy on output and inflation have been at the center of macroeconomic debate for decades. Uribe (2022) argues, by looking at the US, that a better characterization of these effects can be obtained by splitting monetary policy into transitory and permanent shocks. He finds that transitory monetary contractions reduce inflation and output as in traditional New Keynesian models, whereas long termincreases in the inflation rate increase output in the short run. In this paper we extend the analysis to other countries in the world and show that its conclusions can roughly be extended to this larger set. We also broaden the analysis by lifting the overidentifying assumption of superneutrality. We find that although superneutrality does not strictly hold, deviations from it are very small. An increase in long run inflation can slightly improve output but this effect quickly dwindles as inflation increases and eventually becomes negative. Our results provide new evidence to the standard tenets of monetary policy: monetary policy is unable to move output and has negative side effects if it is allowed to increase beyond the range typically defended by central banks.
    Date: 2023–09
  11. By: Albertini, Julien; Langot, François; Sopraseuth, Thepthida
    Abstract: The US and French job polarization appear similar based on employment shares by task. This study shows that they are different when per capita employment by task is used to identify the sources of these structural changes. We build a multi-sectorial general equilibrium model with search frictions, endogenous layoffs, and occupational choices to estimate the relative impact of TBTC (Task-Biased Technological Change) and LMI changes (Labor Market Institutions) on employment patterns. Our analysis suggests that job polarization is mainly driven by TBTC in the US, whereas LMI changes drive job polarization in France.
    Keywords: job polarization, search and matching, labor market institutions, task-biased technological change
    Date: 2023–09
  12. By: Giulia Piccillo; Poramapa Poonpakdee
    Abstract: This paper investigates the effects of uncertainty on the macro economy by replicating its micro effects on individual subjective beliefs. In our model, the representative household has smooth ambiguity preferences and is uncertain about which scenario the economy will be in the next period: normal growth or recession. We anchor the ratio of expected utilities between the two scenarios through the empirical macroeconomic uncertainty index. The higher the macroeconomic uncertainty is, the deeper the recession that the household is expecting. Our estimations demonstrate that the smooth ambiguity model with an appropriate level of ambiguity aversion outperforms the benchmark model with no uncertainty in fitting the US output growth rate, especially during recessions. This holds true even when tested with out-of-sample forecasts. Our analyses show that the effect of uncertainty on the representative household’s beliefs aligns with the corresponding empirical literature. Moreover, the Global Financial Crisis was associated with an increase in both risk aversion and ambiguity aversion, while the Dot-com Crisis only affected risk aversion.
    Keywords: behavioural macro, uncertainty, estimated DSGE models
    JEL: E70 D80 D90 E10 E30
    Date: 2023
  13. By: Dück, Alexander; Verona, Fabio
    Abstract: Optimal monetary policy studies typically rely on a single structural model and identification of model-specific rules that minimize the unconditional volatilities of inflation and real activity. In our proposed approach, we take a large set of structural models and look for the model-robust rules that minimize the volatilities at those frequencies that policymakers are most interested in stabilizing. Compared to the status quo approach, our results suggest that policymakers should be more restrained in their inflation responses when their aim is to stabilize inflation and output growth at specific frequencies. Additional caution is called for due to model uncertainty.
    Keywords: monetary policy rules, policy evaluation, model comparison, model uncertainty, frequency domain, design limits, DSGE models
    JEL: C49 E32 E37 E52 E58
    Date: 2023
  14. By: Diogo Baerlocher (Department of Economics, University of South Florida)
    Abstract: This paper constructs two models of financial exclusion to assess the welfare costs of inflation. In the first, inflation costs are measured within a classical endowment economy. The second includes a production sector and costly credit. Both models are calibrated to account for inflation costs in a high-inflation economy (developing country) and in a low-inflation economy (developed economy). In an endowment economy, when inflation is reduced from 1.5% to zero in a developed economy, the welfare costs for agents with (without) financial access are 0.36% (1.1%) consumption equivalent variation (CEV). In a model with costly credit, the welfare costs for agents with (without) financial access are 0.7% (1.36%) CEV. For developing countries, when inflation is reduced from 6.2% to zero, the welfare costs for agents with (without) financial access are 1.3% (5%) in an endowment economy. In the costly-credit model, the welfare costs for agents with (without) financial access are 0.44% (6%) CEV. The main finding is that there is a substantial asymmetry in welfare costs between individuals with and without access to financial services, especially in developing countries.
    Keywords: Financial Exclusion, Inflation Costs, Costly Credit
    JEL: D53 E31 E51 G23
    Date: 2023–09
  15. By: Elena Del Rey; Maria Racionero; Jose I. Silva
    Abstract: WA relatively large number of firms in Australia and in the US offer employer-funded parental leave to their employees beyond legal requirements. We introduce government-funded parental leave in a theoretical labour search and matching model. Firms choose the duration of paid parental leave offered to prospective employees. Matched firms and workers then negotiate wages through a Nash bargaining process. In equilibrium, the wage and the labour market tightness are determined by the point at which the wage and job creation curves intercept. We study the reasons behind the presence of employer-funded parental leave and its effects on wages and employment. We also explore the labour market and welfare effects of the introduction and extension of government-funded parental leave.
    Keywords: Employer-funded paid parental leave; wages; unemployment
    JEL: J30 J64 J68
    Date: 2023–09
  16. By: Damien Capelle; Bruno Pellegrino
    Abstract: We examine the impact of the last five decades of financial globalization on world GDP and income distribution, using a novel multi-country dynamic general equilibrium model that incorporates a demand system for international assets. We introduce, estimate and validate new country-level measures of inward and outward Revealed Capital Account Openness (RKO), derived from wedge accounting. The implementation of our framework requires only minimal data, which is available as early as 1970 (national income accounts, external assets and liabilities positions). Our RKO wedges reveal enormous heterogeneity in the pace of capital account liberalization, with richer countries liberalizing much faster than poorer ones. We call this pattern Unbalanced Financial Globalization. We then simulate a counterfactual trajectory of the world economy where the RKO wedges are fixed at their pre-globalization levels. We find that unbalanced financial globalization led to a worsening of capital allocation, a 2.8% lower world GDP, a 12% rise in the cross-country dispersion of GDP per capita, lower wages in poorer countries and lower cost of capital in high-income countries. These findings starkly contrast with the predictions of standard models of financial markets integration, where capital account barriers decline symmetrically across countries. In a counterfactual scenario where countries open their capital account in a symmetric or convergent fashion, we find diametrically opposite effects: significant improvements in capital allocation efficiency and lower cross-country inequality, higher wages in poor countries, etc... Our results highlight the pivotal role played by country heterogeneity in shaping the real consequences of capital markets integration.
    Keywords: capital flows, capital allocation, capital misallocation, globalization, international finance, open economy
    JEL: F20 F30 F40 F60
    Date: 2023
  17. By: Del Boca, Daniela (University of Turin); Flinn, Christopher (New York University); Verriest, Ewout (New York University); Wiswall, Matthew (University of Wisconsin-Madison)
    Abstract: We construct a dynamic model of child development where forward-looking parents and children jointly take actions to increase the child's cognitive and non-cognitive skills within a Markov Perfect Equilibrium framework. In addition to time and money investments in their child, parents also choose whether to use explicit incentives to increase the child's self-investment, which may reduce the child's future intrinsic motivation to invest by reducing the child's discount factor. We use the estimated model parameters to show that the use of extrinsic motivation has large costs in terms of the child's future incentives to invest in themselves.
    Keywords: time allocation, child development, parenting styles
    JEL: J13 D1
    Date: 2023–09

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