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on Dynamic General Equilibrium |
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Issue of 2023‒10‒23
seventeen papers chosen by Christian Zimmermann, Federal Reserve Bank of St. Louis |
| By: | Jorge Abad; Galo Nuño Barrau; Carlos Thomas |
| Abstract: | We analyze the impact of introducing a central bank-issued digital currency (CBDC) on the operational framework of monetary policy and the macroeconomy as a whole. To this end, we develop a New Keynesian model with heterogeneous banks, a frictional interbank market, a central bank with deposit and lending facillities, and household preferences for different liquid assets. The model is calibrated to replicate the main monetary and financial aggregates in the euro area. Our analysis predicts that CBDC adoption implies a roughly equivalent reduction in banks' deposit funding. However, this 'deposit crunch' has a rather small effect on bank lending to the real economy, and hence on aggregate investment and GDP. This result reflects the parallel impact of CBDC on the central bank's operational framework. For relatively moderate CBDC adoption levels, the reduction in deposits is absorbed by an almost one-to-one fall in reserves at the central bank, implying a transition from a 'floor' system –with ample reserves– to a 'corridor' one. For larger CBCD adoption, the loss of bank deposits is compensated by increased recourse to central bank credit, as the corridor system gives way to a 'ceiling' one with scarce reserves. |
| Keywords: | central bank digital currency, interbank market, search and matching frictions, reserves |
| JEL: | E42 E44 E52 G21 |
| Date: | 2023–09 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:1126&r=dge |
| By: | Méndez-Vizcaíno, Juan Camilo; Moreno-Arias, Nicolás |
| Abstract: | This paper presents a comprehensive framework examining fiscal sustainability in developing economies. It integrates public capital, labor informality, and global liquidity shocks in a two-sector DSGE model for a small open economy, revealing their intricate interplay and nonlinear impact on State-Dependent Debt Limits. The framework highlights the significance of initial public capital levels and efficiency in determining the benefits of public investment. High informality rates erode the tax base, compromising the efficiency of public capital for fiscal purposes by weakening revenue generation relative to costs. Adverse global liquidity shocks may significantly contract the fiscal limit distribution only if they are perceived as permanent. Through model calibration and sensitivity exercises on Colombia's fiscal limit distribution, quantitative analyses shed light on underlying mechanisms. Findings challenge the frequent practice of cutting public investment in response to declining revenues, emphasizing it can actually reduce fiscal space. The framework underscores the importance of assessing fiscal policy consolidations aimed at ensuring debt sustainability and responses to global shocks using a structural model, while stressing the fiscal benefits of informality-reducing reforms. |
| Keywords: | Public Debt;Labor informality;public investment;Fiscal limit;Fiscal space;fiscal sustainability;Global liquidity |
| JEL: | E32 E62 H20 H30 H50 H60 |
| Date: | 2023–08 |
| URL: | http://d.repec.org/n?u=RePEc:idb:brikps:13049&r=dge |
| By: | Finkelstein-Shapiro, Alan; Nuguer, Victoria |
| Abstract: | We study the labor market and macroeconomic effects of introducing a carbon tax in the energy sector in emerging economies (EMEs) by building a framework with equilibrium unemployment and firm entry that incorporates key elements of the distinct employment and firm structure of EMEs. Our model endogenizes the adoption of green energy-production technologies--a core element of policy discussions regarding the transition to a low-carbon economy. Calibrating the model to EME data, we show that a carbon tax fosters greater green technology adoption and increases the share of green energy produced. However, the tax leads to higher energy prices, which reduce salaried firm creation and formal employment and increase self-employment, labor participation, and unemployment. As a result, the tax generates output and welfare losses. Green technology adoption plays a key role in limiting the quantitative magnitude of these losses, while the response of self-employment is crucial to explaining the adverse labor market and macroeconomic effects of the policy. Given this finding, we show that a carbon tax coupled with a plausible reduction in the cost of becoming a formal firm can offset the adverse effects of the tax and generate a transition to a lower-carbon economy with minimal economic costs. Finally, we show that lowering green-technology adoption costs or the cost of green-energy production inputs--two alternative climate policies--reduces emissions while limiting the output and welfare costs compared to a carbon tax. |
| Keywords: | Environmental and fiscal policy;carbon taxes;Endogenous firm creation;Green technology adoption;Search frictions;Unemployment;Labor force par ticipation;Informality and self-employment;Emerging economies |
| JEL: | E20 E24 E61 H23 J46 J64 O44 Q52 Q55 |
| Date: | 2023–04 |
| URL: | http://d.repec.org/n?u=RePEc:idb:brikps:12813&r=dge |
| By: | Kotlikoff, Laurence J.; Lagarda, Guillermo; Marin, Gabriel |
| Abstract: | The Value-Added Tax (VAT) is the most prevalent consumption tax globally, yet it is frequently deemed highly regressive. To address this, we propose a Personalized VAT (PVAT) devised in conjunction with a distributional policy. We aim to achieve three objectives: increase revenue collection, achieve progressivity, and disrupt the intergenerational dependency of low-income households. We use Mexico as a case study, showing that eliminating all special VAT regimes and standardizing the rate at 16% could contribute an additional 2.2% of GDP to fiscal revenues. However, such a reform could have severe negative welfare impacts on the poor. To tackle this dilemma, we propose several PVAT scenarios. Our results indicate that a PVAT could be fiscally neutral or even increase revenues by up to 0.83% of GDP, while benefiting the lowest-income households. Lastly, we analyze the general equilibrium effects of a PVAT and various distributional policies, including lump-sum and capital transfers. For this purpose, we employ an overlapping generations model calibrated for Mexico. Our simulations reveal welfare enhancing and output growth results through a PVAT policy that includes capital transfers, thereby presenting a viable strategy for breaking intergenerational dependency. |
| Keywords: | Value-added tax;Personalized value-added Tax;Tax reform;Overlapping generations;Inci-dence |
| JEL: | E62 H21 O11 O12 |
| Date: | 2023–07 |
| URL: | http://d.repec.org/n?u=RePEc:idb:brikps:12985&r=dge |
| By: | Nicolas Bonneton; Christopher Sandmann |
| Abstract: | This paper studies assortative matching in a non-stationary search-and-matching model with non-transferable payoffs. Non-stationarity entails that the number and characteristics of agents searching evolve endogenously over time. Assortative matching can fail in non-stationary environments under conditions for which Morgan (1994) and Smith (2006) show that it occurs in the steady state. This is due to the risk of worsening match prospects inherent to non-stationary environments. The main contribution of this paper is to derive the weakest sufficient conditions on payoffs for which matching is assortative. In addition to known steady state conditions, more desirable individuals must be less risk-averse in the sense of Arrow-Pratt. |
| Keywords: | non-stationary, assortative matching, random search, risk preferences, NTU |
| JEL: | C73 C78 D81 E32 |
| Date: | 2023–09 |
| URL: | http://d.repec.org/n?u=RePEc:bon:boncrc:crctr224_2023_465&r=dge |
| By: | Siew Ling Yew (Department of Economics, Monash University); Jie Zhang (School of Economics and Business Administration, Chongqing University and Department of Economics, National University of Singapore) |
| Abstract: | We explore optimal health subsidies in a dynastic model with health externalities to productivity that cause low health spending, productivity, longevity, savings and labor but high fertility. Public or firms’ health subsidies increase health spending, longevity and productivity and decrease fertility. Labor income taxes reduce the marginal benefit of health spending and the time cost of raising a child, while consumption taxes reduce the relative cost of raising a child. Appropriate public or firms’ health subsidies can internalize the externalities through age-specific labor income taxes and consumption taxes. Calibrating the model to the Australia economy, numerical results suggest policy improvements. |
| Keywords: | Health externality, Longevity, Productivity, Fertility, Savings |
| JEL: | H21 I13 I15 |
| Date: | 2023–10 |
| URL: | http://d.repec.org/n?u=RePEc:mos:moswps:2023-13&r=dge |
| By: | Chan, Jenny (Bank of England); Diz, Sebastian (Central Bank of Paraguay); Kanngiesser, Derrick (Bank of England) |
| Abstract: | How does household heterogeneity affect the transmission of an energy price shock? What are the implications for monetary policy? We develop a small, open-economy TANK model that features labour and an energy import good as complementary production inputs (Gas-TANK). Given such complementarities, higher energy prices reduce the labour share of total income. Due to borrowing constraints, this translates into a drop in aggregate demand. Higher price flexibility insures firm profits from adverse energy price shocks, further depressing labour income and demand. We illustrate how the transmission of shocks in a RANK versus a TANK depends on the degree of complementarity between energy and labour in production and the degree of price rigidities. Optimal monetary policy is less contractionary in a TANK and can even be expansionary when credit constraints are severe. Finally, the contractionary effect of an energy price shock on demand cannot be generalised to alternate supply shocks, as the specific nature of the supply shock affects how resources are redistributed in the economy. |
| Keywords: | Energy prices; inflation; household heterogeneity; monetary policy |
| JEL: | E21 E23 E31 E52 F41 |
| Date: | 2023–09–22 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:1041&r=dge |
| By: | Schnattinger, Philip (Bank of England) |
| Abstract: | This paper studies whether beliefs about future labour productivity independent of fundamentals at any horizon are important drivers of job creation. It develops a model with search frictions in the labour market that accounts for imperfectly observed permanent labour productivity changes. The estimation of the model shows that beliefs are important drivers of job creation in economies with larger search frictions. Beliefs explain 2%, 35%, and 55% of employment fluctuations for the US, the UK and France respectively. Furthermore, exogenous belief changes exert a more powerful influence on job creation during times when unemployment is low. |
| Keywords: | Labour productivity; information frictions; fundamentals and beliefs; equilibrium unemployment growth model; search and matching; business cycles |
| JEL: | E24 E32 E37 |
| Date: | 2023–09–22 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:1040&r=dge |
| By: | Arnaud Chéron; Anthony Terriau |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:tep:teppwp:wp23-06&r=dge |
| By: | Miguel H. Ferreira (Queen Mary University of London, School of Economics and Finance) |
| Abstract: | This paper explores the impact of risky asset holdings by U.S. nonfinancial firms. From the early 1990s to 2017, the share of risky securities surged from 28% to over 40% of firms’ financial assets. Using a business-cycle heterogeneous firms model, I show that declining real interest rates since the 1980s increased the risk premium, driving the increase in risky asset holdings. The model predicts that firms with higher exposure to risky assets experience an investment decline up to 50% more pronounced during large shocks, empirically validated by analyzing the Great Financial Crisis. |
| Keywords: | Risky assets; corporate bonds; firm heterogeneity; firm dynamics; business-cycle |
| JEL: | E22 E44 G11 |
| Date: | 2023–09–29 |
| URL: | http://d.repec.org/n?u=RePEc:qmw:qmwecw:967&r=dge |
| By: | Martín Gonzales-Eiras, Dirk Niepelt |
| Abstract: | We develop a exible single-state model to represent tradeoffs between infections and activity during the early phase of an epidemic. We prove that optimal policy is continuous in the state but discontinuous in the deterministic arrival date of a cure; optimal lockdowns are followed by stimulus policies; and re-infection risk renders laissez faire ineffcient even in steady state. Calibrated to the COVID-19 pandemic the model prescribes initial activity reductions of 38 percent. Stimulus policies account for a third of the welfare gains of intervention. Robustness along many dimensions contrasts with sensitivity of the policy prescriptions with respect to the intertemporal elasticity of substitution, activity-infections nexus, and re-infection risk. |
| Keywords: | Epidemic, lockdown, stimulus, logistic model, optimal control, COVID-19 |
| JEL: | D62 I18 |
| Date: | 2023–10 |
| URL: | http://d.repec.org/n?u=RePEc:ube:dpvwib:dp2311&r=dge |
| By: | William Ginn (LabCorp); Marc Pourroy (CRIEF - Centre de recherche sur l'intégration économique et financière - Université de Poitiers, Université de Poitiers) |
| Abstract: | Food price volatility is a major threat for welfare, economic prosperity and political stability. The monetary authority is generally viewed in the literature as the only institution responsible for price stability, however this approach overlooks the importance of food price stabilization policies using fiscal instruments. We develop and estimate a Bayesian DSGE model that incorporates monetary and fiscal policy tailored to India, replicating food demand and food supply subsidies. We find that following a world food price shock, CPI and therefore interest rate volatility would be 21% higher in the absence of food subsidies. Putting this effect aside would lead to overestimating the effectiveness of inflation targeting by the central bank. Accordingly, we find that the subsidy policy has large heterogeneous distributional welfare effects: while farmers benefit from all subsidies, the inclusion of urban households into the demand subsidy program is required to offset supply subsidy welfare cost. |
| Keywords: | DSGE Model, Price stabilisation, Food prices, Commodities, Monetary Policy, India |
| Date: | 2022–08 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-02944209&r=dge |
| By: | James Malley; Apostolis Philippopoulos; Jim Malley |
| Abstract: | We develop an endogenous growth model to quantify how permanent structural policy changes that enhance the fiscal policy mix, markets’ functioning, and public institutions’ quality affect long-term growth and welfare. The reforms include increased public investment, reduced market power through lower price markups for patents and intermediate goods, and an improved institutional framework that reduces rent-seeking. All reforms, except lower patent prices, lead to per-capita output and welfare gains along the transition and balanced growth paths. In contrast, a lower markup in the research sector hurts innovation, leading to lower growth over both paths and welfare losses along the transition. |
| Keywords: | endogenous growth, structural policy, welfare |
| JEL: | H30 O41 O43 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_10658&r=dge |
| By: | Wang, Chien-Chiang; Li, Yiting |
| Abstract: | This paper studies credit using a search-theoretic model with anonymity in which traders cannot reveal their true identities to the public but can create transaction accounts as identities to borrow and store their trade histories. A transaction account that is used to borrow would be excluded from future transactions as a punishment when default occurs, but a defaulter can create a new account to trade again. We show that increasing-credit-limit schemes connected to account ages, as captured by accumulated repayment records, emerges endogenously to ensure debt repayment. We extend the model to consider a situation in which a trader may create multiple accounts to borrow and default intentionally. Requiring that proof of a deterrence activity is provided when an account is created can help deter multi-account fraud and enhance the lifetime value of traders. |
| Keywords: | credit, digital currencies, search, imperfect information |
| JEL: | D83 E40 E51 |
| Date: | 2023–03–06 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:118480&r=dge |
| By: | Josef Schroth |
| Abstract: | Countercyclical bank capital requirements have emerged as a popular regulatory tool to help smooth financial cycles. The idea is to reduce capital requirements when exogenous shocks cause aggregate bank capital to decrease so that regulation does not needlessly constrain banks’ supply of credit. In the model in this paper, banks are rationally forward-looking and thus ignore short-lived reductions in capital requirements. During a financial crisis, a regulator would want to first impose drastic dividend restrictions to force banks to rebuild capital, but also would want to keep capital requirements low for a sufficiently long time afterwards. However, such a policy is not time-consistent. Once banks are sufficiently re-capitalized, the regulator would be tempted to immediately raise capital requirements all the way to pre-crisis levels. Optimal time-consistent capital regulation requires that bank capital is rebuilt gradually during financial crises. In particular, banks must be able to pay dividends even when bank equity is still significantly below pre-crisis levels. |
| Keywords: | Business fluctuations and cycles; Credit and credit aggregates; Credit risk management; Financial stability; Financial system regulation and policies; Lender of last resort |
| JEL: | E13 E32 E44 |
| Date: | 2023–09 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:23-49&r=dge |
| By: | Tomohiro Ara |
| Abstract: | This paper develops a dynamic industry model to study the effect of search frictions on industry structure and aggregate welfare. We consider a search-theoretic setting with two types of agents, firms and suppliers. To customize inputs, each firm needs to find a supplier but search is costly and does not always end in success. Matched firms use customized inputs obtained from matched suppliers to enhance production efficiency, while unmatched firms use generic inputs obtained from a competitive input market. In equilibrium the number of unmatched and matched firms is endogenous. We use this model to contrast the implications of two forms of economic integration: integration of final-good markets allowing firms to export varieties to another market, and integration of matching markets allowing firms to seek suppliers from another market. We show that the former form of integration can amplify the welfare gains from trade by improving firms’ matching frequency associated with resource reallocations from unmatched firms to matched firms. In contrast, the latter might cause welfare losses by hindering the resource-reallocation process of firms. |
| Date: | 2023–08 |
| URL: | http://d.repec.org/n?u=RePEc:toh:tupdaa:42&r=dge |
| By: | Daniela Del Boca; Christopher Flinn; Ewout Verriest; Matthew Wiswall |
| 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 D10 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_10641&r=dge |