nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2023‒10‒30
nineteen papers chosen by
Christian Zimmermann, Federal Reserve Bank of St. Louis

  1. Inequality and Business Cycles By Florin O. Bilbiie; Giorgio Primiceri; Andrea Tambalotti
  2. Labor Market Discrimination and the Racial Unemployment Gap: Can Monetary Policy Make a Difference? By Isabel Cairó; Avi Lipton
  3. Robust monetary policy under shock uncertainty By Mario Carceller del Arco; Jan Willem van den End
  4. Modeling the impact of news shocks on the economy in dynamic stochastic general equilibrium models By Sugaipov, Denis (Сугаипов, Денис)
  5. Climate-conscious monetary policy By Nakov, Anton; Thomas, Carlos
  6. Optimal monetary policy in an estimated SIR model By Benmir, Ghassane; Jaccard, Ivan; Vermandel, Gauthier
  7. A Perturbational Approach for Approximating Heterogeneous Agent Models By Anmol Bhandari; Thomas Bourany; David Evans; Mikhail Golosov
  8. Measuring the Effects of Unconventional Monetary Policy Tools under Adaptive Learning By Cole, Stephen J.; Huh, Sungjun;
  9. Energy Prices and Household Heterogeneity: Monetary Policy in a Gas-TANK By Chan, Jenny; Diz, Sebastian; Kanngiesser, Derrick
  10. Bonus Question: Does Flexible Incentive Pay Dampen Unemployment Dynamics? By Gaur, Meghana; Grigsby, John; Hazell, Jonathon; Ndiaye, Abdoulaye
  11. An algorithm for quickly finding long-term equilibria in models of overlapping generations By Zaytsev, Aleksey (Зайцев, Алексей)
  12. Minimum Wages, Wage Dispersion and Financial Constraints in Firms By Arabzadeh, Hamzeh; Balleer, Almut; Gehrke, Britta; Taskin, Ahmet Ali
  13. How much work experience do you need to get your first job? The macroeconomic implications of bias against labor market entrants By Shisham Adhikari; Athanasios Geromichalos; Ioannis Kospentaris
  14. Obsolescence Rents: Teamsters, Truckers, and Impending Innovations By Costas Cavounidis; Qingyuan Chai; Kevin Lang; Raghav Malhotra
  15. Living Up to Expectations: Central Bank Credibility, the Effectiveness of Forward Guidance and Inflation Dynamics Post-Global Financial Crisis By Stephen J. Cole; Enrique Martinez-Garcia; Eric Sims
  16. Default Risk and Transition Dynamics with Carbon Shocks By Sujan Lamichhane
  17. Effects of Carbon Pricing in Germany and Spain: An Assessment with EMuSe By Natascha Hinterlang
  18. Regional Trade Policy Uncertainty By Céline Poilly; Fabien Tripier
  19. Life Expectancy, Income and Long-Term Care: The Preston Curve Reexamined By Thibault, Emmanuel; Ponthieres, Grégory

  1. By: Florin O. Bilbiie; Giorgio Primiceri; Andrea Tambalotti
    Abstract: We quantify the connection between inequality and business cycles in a medium-scale New Keynesian model with tractable household heterogeneity, estimated with aggregate and cross-sectional data. We find that inequality substantially amplifies cyclical fluctuations. The primary source of this amplification is cyclical precautionary saving behavior. Savers reduce their consumption to insure themselves against the idiosyncratic risk of large income drops, which rises in recessions.
    JEL: E30
    Date: 2023–09
  2. By: Isabel Cairó; Avi Lipton
    Abstract: Black workers experience a higher unemployment rate, as well as more volatile employment dynamics, than white workers, and the racial unemployment rate gap is largely unexplained by observable characteristics. We develop a New Keynesian model with search and matching frictions in the labor market, endogenous separations, and employer discrimination against Black workers to explain these outcomes. The model is consistent with key features of the aggregate economy and is able to explain key labor market disparities across racial groups. We then use this model to assess the effects of the Federal Reserve’s new monetary policy framework---interest rates respond to shortfalls of employment from its maximum level rather than deviations---on racial inequality in the labor market. We find that shifting from a Deviations interest rate rule to a Shortfalls rule reduces the racial unemployment rate gap and the model-based measures of labor market discrimination but increases the average inflation rate. From a welfare perspective, we find that the Shortfalls approach does not do much to reduce racial inequality in our model economy.
    Keywords: Unemployment; Monetary policy; Racial inequality; Discrimination
    JEL: E24 E52 J15 J70
    Date: 2023–10–03
  3. By: Mario Carceller del Arco; Jan Willem van den End
    Abstract: We assess the robustness of monetary policy under shock uncertainty based on a novel empirical method. Shock uncertainty arises from the inability to observe the output gap in real time, by which the contribution of supply and demand shocks to inflation is unknown. We apply our method in a medium-scale Dynamic Stochastic General Equilibrium (DSGE) model to the recent inflation surge in the US. We find that robust monetary policy aimed at limiting extreme welfare losses under shock uncertainty should neither be too strong nor too mild, given the probability that supply shocks are a dominant driver of economic fluctuations. An overly strong response to inflation in supply driven scenarios is associated with large tail losses due to adverse output dynamics.
    Keywords: Monetary policy; Inflation; Policy-making under risk and uncertainty
    JEL: E52 E58 D81
    Date: 2023–10
  4. By: Sugaipov, Denis (Сугаипов, Денис) (The Russian Presidential Academy of National Economy and Public Administration)
    Abstract: This paper systematizes the experience of empirical research on news shocks, in particular on models of vector autoregressions, as well as dynamic stochastic models of general equilibrium. The review examines the work with various types of shocks, presents the main disadvantages of different classes of models used to analyze the impact of news shocks on developed and developing economies. The main prerequisites that need to be included in the DSGE are highlighted models so that these models can demonstrate a co-directional change the main macroeconomic indicators in response to the news shock. It has also been demonstrated that VAR models and DSGE models use many similar ideas – it is useful to include predictive indicators in each of these models. During the research it was found that the proportion of explained variation in works with DSGE models is very different from the proportion of explained variation in works with VAR models. A possible reason may be that VAR models are characterized by the problem of non-fundamentality.
    Keywords: news shocks, aggregate factor productivity, terms of trade, business cycles, dynamic stochastic general equilibrium models
    Date: 2023–06–13
  5. By: Nakov, Anton; Thomas, Carlos
    Abstract: We study the implications of climate change and the associated mitigation measures for optimal monetary policy in a canonical New Keynesian model with climate externalities. Provided they are set at their socially optimal level, carbon taxes pose no trade-offs for monetary policy: it is both feasible and optimal to fully stabilize inflation and the welfare-relevant output gap. More realistically, if carbon taxes are initially suboptimal, trade-offs arise between core and climate goals. These trade-offs however are resolved overwhelmingly in favor of price stability, even in scenarios of decades-long transition to optimal carbon taxation. This reflects the untargeted, inefficient nature of (conventional) monetary policy as a climate instrument. In a model extension with financial frictions and central bank purchases of corporate bonds, we show that green tilting of purchases is optimal and accelerates the green transition. However, its effect on CO2 emissions and global temperatures is limited by the small size of eligible bonds’ spreads. JEL Classification: E31, E32, Q54, Q58
    Keywords: climate change externalities, green QE, Pigouvian carbon taxes, Ramsey optimal monetary policy
    Date: 2023–09
  6. By: Benmir, Ghassane; Jaccard, Ivan; Vermandel, Gauthier
    Abstract: This paper studies the design of Ramsey optimal monetary policy in a Health New Keynesian (HeNK) model with Susceptible, Infected and Recovered (SIR) agents. The nonlinear model is estimated with maximum likelihood techniques on Euro Area data. Our objective is to deconstruct the mechanism by which contagion risk affects the conduct of monetary policy. If monetary policy is the only game in town, we find that the optimal policy features significant deviations from price stability to mitigate the effect of the pandemic. The best outcome is obtained when the optimal Ramsey policy is combined with a lockdown strategy of medium intensity. In this case, monetary policy can concentrate on its price stabilization objective. JEL Classification: E52, E32
    Keywords: Covid-19, HeNK, macroeconomic trade-offs, nonlinear inference, Tin-bergen principle
    Date: 2023–09
  7. By: Anmol Bhandari; Thomas Bourany; David Evans; Mikhail Golosov
    Abstract: We develop a perturbational technique to approximate equilibria of a wide class of discrete-time dynamic stochastic general equilibrium heterogeneous-agent models with complex state spaces, including multi-dimensional distributions of endogenous variables. We show that approximating policy functions and stochastic process that governs the distributional state to any order is equivalent to solving small systems of linear equations that characterize values of certain directional derivatives. We analytically derive the coefficients of these linear systems and show that they satisfy simple recursive relations, making their numerical implementation quick and efficient. Compared to existing state-of-the-art techniques, our method is faster in constructing first-order approximations and extends to higher orders, capturing the effects of risk that are ignored by many current methods. We illustrate how to apply our method to a broad set of questions such as impacts of first- and second-moment shocks, welfare effect of macroeconomic risk and stabilization policies, endogenous household portfolio formation, and transition dynamics in heterogeneous agent general equilibrium settings.
    JEL: E3
    Date: 2023–09
  8. By: Cole, Stephen J.; Huh, Sungjun; (Department of Economics Marquette University; Department of Economics Marquette University)
    Abstract: We compare the economic effects of forward guidance and quantitative easing utilizing the four-equation New Keynesian model of Sims, Wu, and Zhang (2023) with agents forming expectations via an adaptive learning rule. The results indicate forward guidance can have a greater influence on macroeconomic variables compared to quantitative easing, suggesting that forward guidance may have contributed to the high inflation rate after the COVID-19 related recession. Adaptive learning agents estimate a higher effect of forward guidance on the economy leading to a greater impact on expectations, and thus, contemporaneous inflation. However, the performance gap between forward guidance and quantitative easing can change. If quantitative easing includes anticipated shocks, more households finance consumption through long-term borrowing, and the central bank provides a greater percentage of liquidity in the long-term borrowing market, the performance of quantitative easing can increase, and at times, outperform forward guidance.
    Keywords: unconvetional monetary policy, QE, LSAP, forward guidance, adaptive learning
    JEL: E32 E52 E58 D83
    Date: 2023–10
  9. By: Chan, Jenny; Diz, Sebastian; Kanngiesser, Derrick
    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 labor and an energy import good as complementary production inputs (Gas-TANK). Given such complementarities, higher energy prices reduce the labor 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 labor 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 labor 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 generalized to alternate supply shocks, as the specific nature of the supply shock affects how resources are redistributed in the economy.
    Keywords: Heterogenous agent models, business cycle fluctuations, energy, monetary policy
    JEL: E5
    Date: 2022–10
  10. By: Gaur, Meghana (Princeton University); Grigsby, John (Princeton University); Hazell, Jonathon (London School of Economics); Ndiaye, Abdoulaye (NYU Stern)
    Abstract: We introduce dynamic incentive contracts into a model of unemployment dynamics and present three results. First, wage cyclicality from incentives does not dampen unemployment dynamics: the response of unemployment to shocks is first-order equivalent in an economy with flexible incentive pay and without bargaining, vis-a-vis an economy with rigid wages. Second, wage cyclicality from bargaining dampens unemployment dynamics through the standard mechanism. Third, our calibrated model suggests 46% of wage cyclicality in the data arises from incentives. A standard model without incentives calibrated to weakly procyclical wages, matches unemployment dynamics in our incentive pay model calibrated to strongly procyclical wages.
    Keywords: incentive contracts, unemployment dynamics, wage rigidity
    JEL: E24 E32 J41
    Date: 2023–09
  11. By: Zaytsev, Aleksey (Зайцев, Алексей) (The Russian Presidential Academy of National Economy and Public Administration)
    Abstract: In this paper, we consider the problem of finding long-term equilibria in models of overlapping generations with a large number of periods. It is often possible to reduce the solution of a model to finding the roots of a system of equations. Some OLG models, after the introduction of additional variables, can be reduced to the form of a system of polynomials. Thus, one can represent the set of long-term equilibria as algebraic diversity. This makes it possible to use computational methods from algebraic geometry in economic problems. In particular, the method using Grebner bases has become popular. However, this approach can be effectively applied only when there are few variables. We propose an algorithm for finding solutions to the system and use it to investigate the presence of a plurality of solutions in realistically calibrated models with long-lived agents.
    Keywords: OLG models, plurality of equilibria, Groebner bases, system of polynomials
    JEL: C02 C32 D11 D58
    Date: 2023–05–07
  12. By: Arabzadeh, Hamzeh (RWTH Aachen University); Balleer, Almut (RWTH Aachen University); Gehrke, Britta (Freie Universität Berlin); Taskin, Ahmet Ali (Institute for Employment Research (IAB), Nuremberg)
    Abstract: This paper studies how minimum wages affect the wage distribution if firms face financial constraints. Using German employer-employee data and firm balance sheets, we document that the within-firm wage dispersion decreases more with higher minimum wages when firms are financially constrained. We introduce financial frictions into a search and matching labor market model with stochastic job matching, imperfect information, and endogenous effort. In line with the empirical literature, the model predicts that a higher minimum wage reduces hirings and separations. Firms become more selective such that their employment and wage dispersion fall. If effort increases strongly, firms may increase employment at the expense of higher wage dispersion. Financially constrained firms are more selective and reward effort less. As a result, within-firm wage dispersion and employment in these firms fall more with the minimum wage.
    Keywords: minimum wage, wage dispersion, financial frictions, search and matching, unemployment
    JEL: J31 J38 J63 J64
    Date: 2023–09
  13. By: Shisham Adhikari; Athanasios Geromichalos; Ioannis Kospentaris (Department of Economics, University of California Davis)
    Abstract: The first step in a worker’s career is often particularly hard. Many firms seeking workers require experience in a related field, so a vicious circle is created, whereby an entry level job is required in order to get an entry level job. Consequently, entrant workers have lower job-finding rates and longer unemployment durations than the unemployed who have looked for a job in the past. To study the welfare implications of these observations, we consider a version of the DMP model where firms who match with entrant workers have to incur training costs. As a result, firms are biased against entrant workers, who, in turn, stay unemployed for a prolonged period of time, exposing themselves to a persistent skill loss shock. In this environment, an obvious market failure arises. Firms who hire entrant workers provide a benefit to society by helping these workers stay unemployed for a shorter period of time, thus reducing the probability of skill loss. But since firms cannot internalize this societal contribution, they choose to discriminate against entrant workers causing a welfare loss. We use a calibrated version of the model to quantitatively assess the effectiveness of three government interventions, whose common goal is to reduce bias against entrant workers. We find that the most effective intervention takes the form of an “internship”, where firms can hire entrant workers at an (exogenous) lower wage.
    Keywords: search and matching, unemployment, labor market entrants, training, skills
    JEL: E24 E60 J24 J64
    Date: 2023–10–10
  14. By: Costas Cavounidis; Qingyuan Chai; Kevin Lang; Raghav Malhotra
    Abstract: We consider large, permanent shocks to individual occupations whose arrival date is uncertain. We are motivated by the advent of self-driving trucks, which will dramatically reduce demand for truck drivers. Using a bare-bones overlapping generations model, we examine an occupation facing obsolescence. We show that workers must be compensated to enter the occupation - receiving what we dub obsolescence rents - with fewer and older workers remaining in the occupation. We investigate the market for teamsters at the dawn of the automotive truck as an á propos parallel to truckers themselves, as self-driving trucks crest the horizon. As widespread adoption of trucks drew nearer, the number of teamsters fell, the occupation became ‘grayer’, and teamster wages rose, as predicted by the model.
    JEL: J20 J31 J62 O33
    Date: 2023–09
  15. By: Stephen J. Cole; Enrique Martinez-Garcia; Eric Sims
    Abstract: This paper studies the effectiveness of forward guidance when central banks have imperfect credibility. Exploiting unique survey-based measures of expected inflation, output growth and interest rates, we estimate a small-scale New Keynesian model for the United States and other G7 countries plus Spain allowing for deviations from full information rational expectations. In our model, the key parameter that aggregates heterogeneous expectations captures the central bank's credibility and affects the overall effectiveness of forward guidance. We find that the central banks of the U.S., the U.K., Germany and other major advanced economies have similar levels of credibility (albeit far from full credibility); however, Japan's central bank credibility is much lower. For each country, our measure of credibility has declined over time, making forward guidance less effective. In a counterfactual analysis, we document that inflation would have been significantly higher, and the zero lower bound on short-term interest rates much less of an issue, in the wake of the Global Financial Crisis had the public perceived central bank forward guidance statements to be perfectly credible. Moreover, inflation would have declined more, and somewhat faster, with perfect credibility in the wake of the inflation surge post-COVID-19.
    Keywords: forward guidance; central bank credibility; heterogeneous expectations
    JEL: D84 E30 E52 E58 E60 P52
    Date: 2023–09–29
  16. By: Sujan Lamichhane
    Abstract: Climate mitigation policies are being introduced around the world to limit global warming, generating new risks to the economy. This paper develops a continuous time heterogeneous agents model to study the impact of carbon pricing policy shocks on corporate default risk and the consequent transition dynamics. We derive a closed-form solution to corporate default probability based on firms' intertemporal optimization decisions and explicitly characterize the transition speed. This allows for studying policy implications in an analytically tractable way. The model is calibrated to different US corporate sectors to quantify the heterogeneous effects of carbon price shocks. While carbon-intensive sectors face increased default risks, there are notable asymmetric effects within sectors. Higher carbon prices increase default risk but also induce faster transition towards the new post-shock steady state with a highly non-linear impact. Our results suggest that once a range of possible price shocks are accounted for, the increase in the cost of capital/risk premiums might be sharply different across sectors.
    Keywords: Default risk; climate risk; carbon price; transition dynamics; cost of capital; risk premium.; climate mitigation policy; carbon price shock; policy shock; price shock; default rate; Debt default; Greenhouse gas emissions; Manufacturing; Global
    Date: 2023–08–25
  17. By: Natascha Hinterlang (Deutsche Bundesbank and Banco de España)
    Abstract: Using the dynamic, three-region environmental multi-sector general equilibrium model EMuSe, we find that pricing carbon in Germany or Spain only leads to a permanent negative effect on output in these economies. The induced emissions reduction is not large enough to overcompensate for the increase in marginal production costs. If the rest of Europe joins the carbon pricing scheme, long-run output effects are positive. However, in this case, transition costs are even larger due to close trade relations within Europe. We find evidence for carbon leakage, which can be reduced slightly by a border adjustment mechanism. Still, it is no game changer as it mainly protects dirty domestic sectors. While Germany benefits from border adjustment, Spain actually loses throughout the transition. In the long run, the Spanish energy sector benefits most because of its relatively low emission intensity. Finally, Europe has a strong incentive to get the rest of the world on board as then the downturn is shorter and long-run benefits are larger.
    Keywords: carbon pricing, border adjustment, climate clubs, international dynamic general equilibrium model, sectoral heterogeneity, input-output matrix
    JEL: E32 E62 F42 H32 Q58
    Date: 2023–09
  18. By: Céline Poilly (Aix-Marseille Univ., CNRS, AMSE, France.); Fabien Tripier (Université Paris Dauphine, PSL Research University, LEDa, France, & CEPREMAP)
    Abstract: Higher uncertainty about trade policy has recessionary effects in U.S. states. First, this paper builds a novel empirical measure of regional trade policy uncertainty, based on the volatility of national import tariffs at the sectoral level and the sectoral composition of imports in U.S. states. We show that a state which is more exposed to an unanticipated increase in tariff volatility suffers from a larger drop in real output and employment, relative to the average U.S. state. We then build a regional open-economy model and we argue that the transmission channels of uncertainty shocks, in particular the precautionary-pricing channel, are magnified in regions that feature the highest import share and a strongest export intensity. Furthermore, we show that an expansionary monetary policy may amplify the regional divergence since it worsens the recession in the most-exposed region to trade policy uncertainty.
    Keywords: uncertainty shocks, regional effects, precautionary pricing, monetary policy
    JEL: E32 E52 F41
    Date: 2023–10
  19. By: Thibault, Emmanuel; Ponthieres, Grégory
    Abstract: The Preston Curve - the increasing relation between income per capita and life expectancy - cannot be observed in countries where old-age dependency is widespread (that is, where long-term care (LTC) spending per capita is high). The absence of the Preston Curve in countries with high old-age dependency can be related to two other stylized facts: (1) the inverted-U relation between LTC spending and life expectancy; (2) the inverted-U relation between LTC spending and preventive health investments. This paper develops a two-period OLG model where survival to the old age depends on preventive health spending chosen by individuals while anticipating (fixed) old-age LTC costs. In that model, anticipated LTC costs are shown to have a non-monotonic effect on preventive health investment, thus rationalizing stylized facts (1) and (2). This framework is shown to provide an explanation for the absence of the Preston Curve in countries where old-age dependency is more acute.
    Keywords: Preston Curve, ; life expectancy; OLG models, ; long-term care
    JEL: E13 E21 I15 J14
    Date: 2023–10–09

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