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on Dynamic General Equilibrium |
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Issue of 2023‒12‒11
twenty-one papers chosen by Christian Zimmermann, Federal Reserve Bank of St. Louis |
| By: | Isabel Cairó; Hess T. Chung; Francesco Ferrante; Cristina Fuentes-Albero; Camilo Morales-Jimenez; Damjan Pfajfar |
| Abstract: | The deep deterioration in the labor market during the Great Recession, the subsequent slow recovery, and the missing disinflation are hard to reconcile for standard macroeconomic models. We develop and estimate a New-Keynesian model with financial frictions, search and matching frictions in the labor market, and endogenous intensive and extensive labor supply decisions. We conclude that the estimated combination of the low degree of nominal wage rigidities and high degree of real wage rigidities, together with the small role of pre-match costs relative to post-match costs, are key in successfully forecasting the slow recovery in unemployment and the missing disinflation in the aftermath of the Great Recession. We find that endogenous labor supply data are very informative about the relative degree of nominal and real wage rigidities and the slope of the Phillips curve. We also find that none of the model-based labor market gaps are a sufficient statistic of labor market slack, but all contain relevant information about the state of the economy summarized in a new indicator for labor market slack we put forward. |
| Keywords: | Search and matching; Labor supply; Labor force participation; Missing disinflation; Great recession |
| JEL: | E32 J64 J20 E37 |
| Date: | 2023–11–03 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2023-69&r=dge |
| By: | Alkis Blanz (University of Potsdam, MCC Berlin); Ulrich Eydam (University of Potsdam); Maik Heinemann (University of Potsdam); Matthias Kalkuhl (University of Potsdam, MCC Berlin); Nikolaj Moretti (University of Potsdam, MCC Berlin) |
| Abstract: | The effects of energy price increases are heterogeneous between households and firms. Financially constrained poorer households, who spend a larger relative share of their income on energy, are particularly affected. In this analysis, we examine the macroeconomic and welfare effects of energy price shocks in the presence of credit-constrained households that have subsistence-level energy demand. Within a Dynamic Stochastic General Equilibrium (DSGE) model calibrated for the German economy, we compare the performance of different policy measures (transfers and energy subsidies) and different financing schemes (income tax vs. debt). Our results show that credit-constrained households prefer debt over tax financing regardless of the compensation measure due to their difficulty to smooth consumption. On the contrary, rich households tend to prefer tax-financed measures as they increase the labor supply of poor households. From an aggregate perspective, tax-financed measures targeting firms effectively cushion aggregate output losses. |
| Keywords: | energy prices, E-DSGE, fiscal policy, welfare |
| JEL: | E62 E64 H31 H32 Q43 Q52 |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:pot:cepadp:70&r=dge |
| By: | Meghana Gaur (Princeton University); John Grigsby (Princeton University); Jonathon Hazell (London School of Economics and Political Science); Abdoulaye Ndiaye (New York University 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-Ã -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: | Dynamic Incentive Pay, Unemployment Dynamics |
| JEL: | J64 |
| Date: | 2023–09 |
| URL: | http://d.repec.org/n?u=RePEc:pri:econom:2023-05&r=dge |
| By: | Peltonen, Juho |
| Abstract: | This paper evaluates the social optimality of labor markets with search frictions and a job retention policy, named short-time work (STW), which has been applied in developed economies during the Covid-19 crisis. In a general equilibrium model, costs related to the STW cannot be internalized in wages, creating a systematic inefficiency through which job creation is too low. Government transfers to redistribute output to correct the inefficiency are proposed in the model. Furthermore, a calibration exercise matching the German economy over the period 2000-2021 suggests that transfers required for the social optimality are 1.9% of output. In addition, the unemployment rate is 1.8 percentage points lower in the presence of optimal transfers. |
| Keywords: | Search and matching; Short-time work policies; Constraint efficiency; Endogenous separations |
| JEL: | E24 J64 |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:119165&r=dge |
| By: | Takeda, Kohei (National University of Singapore) |
| Abstract: | Economies transform at an uneven pace. This paper develops a dynamic overlapping generations model of economic geography where historical exposure to different industries creates persistence in occupational structure, and non-homothetic preferences and differential productivity spillovers lead to different rates of structural transformation. The model is calibrated to the U.S. economy from 1980 to 2010. The calibration allows us to back out measures of upward mobility and inequality, thereby providing theoretical underpinnings for the Great Gatsby Curve. The counterfactual analysis reveals that structural transformation has substantial effects on a slowdown and explains heterogeneity in upward mobility across cities. |
| Date: | 2023–11–10 |
| URL: | http://d.repec.org/n?u=RePEc:osf:osfxxx:8nfx5&r=dge |
| By: | Peter Haan; Daniel Kemptner; Victoria Prowse; Maximilian Schaller |
| Abstract: | Individuals vary considerably in how much they earn during their lifetimes. This study examines the role of the tax-and-transfer system in mitigating such inequalities, which could otherwise lead to disparities in living standards. Utilizing a life-cycle model, we determine that taxes and transfers offset 45% of lifetime earnings inequality attributed to differences in productive abilities and education. Additionally, the system insures against 48% of lifetime earnings risk. Implementing a lifetime tax reform linking annual taxes to previous employment could improve the system’s insurance capabilities, albeit at the cost of a lower employment rate. |
| Keywords: | Lifetime earnings; lifetime income; tax-and-transfer system; taxation; unemployment insurance; disability benefits; social assistance; inequality; redistribution; insurance; education; productive ability; risk; dynamic life-cycle models |
| JEL: | D63 H23 I24 I38 J22 J31 |
| Date: | 2023–11–13 |
| URL: | http://d.repec.org/n?u=RePEc:bdp:dpaper:0028&r=dge |
| By: | Lahiri, Amartya; Singh, Rajesh |
| Abstract: | We investigate the welfare implications of alternative monetary policy rules in a small open economy with access to world capital markets. Financial market access is costly and induces an endogenous segmentation of households into non-traders who never participate and traders who only participate intermittently in asset markets. The model can reproduce standard business cycle moments of open economies including a countercyclical current account even though the model has no capital and investment. Our main policy result is that procyclical monetary policy outperforms both the Taylor rule and inflation targeting in this environment. Given widespread evidence of endemic financial exclusion throughout the world, these results suggest caution in importing monetary policy prescriptions tailored for developed countries into emerging economies. |
| Date: | 2023–11–06 |
| URL: | http://d.repec.org/n?u=RePEc:isu:genstf:202311061804290000&r=dge |
| By: | Meyer-Gohde, Alexander |
| Abstract: | This paper develops and implements a backward and forward error analysis of and condition numbers for the numerical stability of the solutions of linear dynamic stochastic general equilibrium (DSGE) models. Comparing seven different solution methods from the literature, I demonstrate an economically significant loss of accuracy specifically in standard, generalized Schur (or QZ) decomposition based solutions methods resulting from large backward errors in solving the associated matrix quadratic problem. This is illustrated in the monetary macro model of Smets and Wouters (2007) and two productionbased asset pricing models, a simple model of external habits with a readily available symbolic solution and the model of Jermann (1998) that lacks such a symbolic solution - QZ-based numerical solutions miss the equity premium by up to several annualized percentage points for parameterizations that either match the chosen calibration targets or are nearby to the parameterization in the literature. While the numerical solution methods from the literature failed to give any indication of these potential errors, easily implementable backward-error metrics and condition numbers are shown to successfully warn of such potential inaccuracies. The analysis is then performed for a database of roughly 100 DSGE models from the literature and a large set of draws from the model of Smets and Wouters (2007). While economically relevant errors do not appear pervasive from these latter applications, accuracies that differ by several orders of magnitude persist. |
| Keywords: | Numerical accuracy, DSGE, Solution methods, Condition number, Backward error, Forward error |
| JEL: | C61 C63 E17 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:imfswp:279899&r=dge |
| By: | Pablo Garcia-Sanchez (Banque centrale du Luxembourg, Departement Economie et Recherche); Olivier Pierrard (Banque centrale du Luxembourg, Departement Economie et Recherche) |
| Abstract: | We build a life cycle model to study the implications of two types of lifetime uncertainty on investment in health and welfare. We show that when the hazard rate of death depends on age, uncertainty increases health investment. Instead, when hazard rate depends on human frailty, uncertainty decreases health investment. In both cases, uncertainty reduces welfare. The size of the effects depends on an aggregate parameter related to the natural increase in human frailty with age, to the marginal return on health investment and to the rate of time preference. We first derive the main results from a small model which admits an analytical solution, before generalizing them in a larger model using numerical simulations. We conclude that the role of uncertainty depends on how death is modeled; and that if death is linked to frailty, as suggested by empirical evidence, a health policy reducing health uncertainty would stimulate individual investment in health promoting activities and improve welfare. |
| Keywords: | life cycle, uncertainty, health, welfare |
| JEL: | C60 D15 D81 I12 I18 |
| Date: | 2023–11–14 |
| URL: | http://d.repec.org/n?u=RePEc:ctl:louvir:2023020&r=dge |
| By: | Bouabdallah, Othman; Jacquinot, Pascal; Patella, Valeria |
| Abstract: | In most euro area countries, the monetary/fiscal policy mix is responsible for the changing history of debt and inflation facts. Using a Dynamic Stochastic General Equilibrium model with Markov-switching policy rules, we identify three distinct monetary/fiscal regimes in France and Italy: a Passive Monetary-Active Fiscal regime (PM/AF) before the late 80s/early 90s; an Active Monetary-Passive Fiscal regime (AM/PF) with central bank independence and EMU convergence; a third regime with policy rates at the effective lower bound combined with fiscal active behavior to sustain the recovery. Our simulations reveal that the PM/AF regime in France led to price volatility and debt stabilisation, while the AM/PF regime resulted in disinflation and rising debt trajectory. Meanwhile, Italy’s procyclical fiscal policy in downturns contributed to persisting imbalances, high aggregate volatility, and low growth. JEL Classification: E63, E62, E32, E52, C32 |
| Keywords: | debt, euro area, inflation, Markov-switching, Monetary-fiscal policy mix |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20232871&r=dge |
| By: | Singh, Rajesh; Hasan, Mohammad |
| Abstract: | Financially integrated economies observe a cross-country credit boom prior to financial recessions and a bust afterwards. This paper presents a two-country real business cycle model with banking sector where privately known intermediation efficiency of banks make them heterogeneous and gives rise to an interbank market. Overaccumulation of assets or low productivity in one country may lead to credit freeze in both financially integrated countries due to the existence of moral hazard and asymmetric information in the interbank market. A “sail together” financial integration may go into a “sink together” interbank credit freeze. |
| Date: | 2023–11–01 |
| URL: | http://d.repec.org/n?u=RePEc:isu:genstf:202311011603320000&r=dge |
| By: | Julian di Giovanni; Ṣebnem Kalemli-Özcan; Alvaro Silva; Muhammed A. Yildirim |
| Abstract: | We estimate a multi-country multi-sector New Keynesian model to quantify the drivers of domestic inflation during 2020–2023 in several countries, including the United States. The model matches observed inflation together with sector-level prices and wages. We further measure the relative importance of different types of shocks on inflation across countries over time. The key mechanism, the international transmission of demand, supply and energy shocks through global linkages helps us to match the behavior of the USD/Euro exchange rate. The quantification exercise yields four key findings. First, negative supply shocks to factors of production, labor and intermediate inputs, initially sparked inflation in 2020–2021. Global supply chains and complementarities in production played an amplification role in this initial phase. Second, positive aggregate demand shocks, due to stimulative policies, widened demand-supply imbalances, amplifying inflation further during 2021–2022. Third, the reallocation of consumption between goods and service sectors, a relative sector-level demand shock, played a role in transmitting these imbalances across countries through the global trade and production network. Fourth, global energy shocks have differential impacts on the US relative to other countries’ inflation rates. Further, complementarities between energy and other inputs to production play a particularly important role in the quantitative impact of these shocks on inflation. |
| JEL: | F40 |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:31887&r=dge |
| By: | Johnny Cotoc; Alok Johri; Cesar Sosa-Padilla |
| Abstract: | Nations vary widely in how often they are governed by left-wing governments. Using data from 56 nations over 45 years, we find that the propensity of a nation to elect the left is positively correlated with both the average level and volatility of their sovereign spreads. To explain these facts, we build a quantitative sovereign default model in which two policymakers (left and right) alternate in power. Reelection probabilities are increasing in government spending, with the left having a small advantage (as found in the data). We use variation in the responsiveness of reelection probabilities to government spending in order to create economies that elect the left more or less frequently in equilibrium. We call these the left leaning and the right leaning economy. The left leaning economy faces worse borrowing terms due to higher default risk. Moreover, both policymakers have a greater reluctance for fiscal austerity and choose a higher share of government spending as compared to their counterparts in the right leaning economy. These features imply large welfare losses for households. |
| Keywords: | Sovereign default; Interest rate spread; Political turnover; Left-wing; Right-wing; Cyclicality of fiscal policy |
| JEL: | F34 F41 |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:mcm:deptwp:2023-04&r=dge |
| By: | Alexis Derviz |
| Abstract: | When several central banks decide to introduce CBDCs, interoperability requirements create demand for a common payment infrastructure and a joint digital accounting unit (bridge coin). Many attributes of the latter resemble those of private digital currencies. At the same time, the CBDC-embracing authorities actively contribute to elevating digital wallets to the position of a household technology. Private agents discover ways to make domestic and foreign payments in the (digital) currency of their choice irrespective of the CBDC-issuing authorities' intentions. In such a world, will fiat currencies and the central banks that issue them be sidetracked by the bridge coin, or are old and new forms of international transactions able to coexist? What changes await the traditional FX market? These questions are addressed in a two-country, twogood, two-currency DSGE model with a global digital currency (digicoin). Under a certain structure of FX transaction costs, all three partial FX markets coexist and the use of fiat currency in foreign trade is unlikely to be eliminated completely as long as the bridge coin operator is unable to become a global banker as well. |
| Keywords: | Bridge coin, cash in advance, CBDC, digital currency, FX market |
| JEL: | C61 C63 D58 E02 E59 G23 |
| Date: | 2023–07 |
| URL: | http://d.repec.org/n?u=RePEc:cnb:wpaper:2023/7&r=dge |
| By: | Singh, Rajesh |
| Abstract: | This paper compares the welfare under two standard alternative exchange rate regimes, fixed and flexible, in a stochastic dynamic general equilibrium two-country setting. Conventional wisdom holds that countries often prefer low exchange-rate variability to stabilize trade. This may explain the observed `fear of floating' in emerging markets -- although most of them claim to adopt a flexible system, in reality they often intervene to peg. We show that under incomplete capital markets a fixed exchange rate regime unambiguously increases trade and improves welfare. This provides a potential explanation for the observed exchange rate policies in emerging markets. |
| Date: | 2023–11–06 |
| URL: | http://d.repec.org/n?u=RePEc:isu:genstf:202311061509510000&r=dge |
| By: | Carlos Carrillo-Tudela; Leo Kaas; Benjamin Lochner |
| Abstract: | Firms and workers predominately match via job postings, networks of personal contacts or the public employment agency, all of which help to ameliorate labor market frictions. In this paper we investigate the extent to which these search channels have differential effects on labor market outcomes. Using novel linked survey-administrative data we document that (i) low-wage firms and low-wage workers are more likely to match via networks or the public agency, while high-wage firms and high-wage workers succeed more often via job postings; (ii) job postings help firms the most in poaching and attracting high-wage workers and help workers the most in climbing the job ladder. To evaluate the implications of these findings for employment, wages and labor market sorting, we structurally estimate an equilibrium job ladder model featuring two-sided heterogeneity, multiple search channels and endogenous recruitment effort. The estimation reveals that networks are the most cost-effective channel, allowing firms to hire quickly, yet attracting workers of lower average ability. Job postings are the most costly channel, facilitate hiring workers of higher ability, and matter most for worker-firm sorting. Although the public employment agency provides the lowest hiring probability, its removal has sizeable consequences, with aggregate employment declining by at least 1.4 percent and rising bottom wage inequality. |
| Keywords: | search channels, on-the-job search, recruitment effort, sorting wage dispersion |
| JEL: | E24 J23 J31 J63 J64 |
| Date: | 2023 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_10761&r=dge |
| By: | Singh, Rajesh; Hasan, Mohammad |
| Abstract: | The maturity structure of debt plays an important role in default probability and the resulting pricing of sovereign bonds. Using a calibrated model this paper shows that both the default probabilities and the prices get improved when the sovereign issues long-term bonds or both short- and long-term bonds instead of issuing only short-term bonds. This paper also shows that the inclusion of the compensation covenant mitigates the dilution problem of sovereign debt on a larger scale when the maturity of long-term bonds is sufficiently high. |
| Date: | 2023–11–01 |
| URL: | http://d.repec.org/n?u=RePEc:isu:genstf:202311011433100000&r=dge |
| By: | John Cochran |
| Abstract: | Our central banks set interest rate targets, and do not even pretend to control money supplies. How do interest rates affect inflation? We finally have a complete theory of inflation under interest rate targets and unconstrained liquidity. Its long-run properties mirror those of monetary theory: Inflation can be stable and determinate under interest rate targets, including a peg, analogous to a k-percent rule. The zero bound era is confirmatory evidence. Uncomfortably, stability means that higher interest rates eventually raise inflation, just as higher money growth eventually raises inflation. Sticky prices generate some short-run non-neutrality as well: Higher nominal interest rates can raise real rates and lower output. A model in which higher nominal interest rates temporarily lower inflation, without a change in fiscal policy, is a harder task. I exhibit one such model, but it paints a much more limited picture than standard beliefs. We either need a model with a stronger effect, or to accept that higher interest rates have quite limited power to lower inflation. Empirical understanding of how interest rates affect inflation without fiscal help is also a wide-open question. |
| Keywords: | interest rates, inflation, neutrality, non-neutrality |
| JEL: | E4 E5 |
| Date: | 2023–10 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:1136&r=dge |
| By: | Stefano Bosi (EPEE - Centre d'Etudes des Politiques Economiques - UEVE - Université d'Évry-Val-d'Essonne - Université Paris-Saclay); David Desmarchelier (BETA - Bureau d'Économie Théorique et Appliquée - AgroParisTech - UNISTRA - Université de Strasbourg - Université de Haute-Alsace (UHA) - Université de Haute-Alsace (UHA) Mulhouse - Colmar - UL - Université de Lorraine - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement); Thai Ha-Huy (EPEE - Centre d'Etudes des Politiques Economiques - UEVE - Université d'Évry-Val-d'Essonne - Université Paris-Saclay, TIMAS, Thang Long University) |
| Abstract: | We consider a simple economy where production depends on labor supply and social capital. Networking increases the social capital ("greases the wheel") but also the corruption level ("sands the wheel"). Corruption is a negative productive externality. We compare the market economy, where the negative externality is not taken into account by individuals, with a centralized economy, where the planner internalizes the negative effect. We highlight the possible existence of cycles in the market economy and optimal cycles in the planned economy. We compare the centralized and the decentralized solutions in the short and long run. |
| Keywords: | Corruption, Optimal cycles, Ramsey model |
| Date: | 2022–12 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-03982895&r=dge |
| By: | Mr. Andrew Berg; Yaroslav Hul; Mr. Philippe D Karam; Adam Remo; Diego Rodriguez Guzman |
| Abstract: | This paper presents a semi-structural macroeconomic model aimed at facilitating policy analysis and forecasting, primarily in countries with imperfect capital mobility and hybrid monetary policy regimes. Compared to earlier gap-trend projection models, the Forecasting Model of Internal and External Balance (FINEX) contains three main innovations: it accentuates external and internal balances; explicitly incorporates fiscal policy; and partly endogenizes the main trends. FINEX thus covers a broad set of policy instruments, including foreign exchange interventions (FXI), capital flow management measures (CFM), as well as common fiscal policy instruments. The model incorporates insights from the recent DSGE literature, while maintaining a more accessible gap-trend structure that lends itself to practical policy applications. While the paper refrains from drawing broad policy lessons, it emphasizes the model's ability to interpret recent data in terms of structural shocks and policy responses, thereby aiding policymakers in constructing coherent economic narratives and considering alternative scenarios. |
| Keywords: | Semi-Structural Modeling; Monetary Policy; Fiscal Policy; Foreign Exchange Intervention; Forecasting; Imperfect Capital Mobility |
| Date: | 2023–11–10 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:2023/235&r=dge |
| By: | Tarun Sabarwal (Department of Economics, University of Kansas, Lawrence, KS 66045, USA) |
| Abstract: | We develop a universal theory of equilibrium for models with complementarities on partially ordered sets (posets), unifying lattice-based theories used widely in economics and other disciplines and poset-based theories useful to study stochastic systems in many settings. Our theorems for extremal equilibria, structure of equilibrium set, and monotone comparative statics (MCS) of equilibrium generalize both types of theories in a unified manner. This extends to new theorems for MCS of the infimum equilibrium set, supremum equilibrium set, full equilibrium set, and isotone equilibrium set, and to a universal theory of order approximation of equilibria as well. As an application, we show new, deeper structural features of equilibrium in the canonical isotone stochastic dynamic economy with correlated shocks due to Hopenhayn and Prescott (1992). |
| Keywords: | complementarities; Equilibrium; Fixed Point; Poset; Monotone Comparative Statics; Stochastic System. |
| JEL: | C02 C60 C62 C70 D70 |
| Date: | 2023–11 |
| URL: | http://d.repec.org/n?u=RePEc:kan:wpaper:202312&r=dge |