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on Dynamic General Equilibrium |
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Issue of 2024‒02‒05
seventeen papers chosen by Christian Zimmermann, Federal Reserve Bank of St. Louis |
| By: | Marco Del Negro; Keshav Dogra; Aidan Gleich; Pranay Gundam; Donggyu Lee; Ramya Nallamotu; Brian Pacula |
| Abstract: | We document the real-time forecasting performance for output and inflation of the New York Fed dynamic stochastic general equilibrium (DSGE) model since 2011. We find the DSGE's accuracy to be comparable to that of private forecasters before Covid, but somewhat worse thereafter. |
| Keywords: | DSGE models; real-time forecasts; inflation |
| JEL: | E3 E43 E44 C32 C11 C54 |
| Date: | 2024–01–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:97565&r=dge |
| By: | Jesús Fernández-Villaverde; Joël Marbet; Galo Nuño Barrau; Omar Rachedi |
| Abstract: | This paper studies how household inequality shapes the effects of the zero lower bound (ZLB) on nominal interest rates on aggregate dynamics. To do so, we consider a heterogeneous agent New Keynesian (HANK) model with an occasionally binding ZLB and solve for its fully non-linear stochastic equilibrium using a novel neural network algorithm. In this setting, changes in the monetary policy stance influence households' precautionary savings by altering the frequency of ZLB events. As a result, the model features monetary policy non-neutrality in the long run. The degree of long-run non-neutrality, i.e., by how much monetary policy shifts real rates in the ergodic distribution of the model, can be substantial when we combine low inflation targets and high levels of wealth inequality. |
| Keywords: | heterogeneous agents, HANK models, neural networks, non-linear dynamics |
| JEL: | D31 E12 E21 E31 E43 E52 E58 |
| Date: | 2024–01 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:1160&r=dge |
| By: | Yasin Mimir |
| Abstract: | We study conditions under which a leaning against the wind (LAW)-type monetary policy is advisable to address risks to financial stability. We do so within a regime-switching dynamic stochastic general equilibrium (DSGE) model with endogenous crises and persistent financial cycles based on partly backward-looking house price beliefs. Under empirically plausible financial cycles, LAW increases inflation volatility because it amplifies the effects of supply shocks on inflation. It also leads to a lower average inflation, resulting in more frequent episodes of a binding lower bound on interest rates. LAW is advisable only if (i) the central bank puts more weight on output stability or (ii) financial cycles are less persistent than observed. |
| Keywords: | leaning against the wind, monetary policy, financial cycle, regime-switching DSGE |
| JEL: | E52 E58 G01 |
| Date: | 2023–04–04 |
| URL: | http://d.repec.org/n?u=RePEc:stm:wpaper:56&r=dge |
| By: | Masataka Eguchi; Hidekazu Niwa; Takayuki Tsuruga |
| Abstract: | Implementation lags are a concern of policymakers as they may reduce the efficacy of fiscal policy. Using a standard New Keynesian model with an effective lower bound on the nominal interest rate, we compare the impacts of fiscal stimulus on output across various lengths of implementation lag. We show that despite concerns among policymakers, implementation lags may enhance the efficacy of government purchases on output when the economy is caught in a liquidity trap. |
| Keywords: | fiscal multiplier, effective lower bound, government spending, liquidity trap |
| JEL: | E32 E52 E62 |
| Date: | 2024–01 |
| URL: | http://d.repec.org/n?u=RePEc:een:camaaa:2024-02&r=dge |
| By: | Serdar Birinci; Fatih Karahan; Yusuf Mercan; Kurt See |
| Keywords: | job mobility; monetary policy; heterogeneous-agent New Keynesian (HANK); job search |
| JEL: | E12 E24 E52 J31 J62 J64 |
| Date: | 2024–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:97539&r=dge |
| By: | Yossi Yakhin (Bank of Israel) |
| Abstract: | The paper introduces foreign exchange interventions (FXIs) to an otherwise standard new-Keynesian small open economy model. The paper studies the transmission mechanism of FXIs, solves for the optimal policy, suggests an implementable policy rule, and evaluates the welfare implications of different policies. Relying on the portfolio balance channel, a purchase of foreign reserves crowds out private holdings of foreign assets, thereby raising the UIP premium and the effective real return domestic agents face. As a result, a purchase of foreign reserves contracts domestic demand. At the same time, it depreciates the value of the domestic currency, which raises the price of foreign goods relative to domestic goods, thereby expanding foreign demand for home exports and contracting domestic imports. The effect on production depends on the wealth effect on labor supply. Optimal FXIs completely insulate the economy from the effect of financial shocks, such as capital flows and risk premium shocks. A policy rule that aims at stabilizing the UIP premium brings the economy close to its optimal allocation, regardless of the source of the shocks. The paper discusses the conditions under which strict targeting of the UIP premium is optimal. Calibrating the model to the Israeli economy, lifetime welfare gains from following optimal FXI policy, relative to maintaining a fixed level of foreign reserves, amount to 2.4% of annual steady state consumption. The results are robust to a variety of microstructures of the financial sector suggested in recent literature. |
| Keywords: | Foreign Exchange Interventions, UIP Premium, Monetary Policy, Open Economy Macroeconomics |
| JEL: | E44 E52 E58 F30 F31 F40 F41 G10 G15 |
| Date: | 2024–01 |
| URL: | http://d.repec.org/n?u=RePEc:boi:wpaper:2024.01&r=dge |
| By: | Gustavo Mellior |
| Abstract: | This paper analyses quantitatively the effect that higher education funding policies have on welfare and inequality. We evaluate five different higher education financing schemes with a heterogeneous agent model in continuous time. When educational costs are small, differences in outcomes amongst systems are negligible. As the cost of education and the share of debtors in society rises, it becomes preferable to fund education with subsidies, instead of student loans, as there are pecuniary externalities that arise with debt. Although subsidies can generate large steady state welfare gains, transition costs can be large enough to justify the status quo. |
| Keywords: | Incomplete Markets, Higher education funding, Human capital |
| JEL: | D52 D58 E24 I22 I23 |
| Date: | 2023–05 |
| URL: | http://d.repec.org/n?u=RePEc:liv:livedp:202301&r=dge |
| By: | Carlos Esquivel (Rutgers University; The World Bank Research Department) |
| Abstract: | We study how debt limits can be expansionary in economies facing sovereign risk. We develop a sovereign debt model with capital accumulation, long-term debt, and fiscal rules that features two distortions: debt dilution and a pecuniary externality of private investment on spreads. The optimal debt limit increases capital accumulation due to lower sovereign risk, generating an economic expansion in the long run. Welfare gains are a result of lower sovereign spreads due to expectations about future borrowing and investment. We present evidence of a positive (negative) relation between debt limits and investment (spreads), consistent with the predictions of the model. |
| Keywords: | Fiscal Rules, Sovereign Debt, Expansionary Fiscal Consolidation |
| JEL: | F34 F41 |
| Date: | 2024–11–12 |
| URL: | http://d.repec.org/n?u=RePEc:rut:rutres:202401&r=dge |
| By: | Uchida, Yuki; Ono, Tetsuo |
| Abstract: | This study examines the golden rule of public finance, distinguishing between public investment and consumption spending when borrowing, allowing for exclusively debt-financed public investment. Explored within an overlapping-generations model that encompasses the accumulation of physical and public capital, the rule and its associated fiscal policy emerge internally, selected by short-lived governments that represent current generations. The model is calibrated for Germany, Japan, and the United Kingdom, demonstrating adherence to the rule in Germany and deviation from it in Japan and the United Kingdom, which aligns with the available evidence. The evaluation from the perspective of a long-term planner reveals the government’s excessive choices in public debt across these countries. |
| Keywords: | Fiscal Rule; Golden Rule of Public Finance; Probabilistic Voting; Overlapping Generations; Political Distortions |
| JEL: | D70 E62 H63 |
| Date: | 2023–12–21 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:119724&r=dge |
| By: | Carlos Esquivel (Rutgers University) |
| Abstract: | I study the impact of giant oil field discoveries on default risk. I document that interest rate spreads of emerging economies increase by 1.3 percentage points following a discovery of median size. I develop a sovereign default model with investment, three-sector production, and oil discoveries. Following a discovery, borrowing and investment increase. Capital reallocates from manufacturing toward oil and non-traded sectors, increasing the volatility of tradable income. Borrowing increases default risk and higher volatility increases the risk premium, both of which increase spreads. Discoveries generate welfare gains of 0.44 percent. Insurance against low oil prices increases these gains to 0.60. Select number of author(s): : 1 |
| Keywords: | Soveriegn default, Oil Discoveries |
| JEL: | F34 F41 Q33 |
| Date: | 2024–11–12 |
| URL: | http://d.repec.org/n?u=RePEc:rut:rutres:202404&r=dge |
| By: | Rubén Domínguez-Díaz (Banco de España); Samuel Hurtado (Banco de España); Carolina Menéndez (Banco de España) |
| Abstract: | This paper presents an endogenous growth general equilibrium model (EGGEM) of firm dynamics and innovative investment for the Spanish economy that allows the medium-term effects of economic policies and shocks to be better understood. The model is calibrated using both aggregate and firm-level data. It is then used to assess the medium-term macroeconomic consequences of the different components of the Next Generation EU (NGEU) programme, including public investment, private capital transfers and innovative investment transfers. According to our baseline simulation, the NGEU funds significantly foster economic activity by raising aggregate productivity, private investment and employment. As a result, annual GDP growth is increased by 0.17 percentage points on average over the period of NGEU disbursement. Among the different policy instruments considered, we find that innovation transfers have the largest impact on aggregate output, only matched by increases in the stock of public capital if it is highly efficient. |
| Keywords: | productivity, public investment, endogenous growth, Next Generation EU |
| JEL: | O38 O52 O40 H54 E65 |
| Date: | 2024–01 |
| URL: | http://d.repec.org/n?u=RePEc:bde:wpaper:2402&r=dge |
| By: | Zhouzhou Gu (Princeton University); Mathieu Laurière (NYU Shanghai, NYU-ECNU Institute of Mathematical Sciences); Sebastian Merkel (University of Exeter); Jonathan Payne (Princeton University) |
| Abstract: | We propose a new global solution algorithm for continuous time heterogeneous agent economies with aggregate shocks. First, we approximate the state space so that equilibrium in the economy can be characterized by one high, but finite, dimensional partial differential equation. Second, we approximate the value function using neural networks and solve the differential equation using deep learning tools. We refer to the solution as an Economic Model Informed Neural Network (EMINN). The main advantage of this technique is that it allows us to find global solutions to high dimensional, non-linear problems. We demonstrate our algorithm by solving two canonical models in the macroeconomics literature: the Aiyagari (1994) model and the Krusell and Smith (1998) model. |
| Keywords: | Heterogeneous agents, computational methods, deep learning, inequality, mean field games, continuous time methods, aggregate shocks, global solution |
| JEL: | C70 |
| Date: | 2023–08 |
| URL: | http://d.repec.org/n?u=RePEc:pri:econom:2023-19&r=dge |
| By: | Leo Feler; Arthur Mendes; Wataru Miyamoto; Thuy Lan Nguyen; Steven Pennings |
| Abstract: | This paper provides new evidence on the macroeconomic impact of cash transfers in developing countries. Using a Bartik-style identification strategy, the paper documents that Brazil’s Bolsa Familia transfer program leads to a large and persistent increase in relative state-level GDP, formal employment, and informal employment. A state receiving 1% of GDP in extra transfers grows 2.2% faster in the first year, with R$100, 000 of extra transfers generating five formal-equivalent jobs, half of which are informal. Consistent with a demand-side mechanism, the effects are concentrated in non-tradable sectors. However, an open-economy New Keynesian model only partially captures the high multipliers estimated. |
| Keywords: | fiscal multipliers; cash transfers; Bartik instrument; Bolsa Familia; informality; relative multiplier; local multiplier; developing countries |
| JEL: | E0 E26 E32 O54 |
| Date: | 2023–12–15 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:97580&r=dge |
| By: | Garstenauer, Viola; Siassi, Nawid |
| Abstract: | In this paper, we examine reforms that alleviate large employment disincentives induced by child-related transfers for married mothers. We develop a life-cycle model where married couples face labor market, child care and fertility risk, and make joint labor supply and consumption-saving decisions. The evolution of female human capital is endogenous and shaped by mothers’ employment decisions. We calibrate the model to the U.S. using data from the Current Population Survey. We show that participation tax rates exceed 25 percent for most mothers in our sample, and can be as high as 60 percent when including child care expenses. We then evaluate reforms to existing tax credits for working couples. We find that (i) expanding child care tax credits and (ii) introducing a secondary earner EITC deduction lead to substantially higher employment rates among married mothers. Both reforms are easily implementable, self-financing, and welfare-improving. A combination of both reforms closes the maternal employment gap altogether. |
| Keywords: | Family labor supply, Child-related transfers, Income taxation |
| JEL: | H24 H31 J12 J22 |
| Date: | 2024 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:tuweco:281162&r=dge |
| By: | Tao Wang |
| Abstract: | Models of microeconomic consumption (including those used in heterogeneous-agent macroeconomic models) typically calibrate the size of income risk to match panel data on household income dynamics. But, for several reasons, what is measured as risk from such data may not correspond to the risk perceived by the agent. This paper instead uses data from the Federal Reserve Bank of New York’s Survey of Consumer Expectations to directly calibrate perceived income risks. One of several examples of the implications of heterogeneity in perceived income risks is increased wealth inequality stemming from differential precautionary saving motives. I also explore the implications of the fact that the perceived risk is lower than the calibrated level of risk either because of unobserved heterogeneity by researchers or because of overconfidence by the agents. |
| Keywords: | Monetary policy; Monetary Policy and Uncertainty; Business Fluctuations and Cycles |
| JEL: | D14 E21 E71 G51 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:23-59&r=dge |
| By: | Carlos Esquivel (Rutgers University) |
| Abstract: | Capital and its sectoral allocation affect default incentives. Under general assumptions, default risk is decreasing in the total stock of capital and increasing in the share of capital allocated to non-tradable production. This implies that when competitive households make all investment decisions capital has two externalities: a capital-stock externality and a portfolio externality. These hamper the ability of a benevolent government to make optimal borrowing and default decisions and are exacerbated during periods of distress. Competitive equilibria feature underinvestment, larger non-traded sectors, more default, and lower debt and consumption than a centralized planner's allocation. Select number of author(s): : 1 |
| Keywords: | Soveriegn default, Underinvestment, Investment externalities |
| JEL: | F34 F41 H63 |
| Date: | 2024–11–12 |
| URL: | http://d.repec.org/n?u=RePEc:rut:rutres:202402&r=dge |
| By: | Carlos Esquivel (Rutgers University) |
| Abstract: | I study how, in the presence of default risk, the Dutch disease amplifies an inefficiency in the sectoral allocation of capital. I develop a sovereign default model with production of tradable and non-tradable goods, and endowments of commodities. Default incentives increase when more capital is allocated to non-traded production. Households do not internalize this effect, giving rise to over-investment in the non-traded sector. Commodity windfalls amplify this inefficiency through the classic Dutch disease mechanism and an increased desire to borrow. Policies that reduce the returns of non-traded capital, such as exchange rate sterilization, ameliorate the degree of over-investment during commodity windfalls. Evidence from spreads, commodity endowments, and exchange rate data supports the main findings of the model. Select number of author(s): : 1 |
| Keywords: | Soveriegn default, Dutch Disease, Real exchange rates |
| JEL: | F34 F41 H63 |
| Date: | 2024–11–12 |
| URL: | http://d.repec.org/n?u=RePEc:rut:rutres:202403&r=dge |