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on Dynamic General Equilibrium |
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Issue of 2024‒04‒08
eighteen papers chosen by Christian Zimmermann, Federal Reserve Bank of St. Louis |
| By: | Dengler, Thomas; Gerke, Rafael; Giesen, Sebastian; Kienzler, Daniel; Röttger, Joost; Scheer, Alexander; Wacks, Johannes |
| Abstract: | Optimal policy projections (OPPs) offer a flexible way to derive scenario-based policy recommendations. This note describes how to calculate OPPs for a simple textbook New Keynesian model and provides illustrations for various examples. It also demonstrates the versatility of the approach by showing OPP results for simulations conducted using a medium-scale DSGE model and a New Keynesian model with heterogeneous households. |
| Keywords: | Optimal monetary policy, macroeconomic projections, New Keynesian models, household heterogeneity |
| JEL: | C63 E20 E31 E47 E52 E58 |
| Date: | 2024 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bubtps:285379&r=dge |
| By: | Selahattin Imrohoroglu |
| Abstract: | It is well known that land does not prevent dynamic inefficiency (a rate of capital accumulation higher than the Golden rule level, or, a return to capital, MPK, less than the economys growth rate, g) if land is subject to a transaction tax. This paper attempts to evaluate quantitatively the potency of this argument, both positively as well as normatively. Using a heterogenous-agent, general equilibrium overlapping generations growth model calibrated to the U.S. economy, the main quantitative finding is that a 6.18% tax on the sale of land produces balanced growth paths that exhibit dynamic inefficiency. When an unfunded social security system is introduced, the economy moves toward dynamic efficiency, welfare improves, and the optimal replacement rate is 70%. |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:cnn:wpaper:24-002e&r=dge |
| By: | Alessandro Lin (Bank of Italy); Marcel Peruffo (University of Sydney) |
| Abstract: | We propose a novel methodology for solving Heterogeneous Agent New Keynesian (HANK) models with aggregate uncertainty and the Zero Lower Bound (ZLB) on nominal interest rates. Our efficient solution strategy combines the sequence-state Jacobian methodology in Auclert et al. (2021) with a tractable structure for aggregate uncertainty by means of a two-regime shock structure. We apply the method to a simple HANK model to show that: 1) in the presence of aggregate non-linearities such as the ZLB, a dichotomy emerges between the aggregate impulse responses under aggregate uncertainty against the deterministic case; 2) aggregate uncertainty amplifies downturns at the ZLB, and household heterogeneity increases the extent of this amplification; and 3) the effects of forward guidance are stronger when there is aggregate uncertainty. |
| Keywords: | monetary policy, new Keynesian model, HANK, liquidity traps, Zero Lower Bound, computational methods |
| JEL: | D14 E44 E52 E58 |
| Date: | 2024–03 |
| URL: | http://d.repec.org/n?u=RePEc:bdi:wptemi:td_1442_24&r=dge |
| By: | Parrado, Eric; Heresi, Rodrigo |
| Abstract: | Singapore's unique monetary policy consists of a managed exchange rate framework that can be characterized as a Taylor-like reaction function with the nominal devaluation rate instead of the nominal interest rate as the main policy instrument. We build a small open economy New Keynesian model to estimate and characterize such a monetary rule from a welfare perspective. Welfare gains under an exchange rate rule (ERR) relative to the more standard interest rate-based Taylor rule (IRR) are unambiguously increasing in the degree of trade openness (defined as exports plus imports as a share of GDP). For Singapore, where trade openness is 280% of GDP, we estimate welfare gains of 1.48% of permanent consumption under an ERR. In a counterfactual thought experiment, we find that Chile, an established inflation-targeting economy using an IRR, would be better off under an ERR for any degree of openness above 100% (currently at 70%). |
| Keywords: | Monetary policy;Exchange rate management;Open economy macroeconomics |
| JEL: | E52 E58 F41 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:idb:brikps:13346&r=dge |
| By: | Rodolfo G. Campos (Banco de Espana); Jesus Fernandez-Villaverde (University of Pennsylvania, NBER, CEPR); Galo Nuno (BIS, Banco de Espana, CEMFI, CEPR); Peter Paz (Banco de Espana) |
| Abstract: | We study a new type of monetary-fiscal interaction in a heterogeneous-agent New Keynesian model with a fiscal block. Due to household heterogeneity, the stock of public debt affects the natural interest rate, forcing the central bank to adapt its monetary policy rule to the fiscal stance to guarantee that inflation remains at its target. There is, however, a minimum level of debt below which the steady-state inflation deviates from its target due to the zero lower bound on nominal rates. We analyze the response to a debt-financed fiscal expansion and quantify the impact of different timings in the adaptation of the monetary policy rule, as well as the performance of alternative monetary policy rules that do not require an assessment of the natural rates. We validate our findings with a series of empirical estimates. |
| Keywords: | HANK models, natural rates, fiscal shocks |
| JEL: | E32 E58 E63 |
| Date: | 2024–08–03 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:24-007&r=dge |
| By: | Tommaso Gasparini; Vivien Lewis; Stéphane Moyen; Stefania Villa |
| Abstract: | Increases in firm default risk raise the default probability of banks while decreasing output and inflation in US data. To rationalize the empirical evidence, we analyse firm risk shocks in a New Keynesian model where entrepreneurs and banks engage in a loan contract and both are subject to default risk. In the model, a wave of corporate defaults leads to losses on banks' balance sheets; banks respond by selling assets and reducing credit provision. A highly leveraged banking sector exacerbates the contractionary effects of firm defaults. We show that high minimum capital requirements jointly implemented with a countercyclical capital buffer are effective in dampening the adverse consequences of firm risk shocks. |
| Keywords: | Bank Default, Capital Buffer, Firm Risk, Macroprudential Policy |
| JEL: | E44 E52 E58 E61 G28 |
| Date: | 2024 |
| URL: | http://d.repec.org/n?u=RePEc:bfr:banfra:944&r=dge |
| By: | Alessandro Cantelmo (Bank of Italy); Nikos Fatouros (University of Birmingham); Giovanni Melina (International Monetary Fund); Chris Papageorgiou (International Monetary Fund) |
| Abstract: | With climate change increasing the frequency and intensity of natural disasters, how should central banks respond to these catastrophic events? Looking at IMF reports for 34 disaster-years, which occurred in 16 disaster-prone countries from 1999 to 2017, what emerges is a non-negligible heterogeneity in central banks' responses to climate-related disasters. Using a standard small-open-economy New-Keynesian model with disaster shocks, we show that, consistently with textbook theory, inflation targeting remains the welfare-optimal regime. The best strategy for monetary authorities is to resist the impulse to accommodate in the face of catastrophic natural disasters, and rather to continue to focus on price stability. |
| Keywords: | natural disasters, climate change, DSGE, monetary policy, exchange rate regimes |
| JEL: | E5 E52 E58 F41 Q54 |
| Date: | 2024–03 |
| URL: | http://d.repec.org/n?u=RePEc:bdi:wptemi:td_1443_24&r=dge |
| By: | Fan, Simon; Pang, Yu; Pestieau, Pierre (Université catholique de Louvain, LIDAM/CORE, Belgium) |
| Abstract: | This paper explains why democracies marked by inequalities may not experience aggressive redistribution through the lens of parent-child interactions. Parental concerns about the negative impacts of high taxation on their children’s motivation to study and pursue high-paying careers deter the poor majority from harboring an inclination to expropriate the rich. We construct an overlapping generations model in which workers vote on the redistributive policy under majority rule, while considering the incentive costs that the policy imposes on their children. We analyze the stationary Markov perfect equilibrium where the likelihood that a moderate income tax can be credibly enforced increases with the degree of parental altruism. In an extended model where career prospects are jointly determined by study efforts and received educational resources, we provide an analytical and numerical characterization of the conditions under which full redistribution does not materialize in the steady state under both private and public school systems. |
| Keywords: | Credible tax policy ; parental altruism ; Markov perfect equilibrium ; education ; majority voting |
| JEL: | D72 H31 I24 |
| Date: | 2024–01–18 |
| URL: | http://d.repec.org/n?u=RePEc:cor:louvco:2024002&r=dge |
| By: | Jesus Fernandez-Villaverde (University of Pennsylvania); Yang Yu (Shanghai Jiaotong University); Francesco Zanetti (University of Oxford) |
| Abstract: | This paper shows the importance of technological synergies among heterogeneous firms for aggregate fluctuations. First, we document six novel empirical facts using microdata that suggest the existence of important technological synergies between trading firms, the presence of positive assortative matching among firms, and their evolution during the business cycle. Next, we embed technological synergies in a general equilibrium model calibrated on firm-level data. We show that frictions in forming trading relationships and separation costs explain imperfect sorting between firms in equilibrium. In particular, an increase in the volatility of idiosyncratic productivity shocks significantly decreases aggregate output without resorting to non-convex adjustment costs. |
| Keywords: | Technological synergies, heterogeneous firms, idiosyncratic uncertainty |
| JEL: | C63 C68 C78 E32 E37 E44 G12 |
| Date: | 2024–08–03 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:24-008&r=dge |
| By: | Bruno Biais; Hans Gersbach; Jean-Charles Rochet; Ernst-Ludwig von Thadden; Stéphane Villeneuve |
| Abstract: | We analyze dynamic capital allocation and risk sharing between a principal and many agents, who privately observe their output. The state variables of the mechanism design problem are aggregate capital and the distribution of continuation utilities across agents. This gives rise to a Bellman equation in an infinite dimensional space, which we solve with mean-field techniques. We fully characterize the optimal mechanism and show that the level of risk agents must be exposed to for incentive reasons is decreasing in their initial outside utility. We extend classical welfare theorems by showing that any incentive-constrained optimal allocation can be implemented as an equilibrium allocation, with appropriate money issuance and wealth taxation by the principal. |
| Keywords: | Incomplete Financial Markets, Debt, Interest, Growth, Ponzi Games, Heterogeneous Agents, Political Economy |
| JEL: | E44 E62 |
| Date: | 2024–03 |
| URL: | http://d.repec.org/n?u=RePEc:bon:boncrc:crctr224_2023_412v2&r=dge |
| By: | Nicolò Gnocato (Bank of Italy) |
| Abstract: | This paper studies, analytically and quantitatively, the occurrence of demand-deficient recessions due to uninsurable unemployment risk when jobs are endogenously destroyed. The ensuing unemployment fears induce a precautionary saving motive that counteracts the desire to borrow during recessions: negative productivity shocks may cause falling natural interest rates and positive unemployment gaps. Analytically, these demand-deficient recessions are shown to require a lesser degree of real wage rigidity when jobs are destroyed endogenously rather than exogenously. Quantitatively, the demand-deficient nature of supply-driven recessions can only be captured when accounting for endogenous job destruction. |
| Keywords: | heterogeneous agents, unemployment risk, endogenous separation, Keynesian supply shocks |
| JEL: | E12 E21 E24 E32 J64 |
| Date: | 2024–03 |
| URL: | http://d.repec.org/n?u=RePEc:bdi:wptemi:td_1444_24&r=dge |
| By: | Ayres, JoaÞo; Paluszynski, Radoslaw |
| Abstract: | This paper proposes a model of sovereign default that features interest rate multiplicity driven by rollover risk. Our core mechanism shows that the possibility of a rollover crisis by itself can lead to high interest rates, which in turn reinforces the rollover risk. By exploiting complementarity between the traditional notions of slow- and fast-moving crises, our model generates a rich simulated dynamics that features frequent defaults and a volatile bond spread even in the absence of shocks to fundamentals. In the presence of risky income, our mechanism amplifies the dynamics of debt and spreads relative to model benchmarks where equilibrium multiplicity relies on the underlying shocks to income. |
| Keywords: | sovereign default;self-fulfilling crises |
| JEL: | E44 F34 |
| Date: | 2023–12 |
| URL: | http://d.repec.org/n?u=RePEc:idb:brikps:13315&r=dge |
| By: | Lucio Gobbi; Ronny Mazzocchi; Roberto Tamborini |
| Abstract: | When inflation picks up, central banks are most concerned that the de-anchoring of inflation expectations and the ignition of wage-price spirals will trigger inflation dynamic instability. However, such scenarios do not materialize in the standard New Keynesian theoretical framework for monetary policy. Using a simulative model, we show that they can materialize upon introducing in particularly strong doses boundedly-rational expectations that de-anchor endogenously, as they are updated according to the actual inflation process, with indexed wages, and persistent inflation shocks. In these cases, a more hawkish central-bank stance on inflation expands the stability region of the system, which however remains bounded. On the other hand, the critical combinations of factors that trigger instability can be regarded as extreme in empirical terms, while in "normal times" the system is resilient to shocks and expectation de-anchoring even with more dovish monetary policy. |
| Keywords: | cost-push inflation, New Keynesian models for monetary policy, wage-price spiral, de-anchoring of inflation expectations |
| JEL: | E17 E30 E50 |
| Date: | 2024 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_10966&r=dge |
| By: | Jesus Fernandez-Villaverde (University of Pennsylvania, NBER, and CEPR); Oren Levintal (Reichman University) |
| Abstract: | We study the distributional effects of asset returns using a heterogeneous-agent model estimated to match the joint distribution of wealth and returns. In the model, endogenous portfolio decisions play a key role through their impact on households’ wealth accumulation. We find substantial welfare effects of changes in asset returns. A permanent decline of one percentage point in expected returns increases the consumption share of the top 10% by 6% permanently. Our findings suggest that lower returns increase inequality, which contradicts Piketty’s (2014) r - g formula. To resolve this contradiction, we derive a generalized formula that includes the consumption/wealth ratio and which is consistent with our empirical and theoretical findings. Nonetheless, wealth inequality within the Pareto tail is fairly insensitive to asset returns. Instead, inequality between the Pareto tail and the lower range of the distribution responds strongly to asset returns through their differential effects on active savings relative to wealth. Simulations suggest that asset price dynamics can explain the main variations in U.S. top wealth shares since the 1960s. |
| Date: | 2024–02–21 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:24-009&r=dge |
| By: | Pizzo, Alessandra; Villena-Roldán, Benjamin |
| Abstract: | Employers hire more selectively between heterogeneous productivity workers when applicants’ queues are longer. Consistently, CPS data reveal a positive and concave relation between unemployment rates and wage inequality. We rationalize intuition and evidence altogether using a nonsequential search model in which selective hiring stretches out the right tail of the wage distribution and compresses the left one. Using GMM estimated parameters, we show that mean worker productivity distribution shifts are consistent with the evidence. Welfare analysis suggests that regressive taxation may enhance efficiency because expected good matches stimulate vacancies, creating a positive externality for other job seekers. |
| Keywords: | Nonsequential search, Hiring, Inequality, Unemployment, Worker Flows, Efficiency |
| JEL: | E24 J64 |
| Date: | 2024–02–23 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:120281&r=dge |
| By: | Keiichiro KOBAYASHI |
| Abstract: | We provide a tractable two-period model of financial crises that replicates empirical regularities that credit-fueled asset-price booms are often followed by the busts and deep and persistent recessions associated with productivity declines. We argue that the risk-shifting booms of asset prices tend to collapse, and resultant debt overhang lowers productivity and output by discouraging borrowers from expending efforts. This inefficiency is amplified by externality of a decrease in aggregate demand. Larger asset-price booms lead to deeper recessions. Ex-post government intervention to facilitate debt restructuring can be welfare improving, because it mitigates the demand externality and the associated time inconsistency may not have dominant effects. |
| Date: | 2024–02 |
| URL: | http://d.repec.org/n?u=RePEc:cnn:wpaper:24-004e&r=dge |
| By: | Ms. Mai Hakamada; Carl E. Walsh |
| Abstract: | Central banks in major industrialized economies were slow to react to the surge in inflation that began in early 2021. The proximate causes of this surge were the supply chain disruptions associated with the easing of COVID restrictions, fiscal policies designed to cushion the economic impact of COVID, and the impact on commodity prices and supply chains of the war in Ukraine. We investigate the consequences of policy delay in responding to inflation shocks. First, using a simple three-period model, we show how policy delay worsens inflation outcomes, but can mitigate or even reverse the output decline that occurs when policy responds without delay. Then, using a calibrated new Keynesian framework and two measures of loss that incorporate a “balanced approach” to weigh inflation and the output gap, we find that loss is monotonically increasing in the length of the delay. Loss is reduced if policy, when it does react, is more aggressive. To investigate whether these results are sensitive to the assumption of rational expectations, we consider cognitive discounting as an alternative assumption about expectations. With cognitive discounting, forward guidance is less powerful and results in a reduction in the costs of delay. Under either assumption about expectations, the costs of a short delay can be eliminated by adopting a less inertial policy rule and a more aggressive response to inflation. |
| Keywords: | monetary policy; inflation policy delay; behavioral expectations; falling behind the curve |
| Date: | 2024–03–01 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:2024/042&r=dge |
| By: | Tim Mensinger; Christian Zimpelmann |
| Abstract: | We examine the influence of gender role attitudes, specifically views about the appropriate role of mothers, on post-childbirth employment decisions. German panel data reveals that mothers with traditional attitudes are 15% less likely to work during early motherhood than their egalitarian counterparts. Among working mothers, those with traditional attitudes work four hours less per week, and these differences persist for at least seven years. Fathers’ attitudes also predict maternal labor supply, highlighting joint decision-making within couples. Examining the interaction of attitudes with policies, we find that the introduction of a cash-for-care payment for parents who abstain from using public childcare substantially reduced the labor supply of traditional mothers, whereas egalitarian mothers’ labor supply remained unaffected. Moreover, a structural life-cycle model of female labor supply demonstrates that labor supply elasticities are substantially larger for traditional mothers, while a counterfactual policy facilitating full-time childcare access has a more pronounced effect on egalitarian mothers. Our findings stress that gender role attitudes moderate the impact of policies, which implies that measured average policy effects depend on the distribution of attitudes and cannot easily be transferred over time or to other countries. |
| Keywords: | Gender role attitudes, Parental labor supply, Gender gaps, Childcare costs, Life cycle |
| JEL: | Z1 J13 J16 J22 D15 |
| Date: | 2024–03 |
| URL: | http://d.repec.org/n?u=RePEc:bon:boncrc:crctr224_2024_513&r=dge |