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on Dynamic General Equilibrium |
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Issue of 2024‒07‒22
seventeen papers chosen by |
| By: | Bilbiie, F. O. |
| Abstract: | THANK is a tractable heterogeneous-agent New-Keynesian model that captures analytically core micro heterogeneity channels of quantitative-HANK: cyclical inequality and risk; self-insurance, pre-cautionary saving, and realistic intertemporal marginal propensities to consume. I use it to elucidate key transmission mechanisms and dynamic properties of HANK models. Countercyclical inequality yields aggregate-demand amplification and makes determinacy with Taylor rules more stringent; but solving the forward guidance puzzle requires procyclical inequality: a Catch-22. Solutions include combining inequality with a distinct risk channel, with compensating cyclicalities; I provide evidence that disposable income inequality was procyclical in the last two, Great and COVID recessions, while risk is countercyclical. Alternative policy rules also solve the Catch-22, e.g. price-level-targeting or, in the model version with liquidity, setting nominal public debt. Optimal policy with heterogeneity features a novel inequality-stabilization motive generating higher inflation volatility—but is unaffected by risk, insofar as the target efficient equilibrium entails no inequality. |
| Keywords: | Determinacy, Forward Guidance Puzzle, Heterogeneity, Inequality, Interest Rate Rules, Liquidity, Multipliers, Optimal Monetary Policy, Risk |
| JEL: | E21 E31 E40 E44 E50 E52 E58 E60 E62 |
| Date: | 2024–06–13 |
| URL: | https://d.repec.org/n?u=RePEc:cam:camdae:2432&r= |
| By: | Marco Cozzi (Department of Economics, University of Victoria) |
| Abstract: | A vast experimental literature in both psychology and economics documents that individuals exhibit rankdependent probability weighting in economic decisions characterized by risk. I incorporate this well-known behavioral bias in a rank-dependent expected utility (RDEU) model. I develop a dynamic general equilibrium model with heterogeneous agents, labor market risk, and aggregate fluctuations, featuring households that are RDEU maximizers in an environment characterized by realistic labor market dynamics. I use the model to quantify the importance of RDEU for a number of macroeconomic outcomes. In a calibration of the model exploiting U.S. data, I find that RDEU plays a quantitatively important role for both the amount of aggregate wealth and the degree of wealth inequality, which are affected by the increased importance of precautionary saving, driven by households' pessimism. As for the outcomes routinely studied in the analysis of business-cycles, such as the volatility of both consumption and investment (relative to income), I find that RDEU improves the fit of the model. Overall, in terms of the discrepancy between model-generated business-cycle statistics and data, the RDEU models attain lower root mean squared errors than the EU one. |
| Keywords: | Rank-dependent Probability Weighting, Rank-dependent Expected Utility, Heterogeneous Agents, Incomplete Markets, Labor Market Risk, Business Cycles. JEL Classifications: C63, D15, D52, D58, D90, E32, E71, J64. |
| Date: | 2024–05–26 |
| URL: | https://d.repec.org/n?u=RePEc:vic:vicddp:2402&r= |
| By: | Delalibera, Bruno Ricardo; Ferreira, Pedro Cavalcanti; Parente, Rafael Machado |
| Abstract: | In many countries, the regulations governing public and private pension systems, hiring procedures, and job contracts differ. Public sector employees tend to have longer tenures and higher wages compared to workers in the private sector. As such, social security reforms can affect both retirement decisions and sectoral choices. We study the effects of social security reforms on retirement and sectoral behavior in an economy with multiple pension systems. We develop a general equilibrium life-cycle model with three sectors - private formal, private informal and public - and endogenous retirement. In a model calibrated to Brazil, we quantitatively assess the long-run effects of reforms being discussed and implemented across countries. Among them, we study the unification of pension systems and increasing the minimum retirement age. We find that these reforms affect the decision to apply to a public job, the profile of savings over the life cycle, and informality. In the long run, these reforms lead to higher output and capital, reduced informality, and average welfare gains. They also drastically reduce the social security deficit |
| Date: | 2024–05–29 |
| URL: | https://d.repec.org/n?u=RePEc:fgv:epgewp:842&r= |
| By: | Du, Zaichuan |
| Abstract: | This paper proposes a new approach to numerically solving a wide class of heterogeneous agent models in continuous time using adaptive sparse grids. I combine the sparse finite difference method with the sparse finite volume method to solve the Hamilton-Jacobian-Bellman equation and Kolmogorov Forward equation, respectively. My algorithm automatically adapts grids and adds local resolutions in regions of the state space where both the value function and the distribution approximation errors remains large. I demonstrate the power of my approach in applications feature high-dimensional state spaces, occasionally binding constraints, lifecycle and overlapping generations. |
| Keywords: | heterogeneous agent, mean field game, continuous time, adaptive sparse grids, occasionally binding constraints, overlapping generation, lifecycle |
| JEL: | C61 C63 E21 |
| Date: | 2024–07–04 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:121381&r= |
| By: | Giovanardi, Francesco; Kaldorf, Matthias |
| Abstract: | This paper proposes a quantitative multi-sector DSGE model with bank failure and firm default to study the interactions between bank regulation and climate policy. Households value the liquidity of deposits, which are protected by deposit insurance. Banks collect deposits and issue equity to extend defaultable loans to clean and fossil energy firms. Bank capital regulation affects liquidity provision to households, bank risk-taking, and loan supply across sectors. Using a calibrated version of the model, we obtain four results: first, fossil penalizing capital requirements can be discarded as climate policy instrument, since their effect on sector-specific investment is quantitatively negligible in general equilibrium. Second, Ramsey-optimal capital requirements in response to a tax-induced clean transition decline to counteract negative loan demand effects. Third, differentiated capital requirements are only necessary if banks are not perfectly diversified across sectors. Fourth, nominal rigidities induce a temporary tightening of capital requirements if the transition is inflationary and, thus, spurs a boom on the loan market. |
| Keywords: | Bank Regulation, Liquidity Provision, Risk-Taking, ClimatePolicy, Clean Transition, Multi-Sector Model |
| JEL: | E44 G21 G28 Q58 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:bubdps:298857&r= |
| By: | Ryota Nakano |
| Abstract: | The decision of whether and how much to borrow from the credit market in order to finance education costs depends crucially on parental investment in education. This study constructs a simple two-period overlapping generations model incorporating both educational investment from parents and educational borrowing. The analysis shows that in the case where educational investment from parents and educational borrowing are substitutive, the relaxation of the borrowing constraint improves intergenerational mobility. In the complementary case, the relaxation of the borrowing constraint may impair intergenerational mobility. Implications differ depending on whether the relationship between parental investments and borrowings is substitutive or complementary. |
| Date: | 2024–07 |
| URL: | https://d.repec.org/n?u=RePEc:dpr:wpaper:1248&r= |
| By: | Fatih Guvenen; Gueorgui Kambourov; Burhan Kuruscu; Sergio Ocampo-Diaz |
| Abstract: | When is a wealth tax preferable to a capital income tax? When is the opposite true? More generally, can capital taxation be structured to improve productivity, incentivize innovation, and ultimately increase welfare? We study these questions theoretically in an infinite-horizon model with entrepreneurs and workers, in which entrepreneurial firms differ in their productivity and are subject to collateral constraints. The stationary equilibrium features heterogeneous returns and misallocation of capital. We show that increasing the wealth tax increases aggregate productivity. The gains result from the “use-it-or-lose-it” effect of wealth taxes when returns are heterogeneous, which causes a reallocation of capital from entrepreneurs with low productivity to those with high productivity. Furthermore, if the capital income tax is adjusted to balance the government's budget, aggregate capital, output, and wages also increase. We then study the welfare maximizing combination of wealth and capital income taxes and show that the optimal mix shifts towards a higher wealth tax and a lower capital income tax as the capital intensity of production increases. For a range of plausible parameter values, the optimal wealth tax is positive, whereas the capital income tax can be positive or negative (a subsidy). We then endogenize the entrepreneurial productivity distribution by introducing either ex ante innovation or entrepreneurial effort in production and show that this strengthens our results: by allowing entrepreneurs to keep more of the upside relative to a capital income tax, a wealth tax incentivizes more innovation and entrepreneurial effort, leading to larger increases in productivity, output, and welfare. |
| JEL: | E21 E25 E60 H21 H24 J31 |
| Date: | 2024–06 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:32585&r= |
| By: | Christian Bayer (University of Bonn); Ralph Luetticke (Eberhard Karls University of Tübingen); Maximilian Weiss (Eberhard Karls University of Tübingen); Yannik Winkelmann (Eberhard Karls University of Tübingen) |
| Abstract: | The "histogram method" (Young, 2010), while the standard approach for analyzing distributional dynamics in heterogeneous agent models, is linear in optimal policies. We introduce a novel method that captures nonlinearities of distributional dynamics. This method solves the distributional dynamics by interpolation instead of integration, which is made possible by making the grid endogenous. It retains the tractability and speed of the histogram method, while increasing numerical efficiency even in the steady state and producing significant economic differences in scenarios with aggregate risk. We document this by studying aggregate investment risk with a third-order solution using perturbation techniques. |
| Keywords: | Numerical Methods, Distributions, Heterogeneous Agent Models, Linearization |
| JEL: | C46 C63 E32 |
| Date: | 2024–06 |
| URL: | https://d.repec.org/n?u=RePEc:ajk:ajkdps:311&r= |
| By: | Bilbiie, F. O.; Monacelli, T.; Perotti, R. |
| Abstract: | Stabilization and redistribution are intertwined in a model with heterogeneity, imperfect insurance, and nominal rigidity-making fiscal and monetary policy inextricably linked for aggregate-demand management. Movements in inequality induced by fiscal transfers make the flexible-price equilibrium suboptimal, thus triggering a stabilization vs redistribution tradeoff. Likewise, changes in government spending that are associated with changes in the distribution of taxes (progressive vs. regressive) induce a tradeoff for monetary policy: the central bank cannot stabilize real activity at its efficient level (including insurance) and simultaneously avoid inflation. Fiscal policy can be used in conjunction to monetary policy to strike the optimal balance between stabilization and insurance (redistribution) motives. |
| Keywords: | Inequality, Redistribution, Aggregate Demand, Fiscal Transfers, Optimal Monetary-Fiscal Policy, TANK |
| JEL: | D91 E21 E62 |
| Date: | 2024–06–17 |
| URL: | https://d.repec.org/n?u=RePEc:cam:camdae:2436&r= |
| By: | Boaz Abramson; Stijn Van Nieuwerburgh |
| Abstract: | A rent guarantee insurance (RGI) policy makes a limited number of rent payments to the landlord on behalf of an insured tenant unable to pay rent due to a negative income or health expenditure shock. We introduce RGI in a rich quantitative equilibrium model of housing insecurity and show it increases welfare by improving risk sharing across idiosyncratic and aggregate states of the world, reducing the need for a large security deposits, and reducing homelessness which imposes large costs on society. While unrestricted access is not financially viable with either private or public insurance providers due to moral hazard and adverse selection, restricting access can restore viability. Private insurers must target better off renters to break even, while public insurers focus on households most at-risk of homelessness. |
| JEL: | E20 E62 G11 G18 G22 G5 R21 R38 |
| Date: | 2024–06 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:32582&r= |
| By: | Francisca Sara-Zaror |
| Abstract: | In standard macroeconomic models, the costs of inflation are tightly linked to the price dispersion of identical goods. Therefore, understanding how price dispersion empirically relates to inflation is crucial for welfare analysis. In this paper, I study the relationship between steady-state inflation and price dispersion for a cross section of U.S. retail products using scanner data. By comparing prices of items with the same barcode, my measure of relative price dispersion controls for product heterogeneity, overcoming an important challenge in the literature. I document a new fact: price dispersion of identical goods increases steeply around zero inflation and becomes flatter as inflation increases, displaying an Upsilon-shaped pattern. Current sticky-price models are inconsistent with this finding. I develop a menu-cost model with idiosyncratic productivity shocks and sequential consumer search that reproduces the new fact and exhibits realistic price-setting behavior. In the model, inflation-induced price dispersion increases shoppers' incentives to search for low prices and thus competition among retailers. The positive welfare-maximizing inflation rate optimally trades off the efficiency gains from lower markups and the resources spent on search. |
| Keywords: | Consumer search; Welfare; Microdata; Inflation |
| JEL: | E31 E50 L11 L16 |
| Date: | 2024–06–24 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedgfe:2024-47&r= |
| By: | Zhouzhou Gu; Mathieu Lauri\`ere; Sebastian Merkel; Jonathan Payne |
| Abstract: | We propose and compare new global solution algorithms for continuous time heterogeneous agent economies with aggregate shocks. First, we approximate the agent distribution so that equilibrium in the economy can be characterized by a high, but finite, dimensional non-linear partial differential equation. We consider different approximations: discretizing the number of agents, discretizing the agent state variables, and projecting the distribution onto a finite set of basis functions. Second, we represent the value function using a neural network and train it to 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 important models in the macroeconomics and spatial literatures (e.g. Krusell and Smith (1998), Khan and Thomas (2007), Bilal (2023)). |
| Date: | 2024–06 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2406.13726&r= |
| By: | Luduvice, André Victor D.; Martinez, Tomás R.; Sollaci, Alexandre B. |
| Abstract: | This paper studies the effects of the minimum wage on the life cycle of firms. We first build a tractable model where heterogeneous firms have labor market power, invest in innovation, and choose formal or informal sectors. The model predicts that a minimum wage hike not only shrinks young and low-productivity firms but also lowers incentives to innovate, resulting in lower life cycle growth. We then test the predictions of the model using Brazilian administrative and census data leveraging the variation in exposure across establishments and municipalities to the large increase in the minimum wage between 1999 and 2010. At the establishment level, an increase in the minimum wage: i) decreases the growth rates of small and young establishments and ii) increases the growth rates of old and large establishments. When analyzing exposed municipalities, we observe an increase in the earnings of workers in both the formal and informal sectors, as well as informal employment. Our findings suggest that the minimum wage is a possible explanation for the decline in the importance of young establishments and business dynamism in Brazil. |
| Keywords: | Monopsony;Business Dynamism;Firm Heterogeneity;Minimum Wage;Informality |
| JEL: | J38 J42 E24 E26 L25 |
| Date: | 2024–03 |
| URL: | https://d.repec.org/n?u=RePEc:idb:brikps:13444&r= |
| By: | Pablo GARCIA SANCHEZ (Banque Centrale du Luxembourg); Luca MARCHIORI (Banque Centrale du Luxembourg); Olivier PIERRARD (Banque Centrale du Luxembourg) |
| Abstract: | We propose a two-period overlapping generation economy that incorporates health investment in preventive measures during youth. These preventive measures contribute to increased longevity and reduced frailty, which influence old-age dependency and pension costs. As these costs are partly funded through pay-as-you-go social security contributions, investment in prevention creates externalities for the next generation. We analytically determine the optimal level of prevention and characterize the optimal health policy that a government should implement to achieve it. Our findings reveal that the optimal subsidy to long-term care exceeds the optimal subsidy to preventive measures. Furthermore, both subsidies are inversely related to the generosity of the public pension scheme. We explore the robustness of our results through various extensions and demonstrate their consistency with several patterns observed in cross-country OECD data. |
| Keywords: | Health, Prevention, Optimal Ramsey policy, Overlapping generations |
| JEL: | H23 I18 O41 |
| Date: | 2024–06–10 |
| URL: | https://d.repec.org/n?u=RePEc:ctl:louvir:2024008&r= |
| By: | Amaral, Pedro; Rivera-Padilla, Alberto |
| Abstract: | Countries with high levels of human capital also tend to be technologically advanced. We study whether modeling technology adoption can significantly amplify the importance of human capital differences in accounting for cross-country income gaps. We document that schooling is positively and robustly correlated with measures of technology adoption and usage, and negatively correlated with the prevalence of traditional forms of production, where technology adoption is limited, and productivity is lower. Motivated by this, we build a general equilibrium model with human capital investment, endogenous occupational choices, and technology adoption. Production takes place either in a traditional sector, where technology adoption is absent, or in a modern sector, where managers hire a workforce and optimally choose technology. Economies differ in terms of schooling levels by occupation and in the size of barriers to technology adoption. These differences, working together, result in a factor of 6 between US income and that of the bottom quartile of countries. Schooling differences on their own result in a factor of 3.5, compared to a factor of 2 in a one-sector version of the model where technology choices are absent. |
| Keywords: | Human capital; Technology adoption; Cross-country income differences |
| JEL: | J24 O11 O33 O41 |
| Date: | 2024–04 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:121157&r= |
| By: | Marco Cozzi (Department of Economics, University of Victoria) |
| Abstract: | I propose a modified implementation of the popular Hamilton filter, to make the cyclical component extracted from an aggregate variable consistent with the aggregation of the cyclical components extracted from its underlying variables. This procedure is helpful in many circumstances, for instance when dealing with a variable that comes from a definition or when the empirical relationship is based on an equilibrium condition of a growth model. The procedure consists of the following steps: 1) build the aggregate variable, 2) run the Hamilton filter regression on the aggregate variable and store the related OLS estimates, 3) use these estimated parameters to predict the trends of all the underlying variables, 4) rescale the constant terms to obtain mean-zero cyclical components that are aggregation-consistent. I consider two applications, exploiting U.S. and Canadian data. The former is based on the GDP expenditure components, while the latter on the GDP of its Provinces and Territories. I find sizable differences between the cyclical components of aggregate GDP computed with and without the adjustment, making it a valuable procedure for both assessing the output gap and validating empirically DSGE models. |
| Keywords: | Business cycles, Filtering, Hamilton filter, Output gap, Trend-cycle decomposition. JEL Classifications: C22, E30, E32. |
| Date: | 2024–05 |
| URL: | https://d.repec.org/n?u=RePEc:vic:vicddp:2401&r= |
| By: | Stefano Gnocchi; Fanny McKellips; Rodrigo Sekkel; Laure Simon; Yinxi Xie; Yang Zhang |
| Abstract: | We explain how the Bank of Canada’s policy models capture the trade-off between output and inflation in Canada. We start by briefly revisiting the determinants of the New Keynesian Phillips curve. Next, we provide an overview of the Phillips curves that are currently embedded in the two main policy models the Bank uses for macroeconomic projections and analysis, known for short as ToTEM and LENS. We then discuss the challenges in identifying the trade-off between output and inflation and provide new estimates of the trade-off using recently proposed methods. Finally, we contrast these estimates with the ones in the Bank’s policy models. |
| Keywords: | Business fluctuations and cycles; Econometric and statistical methods; Inflation and prices; Monetary policy transmission |
| JEL: | E3 E31 E5 E52 |
| Date: | 2024–07 |
| URL: | https://d.repec.org/n?u=RePEc:bca:bocadp:24-07&r= |