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on Dynamic General Equilibrium |
| By: | Montes-Galdón, Carlos; Ajevskis, Viktors; Brázdik, František; Garcia, Pablo; Gatt, William; Lima, Diana; Mavromatis, Kostas; Ortega, Eva; Papadopoulou, Niki; De Lorenzo, Ivan; Kolb, Benedikt |
| Abstract: | Understanding asymmetric risks in macroeconomic variables is challenging. Most structural models used for policy analysis are linearised and therefore cannot generate asymmetries such as those documented in the empirical growth-at-risk (GaR) literature. This report examines how structural models can incorporate non-linearities to generate tail risks. The first part reviews the various extensions to dynamic stochastic general equilibrium (DSGE) models and the computational challenges involved in accounting for risk distributions. This includes the use of occasionally binding constraints and more recent developments, such as deep learning, to solve non-linear versions of DSGEs. The second part shows how the New Keynesian DSGE model, augmented with the vulnerability channel as proposed by Adrian et al. (2020a, b), satisfactorily replicates key empirical facts from the GaR literature for the euro area. Furthermore, introducing a vulnerability channel into an open-economy set-up and a medium-sized DSGE highlights the importance of foreign financial shocks and financial frictions, respectively. Other non-linearities arising from financial frictions are also addressed, such as borrowing constraints that are conditional on an asset’s value, and the way macroprudential policies acting against those constraints can help stabilise the economy and generate positive spillovers to monetary policy. Finally, the report examines how other types of tail risk beyond financial frictions – such as the recent asymmetric supply-side shocks – can be incorporated into macroeconomic models used for policy analysis. JEL Classification: E70, D50, G10, G12, E52 |
| Keywords: | asymmetric shocks, DSGE, macroprudential policies, non-linearities, structural models, tail risks, vulnerability channel |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:ecb:ecbops:2024357 |
| By: | Felipe Alves; Giovanni L. Violante |
| Abstract: | We develop a Heterogeneous Agent New Keynesian model with a three-state frictional labour market that is consistent with the empirical evidence that (i) low-skilled workers are more exposed to the business cycle, (ii) displacement leads to long-lasting earnings losses, and (iii) unemployment is a stepping stone toward exit from the labor force. In this environment, a transient contractionary monetary policy shock induces a very persistent reduction in labour force participation and labour productivity, especially among workers at the bottom of the skill distribution. Despite the negative hysteresis on output, the model does not give rise to protracted deflation. |
| Keywords: | Monetary Policy Transmission; Labour Markets |
| JEL: | E21 E24 E31 E32 E52 J24 J64 |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:bca:bocawp:24-39 |
| By: | Ayse Imrohoroglu; Kai Zhao |
| Abstract: | We present a dynamic general equilibrium model of homelessness calibrated to the U.S. data and evaluate the effectiveness of several policies in the fight against homelessness. The model is designed to capture the most at-risk groups, producing a diverse homeless population that includes a significant portion experiencing short-term homelessness due to labor market shocks and a smaller portion facing chronic homelessness mostly due to health shocks. Our policy experiments reveal that the existing housing voucher program effectively reduces homelessness especially when the general equilibrium effects are accounted for. We show that increasing the reach of the program for eligible individuals can lead to further declines in the aggregate homeless rate relative to alternative forms of subsidies. However, policies targeted to help decrease homelessness are not as popular as general poverty reduction tools such as cash subsidies, which generate a larger welfare gain in our experiments. |
| Keywords: | Income Shock; General equilibrium; Health shock; Homeless; Housing |
| JEL: | H20 E20 |
| Date: | 2024–10–22 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedmoi:99008 |
| By: | Rodolfo G. Campos (BANCO DE ESPAÑA); Jesús Fernández-Villaverde (UNIVERSITY OF PENNSYLVANIA, NBER, CEPR); Galo Nuño (BIS, BANCO DE ESPAÑA, CEPR, CEMFI); Peter Paz (BANCO DE ESPAÑA) |
| 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 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 natural rates. We validate our findings with a series of empirical estimates. |
| Keywords: | HANK models, natural rates, fiscal shocks |
| JEL: | E32 E58 E63 |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:bde:wpaper:2439 |
| By: | Jorge Abad (BANCO DE ESPAÑA); David Martínez-Miera (UC3M AND CEPR); Javier Suárez (CEMFI AND CEPR) |
| Abstract: | We study banks’ systemic risk-taking decisions in a dynamic general equilibrium model, highlighting the macroprudential role of bank capital requirements. Banks decide on their unobservable exposure to systemic shocks by balancing risk-shifting gains against the value of preserving their capital after such shocks. Capital requirements reduce systemic risk taking, but at the cost of reducing credit and output in calm times, generating welfare trade-offs. We find that systemic risk taking is maximal after long periods of calm and may worsen if capital requirements are countercyclically adjusted. Removing deposit insurance introduces market discipline but increases the bank capital necessary to support credit, implies lower (though far from zero) optimal capital requirements and has nuanced social welfare effects. |
| Keywords: | capital requirements, risk shifting, deposit insurance, systemic risk, financial crises, macroprudential policies |
| JEL: | G01 G21 G28 E44 |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:bde:wpaper:2441 |
| By: | Gene Kindberg-Hanlon |
| Abstract: | This paper seeks to show that a New Keynesian model can produce highly persistent and large output responses to fiscal transfers and excess wealth, in line with recent empirical literature. The introduction of myopia to households to allow realistic degrees of dissaving from wealth and accumulated transfers, alongside more standard Keynesian features, achieves this goal. Model IRFs closely match the high fiscal multipliers from the tax stimulus SVAR literature, and also have important inflationary consequences. An application of this model to the COVID era, where transfer payments in the United States supported an accumulation of ``excess savings", results in inflation rising by over 1 percentage point for several years as well as a persistent increase in output over the same horizon. Finally, under the same framework and calibration, it is found that high debt and a weak fiscal rule can dull the transmission of monetary policy due to the wealth effect from higher interest payments. |
| Keywords: | Fiscal multipliers; excess savings; COVID-19; inflation |
| Date: | 2024–09–27 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2024/208 |
| By: | Michael Gilraine; James Graham; Angela Zheng |
| Abstract: | While rising house prices are known to benefit existing homeowners, we document a new channel through which house price shocks have intergenerational wealth effects. Using panel data from school zones within a large U.S. school district, we find that higher local house prices lead to improvements in local school quality, thereby increasing children's human capital and future incomes. We quantify this housing wealth channel using an overlapping generations model with neighborhood choice, spatial equilibrium, and endogenous school quality. We find that housing market shocks generate large intergenerational wealth effects that account for around one-third of total housing wealth effects. |
| Keywords: | Intergenerational mobility; Intergenerational wealth effects; school quality; Neighborhood choice; House prices |
| JEL: | R23 E24 J62 I24 E21 R21 |
| Date: | 2024–10–11 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedmoi:98965 |
| By: | Barreto Otazú, César; Merkl, Christian |
| Abstract: | Our paper documents the importance of workers' ex-ante heterogeneity for labor market dynamics and for the composition of the unemployment pool. We show that workers with high wages have both lower separation rates and larger log-deviations of these separations over the business cycle than those with low wages. Thereby, more high-wage workers enter the unemployment pool in recessions, leading to a positive correlation between unemployment and the prior wage of those losing their job. Based on administrative data for Germany and two-way fixed effects, we show that worker fixed effects are key for the documented facts. We contrast our empirical results with a search and matching model with worker ex-ante productivity heterogeneity. The simulated model can replicate the empirical facts when calibrated to the measured flow rates and to the relative residual wage dispersion from the administrative data for different wage groups. It is the combination of low steady state separation rates and low residual wage dispersion for high-wage workers that generates the patterns documented in the data. |
| Keywords: | Labor Market Flows, Separations, Fixed Effects, Labor Market Dynamics |
| JEL: | E24 E32 J31 J60 J64 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:iwqwdp:304409 |
| By: | Miroslav Gabrovski; Ioannis Kospentaris; Lucie Lebeau |
| Abstract: | An increasing share of corporate loans, a critical source of firm credit, are sold off banks’ balance sheets and actively traded in a secondary over-the-counter market. We develop a microfounded equilibrium search-theoretic model with labor, credit and financial markets to explore how this secondary loan market affects the real economy, highlighting a trade-off: while the market reduces the steady-state level of unemployment by 0.6pp, it amplifies its response to a 1% productivity drop from 3.6% to 4.3%. Secondary market frictions matter significantly: eliminating them would not only reduce unemployment by 1.2pp, but also dampen its volatility down to 2.7%. |
| Keywords: | search frictions; labor market; credit markets; financial linkages; secondary loan markets; over-the-counter markets |
| JEL: | E24 E44 E51 G11 G12 G21 J64 |
| Date: | 2024–10–22 |
| URL: | https://d.repec.org/n?u=RePEc:fip:feddwp:99019 |
| By: | Pellegrino, Bruno; Spolaore, Enrico; Wacziarg, Romain |
| Abstract: | Observed international investment positions and cross-country heterogeneity in rates of return to capital are hard to reconcile with frictionless capital markets. In this paper, we develop a theory of international capital allocation: a multi-country dynamic spatial general equilibrium model in which the entire network of cross-border investment is endogenously determined. Our model features cross-country heterogeneity in fundamental risk, a demand system for international assets, and frictions that cause segmentation in international capital markets. We measure frictions affecting international investment and apply our model to data from nearly 100 countries, using a new dataset of international capital taxes and cultural, geographic and linguistic distances between countries (geopoliticaldistance.org). Our model performs well in reproducing the composition of international portfolios, the cross-section of home bias and rates of return to capital, and other key features of international capital markets. Finally, we carry out counterfactual exercises: we show that barriers to international investment reduce world output by almost 7% and account for nearly half of the observed cross-country differences in capital stock per employee. |
| Keywords: | Capital Allocation, Cultural Distance, Geography, Information Frictions, International Finance, International Investment, Misallocation, Open Economy, Rational Inattention |
| JEL: | E22 E44 F2 F3 F4 G15 O4 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:cbscwp:303525 |
| By: | Sylvain Catherine; Mehran Ebrahimian; Constantine Yannelis |
| Abstract: | The rapid rise in student loan balances has raised concerns among economists and policymakers. Using administrative credit bureau data, we find that nearly half of the increase in balances from 2010 to 2020 is due to deferred payments, largely driven by the expansion of income-driven repayment (IDR) plans, which link payments to income. These plans help borrowers by smoothing consumption, insuring against labor income risk, and reducing the present value of future payments. We build a life-cycle model to quantify the welfare gains from this payment deferment and the channels through which borrower welfare increases. New, more generous IDR rules increase this transfers from taxpayers to borrowers without yielding net welfare gains. By lowering the average marginal cost of undergraduate debt to less than 50 cents per dollar, these rules may also incentivize excessive borrowing. We demonstrate that an optimally calibrated IDR plan can achieve similar welfare gains for borrowers at a much lower cost to taxpayers, and without encouraging additional borrowing, primarily through maturity extension. |
| JEL: | G50 H52 I20 |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:33059 |
| By: | Zachary Bethune; Joaquín Saldain; Eric R. Young |
| Abstract: | We investigate the welfare consequences of consumer credit regulation in a dynamic, heterogeneous-agent model with endogenous lender market power. We incorporate a decentralized credit market with search and incomplete information frictions into an off-the-shelf Eaton–Gersovitz model of consumer credit and default. Lenders post credit offers and borrowers apply for credit. Some borrowers are informed and direct their application toward the lowest offers while others are uninformed and apply randomly. Equilibrium features price dispersion — controlling for a borrower’s default risk, both high- and low-cost lending exist. Importantly, the distribution of loan prices and the extent of lenders’ market power are disciplined by borrowers’ outside options. We calibrate the model to match characteristics of the unsecured consumer credit market, including high-cost options such as payday loans. We use the calibrated model to evaluate interest rate ceilings. In a model with a competitive financial market, ceilings can only harm borrower welfare. In contrast, with lender market power, interest rate ceilings can raise borrower welfare by reducing markups, but that requires households to have some degree of financial illiteracy (lack of information about interest rates). |
| Keywords: | Interest rates; Credit and credit aggregates; Financial markets |
| JEL: | D15 D43 D60 D83 E21 G51 |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:bca:bocawp:24-36 |
| By: | Fabio Bertolotti; Andrea Lanteri; Alessandro Villa |
| Abstract: | We develop a model of capital accumulation in an economy that imports investment goods from large firms with market power. We model investment-goods producers as a dynamic oligopoly and characterize the equilibrium with a Generalized Euler Equation. We use this characterization to analyze the evolution of investment and prices. The markup on investment goods acts as an endogenous adjustment cost, which decreases as the economy grows. We calibrate the model to simulate the post-2020 shocks to demand for semiconductors. The model attributes the equipment-price increase mainly to increasing marginal costs. Finally, we analyze policy interventions to address market power. |
| Date: | 2024–09 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedhwp:98999 |
| By: | Hänsel, Matthias |
| JEL: | E31 E52 E63 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:vfsc24:302403 |
| By: | Holmberg, Johan (Department of Economics, Umeå University); Simmons, Michael (Department of Economics, Umeå University); Trapeznikova, Ija (Royal Holloway) |
| Abstract: | We use employer-employee data matched to detailed wealth records for the population of Sweden to study the relationship between initial wealth and labor market outcomes in early careers. Controlling for a detailed array of observable characteristics, including the educational major and parents' earnings before labor market entry, those with higher levels of wealth earn more. The relationship, however, is non-monotonic - the wealthiest and poorest earn less than those in the middle of the initial wealth distribution. We show that the correlation between initial wealth and average earnings in early careers is largely driven by between-firm differences, suggesting an important role for the allocation of workers across firms, and provide some descriptive evidence suggesting parental connections do not play a major role. We document several features of worker flows by parental wealth. We build a search model with on-the-job search, savings, disutility of work and heterogeneity in job destruction to understand these patterns. Providing greater benefits to workers upon labor market entry, taxed through labor income, can significantly increase wages and welfare. |
| Keywords: | earnings inequality; parental wealth; social mobility |
| JEL: | D31 E24 J62 J64 |
| Date: | 2024–10–28 |
| URL: | https://d.repec.org/n?u=RePEc:hhs:umnees:1029 |