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on Dynamic General Equilibrium |
| By: | Burkhard Heer |
| Abstract: | The optimal capital income tax rate has been shown to be nonzero in overlapping generations (OLG) models, as it helps redistribute income between cohorts and individuals with different labor supply elasticities and individual productivities. We show in a medium-scale OLG model that the optimal capital income tax rate is highly sensitive to the assumption of capital-skill complementarity in production technology. The imposition of the production function of Krusell et al. (2000) rather than the standard Cobb - Douglas function increases the optimal capital tax from 9.2% to 27.3% in our benchmark model. We also study the sensitivity of this result in the context of an aging economy and find that the optimal capital income tax increases over the upcoming decades depending on possible pension reforms and debt policies. |
| Keywords: | capital income taxes, Chamley-Judd result, skill-biased technological change, demographic change. |
| JEL: | E13 H21 H24 H25 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:ces:ceswps:_11845 |
| By: | Javier Bianchi; Louphou Coulibaly |
| Abstract: | What is the optimal monetary policy response to tariffs? This paper explores this question within an open-economy New Keynesian model and shows that the optimal monetary policy response is expansionary, with inflation rising above and beyond the direct effects of tariffs. This result holds regardless of whether tariffs apply to consumption goods or intermediate inputs, whether the shock is temporary or permanent, and whether tariffs address other distortions. |
| JEL: | E24 E44 E52 F13 F41 |
| Date: | 2025–03 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:33560 |
| By: | Cantore, Cristiano; Leonardi, Edoardo |
| Abstract: | How does the monetary and fiscal policy mix alter households’ saving incentives? To answer these questions, we build a heterogenous agents New Keynesian model where three different types of agents can save in assets with different liquidity profiles to insure against idiosyncratic risk. Policy mixes affect saving incentives differently according to their effect on the liquidity premium- the return difference between less liquid assets and public debt. We derive an intuitive analytical expression linking the liquidity premium with consumption differentials amongst different types of agents. This underscores the presence of a transmission mechanism through which the interaction of monetary and fiscal policy shapes economic stability via its effect on the portfolio choice of private agents. We call it the self-insurance demand channel, which moves the liquidity premium in the opposite direction to the standard policy-driven supply channel. Our analysis thus reveals the presence of two competing forces driving the liquidity premium. We show that the relative strength of the two is tightly linked to the policy mix in place and the type of business cycle shock hitting the economy. This implies that to stabilize the economy, monetary policy should consider the impact of the self-insurance on the liquidity premium. |
| Keywords: | monetary–fiscal interaction; HANK; government debt; liquidity |
| JEL: | E12 E52 E62 E58 E63 |
| Date: | 2025–04–30 |
| URL: | https://d.repec.org/n?u=RePEc:ehl:lserod:127221 |
| By: | Volker Hahn (University of Konstanz); Michal Marencak (National Bank of Slovakia) |
| Abstract: | Consumers’ perceptions of current inflation rates depend disproportionately strongly on changes in food prices. We construct a new Keynesian model with bounded rationality that is compatible with this finding. We calibrate the model to the UK and show that, in combination with heterogeneity in sectoral price stickiness, bounded rationality leads to larger real effects of monetary-policy shocks. Moreover, price misperceptions make consumers overestimate the magnitude of aggregate real fluctuations. Consumer welfare is maximized by a central bank that takes core inflation and food prices into account in its monetary-policy making. |
| JEL: | D01 E70 E52 E50 |
| Date: | 2025–05 |
| URL: | https://d.repec.org/n?u=RePEc:svk:wpaper:1119 |
| By: | Julien Pascal |
| Abstract: | This paper presents a novel method to solve high-dimensional economic models using neural networks when the exact calculation of the gradient by backpropagation is impractical or inapplicable. This method relies on the gradient-free bias-corrected Monte Carlo (bc-MC) operator, which constitutes, under certain conditions, an asymptotically unbiased estimator of the gradient of the loss function. This method is well-suited for high-dimensional models, as it requires only two evaluations of a residual function to approximate the gradient of the loss function, regardless of the model dimension. I demonstrate that the gradient-free bias-corrected Monte Carlo operator has appealing properties as long as the economic model satisfies Lipschitz continuity. This makes the method particularly attractive in situations involving non-differentiable loss functions. I demonstrate the broad applicability of the gradient-free bc-MC operator by solving large-scale overlapping generations (OLG) models with aggregate uncertainty, including scenarios involving borrowing constraints that introduce non-differentiability in household optimization problems. |
| Keywords: | Dynamic programming, neural networks, machine learning, Monte Carlo, overlapping generations, occasionally binding constraints. |
| JEL: | C45 C61 C63 C68 E32 E37 |
| Date: | 2025–04 |
| URL: | https://d.repec.org/n?u=RePEc:bcl:bclwop:bclwp196 |
| By: | Albuquerque, Daniel (Bank of England); Lazarowicz, Thomas (University College, London); Lenney, Jamie (Bank of England) |
| Abstract: | The simultaneous rise in housing rents and interest rates over 2022–24 brought scrutiny to the interaction between monetary policy and the housing market. We start by providing evidence on this interaction using data from the United Kingdom and a high frequency identification. Our main empirical finding is that house prices and rents do not move together after an increase in interest rates. House prices fall strongly but gradually, reaching their trough after one year, while nominal rents are stable for one to two years, before eventually falling. Next, we develop a quantitative Heterogeneous Agent New Keynesian model that includes housing and rental sectors. In particular, we model individual landlords as the marginal providers of rental housing. We use the model to examine the housing channel of monetary policy where we find: (1) the housing channel is large and falls disproportionality on mortgagors; (2) deviations from rational expectations mean landlords largely fail to pass on mortgage costs and act more like wealthy hand to mouth; (3) these behavioural biases dampen the potential trade-off between prices and output induced by the rental market; and (4) that it may be optimal for monetary policy makers to look through and accommodate housing supply shocks. |
| Keywords: | Monetary policy; housing; heterogeneous agents |
| JEL: | D31 E21 E52 R21 |
| Date: | 2025–02–14 |
| URL: | https://d.repec.org/n?u=RePEc:boe:boeewp:1115 |
| By: | Castellanos, Juan (Bank of England) |
| Abstract: | This paper conducts a Monte Carlo study to examine the small sample performance of impulse response (IRF) matching and Indirect Inference estimators that target IRFs that have been estimated with Local Projections (LP) or Vector Autoregressions (VAR). The analysis considers various identification schemes for the shocks and several variants of LP and VAR estimators. Results show that the lower bias from LP responses is a big advantage when it comes to IRF matching, while the lower variance from VAR is desirable for Indirect Inference applications as it is robust to the higher bias of VAR-IRFs. Overall, I recommend the use of Indirect Inference over IRF matching when estimating Dynamic Stochastic General Equilibrium (DSGE) models as the former is robust to potential misspecification coming from invalid identification assumptions, small sample issues or incorrect lag selection. |
| Keywords: | DSGE estimation; impulse responses; Indirect Inference; Local Projection; Vector Autoregression; Monte Carlo analysis |
| JEL: | C13 C15 E00 |
| Date: | 2025–02–14 |
| URL: | https://d.repec.org/n?u=RePEc:boe:boeewp:1116 |
| By: | Kanta Ogawa |
| Abstract: | Older male workers exhibit diverse retirement behaviors across occupations and respond differently to policy changes, influenced significantly by the part-time penalty, wage reduction faced by part-time workers compared to their full-time counterparts. Many older individuals reduce their working hours, and in occupations with high part-time penalties, they tend to retire earlier, as observed in data from Japan and the United States. This study develops a general equilibrium model that incorporates occupational choices, endogenous labor supply, highlighting that the impact on the retirement decision is amplified by the presence of assets and pensions. I find that cutting employees' pension benefits reduce aggregate labor supply in occupations with high part-time penalties in Japan, reducing overall welfare across the economy. In contrast, increasing income tax credits and exempting pension form income tax boost labor supply across all occupations and enhance welfare by raising disposable wages relative to the reservation wage. Reducing part-time penalties in high-penalty occupations also stimulate the labor supply in high-penalty occupations and improve long-term welfare. |
| Date: | 2025–03 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2503.17917 |
| By: | Adrien Bilal; Shlok Goyal |
| Abstract: | This paper proposes an analytic representation of sequence-space Jacobians in heterogeneous agent models with aggregate shocks in continuous time. Our approach is based on a pen-and-paper perturbation of individual policy functions with respect to price changes, rather than numerical or automatic differentiation. We obtain linear partial differential equations that can be solved efficiently. Our continuous time algorithm speeds up computation of Jacobians and impulse responses threefold relative to discrete time. Continuous time is key to take the analytic perturbation in the presence of binding borrowing constraints. We illustrate our approach in leading heterogeneous agent models with and without nominal rigidities. |
| JEL: | C02 C6 E10 |
| Date: | 2025–02 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:33525 |
| By: | Adrien Auclert; Matthew Rognlie; Ludwig Straub |
| Abstract: | We study the short-run effects of import tariffs on GDP and the trade balance in an open-economy New Keynesian model with intermediate input trade. We find that temporary tariffs cause a recession whenever the import elasticity is below an openness-weighted average of the export elasticity and the intertemporal substitution elasticity. We argue this condition is likely satisfied in practice because durable goods generate great scope for intertemporal substitution, and because it is easier to lose competitiveness on the global market than to substitute between home and foreign goods. Unilateral tariffs do tend to improve the trade balance, but when other countries retaliate the trade balance worsens and the recession deepens. Taking into account the recessionary effect of tariffs dramatically brings down the optimal unilateral tariff level derived in standard trade theory. |
| JEL: | E0 F10 F40 |
| Date: | 2025–04 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:33726 |
| By: | Martin S. Eichenbaum; Federico Puglisi; Sergio Rebelo; Mathias Trabandt |
| Abstract: | We show that the response of banks’ net interest margin (NIM) to monetary policy shocks is state dependent. Following a period of low (high) Federal Funds rates, a contractionary monetary policy shock leads to an increase (decrease) in NIM. Aggregate economic activity exhibits a similar state-dependent pattern. To explain these dynamics, we develop a banking model in which social interactions influence households’ attentiveness to deposit interest rates. We embed that framework within a nonlinear heterogeneous-agent NK model. The estimated model accounts well quantitatively for our key empirical findings. |
| JEL: | E44 |
| Date: | 2025–02 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:33523 |
| By: | Isabel Gödl-Hanisch; Jordan Pandolfo |
| Abstract: | We provide empirical evidence on banks’ market power in financial services and its implications for monetary policy transmission through deposit rates. Banks with market power in financial services charge higher fees for their service and also offer lower deposit rates with less pass-through from monetary policy. We argue that this is the result of product tying: consumers must open a deposit account to access a bank’s financial services. We develop and calibrate a quantitative model of the U.S. banking industry where banks generate non-interest income from services in addition to a standard loan-deposit model. Counterfactuals emphasize the importance of non-interest income for credit supply, financial stability, and deposit pricing. |
| Keywords: | monetary policy, banks, pass-through, market power, product tying. |
| JEL: | D43 E44 E52 G21 G51 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:ces:ceswps:_11847 |
| By: | Mark Robinson; Pedro Silos; Diego Vilán |
| Abstract: | We show that the secular decline in real interest rates in the United States, which began in the early 1980s and persisted for nearly four decades, reduced the labor’s share of output and the unemployment rate, and increased earnings inequality. We establish this link using a model of frictional labor markets, estimated from household-level data, in which unemployment risk is only partially insurable. Rising debt resulting from lower interest rates reduces the value of unemployment, leading to lower equilibrium wages relative to productivity and a lower unemployment rate. Wage dispersion also rises. The model is consistent with panel-data reduced-form evidence linking unemployment duration, assets, debt, and post-unemployment wages. In the model, a decline in the real interest rate of the magnitude observed in the data generates a decline in the labor’s share of 6 percentage points and in the unemployment rate of 0.3 percentage points. The variance of log earnings rises from 0.66 to 0.75. |
| Keywords: | Labor share; Household indebtedness; Reservation wage |
| JEL: | J30 E24 E27 |
| Date: | 2025–04–09 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedgfe:2025-28 |
| By: | Stephanie Schmitt-Grohé; Martín Uribe |
| Abstract: | This paper embeds a circular Hotelling model of spatial competition into a new-Keynesian model with staggered price setting. The resulting framework provides microfoundations for a cost-push shock, taking the form of random variations in transportation costs. An increase in transportation costs raises price markups and is contractionary and inflationary. Spatial frictions also have consequences for the propagation of aggregate demand disturbances (including monetary shocks), as they dampen their output effects and amplify their inflationary effects. Empirically, the paper shows that the cost of time spent shopping represents a significant fraction of consumption expenditure, suggesting that spatial frictions broadly defined are a nonnegligible feature of aggregate demand. |
| JEL: | E31 E32 L13 |
| Date: | 2025–03 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:33628 |
| By: | Christophe Bruneel-Zupanc |
| Abstract: | This paper develops a general framework for dynamic models in which individuals simultaneously make both discrete and continuous choices. The framework incorporates a wide range of unobserved heterogeneity. I show that such models are nonparametrically identified. Based on constructive identification arguments, I build a novel two-step estimation method in the lineage of Hotz and Miller (1993) and Arcidiacono and Miller (2011) but extended to simultaneous discrete-continuous choice. In the first step, I recover the (type-dependent) optimal choices with an expectation-maximization algorithm and instrumental variable quantile regression. In the second step, I estimate the primitives of the model taking the estimated optimal choices as given. The method is especially attractive for complex dynamic models because it significantly reduces the computational burden associated with their estimation compared to alternative full solution methods. |
| Date: | 2025–04 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2504.16630 |