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on Dynamic General Equilibrium |
| By: | Arpan Chakraborty |
| Abstract: | The Dynamic Stochastic General Equilibrium (DSGE) model has become a cornerstone of macroeconomic analysis, yet research in emerging economies like India remains limited. This study makes a significant contribution by introducing behavioral expectation formation into a New Keynesian DSGE model of the Indian economy, a novel approach absent in existing literature. While previous studies have exclusively employed rational expectations, this research comparatively examines behavioral and rational expectation frameworks. Using the output gap and the inflation rate, we find nuanced differences in model performance: behavioral expectations more effectively capture the constructed output gap characteristics, while rational expectations capture the inflation dynamics better. These findings have critical implications for future macroeconomic modeling and policy design, suggesting context-specific expectation formation strategies. |
| Date: | 2024–11 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2411.17165 |
| By: | Kim, Cholwoo (Department of Economics, University of Warwick) |
| Abstract: | This paper examines Ramsey-type optimal monetary policy in an open economy with a two-country dynamic general equilibrium model where search and matching frictions exist in labor markets along with the limited participation in the financial markets. Monetary policy affects the decision of firms in labor markets because firms finance their wage bills with loans from domestic financial intermediaries in advance. There are two main results associated with optimal monetary policy. The long-term optimal nominal interest rate could be zero suggesting negative optimal inflation rate in the long run because the terms of trade effect on consumption could be weaken by search frictions. As a result of Ramsey optimal monetary policy, dynamics of business cycles in both countries show similar patterns in response to a productivity shock and, in turn, higher cross-country correlations of real variables. |
| Keywords: | labor market frictions ; search and matching ; working capital ; optimal monetary policy JEL Codes: E24 ; E52 ; F41 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:wrk:warwec:1539 |
| By: | Ken-ichi Hashimoto; Ryonghun Im; Takuma Kunieda; Akihisa Shibata |
| Abstract: | By applying a simple dynamic general equilibrium model without exogenous shocks inhabited by infinitely lived capitalists and workers, we show that a higher degree of relative risk aversion can destabilize an economy. In traditional real business cycle (RBC) theory, a higher degree of relative risk aversion dampens the amplitude of the consumption fluctuations caused by exogenous shocks through consumption smoothing. However, a higher degree of relative risk aversion combined with a high degree of elasticity of the marginal product of capital can also lead to the emergence of a nonlinear mechanism that causes endogenous business fluctuations. The nontrivial steady state loses stability due to the higher degree of relative risk aversion; thus, endogenous business fluctuations can occur. This result suggests that for a deeper understanding of boom-bust cycles, researchers should merge exogenous and endogenous business fluctuations when investigating economies. |
| Date: | 2025–01 |
| URL: | https://d.repec.org/n?u=RePEc:dpr:wpaper:1272 |
| By: | Joanna Tyrowicz (Group for Research in Applied Economics (GRAPE); University of Warsaw; Institute of Labor Economics (IZA)); Krzysztof Makarski (Katedra Ekonomii IloÅ›ciowej SzkoÅ‚a GÅ‚ówna Handlowa w Warszawie; Group for Research in Applied Economics (GRAPE); Narodowy Bank Polski); Piotr Zoch (Group for Research in Applied Economics (GRAPE); WydziaÅ‚ Nauk Ekonomicznych Uniwersytet Warszawski) |
| Abstract: | We analyze the contribution of rising longevity to the increase in wealth inequality in the U.S. over the past seventy years. To do so, we construct an overlapping generations (OLG) model with multiple sources of inequality, carefully calibrated to the data. Our key finding is that improvements in old-age longevity have a substantial impact on wealth inequality, accounting for approximately half the effect of income inequality, which has been the focus of much of the existing literature. In contrast, the impact of tax changes is relatively minor. The contribution of rising longevity is expected to continue driving wealth inequality upward in the coming decades. |
| Keywords: | wealth inequality, rising longevity, OLG |
| JEL: | J15 D31 E21 E24 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:fme:wpaper:101 |
| By: | Abolfazl Rezghi |
| Abstract: | How does rational inattention interact with financial frictions? I provide new empirical evidence from survey data suggesting that this interaction likely plays a critical role in understanding macroeconomic dynamics. In a simple model, I demonstrate that financially constrained firms tend to be more attentive to economic conditions, consistent with my empirical findings. Embedding this mechanism into a DSGE model, I show that the aggregate investment response to a monetary policy shock depends on this interaction. The model further predicts that credit-constrained firms reduce their investment after an expansionary shock due to tighter borrowing constraints and higher production costs, a prediction I empirically confirm. |
| Keywords: | Monetary policy; Rational inattention; Financial frictions; Investment |
| Date: | 2025–01–24 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2025/025 |
| By: | Brotherhood, Luiz; Da Mata, Daniel; Santos, Cezar; Guner, Nezih; Kircher, Philipp |
| Abstract: | This paper investigates informal employment in Brazil's highly regulated labor market, focusing on the intensive margin of informality within formal firms. Using a comprehensive dataset of labor audits conducted from 1997 to 2012, we find that formal firms caught with informal workers face sustained slower growth. Informal workers are found across firms of all sizes, and their characteristics closely resemble those of formal employees. Building on these empirical findings, we develop a dynamic general equilibrium model where firms balance the flexibility of informality against potential costs. Our framework can be used to explore government policy implications and to examine the impact of audit strategies on informality, output, and workers welfare. |
| JEL: | J01 H20 J2 L11 |
| Date: | 2024–11 |
| URL: | https://d.repec.org/n?u=RePEc:idb:brikps:13864 |
| By: | Mr. Yehenew Endegnanew; Rafael D Goncalves; Samuel Mann; Ms. Marina Mendes Tavares; Harold Zavarce |
| Abstract: | Natural disasters often have high economic costs, setting back years of investment in developing countries. This paper develops a multi-sector DSGE model to study the macroeconomic and welfare implications of financing resilience-building using different fiscal instruments. The model includes developing countries’ macroeconomic and distributional features, such as a large unproductive rural sector, an incomplete credit market, and an informal sector. The results indicate that investing in resilience capital in a disaster-prone country improves welfare despite its high economic cost, but the financial instrument used to mobilize revenue matters. |
| Keywords: | Resilient investment; natural disasters; macroeconomics; fiscal sustainability. |
| Date: | 2025–01–17 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2025/013 |
| By: | Choukhmane, Taha; Coeurdacier, Nicolas; Jin, Keyu |
| Abstract: | We investigate whether the "one-child policy" has contributed to the rise in China's household saving rate and human capital in recent decades. In a life-cycle model with intergenerational transfers and human capital accumulation, fertility restrictions lower expected old-age support coming from children - inducing parents to raise saving and education investment in their offspring. Quantitatively, the policy can account for at least 30% of the rise in aggregate saving. Using the birth of twins under the policy as an empirical out-of-sample check to the theory, we find that quantitative estimates on saving and education decisions line up well with micro-data. |
| Keywords: | AAM requested |
| JEL: | D10 D91 E21 |
| Date: | 2023–06–01 |
| URL: | https://d.repec.org/n?u=RePEc:ehl:lserod:119964 |
| By: | Yang, Xiaoliang (Zhongnan University of Economics and Law); Zhou, Peng (Cardiff Business School); Dong, Xue |
| Abstract: | This paper investigates the long-run nexus between wealth inequality and aggregate output using a DSGE model in which wealth inequality endogenously affects individual entrepreneurship incentives, thereby influencing aggregate output. Our model passes the indirect inference test against the UK data from 1870 to 2015. We find that shocks to aggregate TFP, entrepreneurial barriers, government grant support and general government spending played significant roles in shaping historical inequality dynamics in the UK. Directly removing entrepreneurial barriers or indirectly providing government grant support to the private sector such as through inclusive loan subsidies are effective means of reducing inequality and stimulating output growth. |
| Keywords: | Wealth Inequality, Aggregate Output, Entrepreneurship, Indirect Inference |
| JEL: | C72 C92 D83 |
| Date: | 2025–01 |
| URL: | https://d.repec.org/n?u=RePEc:cdf:wpaper:2025/1 |
| By: | Marco Bonomo; Tiago Cavalcanti; Fernando Chertman; Amanda Fantinatti; Andrew Hannon; Cezar Santos |
| Abstract: | Consumer loans are key for consumption smoothing. But what if individuals who need them the most find it harder to access these loans? We examine this question empirically and quantitatively, using Brazilian credit registry and matched employer-employee data. Low-income individuals face higher interest rates, even after controlling for several risk factors and characteristics. Our model includes life-cycle dynamics, different credit types, occupations, and income shocks with endogenous default. According to the calibrated model, reforms reducing loan interest rate spreads could significantly benefit individuals, especially young and poor informal workers. The pro-competition 2013 Loan Portability reform increased welfare by 0.2% of annual consumption. |
| Date: | 2025–01 |
| URL: | https://d.repec.org/n?u=RePEc:bcb:wpaper:614 |
| By: | Rodrigo Jardim Raad (Cedeplar/UFMG); Aloísio Araújo (Cedeplar/UFMG) |
| Abstract: | Kubler and Schmedders (2005) showed that a competitive equilibrium can be far from an exact equilibrium when computed using first-order conditions. This paper shows that a competitive equilib- rium is implemented by recursive statistics with a minimal state space. This result allows us to develop an alternative method for computing the equilibrium without using first order conditions and smoothness assumptions. We compute the recursive equilibrium through a functional iteration algorithm and show that its implemented equilibrium allocation is arbitrarily close to an exact competitive equilibrium. In particular, we simulate some stochastic equilibrium processes in which agents anticipate exogenous un- certainty using some rules described in the literature of behavioral finance. An important stylized fact that is found suggests that incomplete markets favor agents with rational expectations when the expected asset return is high in relation to the risk-free asset. |
| Keywords: | Survival; Recursive Equilibrium; Ambiguity Aversion; Behavioral finance; Noise Traders; Incomplete Markets. |
| JEL: | D58 D52 |
| Date: | 2024–12 |
| URL: | https://d.repec.org/n?u=RePEc:cdp:texdis:td677 |
| By: | Meier, Mario; Obermeier, Tim |
| Abstract: | Field experiments show that employers are less likely to consider long-term unemployed job seekers for interviews. We study the implications for optimal unemployment insurance. Based on a structural model of job search and recruitment, estimated with German data, we analyse the optimal two-tier unemployment system. We find that screening makes the optimal initial benefit level 4 percentage points higher and the potential benefit duration seven months longer. Using an extended Baily–Chetty formula, we study the mechanisms through which screening affects the consumption smoothing gain and moral hazard cost of providing unemployment insurance and highlight the role of the externality from endogenous firm behaviour. |
| JEL: | R14 J01 |
| Date: | 2024–12–24 |
| URL: | https://d.repec.org/n?u=RePEc:ehl:lserod:126865 |
| By: | Arteaga, Julián (World Bank); de Roux, Nicolás (Universidad de los Andes); Gáfaro, Margarita (Banco de la República); Ibáñez, Ana María (Banco Interamericano de Desarrollo - IADB); Pellegrina, Heitor (University of Notre Dame) |
| Abstract: | This paper studies the dynamics of farm size distribution, how they are influenced by weather shocks, and the implications for aggregate productivity. Using data from several developing countries, we first document new empirical facts about households’ landholding choices and how weather shocks influence these decisions. Building on a rich longitudinal dataset for Colombia on farm sizes, land transactions, and households’ consumption and investment decisions, we then show that weather shocks increase the frequency of land sales and reduce farm sizes within municipalities, especially among smaller farms. To rationalize these facts, we develop a dynamic, heterogeneous household model in which uninsured farmers make landholding and occupational choices. Our calibrated model shows that uninsured risk substantially curbs aggregate agricultural productivity, and that the effects of temporary weather shocks on farm size and agricultural output are highly persistent, taking more than a decade to fade out. |
| Keywords: | Farm Size; Weather Shocks; Aggregate Shocks; Heterogeneous Agent Model |
| JEL: | D52 O13 Q12 Q15 Q54 |
| Date: | 2025–01–27 |
| URL: | https://d.repec.org/n?u=RePEc:col:000089:021308 |
| By: | Maxted, Peter; Laibson, David; Moll, Ben |
| Abstract: | We study the effect of monetary and fiscal policy in a heterogeneous-agent model where households have present-biased time preferences and naive beliefs. The model features a liquid asset and illiquid home equity, which households can use as collateral for borrowing. Because present bias substantially increases households’ marginal propensity to consume (MPC), present bias increases the effect of fiscal policy. Present bias also amplifies the effect of monetary policy, but at the same time, slows down the speed of monetary transmission. Interest rate cuts incentivize households to conduct cash-out refinances, which become targeted liquidity injections to high-MPC households. Present bias also introduces a motive for households to procrastinate refinancing their mortgages, which slows down the speed with which this monetary channel operates. |
| JEL: | E21 E60 |
| Date: | 2025–02–28 |
| URL: | https://d.repec.org/n?u=RePEc:ehl:lserod:123935 |
| By: | Tomohiro Hirano; Keiichi Kishi; Alexis Akira Toda |
| Abstract: | This paper identifies the conditions and mechanisms that give rise to stochastic bubbles that are expected to collapse. To illustrate the essence of the emergence of stochastic bubbles, we first present a toy model that shows that land price bubbles that are expected to collapse emerge as the unique equilibrium outcome. Then we present a full-fledged macro-finance model of intangible capital and show that stochastic stock bubbles attached to intangible capital emerge in the process of spillover of technological innovation. The dynamics with stochastic bubbles, which is characterized by unbalanced growth, can be seen as a temporary deviation from a balanced growth path in which asset prices equal the fundamentals. |
| Date: | 2025–01 |
| URL: | https://d.repec.org/n?u=RePEc:cnn:wpaper:25-001e |
| By: | Masashige Hamano; Philip Schnattinger; Mototsugu Shintani; Iichiro Uesugi; Francesco Zanetti |
| Abstract: | We develop a simple model of financial intermediation with search and matching frictions between banks and firms. The model links credit market tightness –encapsulating the abundance of credit– to the search and opportunity costs of credit intermediation. Search costs generate lending to unprofitable firms (i.e., zombies) and the opportunity costs of searching exert countervailing forces on the incentives for banks and firms to participate in zombie lending, generating an inverted U-shaped relationship between credit market tightness and the share of zombie lending. High bargaining power of firms decreases the opportunity cost of firms foregoing credit relationships, reduces the share of zombie firms and increases the efficacy of capital injections to reduce zombie lending. Using data for 31 industries in Japan over the period 2000-2019, we test and corroborate our theoretical predictions by constructing theory-consistent measures of credit market tightness and bargaining power. Consistent with our theory, the findings reveal that capital injections are more effective in industries with higher credit market tightness and greater bargaining power of firms. |
| Keywords: | zombie firms, bank lending, credit market tightness |
| JEL: | E22 E23 E32 E44 |
| Date: | 2025–01 |
| URL: | https://d.repec.org/n?u=RePEc:een:camaaa:2025-05 |
| By: | Michal Kobielarz |
| Abstract: | The Eurozone bailouts consisted of credit lines with favorable lending conditions, equivalent to countries receiving implicit fiscal transfers. They are often interpreted as meant to prevent a default in the Eurozone or resolve the crisis. Contrary to this nar rative, Greece defaulted on its debt and went through a deep and prolonged recession, despite receiving fiscal assistance. This paper analyzes country bailouts in a monetary union within a framework where sovereign default and exit from the union are two separate decisions. The studied bailouts prevent an exit and, thus, do not exclude subsequent defaults. The model replicates the experience of Greece and captures the coexistence of bailouts, defaults, and recession. It also sheds new light on the moral hazard discussion of bailouts by showing no significant effects from exit-driven bailouts. |
| Date: | 2023–03 |
| URL: | https://d.repec.org/n?u=RePEc:ete:ceswps:746842 |