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on Dynamic General Equilibrium |
| By: | Meenagh, David (Cardiff Business School); Minford, Patrick (Cardiff Business School, Cardiff University); Xu, Yongdeng (Cardiff Business School, Cardiff University) |
| Abstract: | This paper examines how Bayesian estimation performs in applied macroeconomic DSGE models when prior beliefs are misspecified. Using controlled Monte Carlo experiments on a standard Real Business Cycle model and a New Keynesian model, the authors show that Bayesian procedures can deliver severely biased and misleading parameter estimates, with posteriors pulled toward the researcher’s prior rather than the true data-generating process. In contrast, a classical simulation-based method, Indirect Inference, remains largely unbiased and robust even under substantial model uncertainty. The results imply that heavy reliance on Bayesian estimation can entrench false conclusions about key structural features, such as the degree of nominal rigidity, and thereby mislead policy analysis. The paper argues for greater use of robust estimation and model-validation techniques, such as Indirect Inference, to ensure that DSGE-based policy advice rests on credible empirical evidence. |
| Keywords: | Bayesian Estimation; DSGE Models; Indirect Inference; Monte Carlo Simulation; Model Misspecification |
| JEL: | C11 C15 C52 E32 |
| Date: | 2025–11 |
| URL: | https://d.repec.org/n?u=RePEc:cdf:wpaper:2025/22 |
| By: | Marlon Azinovic-Yang; Jan Zemlicka |
| Abstract: | We develop a deep learning algorithm for approximating functional rational expectations equilibria of dynamic stochastic economies in the sequence space. We use deep neural networks to parameterize equilibrium objects of the economy as a function of truncated histories of exogenous shocks. We train the neural networks to fulfill all equilibrium conditions along simulated paths of the economy. To illustrate the performance of our method, we solve three economies of increasing complexity: the stochastic growth model, a high-dimensional overlapping generations economy with multiple sources of aggregate risk, and finally an economy where households and firms face uninsurable idiosyncratic risk, shocks to aggregate productivity, and shocks to idiosyncratic and aggregate volatility. Furthermore, we show how to design practical neural policy function architectures that guarantee monotonicity of the predicted policies, facilitating the use of the endogenous grid method to simplify parts of our algorithm. |
| Keywords: | deep learning, heterogeneous firms, heterogeneous households, overlapping generations, deep neural networks, global solution method, life-cycle, occasionally binding constraints |
| JEL: | C61 C63 C68 D52 E32 |
| Date: | 2025–10 |
| URL: | https://d.repec.org/n?u=RePEc:cer:papers:wp802 |
| By: | Youngsoo Jang (Yonsei University); Ji-Woong Moon (Chung-Ang University) |
| Abstract: | We examine (i) how Labor-Force Participation (LFP) margins influence unemployment through their interaction with wealth accumulation and (ii) their impact on the optimal design of unemployment insurance (UI). To this end, we construct a job search and matching model that incorporates incomplete financial markets and LFP decisions in general equilibrium. We find that LFP margins are crucial for explaining the negative relationship between unemployment and wealth observed in micro-level data. In both the model and the data, declining inflows into unemployment with wealth are the key driver of this negative relationship. Without LFP choices, however, the unemployment rate increases with wealth because inflows into unemployment do not decline with wealth, contradicting empirical findings. This disparity has significant policy implications for the design of UI: the optimal UI benefit is 75% of the current level when LFP decisions are incorporated, whereas in the model without LFP margins the optimal benefit is 0%. |
| Keywords: | Labor Force Participation, Unemployment, Unemployment Insurance, Incomplete Markets, General Equilibrium |
| JEL: | E24 J64 J65 |
| Date: | 2025–09 |
| URL: | https://d.repec.org/n?u=RePEc:yon:wpaper:2025rwp-270 |
| By: | Luca Pensieroso (Université Catholique de Louvain); Alessandro Sommacal (Department of Economics (University of Verona)); Gaia Spolverini (Université Catholique de Louvain) |
| Abstract: | We study the U.S. fertility transition by family type and document a novel fact: intergenerational coresidence has been systematically associated with lower fertility than nuclear families. This gap has been narrowing over time. This fact cannot be easily explained by existing theories. We propose a new theory in which both fertility and family structure are endogenous. In our theory, a positive fertility differential in favour of the nuclear family emerges when the amount of resources allocated to the young generation under coresidence is lower than the amount they would enjoy in a nuclear family. The allocation of resources depends on the income of the young relative to that of their coresiding parents and on preferences for intergenerational coresidence. We derive the model analytically, and find empirical support for its main mechanism. Simulations from a calibrated dynamic general equilibrium version of the model confirm that the model has the right qualitative behaviour, and is quantitatively meaningful. |
| Keywords: | Family type, Family structure, Quantity-quality trade off, Overlapping generations, Dynamic General Equilibrium, Unified Growth Theory |
| JEL: | J10 O40 O11 E13 |
| Date: | 2025–10 |
| URL: | https://d.repec.org/n?u=RePEc:ver:wpaper:08/2025 |
| By: | Zainab Iftikhar; Anna Zaharieva |
| Abstract: | This paper evaluates the effects of low-skill immigration on small businesses, wages, and employment in Germany. We develop a search and matching model with heterogeneous workers, cross-skill matching, and endogenous entry into entrepreneurship. The model is calibrated using data from the German SocioEconomic Panel (SOEP). Quantitative analysis shows that low-skill immigration increases the welfare of high-skill workers. It also leads to the endogenous expansion of immigrant entrepreneurial activities, generating positive spillovers for all demographic groups except native entrepreneurs. However, the gains are outweighed by the losses in welfare of low-skill workers, and overall, there is a marginal loss of per-worker welfare to the economy. Policies restricting immigrant entrepreneurship relax competition for native small businesses but reduce welfare for all other worker groups. |
| Keywords: | entrepreneurship, small business, self-employment, search frictions, immigration |
| JEL: | J23 J31 J61 J64 L26 |
| Date: | 2025–11 |
| URL: | https://d.repec.org/n?u=RePEc:bon:boncrc:crctr224_2025_714 |
| By: | Ralph Luetticke; Timothy Meyer; Gernot Müller; Moritz Schularick |
| Abstract: | Using historical income and wealth data, we show that war reduces inequality: the top-1% income share falls by 20% and the top-1% wealth share by 10%. We measure three key drivers of inequality - capital destruction, taxation, and inflation - in the data and quantify their role with a Heterogeneous Agent New Keynesian (HANK) model. Destruction depresses profits and thus top incomes. Taxation primarily influences wealth dynamics, while inflation has little effect on top shares, but reduces indebtedness among poorer households. We validate our findings using new data on inequality across German towns in World War 2 and cross-country data on profits. |
| Keywords: | interstate wars, inequality, income share, wealth share |
| JEL: | F40 F50 E50 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:ces:ceswps:_12276 |
| By: | Volker Grossmann; Johannes Schünemann; Holger Strulik |
| Abstract: | Sick pay compensates for income loss during illness. However, it may distort labor supply by affecting gross wages if paid by employers and net wages if financed by social insurance contributions. We develop a dynamic general equilibrium model with endogenous, biologically founded health and aging in an education-stratified society to study how the level and financing of sick pay affect the socioeconomic health gradient, income inequality, life expectancy, and welfare. Our analysis shows that reducing the sick pay replacement rate would significantly raise distributional disparities in income and health in Germany. We also show that the individually preferred sick pay replacement rate decreases with the level of educational attainment and that most individuals prefer employer-funded sick pay over public financing. |
| Keywords: | health deficit accumulation, sick pay, social insurance, socioeconomic health gradient, welfare |
| JEL: | H51 I14 I18 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:ces:ceswps:_12265 |
| By: | Quang-Thanh Tran (Development and Policies Research Center (DEPOCEN)); Akiomi Kitagawa (Graduate School of Economics and Management, Tohoku University) |
| Abstract: | This paper employs an overlapping generations model to analyze how placing the burden of caring for both elderly parents and children on the working generation shapes fertility and other economic outcomes. In the model, fertility decisions create intergenerational spillovers. When one generation has fewer children, the next generation faces a heavier caregiving burden for its elderly parents, which in turn discourages childbearing. The model reveals sharply different long-run trajectories depending on the time intensity of caregiving. If care demands are moderate, sustainable growth remains feasible despite these externalities. However, when care becomes highly time-intensive, fertility declines, labor supply contracts, and the economy risks falling into a ``nursing hell, " where most time is devoted to caregiving. Policy measures, such as child allowances, can alleviate this dynamic by expanding the number of siblings and reducing the per-capita caregiving burden. Yet if care demands are extremely high from the outset, even such interventions cannot avert structural collapse. |
| Keywords: | dual caregiving, endogenous fertility, overlapping generations, sustainability |
| JEL: | E13 J13 J14 J22 J24 O11 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:dpc:wpaper:0325 |
| By: | Thomas Douenne; Sebastian Dyrda; Albert Jan Hummel; Marcelo Pedroni |
| Abstract: | How should governments design climate policies in the presence of inequality, uninsurable risk, and fiscal constraints? To address this question, we develop a climate--economy model with incomplete markets and idiosyncratic labor-income risk, where Ricardian equivalence fails and optimal long-run capital taxes are positive, leading to important inter-temporal wedges. We analytically show that the optimal carbon tax equals the social cost of carbon (SCC) adjusted for fiscal distortions. Calibrating the model to the U.S., we show that these adjustments are quantitatively negligible: high levels of household inequality, income risk, and fiscal distortions do not, in themselves, justify lowering climate ambitions. Welfare gains under the optimal policy come almost entirely from efficiency and environmental amenities, with almost no effect on redistribution and insurance, and are fairly evenly distributed across households. |
| Keywords: | Climate policy; Carbon taxes; Optimal taxation; Heterogeneous agents; Incomplete markets; Inequality and risk. |
| JEL: | E62 H21 H23 Q5 D52 |
| Date: | 2025–11–10 |
| URL: | https://d.repec.org/n?u=RePEc:tor:tecipa:tecipa-807 |
| By: | Li, Mingzhe |
| Abstract: | The Merton framework has difficulty explaining empirical phenomena in household finance and life-cycle patterns. This paper proposes a continuous-time heterogeneous agent model with common noise to study portfolio choice for heterogeneous investors. Households pay an "asset-exposure premium" (AEP) based on their wealth for bearing common financial risk. The AEP effect serves as a non-monotonic third term in optimal portfolio choice. For households near the borrowing constraint, the AEP effect is large and negative, overwhelming other motives and explaining limited participation. As wealth increases, the AEP effect turns positive before disappearing at high wealth, resulting in a hump-shaped profile of risky holdings. The AEP enables households to identify the risk characteristics of their portfolio, explaining why the low wealth exhibits underdiversification and why middle-to-high wealth households hold diversified portfolios. Furthermore, this paper introduces a steady state and solves the degeneration problem of the wealth distribution in the continuous-time ABH framework. |
| Keywords: | portfolio choice; household finance; limited participation; wealth distribution; heterogeneous agent; continuous time; underdiversification; life cycle |
| JEL: | C73 D91 E21 G11 |
| Date: | 2025–06–17 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:126642 |
| By: | Pau Roldan-Blanco; Josep Pijoan-Mas |
| Abstract: | We study how the co-existence of fixed-term (FT) and open-ended (OE) contracts shapes firm dynamics, firm selection, worker allocation, aggregate productivity, and output. Using rich Spanish administrative data, we document that the use of fixed- term contracts is very heterogeneous across firms within narrowly defined sectors. Particularly, the relationship between the share of temporary workers and firm size is positive within firm but negative between firms. To explain these facts, we write a model of firm dynamics with technology heterogeneity, search-and-matching frictions, and a two-tier labor market structure. Our model emphasizes a key trade-off between contracts, namely, that while FT contracts give flexibility to firms, they also create more worker turnover, which is costly through the need to hire new workers and through the loss of firm-specific human capital. We find that limiting the use of FT contracts decreases the share of temporary employment and increases aggregate productivity —as better firm selection offsets increased misallocation of workers— but it also increases unemployment, output, and welfare. |
| Keywords: | dual labor markets, firm dynamics, temporary contracts, unemployment |
| JEL: | D83 E24 J41 L11 |
| Date: | 2025–11 |
| URL: | https://d.repec.org/n?u=RePEc:bge:wpaper:1531 |
| By: | Youngsoo Jang (Yonsei University) |
| Abstract: | I study a dynamic game of successive governments in an incomplete-markets economy, where governments set labor income taxes and lump-sum taxes/transfers depending on their commitment ability. I find that commitment enables the government to coordinate policies across periods, thereby internalizing the effects of current policy decisions on the evolution of factor prices and wealth distributions shaped by past history. Commitment facilitates substantial long-term taxes and transfers, incurring long-run welfare losses but yielding short-run welfare gains through front-loaded reductions in precautionary savings and favorable factor price adjustments for low-income individuals. Without commitment, the government overlooks this intertemporal trade-off, yielding smaller short-run gains. |
| Keywords: | Taxes and Transfers, Commitment, Time Inconsistency, Incomplete Markets, Transition Dynamics. |
| JEL: | E61 H21 |
| Date: | 2025–07 |
| URL: | https://d.repec.org/n?u=RePEc:yon:wpaper:2025rwp-269 |
| By: | Mazza, Jan |
| Abstract: | Using Italian microdata, this paper documents that, conditional on parental resources, education, and transfers, (i) expecting an inheritance predicts a 19.6 percentage points (63.5%) higher probability of university enrollment, and (ii) expected heirs tend to belong to altruistic dynasties, since having received an inheritance nearly doubles the intention to leave a bequest. I rationalize these findings with a stylized model where dynastic altruism underpins expected heirs’ stronger bequest motives. They accumulate human capital to increase lifetime income, hence the ability to finance bequests. The quantitative model attributes 44% of the gap in student rates between expected heirs and the rest to dynastic bequest motives, 35% to coresidence with parents and inter vivos transfers, whereas the expected wealth transfer itself has a strong negative effect on education. Policy counterfactuals show that inheritance taxation raises enrollment, especially when it funds student grants, and that the link between inheritance expectations and education is stronger when the discounted returns to education are lower. These findings help explain intergenerational persistence in education, wealth, and income, and highlight how inheritance taxation can affect the level and composition of human capital. (Stone Center on Socio-Economic Inequality Working Paper) |
| Date: | 2025–11–18 |
| URL: | https://d.repec.org/n?u=RePEc:osf:socarx:6dzwq_v1 |
| By: | Youngsoo Jang (Yonsei University); Svetlana Pashchenko (University of Georgia); Ponpoje Porapakkarm (National Graduate Institute for Policy Studies) |
| Abstract: | What is the best way to reform Social Security? Academic literature offers diverging advice. There is a well-known result that the optimal size of Social Security is zero, implying it is best to phase the program out. Other studies argue that much can be gained by redesigning the program, given its current size. We provide a unified analysis that examines how the optimal size of Social Security depends on the key features of its design. We first develop a theoretical decomposition tracing the program's welfare effects to (i) income redistribution, (ii) distortions on the annuitization level, and (iii) intertemporal distortions. We then quantitatively assess the role of these channels. We show that the zero-optimal-size result arises because Social Security is too distortive and not redistributive enough. Once these design flaws are corrected, it is even optimal to increase the size of the program. |
| Keywords: | Social Security, Pensions, Annuities, Consumption and Saving, Life-Cycle Models |
| JEL: | D15 E60 H55 |
| Date: | 2025–10 |
| URL: | https://d.repec.org/n?u=RePEc:yon:wpaper:2025rwp-271 |
| By: | Estelle Campenet; David Desmarchelier; Markus Herrmann |
| Abstract: | This paper develops a simple general equilibrium model with social capital accumulation. The representative household chooses how much time to allocate between work and social capital accumulation. Social capital generates satisfaction, but this satisfaction is affected by pollution. This paper considers two cases: (1) pollution reduces the marginal utility of social capital (social withdrawal effect) and (2) pollution increases the marginal utility of social capital (social engagement effect). Pollution, treated as a pure externality, is assumed to originate from production. In line with Pigouvian principles, the government introduces a proportional tax on production to finance depollution expenditures under a balanced budget rule. When preferences exhibit a social engagement effect or a weak social withdrawal effect, the economy has a unique steady state, which may experience a Laffer Curve. When preferences exhibit a strong social withdrawal effect, two steady states can coexist: one characterized by a high level of social capital and low consumption (voluntary simplicity steady state), and the other by a low level of social capital and high consumption (consumerist steady state). As in the case of a unique steady state, a Laffer Curve may emerge at the consumerist steady state but never at the voluntary simplicity steady state. However, the voluntary simplicity steady state always exhibits a Green Paradox, a phenomenon that never occurs at the consumerist steady state. Regarding the dynamics, the unique steady state that arises when preferences exhibit a social engagement effect or a weak social withdrawal effect is saddle-path stable. When preferences are described by a strong withdrawal effect, we prove that the consumerist steady state is also always saddle-path stable while the voluntary simplicity steady state is always locally indeterminate. |
| Keywords: | Green Paradox, Laffer Curve, local indeterminacy and social capital. |
| JEL: | C62 H23 O44 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:ulp:sbbeta:2025-44 |
| By: | Eftekhari, Aryan; Juillard, Michel; Rion, Normann; Scheidegger, Simon |
| Abstract: | For over three decades, Dynare has been a cornerstone of dynamic stochastic modeling in economics, relying primarily on perturbation-based local solution methods. However, these techniques often falter in high-dimensional, non-linear models that demand more comprehensive approaches. This paper demonstrates that global solutions of economic models with substantial heterogeneity and frictions can be computed accurately and swiftly by augmenting Dynare with adaptive sparse grids (SGs) and high-dimensional model representation (HDMR). SGs mitigate the curse of dimensionality, as the number of grid points grows significantly slower than in traditional tensor-product Cartesian grids. Additionally, adaptivity focuses grid refinement on regions with steep gradients or non-differentiabilities, enhancing computational efficiency. Complementing SGs, HDMR tackles large state spaces by approximating policy functions with a hierarchical expansion of low-dimensional terms. Using a time iteration algorithm, we benchmark our approach on an international real business cycle model. Our results show that both SGs and HDMR alleviate the curse of dimensionality, enabling accurate solutions for at least 100-dimensional models on standard hardware in relatively short times. This advancement extends Dynare’s capabilities beyond perturbation approaches, establishing a versatile platform for sophisticated nonlinear models and paving the way for integrating the most recent global solution methods, such as those from machine learning. |
| Keywords: | Adaptive Sparse Grids; High-dimensional Model Representation; Global Solution Methods; International Real Business Cycles; Time Iteration |
| JEL: | C63 E30 F44 |
| Date: | 2025–11 |
| URL: | https://d.repec.org/n?u=RePEc:cpm:dynare:086 |
| By: | Li, David; Lukyanov, Georgy |
| Abstract: | This paper studies an infinite-horizon framework in which two large populations of players are randomly matched to play a Prisoner’s Dilemma. Each player lives for two consecutive periods: as a young player from one group, and then as an old player in the other group. Each population has a known fraction of honest types—individuals who always cooperate unless paired with a player who has been observed to defect against a cooperating partner in the past. Because such defections (i.e., breakdowns of trust) are publicly observed, any defector risks carrying a stigma into future interactions. We show that when the benefits from defection are sufficiently large, there exists an equilibrium in which an increase in the fraction of honest types can reduce the likelihood of cooperation. Moreover, we demonstrate that introducing imperfect public memory—allowing past misdeeds to be probabilistically “cleared”—does not enhance cooperation. |
| Keywords: | Overlapping generations; Prisoner’s Dilemma; Reputation; Stigma. |
| JEL: | C72 C73 D82 D83 |
| Date: | 2025–10 |
| URL: | https://d.repec.org/n?u=RePEc:tse:wpaper:131096 |
| By: | Sistelo, Marta; Mazeda Gil, Pedro |
| Abstract: | Culture and social capital may be variables of particular interest when explaining economic growth. In recent years, policymakers and economists have increasingly considered their role in economic growth, yet cultural capital and social capital are analyzed separately. Despite being different concepts of capital, in this paper we argue that there is a link between cultural and social capital, and both need to be accounted for when analyzing economic growth and welfare. We develop a theoretical dynamic general-equilibrium model using a mainstream endogenous economic growth set-up (namely with human capital accumulation), incorporating cultural and social capital. We use the model to devise long-run and transitional-dynamics effects from the perspective of both economic growth and welfare, explicitly considering the interplay between cultural and social capital and other forms of capital. A detailed calibration of the model allows for the derivation of quantitative results, with an emphasis on policy implications. |
| Keywords: | Endogenous Growth; Social Capital; Cultural Capital; Human Capital; Welfare |
| JEL: | J24 O4 Z10 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:126644 |
| By: | Hyeongwoo Kim; Shuwei Zhang |
| Abstract: | This paper investigates the design of optimal monetary policy responses to technology shocks in a two-country model framework featuring sticky prices and local currency pricing, where technology shocks propagate internationally. We demonstrate that technology shocks originating in the tradable sector, regardless of their country of origin, elicit monetary policy responses that are symmetric and closely aligned across countries, thereby providing a rationale for a fixed exchange rate regime. In contrast, technology shocks in the nontradable sector generate asymmetric policy reactions and weaken the source country's currency, supporting the case for exchange rate flexibility. In addition, the international transmission of technology shocks amplifies real-sector dynamics through news effects, prompting central banks to adopt contractionary policies, starkly contrasting with the findings of previous literature. |
| Keywords: | Sticky Price; Local Currency Pricing; Exchange Rate Regimes; Technology Diffusion; Interest Rate Rules |
| JEL: | F31 F41 O0 E52 |
| Date: | 2025–11 |
| URL: | https://d.repec.org/n?u=RePEc:abn:wpaper:auwp2025-11 |
| By: | J. Scott Davis; Kevin X. D. Huang; Zheng Liu; Mark M. Spiegel |
| Abstract: | We document evidence of a U-shaped relationship between financial development and the adjustments of foreign exchange (FX) reserve holdings in response to a U.S. interest rate increase. Countries with intermediate levels of financial development sell reserves aggressively, while those with low or high development adjust little. Domestic interest rate responses are not systematically related to financial development. A model with borrowing constraints and foreign-currency debt rationalizes these findings: the associated pecuniary externality is maximized at intermediate levels of financial development. Calibrated to match the observed leverage and currency composition, the model reproduces the empirical U-shaped relationship under optimal FX reserve policy, and this relation is robust under a range of conventional interest-rate policy regimes. |
| Keywords: | Foreign reserves; financial development; capital flows; optimal policy. |
| JEL: | F32 F38 E52 |
| Date: | 2025–11–13 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedfwp:102100 |