Standard RBC Model Research Articles

The inverted leading indicator property and redistribution effect of the interest rate

The interest rate at which US firms borrow funds has two features: (i) it moves in a countercyclical fashion and (ii) it is an inverted leading indicator of real economic activity: low interest rates today forecast future booms in GDP, consumption, investment, and employment. We show that a Kiyotaki–Moore model accounts for both properties when interest-rate movements are driven, in a significant way, by self-fulfilling belief shocks that redistribute income away from lenders and to borrowers during booms. The credit-based nature of such self-fulfilling equilibria is shown to be essential: the dynamic correlation between current loanable funds rate and future aggregate economic activity depends critically on the property that the interest rate is state-contingent. Bayesian estimation of our benchmark DSGE model on US data shows that the model driven by redistribution shocks results in a better fit to the data than both standard RBC models and Kiyotaki–Moore type models with unique equilibrium.

The role of endogenous capital depreciation rate for business cycle dynamics: lessons from Bulgaria (1999-2018)


 
 
 We allow for an endogenous depreciation rate of physical capital stock into a real-business-cycle model with a government sector. We calibrate the model to Bulgarian data for the period following the introduction of the currency board arrangement (1999-2018). We investigate the quantitative importance of the endogenous depreciation rate, and indirectly, the capital utilization mechanism for cyclical fluctuations in Bulgaria. Allowing for endogenous variations in the depreciation rate of capital improves the model performance against data, and in addition this extended setup dominates the standard RBC model framework with constant depreciation and a fixed utilization rate of physical capital, and a fixed depreciation rate e.g., Vasilev (2009).
 
 

Gender differences in the volatility of work hours and labor demand

This paper examines the role of heterogeneity in a real business cycle model, which traditionally has not fully captured the relative volatility of hours to output. Men and women have different cyclical volatilities in hours worked, which is robust to different filtering methods. This empirical regularity is used to motivate a standard RBC model augmented to allow for two different agents following Jaimovich et al. (2013). These two agents have identical utility functions, but face different elasticities of labor demand due to their different complementarities with capital. These estimated elasticities find that women are more complementary to capital. The calibrated model generates the cyclical volatility of work hours by gender and for the total hours worked that matches the U.S. data better than the traditional representative agent model. I then explore other extensions to this model including investigating the stability of the estimated labor demand elasticities and allowing for various Frisch elasticities of labor supply. This paper demonstrates that allowing for even broad levels of heterogeneity in a simple framework can increase the model’s tractability with the data. Since gender is important to explain U.S. business cycle dynamics, we need to carefully consider heterogeneity when analyzing counter-cyclical economic policy, as it may not have symmetric effects across assorted groups.

Aggregate labor market fluctuations under news shocks

The standard RBC model fails to replicate the relationship between aggregate hours worked and average productivity. We propose a DSGE model that incorporates habit formation preferences, capital adjustment costs, and news shocks to solve the puzzle implied in the standard RBC model with only technological shocks. The aggregate labor supply curve is shifted due to the wealth effect caused by the variation of consumption under a news shock. Moreover, capital adjustment costs help amplify the variation of consumption, and thus the movement of the aggregate labor supply curve under the news shock. Also, the aggregate demand curve will be shifted, as it operates in the standard RBC model after the realization of the news shock. As a result of the joint movement of the aggregate labor supply curve and aggregate labor demand curve under the news shock, the model achieves a relationship quite close to the empirically observed relationship.

Labour market fluctuations: An RBC model for emerging countries

In this paper, we examine the labour market properties of business cycle fluctuations for a group of 15 emerging market economies (EMEs) and the US using annual data from 1970 to 2013. We find that on average, the hours worked and employment volatility (relative to output volatility) are lower, while the volatility of productivity and wages are 2–3 times higher in EMEs compared to the US. We then assess the performance of a standard RBC model and an augmented RBC model with capacity utilization, investment adjustment cost and indivisible labour with temporary and permanent productivity shocks to explain labour market facts observed in the data. We find that these models fail to explain labour market fluctuations in the business cycles of these countries, but the model with investment adjustment cost improves the performance of relative volatility of wages and hours, as well as the cyclicality of hours, compared to the standard RBC model. Lastly, we investigate the cyclical properties of the labour wedge and find that the total labour wedge (relative to output volatility) is more volatile over the business cycle in emerging economies (1.72) compared to the US (0.95). Further, fluctuations in the total labour wedge reflect the ones in the household component rather than the firm component of the wedge in EMEs and the US.

Growth and real business cycles in Vietnam and the Asean-5. Does the trend shock matter?

We examine Vietnam’s economy in comparison with its closest trade partners. We show that capital accumulation has been the primary growth engine since the start of its transition to the pro-market economy in 1986 – the Doi Moi. We also show that the cyclical behavior of its macro aggregates is similar to that of its ASEAN-5 peers and other developing countries. We extend the standard small open economy RBC model by considering habit persistence and government consumption, which allows a close match of the moments of the growth variables. At the business cycle frequency, transitory productivity shocks account for approximately one-half of Vietnam’s output variance, while country risk and non-transitory productivity shocks account to close to one-fifth each. Regarding the Solow residual’s volatility, we find that the trend component merely accounts for 12 % of this variance in Vietnam, while in Thailand it is only 6 %. These findings refute the “the cycle is the trend” hypothesis in Aguiar and Gopinath (2007) and align with the hypotheses in García-Cicco et al. (2010) and Rhee (2017), where the stationary component is overwhelmingly dominant. We claim that technological progress and productivity-enhancing measures are fundamental for Vietnam’s economy to sustain high growth.

The Role of Energy in a Real Business Cycle Model with an Endogenous Capital Utilization Rate in a Government Sector: Lessons from Bulgaria (1999–2016)

Abstract We introduce a pro-cyclical endogenous utilization rate of physical capital stock into a real business cycle model augmented with a government sector in detail. We calibrate the model to Bulgarian data for the period following the introduction of the currency board arrangement (1999–2016). We investigate the quantitative importance of the endogenous depreciation rate and the capital utilization mechanism working through the use of energy for cyclical fluctuations in Bulgaria. In particular, a positive shock to energy prices in the model works like a negative technological shock. Allowing for variations in factor utilization and the presence of energy as a factor of production improves the model performance against data, and in addition this extended setup dominates the standard RBC model framework with constant depreciation and a fixed utilization rate of physical capital (e.g., Vasilev (2009)).

Risk Weighting, Private Lending and Macroeconomic Dynamics

According to current regulation, European banks can apply zero risk weights to sovereign exposures in their balance sheet, irrespective of the assigned rating. We show that a zero risk weighting of sovereign bonds has implications by distorting banks' asset allocation decisions. Due to the lower regulatory cost of sovereign bonds, banks invest more in those bonds at the expense of lending to the real sector. To quantify the effect of this distortion, we build a standard RBC model featuring financial intermediation and a government sector calibrated to the euro area economy. Financial regulation is introduced via a penalty function that punishes banks if they deviate from the target capital ratio. We study the zero risk weight policy during normal times when there is no sovereign default risk and find that a policy introducing positive risk weights on government bonds has both long-run effects and stabilising properties with respect to the business cycle. This policy makes the steady state lending spread on loans to firms decline, stimulating investment and output. Also, it stabilises the lending spread, leading to a lower volatility of investment and output.

Eductive Stability in Real Business Cycle Models

We reexamine issues of coordination in the standard RBC model. Is the unique rational expectations equilibrium attainable by rational agents who contemplate the possibility of small deviations from equilibrium? Surprisingly, we …nd that coordination cannot be expected. Even with strong common knowledge assumptions, rational agents anticipating small but persistent deviations are led to take actions that eventually contradict the common knowledge assumption. This “impossibility”theorem for eductive learning is not fully overcome when adaptive learning is incorporated into the framework.

Expectation shocks and fiscal rules

This paper discuss expectation (or news) shocks to government expenditures: consumption or investment spending in an otherwise standard RBC model of the U.S. economy. In addition, we study the differences emerging from modelling fiscal policy with and without fiscal rules. We find that news about future fiscal policy generate dramatically different effects, if fiscal policy follows a rule. Our findings have several implications for the design and the implementation of fiscal policy as well as the estimation of fiscal shocks.

How Large Are Returns to Scale in the U.S.? A View Across the Boundary

I study the degree of returns to scale in aggregate U.S. data by estimating the standard RBC model with and without variable capacity utilization using Bayesian methods. The source of increasing returns is the presence of an externality in production. I find that, at best, returns are mildly increasing at a level statistically indistinguishable from the constant-returns case. A high enough degree of increasing returns is needed to support equilibrium indeterminacy and sunspot-driven business cycle fluctuations. In my estimation results, I find that I can conclusively rule out this possibility on account of a low estimated degree of increasing returns and a fairly inelastic labor supply.

The Inverted Leading Indicator Property and Redistribution Effect of the Interest Rate

The interest rate at which US firms borrow funds has two features: (i) it moves in a countercyclical fashion and (ii) it is an inverted leading indicator of real economic activity: low interest rates today forecast future booms in GDP, consumption, investment, and employment. We show that a Kiyotaki-Moore model accounts for both properties when interest-rate movements are driven, in a significant way, by self-fulfilling shocks that redistribute income away from lenders and to borrowers during booms. The credit-based nature of such self-fulfilling equilibria is shown to be essential: the dynamic correlation between current loanable funds rate and future aggregate economic activity depends critically on the property that the interest rate is state-contingent. Bayesian estimation of our benchmark DSGE model on US data shows that the model driven by redistribution shocks results in a better fit to the data than both standard RBC models and Kiyotaki-Moore type models with unique equilibrium.

The Inverted Leading Indicator Property and Redistribution Effect of the Interest Rate

The interest rate at which US firms borrow funds has two features: (i) it moves in a countercyclical fashion and (ii) it is an inverted leading indicator of real economic activity: low interest rates today forecast future booms in GDP, consumption, investment, and employment. We show that a Kiyotaki–Moore model accounts for both properties when interest-rate movements are driven, in a significant way, by self-fulfilling belief shocks that redistribute income away from lenders and to borrowers during booms. The credit-based nature of such self-fulfilling equilibria is shown to be essential: the dynamic correlation between current loanable funds rate and future aggregate economic activity depends critically on the property that the interest rate is state-contingent. Bayesian estimation of our benchmark DSGE model on US data shows that the model driven by redistribution shocks results in a better fit to the data than both standard RBC models and Kiyotaki–Moore type models with unique equilibrium.

Comparing Solution Methods for a Basic RBC Model

This short article compares different solution methods for a basic RBC model (Hansen, 1985). We solve and simulate the model using two main algorithms: the methods of perturbation and projection, respectively. One novelty is that we offer a type of the hybrid method: we compute easily a second-order approximation to decision rules and use that approximation as an initial guess for finding Chebyshev polynomials. We also find that the second-order perturbation method is most competitive in terms of accuracy for standard RBC model.

Indeterminacy and sunspots in two-sector RBC models with generalized no-income-effect preferences

We analyze sunspot-driven fluctuations in the standard two-sector RBC model with moderate increasing returns to scale and generalized no-income-effect preferences à la Greenwood, Hercovitz and Huffman [13]. We provide a detailed theoretical analysis enabling us to derive relevant bifurcation loci and to characterize the steady-state local stability properties as a function of various structural parameters. We show that local indeterminacy occurs through flip and Hopf bifurcations for a large set of values for the elasticity of intertemporal substitution in consumption, provided that the labor supply is sufficiently inelastic. Finally, we provide a detailed quantitative analysis of the model. Computing, on a quarterly basis, a new set of empirical moments related to two broadly defined consumption and investment sectors, we are able to identify, among the set of admissible calibrations consistent with sunspot equilibria, the ones that provide the best fit of the data. The model properly calibrated solves several empirical puzzles traditionally associated with two-sector RBC models.

Some Notes on Historical, Theoretical, and Empirical Background of DSGE Models

Abstract In this paper I present the historical, theoretical and empirical background of DSGE models. I show that the fundament of these models lies in optimizing agents framework and argue which impulses fueled the development of DSGE models. I demonstrate the evolution of DSGE models with an accent on the role and effects of the monetary policy, using distinction between RBC models and New Keynesian models. I explain the paradigm shift from the RBC models to the New Keynesian models by pointing out the main pitfalls of the RBC models and showing how adding nominal rigidities to the otherwise standard RBC models enhances empirical properties of these models. I also discuss how nominal rigidities are modeled in New Keynesian DSGE models and what the pros and cons of different approaches are. Finally, I review the most important New Keynesian theories of nominal rigidities and some of the empirical evidence on price and wage rigidities

Flexible prices, labor market frictions and the response of employment to technology shocks

Recent empirical evidence establishes that a positive technology shock leads to a decline in labor inputs. Standard RBC models fails to replicate this stylized fact, while recent papers show that augmenting the model with implementation lags, or habit formation, or shock persistence in growth rates among others accounts for this fact. In this paper, we show that a standard flexible price model with labor market frictions that allows hiring costs to depend on technology shocks may also lead to the same negative impact on labor inputs. Labor market frictions are therefore able to account for the fall in labor inputs. However, the elasticity of hiring costs to technology shocks is large, suggesting that additional extensions to the model are needed.

Flexible Prices, Labor Market Frictions, and the Response of Employment to Technology Shocks

Abstract Recent empirical evidence establishes that a positive technology shock leads to a decline in labor inputs. Standard RBC models fails to replicate this stylized fact, while recent papers show that augmenting the model with implementation lags, or habit formation, or shock persistence in growth rates among others accounts for this fact. In this paper, we show that a standard flexible price model with labor market frictions that allows hiring costs to depend on technology shocks may also lead to the same negative impact on labor inputs. Labor market frictions are therefore able to account for the fall in labor inputs. However, the elasticity of hiring costs to technology shocks is large, suggesting that additional extensions to the model are needed.

Risk Aversion, Risk Premia, and the Labor Margin with Generalized Recursive Preferences

A flexible labor margin allows households to absorb shocks to asset values with changes in hours worked as well as changes in consumption. This ability to absorb shocks along either or both margins greatly alters the household’s attitudes toward risk, as shown by Swanson (2012). The present paper extends that work to the case of generalized recursive preferences, as in Epstein and Zin (1989) and Weil (1989), which are increasingly being used to bring macroeconomic models into closer agreement with basic asset pricing facts. Measures of risk aversion commonly used in the literature show no stable relationship to the equity premium in a standard RBC model, while the closed-form expressions derived in this paper match the equity premium closely. Thus, measuring risk aversion correctly is crucial for understanding asset prices in the model.

Indeterminacy and multiple steady states with sector-specific externalities

This paper studies a two-sector model with aggregate and sector-specific external effects in production and inelastic labor supply. We first characterize the existence, uniqueness and multiplicity of the steady states as well as their welfare properties. We particularly focus on the CES production functions and show that the steady state is generically either unique or there are exactly two. A simple geometrical methodology enables us to characterize the local dynamics of the steady state. We show that in order to get indeterminacy, the presence of both aggregate and sector-specific external effects is needed, along with low capital–labor elasticities of substitution and high, but bounded from above, elasticities in intertemporal consumption. We perform a sensitivity analysis and show that indeterminacy emerges for parameter values in line with those used in calibrations of standard RBC models, that is for unitary elasticities of input substitution and of intertemporal substitution in consumption.