Testing part of a DSGE model by Indirect Inference

December 21, 2016

By Patrick Minford, Michael Wickens and Yongdeng Xu


e propose a new type of test. Its aim is to test subsets of the structural equations of a DSGE model. The test draws on the statistical inference for limited information models and the use of indirect inference to test DSGE models. Using Monte Carlo experiments on two subsets of equations of the Smets-Wouters model we show that the model has accurate size and good power in small samples. In a test of the Smets-Wouters model on US Great Moderation data we reject the specification of the wage-price but not the expenditure sector, pointing to the first as the source of overall model rejection.

It is very easy for DSGE model to be rejected. That should be expected, as they are a simplification of the real world and they are disciplined in ways that does not lend to data fitting at any cost. But as every research question that deserves its own model that highlights what is needed to answer that question and leaves aside what appears to be marginal, it is of great use to see whether the particular model features the right ingredients. This paper shows a method that can help us here, testing only part of the model, the one we really care about, without having the neglected parts dragging the whole model down.


Opportunity to Move: Macroeconomic Effects of Relocation Subsidies

December 14, 2016

By Andrii Parkhomenko


The unemployment insurance system in the U.S. does not provide incentives to look for jobs outside local labor markets. In this paper I introduce relocation subsidies as a supplement to unemployment benefits, and study their effects on unemployment, productivity and welfare. I build a job search model with heterogeneous workers and multiple locations, in which migration is impeded by moving expenses, cross-location search frictions, borrowing constraints, and utility costs. I calibrate the model to the U.S. economy, and then introduce a subsidy that reimburses a part of the moving expenses to the unemployed and is financed by labor income taxes. During the Great Recession, a relocation subsidy that pays half of the moving expenses would lower unemployment rate by 0.36 percentage points (or 4.8%) and increase productivity by 1%. Importantly, the subsidies cost nothing to the taxpayer: the additional spending on the subsidies is offset by the reduction in spending on unemployment benefits. Unemployment insurance which combines unemployment benefits with relocation subsidies appears to be more effective than the insurance based on the benefits only.

I have followed and tried to contribute to the optimal unemployment insurance literature. It surprises me that no one, including myself, has looked at relocation subsidies. It seems like an obvious solution to spatial mismatch. Yes, some fiscal systems allow you to deduct moving expenses, but this is not tied to unemployment insurance benefits.

Quantitative Impact of Reducing Barriers to Skilled Labor Immigration: The Case of the US H-1B Visa

December 7, 2016

By Hyun Lee


In this paper, I develop a novel two-country general equilibrium model of immigration and return migration with incomplete markets and heterogeneous agents. I use the model to quantify the short-run and the long-run macroeconomic impacts of permanently doubling the US H-1B visa quota. In the short-run, I find huge endogenous increase in visa application by less talented skilled foreigners, which increases the probability of obtaining the H-1B visa by only 11 percentage points. In the long-run, US experiences a modest gain in output per capita. Most importantly, I find that there exists a sizable mass of US native skilled workers who—despite the decrease in their equilibrium wage—gain in welfare because of their accumulated capital holdings. Furthermore, I highlight the importance of including return migration in a quantitative model of international labor mobility by showing that shutting down return migration in my model results in overestimating the magnitude of the welfare changes by more than sixfold for certain cohorts.

The temporary visa question is a hot topic now, and this paper shows that looking at the answer in general equilibrium may lead to some outcomes you would not necessarily have thought about beforehand. Let us hope policymakers will look at the issue with some good thought.