nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2005‒02‒13
eighteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Efficiency Wages Revisited: The Internal Reference Perspective By Danthine, Jean-Pierre; Kurmann, Andre
  2. Technology Shocks and Aggregate Fluctuations: How Well Does the RBC Model Fit Post-War US Data? By Galí, Jordi; Rabanal, Pau
  3. What Does A Technology Shock Do? A VAR Analysis with Model-based Sign Restrictions By Dedola, Luca; Neri, Stefano
  4. Time Consistent Public Expenditures By Klein, Paul; Krusell, Per; Ríos-Rull, José-Víctor
  5. International Trade and Macroeconomic Dynamics with Heteroegenous Firms By Ghironi, Fabio; Melitz, Marc J
  6. The Employment Effects of Severance Payments with Wage Rigidities By Garibaldi, Pietro; Violante, Giovanni L
  7. When Can Changes in Expectations Cause Business Cycle Fluctuations in Neo-Classical Settings? By Beaudry, Paul; Portier, Franck
  8. Population Ageing and International Capital Flows By Domeij, David; Flodén, Martin
  9. On the Optimal Timing of Taxes By Hassler, John; Krusell, Per; Storesletten, Kjetil; Zilibotti, Fabrizio
  10. International Risk Sharing and the Transmission of Productivity Shocks By Corsetti, Giancarlo; Dedola, Luca; Leduc, Sylvain
  11. Forecasting with a Bayesian DSGE Model: An Application to the Euro Area By Smets, Frank; Wouters, Rafael
  12. Comparing Shocks and Frictions in US and Euro Area Business Cycles: A Bayesian DSGE Approach By Smets, Frank; Wouters, Rafael
  13. Optimal Taxation in an RBC Model: A Linear-Quadratic Approach By Benigno, Pierpaolo; Woodford, Michael
  14. Real Business Cycle Models of the Great Depression : a Critical Survey By Luca, PENSIEROSO
  15. Endogenous Growth and Regional Dynamics in an OLG Model with Land By Lionel, ARTIGE
  16. Avoiding the Curse of Dimensionality in Dynamic Stochastic Games By Ulrich Doraszelski; Kenneth L. Judd
  17. Technology Shocks and Robust Sign Restrictions in a Euro Area SVAR By G. PEERSMAN; R. STRAUB
  18. The Welfare Cost of Business Cycles in an Economy with Nonclearing Markets By Frank Portier; Luis A. Puch

  1. By: Danthine, Jean-Pierre; Kurmann, Andre
    Abstract: The missing wage rigidity in general equilibrium models of efficiency wages is an artifact of the external wage reference perspective conventionally adopted by the literature. Efficiency wage models based on an internal wage reference perspective are capable of generating strong wage rigidity. We propose a structural model of efficiency wages that is broadly consistent with the reported evidence on fairness in labour relations and rent-sharing. Our model provides a robust explanation for wage rigidity and procyclical effort. It also rationalizes reciprocal behaviour by workers and the observation that firm productivity is a significant predictor of wage setting.
    Keywords: efficiency wages; reciprocity; rent-sharing; wage rigidity
    JEL: E24 E32 J50
    Date: 2004–08
  2. By: Galí, Jordi; Rabanal, Pau
    Abstract: Our answer: not so well. We reach that conclusion after reviewing recent research on the role of technology as a source of economic fluctuations. The bulk of the evidence suggests a limited role for aggregate technology shocks, pointing instead to demand factors as the main force behind the strong positive co-movement between output and labor input measures.
    Keywords: nominal rigidities; real business cycles; real frictions; technology shocks
    JEL: E32
    Date: 2004–08
  3. By: Dedola, Luca; Neri, Stefano
    Abstract: This Paper estimates the effects of technology shocks in VAR models of the United States, Japan and Germany, identified imposing restrictions on the sign of impulse responses. These restrictions are motivated with priors on the parameters of a class of DSGE models with both real and nominal frictions. Estimated technology shocks lead to substantial and persistent increases in labour productivity, real wages, consumption, investment and output. In contrast with most results in the VAR literature, hours worked are much more likely to increase, displaying a hump-shaped pattern. These results are shown to stem primarily from the identification strategy proposed in the Paper, which substitutes theoretical restrictions for the atheoretical assumptions on the time series properties of the data, that are the hallmark of long-run restrictions.
    Keywords: Bayesian VAR methods; DSGE models; impulse responses; technology shocks
    JEL: C30 E30
    Date: 2004–09
  4. By: Klein, Paul; Krusell, Per; Ríos-Rull, José-Víctor
    Abstract: How should aggregate public expenditures be traded off against their financing costs? We incorporate public expenditures into a standard neoclassical growth setup with model policy choice as made by a government choosing tax rates and spending so that the resulting competitive equilibrium allocation maximizes consumer welfare. An additional key restriction that the government faces in our model is that it cannot commit to future policy. This restriction binds: current income taxes influence past savings decisions as well as past work decisions, and these effects are ignored by governments without access to commitment. We solve for equilibria where ‘reputational’ mechanisms are not operative: we characterize Markov-perfect equilibria of the dynamic game between successive governments. We characterize equilibria in terms of an intertemporal first-order condition (a ‘generalized Euler equation’, GEE) for the government and we use this condition both to gain insight into the nature of the equilibrium and as a basis for computation. The GEE reveals how the government optimally trades off tax wedges over time. For a calibrated economy, we find that when the tax base available to the government is capital income – an inelastic source of funds at any moment in time – the government still refrains from taxing at confiscatory rates. As a result, the economy is far from the mix of public and private goods that would be optimal in a static context; in return, steady-state savings are less distorted.
    Keywords: Markov-perfect equilibrium; optimal taxation; time-consistency
    JEL: E62 H21
    Date: 2004–08
  5. By: Ghironi, Fabio; Melitz, Marc J
    Abstract: We develop a stochastic, general equilibrium, two-country model of trade and macroeconomic dynamics. Productivity differs across individual, monopolistically competitive firms in each country. Firms face a sunk entry cost in the domestic market and both fixed and per-unit export costs. Only relatively more productive firms export. Exogenous shocks to aggregate productivity and entry or trade costs induce firms to enter and exit both their domestic and export markets, thus altering the composition of consumption baskets across countries over time. In a world of flexible prices, our model generates endogenously persistent deviations from PPP that would not exist absent our microeconomic structure with heterogeneous firms. It provides an endogenous, microfounded explanation for a Harrod-Balassa-Samuelson effect in response to aggregate productivity differentials and deregulation. Finally, the model successfully matches several moments of US and international business cycles.
    Keywords: endogenous non-tradeness; entry; Harrod-Balassa-Samuelson effect; heterogenous producers; international business cycles; persistence; real exchange rate dynamics
    JEL: F12 F41
    Date: 2004–09
  6. By: Garibaldi, Pietro; Violante, Giovanni L
    Abstract: Firing costs due to employment protection legislation have two separate dimensions: a transfer from the firm to the worker to be laid off and a tax paid outside the firm-worker pair. We document that quantitatively transfers are a much larger component than taxes. Nevertheless, to avoid the ‘bonding critique’ most of the existing literature overlooks the transfer component by making the implicit assumption that, in the presence of wage rigidity, mandatory severance payments have the same real effects as firing taxes. This Paper shows, in the context of a search model with insider and outsider workers, that this presumption is in general misplaced: the impact of severance payments on unemployment is qualitatively different from that of firing taxes, and it varies according to the bite of the wage rigidity. When the wage rigidity is endogenously determined by a centralized monopoly union of insiders, severance payments are either neutral or they increase unemployment, depending on the union’s coverage of outsiders’ contracts. This prediction finds empirical support in a panel dataset of OECD countries.
    Keywords: firing tax; severance payment; unemployment; wage rigidity
    JEL: E24 J64 J65
    Date: 2004–09
  7. By: Beaudry, Paul; Portier, Franck
    Abstract: It is often argued that changes in expectation are an important driving force of the business cycle. It is well known, however, that changes in expectations cannot generate positive co-movement between consumption, investment and employment in the most standard neo-classical business cycle models. This gives rise to the question of whether changes in expectation can cause business cycle fluctuations in any neo-classical setting or whether such a phenomenon is inherently related to market imperfections. This Paper offers a systematic exploration of this issue. Our finding is that expectation driven business cycle fluctuations can arise in neo-classical models when one allows for a sufficiently rich description of the inter-sectorial production technology; however, such a structure is rarely allowed or explored in macro-models. In particular, the key characteristic which we isolate as giving rise to the possibility of expectation driven business cycles is that intermediate good producers exhibit cost complementarities (i.e., economies of scope) when supplying goods to different sectors of the economy.
    Keywords: business cycles; expectations; multi-sectoral models
    JEL: E30
    Date: 2004–09
  8. By: Domeij, David; Flodén, Martin
    Abstract: We use the neoclassical growth framework to model international capital flows in a world with exogenous demographic change. We compare model implications and actual current account data and find that the model explains a small but significant fraction of capital flows between OECD countries, in particular after 1985.
    Keywords: current account; demographics; Feldstein-Horioka puzzle; international capital mobility
    JEL: E22 F21 F41 F47
    Date: 2004–09
  9. By: Hassler, John; Krusell, Per; Storesletten, Kjetil; Zilibotti, Fabrizio
    Abstract: This Paper analyses the optimal timing of taxes on capital income. We show that the celebrated result that taxes should front-loaded with an initially high tax followed by a discrete jump to the steady state is knife-edge, hinging on capital having a constant depreciation rate. An empirically supported deviation from this case, involving depreciation rates that increase over the lifespan of the investment, implies that optimal taxes should oscillate. Furthermore, the optimality of fluctuating tax rates hinges on the government being able to commit to the path of future tax rates. Without commitment, optimal taxes may be smooth also under accelerating depreciation. In a calibrated example, we find that optimal taxes are oscillating under commitment and smooth without commitment.
    Keywords: capital depreciation; optimal taxation; tax dynamics; time-consistency
    JEL: D90 E61 H21 H30
    Date: 2004–11
  10. By: Corsetti, Giancarlo; Dedola, Luca; Leduc, Sylvain
    Abstract: A central puzzle in international finance is that real exchange rates are volatile and, in stark contradiction to efficient risk sharing, negatively correlated with cross-country consumption ratios. This Paper shows that a standard international business cycle model with incomplete asset markets augmented with distribution services can account quantitatively for these properties of real exchange rates. Distribution services, intensive in local inputs, drive a wedge between producer and consumer prices, thus lowering the impact of terms-of-trade changes on optimal agents’ decisions. This reduces the price elasticity of tradables separately from assumptions on preferences. Two very different patterns of the international transmission of positive technology shocks generate the observed degree of risk sharing: one associated with improving, the other with deteriorating terms of trade and real exchange rate. In both cases, large equilibrium swings in international relative prices magnify consumption risk due to country-specific shock, running counter to risk sharing. Suggestive evidence on the effect of productivity changes in US manufacturing is found in support of the fist transmission pattern, questioning the presumption that terms-of-trade movements in response to supply shocks invariably foster international risk pooling.
    Keywords: consumption-real exchange rate correlation puzzle; distribution cost; incomplete asset markets
    JEL: F32 F33 F41
    Date: 2004–11
  11. By: Smets, Frank; Wouters, Rafael
    Abstract: In monetary policy strategies geared towards maintaining price stability, conditional and unconditional forecasts of inflation and output play an important role. In this Paper we illustrate how modern sticky-price dynamic stochastic general equilibrium (DSGE) models, estimated using Bayesian techniques, can become an additional useful tool in the forecasting kit of central banks. First, we show that the forecasting performance of such models compares well with atheoretical vector autoregressions. Moreover, we illustrate how the posterior distribution of the model can be used to calculate the complete distribution of the forecast, as well as various inflation risk measures that have been proposed in the literature. Finally, the structural nature of the model allows computing forecasts conditional on a policy path. It also allows examining the structural sources of the forecast errors and their implications for monetary policy. Using those tools, we analyse macroeconomic developments in the euro area since the start of EMU.
    Keywords: DSGE models; euro area; forecasting; monetary policy
    JEL: E40 E50
    Date: 2004–11
  12. By: Smets, Frank; Wouters, Rafael
    Abstract: This Paper estimates a DSGE model with many types of shocks and frictions for both the US and the euro area economy over a common sample period (1974-2002). The structural estimation methodology allows us to investigate whether differences in business cycle behaviour are due to differences in the type of shocks that affect the two economies, differences in the propagation mechanism of those shocks or differences in the way the central bank responds to those economic developments. Our main conclusion is that each of those characteristics is remarkably similar across both currency areas.
    Keywords: business cycle fluctuations; DSGE models
    JEL: E10 E30
    Date: 2004–11
  13. By: Benigno, Pierpaolo; Woodford, Michael
    Abstract: We reconsider the optimal taxation of income from labour and capital in the stochastic growth model analysed by Chari et al. (1994, 1995), but using a linear-quadratic (LQ) approximation to derive a log-linear approximation to the optimal policy rules. The example illustrates how inaccurate ‘naïve’ LQ approximation - in which the quadratic objective is obtained from a simple Taylor expansion of the utility function of the representative household - can be, but also shows how a correct LQ approximation can be obtained, which will provide a correct local approximation to the optimal policy rules in the case of small enough shocks. We also consider the numerical accuracy of the LQ approximation in the case of shocks of the size assumed in the calibration of Chari et al. We find that the correct LQ approximation yields results that are quite accurate, and similar in most respects to the results obtained by Chari et al. using a more computationally intensive numerical method.
    Keywords: LQ solution; optimal taxation
    JEL: C61 E62
    Date: 2004–11
  14. By: Luca, PENSIEROSO (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES))
    Abstract: Recent years have witnessed a revival of interest in the Great Depression of the 1930s. Among the differing new interpretations, that of the real business cycle (RBC) is particularly significant. It represents an outstanding methodological innovation in trying to cast the Great Depression within an “equilibrium” framework. This paper critically reiews the RBC interpretation of the Great Depression, clarifying its theoretical and methodological foundations, and paving the way for future assessments of its validity.
    Keywords: Great Depression; Real Business Cycle Theory
    JEL: B22 N12
    Date: 2005–02–09
  15. By: Lionel, ARTIGE (Universitat Autonoma de Barcelona (Spain))
    Abstract: This paper examines the existence condition of a balanced growth path in an overlapping generations model in which production uses three inputs, physical capital, human capital and land, with increasing returns to scale. Human capital is the engine of economic growth. It is shown that, unlike standard economic geography models, increasing returns verifying balanced growth always lead to regional convergence. Physical capital mobility turns out to be an overwhelming convergence force.
    Keywords: Endogenous growth; human capital; land; overlapping generations; regional dynamics
    JEL: E13 O41 R11
    Date: 2004–10–14
  16. By: Ulrich Doraszelski; Kenneth L. Judd
    Abstract: Continuous-time stochastic games with a finite number of states have substantial computational and conceptual advantages over the more common discrete-time model. In particular, continuous time avoids a curse of dimensionality and speeds up computations by orders of magnitude in games with more than a few state variables. The continuous-time approach opens the way to analyze more complex and realistic stochastic games than is feasible in discrete-time models.
    JEL: C63
    Date: 2005–01
    Abstract: We use a model-based identification strategy to estimate the impact of technology, labor supply, monetary policy and aggregate demand shocks on hours worked and employment in the euro area. The restrictions applied in the SVAR analysis are consistent with a large class of DSGE models and are robust given a sensible range of parametrization. In contrast to most of the existing literature for the United States, our results are in line with the conventional real business cycle interpretation that hours worked rise as a result of a positive technology shock. In addition, we also find an important role for technology shocks in explaining business cycle fluctuations.
    Keywords: Technology shocks; Real business cycle models; Sticky price models; Vector autoregressions, DSGE priors
    JEL: E32 E24
    Date: 2005–01
  18. By: Frank Portier (Université de Toulouse); Luis A. Puch (Universidad Complutense de Madrid. Facultad de Ciencias Económicas y Empresariales)
    Abstract: In this paper we measure the welfare cost of fluctuations in a simple representative agent economy with nonclearing markets. The market friction we consider involves price rigidities and a voluntary exchange rationing scheme. These features are incorporated into an otherwise standard neoclassical growth model. We show that the frictions we introduce make the losses from fluctuations much bigger than in a frictionless environment.
    Date: 2004

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