nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2005‒02‒20
eleven papers chosen by
Christian Zimmermann
University of Connecticut

  1. Why are More Redistributive Social Security Systems Smaller? A Median Voter Approach By Marko Köthenbürger; Panu Poutvaara; Paola Profeta
  2. Personal Security Accounts and Mandatory Annuitization in a Dynastic Framework By Luisa Fuster; Ayse Imrohoroglu; Selahattin Imrohoroglu
  3. Fertility and Social Security By Michele Boldrin; Maria Cristina De Nardi; Larry E. Jones
  4. Precautionary Saving Over the Lifecycle By John Laitner
  5. Grasshoppers, Ants and Pre-Retirement Wealth: A Test of Permanent Income Consumers By Erik Hurst
  6. Trends in Hours, Balanced Growth, and the Role of Technology in the Business Cycle By Jordi Gali
  7. The Market Price of Aggregate Risk and the Wealth Distribution By Hanno Lustig
  8. Sudden Stops and Output Drops By V.V. Chari; Patrick Kehoe; Ellen R. McGrattan
  9. Welfare Effects of Tax Policy in Open Economies: Stabilization and Cooperation. By Henry Kim
  10. Applying perturbation methods to incomplete market models with exogenous borrowing constraints By Henry Kim
  11. Calculating and Using Second Order Accurate Solutions of Discrete Time Dynamic Equilibrium Models By Henry Kim

  1. By: Marko Köthenbürger; Panu Poutvaara; Paola Profeta
    Abstract: We suggest a political economy explanation for the stylized fact that intragenerationally more redistributive social security systems are smaller. Our key insight is that linking benefits to past earnings (less redistributiveness) reduces the efficiency cost of social security (due to endogenous labor supply). This encourages voters who benefit from social security to support higher contribution rates in political equilibrium. We test our theory with a numerical analysis of eight European countries. Our simple, but suggestive median voter model performs relatively well in explaining the stylized fact and cross-country differences in social security contribution rates.
    Keywords: earnings-related and flat-rate benefits, social security, public pensions, median voter model
    JEL: D72 H55
    Date: 2005
  2. By: Luisa Fuster; Ayse Imrohoroglu; Selahattin Imrohoroglu
    Abstract: The aging of the populations in the OECD countries has prompted various calls for reforming the existing pay-as-you-go (PAYG) pension systems. Currently, there is renewed discussion in the United States about partial privatization where a fraction of the social security payroll tax would be diverted to Personal Security Accounts. In this paper, we quantitatively evaluate the welfare effects of reforming social security by introducing a PSA with and without mandatory annuitization in an economic environment with bequests and borrowing constraints. Our setup allows us to assess whether mandatory saving or mandatory annuitization of accumulated PSA wealth at retirement is welfare enhancing, and if so, for what type of individuals. Our setup follows Fuster, Imrohoroglu, and Imrohoroglu (2003) and studies various pension schemes in a two-sided altruistic framework where social security provides insurance against individual income and lifespan uncertainty. This framework is well suited to consider the annuity role of social security for single individuals versus for households where families also provide annuity insurance to their members. Our main findings can be summarized as follows: - A majority of households prefer a PSA reform (with or without mandatory annuitization) over the current PAYG pension system. Aggregate capital, output, and consumption, as well as individuals' lifetime welfare, are higher in the reformed pension system. - Mandatory annuitization benefits most households. In light of these findings, structuring the social security reform along a two-tiered system with a safety net for low income households that do not have access to family insurance, and allowing all households to accumulate retirement wealth faster through PSAs, and finally, requiring some level of annuitization of this wealth appear welfare improving for a large fraction of households.
    JEL: E20 E60
    Date: 2005
  3. By: Michele Boldrin; Maria Cristina De Nardi; Larry E. Jones
    Date: 2005–02–13
  4. By: John Laitner (Institute for Social Research)
    Abstract: This paper studies the quantitative importance of precautionary wealth accumulation relative to life—cycle saving for retirement. Section 1 examines panel data on earnings from the PSID. Using a bivariate normal model of random effects, we find that second— period—of—life earnings are strongly positively correlated with initial earnings but have a higher variance. Section 2 studies the consequences for life—cycle saving. Households know their youthful earning power as they enter the labor market, but only in midlife do they learn their actual second—period earning ability. For plausible calibrations, precautionary saving only adds 5—6% to aggregative life—cycle wealth accumulation. Nevertheless, we find that, given borrowing constraints on households’ behavior, the variety of earning profiles that our bivariate normal model generates itself stimulates more than twice as much extra wealth accumulation as precautionary saving.
    Date: 2004–03
  5. By: Erik Hurst (University of Chicago and NBER)
    Abstract: This paper shows that households who enter retirement with low wealth consistently followed non-permanent income consumption rules during their working years. Using the Panel Study of Income Dynamics (PSID), household wealth in 1989 is predicted for a sample of 50-65 year olds using both current and past income, occupation, demographic, employment, and health characteristics. Using the residuals from this first stage regression, the sample of pre-retired households is subsetted into households who save ‘lower’ than predicted and all other households. By construction, these households had similar opportunities to save; the average household in both these sub-samples are very similar along all observable income and demographic characteristics. It is then shown that households in the low wealth residual sample had much larger declines in consumption upon retirement. Such a result is consistent with the household having inadequately planned for retirement. The panel component of the PSID is then used to analyze the consumption behavior of these households early in their lifecycle. It is shown that these low pre-retirement wealth households had consumption growth that responded to predictable changes in income during their early working years. No such behavior was found among the other pre-retired households. Moreover, the low wealth residual households responded both to predictable income increases as well as predictable income declines, a result that is inconsistent with a liquidity constraints explanation. After ruling out other theories of consumption to explain these facts, it is concluded that households who entered retirement with lower than predicted wealth consistently followed near sighted consumption plans during their working lives.
    Date: 2004–09
  6. By: Jordi Gali
    Abstract: The present paper revisits a property embedded in most dynamic macroeconomic models: the stationarity of hours worked. First, I argue that, contrary to what is often believed, there are many reasons why hours could be nonstationary in those models, while preserving the property of balanced growth. Second, I show that the postwar evidence for most industrialized economies is clearly at odds with the assumption of stationary hours per capita. Third, I examine the implications of that evidence for the role of technology as a source of economic fluctuations in the G7 countries.
    JEL: E32
    Date: 2005–02
  7. By: Hanno Lustig
    Abstract: I introduce bankruptcy into a complete markets model with a continuum of ex ante identical agents who have power utility. Shares in a Lucas tree serve as collateral. The model yields a large equity premium, a low risk-free rate and a time-varying market price of risk for reasonable risk aversion. Bankruptcy gives rise to a second risk factor in addition to aggregate consumption growth risk. This liquidity risk is created by binding solvency constraints. The risk is measured by one moment of the wealth distribution, which multiplies the standard Breeden-Lucas stochastic discount factor. This captures the aggregate shadow cost of the solvency constraints. The economy is said to experience a negative liquidity shock when this growth rate is high and a large fraction of agents faces severely binding solvency constraints. These shocks occur in recessions. The average investor wants a high excess return on stocks to compensate for the extra liquidity risk, because of low stock returns in recessions. In that sense stocks are "bad collateral". The adjustment to the Breeden-Lucas stochastic discount factor raises the unconditional risk premium and induces time variation in conditional risk premia.
    JEL: G0
    Date: 2005–02
  8. By: V.V. Chari; Patrick Kehoe; Ellen R. McGrattan
    Abstract: In recent financial crises and in recent theoretical studies of them, abrupt declines in capital inflows, or sudden stops, have been linked with large drops in output. Do sudden stops cause output drops? No, according to a standard equilibrium model in which sudden stops are generated by an abrupt tightening of a country's collateral constraint on foreign borrowing. In this model, in fact, sudden stops lead to output increases, not decreases. An examination of the quantitative effects of a well-known sudden stop, in Mexico in the mid-1990s, confirms that a drop in output accompanying a sudden stop cannot be accounted for by the sudden stop alone. To generate an output drop during a financial crisis, as other studies have done, the model must include other economic frictions which have negative effects on output large enough to overwhelm the positive effect of the sudden stop.
    JEL: F4 F41 E3 E32
    Date: 2005–02
  9. By: Henry Kim
    Abstract: This paper studies optimal tax policy design problem by employing a two-country dynamic general equilibrium model with incomplete asset markets. We investigate the possibility of welfare-improving active, contingent tax policies (tax rates respond to changes in productivity) on consumption, and capital and labor income taxes. Unlike the conventional wisdom regarding stabilization policies, procyclical factor income tax policy is optimal in open economy. Procyclical tax policy generates efficiency gains by correcting market incompleteness. Optimal tax policy under cooperative equilibrium is similar to that under the Nash equilibrium and welfare gains from tax policy coordination is quite small.
    Keywords: optimal tax, procyclical, countercyclical, stabilization, cooperation.
    JEL: F4 E6
  10. By: Henry Kim
    Abstract: This paper solves an incomplete market model with infinite number of agents and exogenous borrowing constraints described in den Haan, Judd and Juillard (2004). We apply the idea of “barrier methods” to convert optimization problem with borrowing constraints as inequalities into a problem with equality constraints, and the converted model is solved by a second-order perturbation method. The simulation results of impulse responses and second moments match the standardized features of incomplete market models. Accuracy of the solution is in a reasonable range but significantly decreases when the economy is near the borrowing limit or moves away from the steady state.
    Keywords: perturbation, barrier method, borrowing constraint, incomplete market, accuracy.
    JEL: C63 C68 C88 F41
  11. By: Henry Kim
    Abstract: We describe an algorithm for calculating second order approximations to the solutions to nonlinear stochastic rational expectations models. The paper also explains methods for using such an approximate solution to generate forecasts, simulated time paths for the model, and evaluations of expected welfare differences across different versions of a model. The paper gives conditions for local validity of the approximation that allow for disturbance distributions with unbounded support and allow for non-stationarity of the solution process.

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