|
on Dynamic General Equilibrium |
| By: | Jesús Fernández-Villaverde; Juan Francisco Rubio-Ramírez; Manuel Santos |
| Abstract: | This paper studies the econometrics of computed dynamic models. Since these models generally lack a closed-form solution, economists approximate the policy functions of the agents in the model with numerical methods. But this implies that, instead of the exact likelihood function, the researcher can evaluate only an approximated likelihood associated with the approximated policy function. What are the consequences for inference of the use of approximated likelihoods? First, we show that as the approximated policy function converges to the exact policy, the approximated likelihood also converges to the exact likelihood. Second, we prove that the approximated likelihood converges at the same rate as the approximated policy function. Third, we find that the error in the approximated likelihood gets compounded with the size of the sample. Fourth, we discuss convergence of Bayesian and classical estimates. We complete the paper with three applications to document the quantitative importance of our results. |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedawp:2004-27&r=dge |
| By: | Marco Del Negro; Frank Schorfheide; Frank Smets; Raf Wouters |
| Abstract: | The paper provides new tools for the evaluation of DSGE models and applies them to a large-scale New Keynesian dynamic stochastic general equilibrium (DSGE) model with price and wage stickiness and capital accumulation. Specifically, we approximate the DSGE model by a vector autoregression (VAR) and then systematically relax the implied cross-equation restrictions. Let --denote the extent to which the restrictions are being relaxed. We document how the in- and out-of-sample fit of the resulting specification (DSGE-VAR) changes as a function of --. Furthermore, we learn about the precise nature of the misspecification by comparing the DSGE model’s impulse responses to structural shocks with those of the best-fitting DSGE-VAR. We find that the degree of misspecification in large-scale DSGE models is no longer so large as to prevent their use in day-to-day policy analysis, yet it is not small enough that it cannot be ignored. |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedawp:2004-37&r=dge |
| By: | Jesús Fernández-Villaverde; Juan Francisco Rubio-Ramírez |
| Abstract: | Recent work by Greenwood, Hercowitz, and Krusell (1997 and 2000) and Fisher (2003) has emphasized the importance of investment-specific technological change as a main driving force behind long-run growth and the business cycle. This paper shows how the growth model with investment-specific technological change has a closed-form solution if capital fully depreciates. This solution furthers our understanding of the model, and it constitutes a useful benchmark to check the accuracy of numerical procedures to solve dynamic macroeconomic models in cases with several state variables. |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedawp:2004-39&r=dge |
| By: | Marco Del Negro |
| Abstract: | Using data on workers’ flows into and out of employment, unemployment, and not-in-the-labor-force, I construct transition probabilities between “employment” and “unemployment” that can be used in the calibration of economies such as Krusell and Smith’s (1998). I show that calibration in Krusell and Smith has some counterfactual features. Yet the gains from adopting alternative calibrations in terms of matching the data are not very large, unless one assumes that the duration of unemployment spells is well above what is usually assumed in the literature. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedawp:2005-06&r=dge |
| By: | Ricardo Lagos; Guillaume Rocheteau |
| Abstract: | This paper studies the effects of anticipated inflation on aggregate output and welfare within a search-theoretic framework. We allow money-holders to choose the intensities with which they search for trading partners, so inflation affects the frequency of trade as well as the quantity of output produced in each trade. We consider the standard pricing mechanism for search models, i.e., ex-post bargaining, as well as a notion of competitive pricing. If prices are bargained over, the equilibrium is generically inefficient and an increase in inflation reduces buyers’ search intensities, output, and welfare. If prices are posted and buyers can direct their search, search intensities are increasing with inflation for low inflation rates and decreasing for high inflation rates. The Friedman rule achieves the first best allocation and inflation always reduces welfare even though it can have a positive effect on output for low inflation rates. |
| Keywords: | Inflation (Finance) |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedcwp:0407&r=dge |
| By: | Aleksander Berentsen; Guillaume Rocheteau; Shouyong Shi |
| Abstract: | In this paper the authors study the inefficiencies of the monetary equilibrium and optimal monetary policies in a search economy. They show that the same frictions that give fiat money a positive value generate an inefficient quantity of goods in each trade and an inefficient number of trades (or search decisions). The Friedman rule eliminates the first inefficiency, and the Hosios rule the second. A monetary equilibrium attains the social optimum if and only if both rules are satisfied. When the two rules cannot be satisfied simultaneously, which occurs in a large set of economies, optimal monetary policy achieves only the second best. The authors analyze when the second-best monetary policy exceeds the Friedman rule and when it obeys the Friedman rule. Furthermore, they extend the analysis to an economy with barter and show how the Hosios rule must be modified in order to internalize all search externalities. |
| Keywords: | Monetary policy - Mathematical models ; Money - Mathematical models |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedcwp:0408&r=dge |
| By: | Charles T. Carlstrom; Timothy S. Fuerst |
| Abstract: | Should monetary policy respond to asset prices? This paper analyzes this question from the vantage point of equilibrium determinacy. |
| Keywords: | Monetary policy ; Banks and banking, Central |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedcwp:0413&r=dge |
| By: | David E. Altig; Lawrence J. Christiano; Martin Eichenbaum; Jesper Linde |
| Abstract: | Macroeconomic and microeconomic data paint conflicting pictures of price behavior. Macroeconomic data suggest that inflation is inertial. Microeconomic data indicate that firms change prices frequently. We formulate and estimate a model which resolves this apparent micro - macro conflict. Our model is consistent with post-war U.S. evidence on inflation inertia even though firms re-optimize prices on average once every 1.5 quarters. The key feature of our model is that capital is firm-specific and predetermined within a period. |
| Keywords: | Inflation (Finance) ; Monetary policy ; Business cycles |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedcwp:0416&r=dge |
| By: | Guillaume Rocheteau; Christopher Waller |
| Abstract: | Search models of monetary exchange have typically relied on Nash (1950) bargaining or strategic games that yield an equivalent outcome to determine the terms of trade. By considering alternative axiomatic bargaining solutions in a simple search model with divisible money, we show how this choice matters for important results such as the ability of the optimal monetary policy to generate an efficient allocation. We show that the quantities traded in bilateral matches are always inefficiently low under the Nash (1950) and Kalai-Smorodinsky (1975) solutions, whereas under strongly monotonic solutions such as the egalitarian solution (Luce and Raiffa, 1957; Kalai, 1977), the Friedman Rule achieves the first best allocation. We evaluate quantitatively the welfare cost of inflation under the different bargaining solutions, and we extend the model to allow for endogenous market composition. |
| Keywords: | Money ; Monetary policy ; Game theory |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedcwp:0501&r=dge |
| By: | Morris A. Davis; Robert F. Martin |
| Abstract: | Many recent papers have claimed that when housing services are treated separately from other forms of consumption in utility, a wide range of economic puzzles such as the equity premium puzzle can be explained. Our paper challenges these claims. The key assumption embedded in this literature is that households are not very willing to substitute housing services for consumption. We show that housing services and consumption must be much more substitutable than has been assumed for a neoclassical consumption model to be consistent with U.S. house price data. Further, when forced to match both historical house prices and stock returns, the lowest risk-free rate the model can generate is 11 percent. |
| Keywords: | Housing - Prices ; Housing |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2005-13&r=dge |
| By: | Christopher J. Erceg; Luca Guerrieri; Christopher Gust |
| Abstract: | In this paper, we use an open economy DGE model (SIGMA) to assess the quantitative effects of fiscal shocks on the trade balance in the United States. We examine the effects of two alternative fiscal shocks: a rise in government consumption, and a reduction in the labor income tax rate. Our salient finding is that a fiscal deficit has a relatively small effect on the U.S. trade balance, irrespective of whether the source is a spending increase or tax cut. In our benchmark calibration, we find that a rise in the fiscal deficit of one percentage point of GDP induces the trade balance to deteriorate by less than 0.2 percentage point of GDP. Noticeably larger effects are only likely to be elicited under implausibly high values of the short-run trade price elasticity. |
| Keywords: | Balance of trade ; Budget deficits |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:825&r=dge |
| By: | Giancarlo Corsetti; Luca Dedola; Sylvain Leduc |
| 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 shocks, running counter to risk sharing. Suggestive evidence on the effect of productivity changes in U.S. manufacturing is found in support of the first transmission pattern, questioning the presumption that terms-of-trade movements in response to supply shocks invariably foster international risk-pooling. |
| Keywords: | International finance ; Foreign exchange rates ; Consumption (Economics) |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:826&r=dge |
| By: | Sanjay Chugh |
| Abstract: | Ramsey models of fiscal and monetary policy with perfectly-competitive product markets and a fixed supply of capital predict highly volatile inflation with no serial correlation. In this paper, we show that an otherwise-standard Ramsey model that incorporates capital accumulation and habit persistence predicts highly persistent inflation. The result depends on increases in either the ability to smooth consumption or the preference for doing so. The effect operates through the Fisher relationship: a smoother profile of consumption implies a more persistent real interest rate, which in turn implies persistent optimal inflation. Our work complements a recent strand of the Ramsey literature based on models with nominal rigidities. In these models, inflation volatility is lower but continues to exhibit very little persistence. We quantify the effects of habit and capital on inflation persistence and also relate our findings to recent work on optimal fiscal policy with incomplete markets. |
| Keywords: | Inflation (Finance) ; Econometric models ; Monetary policy |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:829&r=dge |
| By: | Neville Francis; Michael T. Owyang; Jennifer E. Roush |
| Abstract: | Recent empirical studies using infinite horizon long-run restrictions question the validity of the technology-driven real business cycle hypothesis. These results have met with their own controversy, stemming from their sensitivity to changes in model specification and the general poor performance of long run restrictions in Monte Carlo experiments. We propose a alternative identification that maximizes the contribution of technology shocks to the forecast error variance of labor productivity at a long, but finite horizon. In small samples, our identification outperforms its infinite horizon counterpart by producing less biased impulse responses and technology shocks that are more highly correlated with the technology shocks from the underlying model. For U.S. data, we show that the negative hours response is not robust to allowing a greater role for non-technology shocks in the forecast error variance share at a ten year horizon. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:832&r=dge |
| By: | Susanto Basu; John Fernald; Miles Kimball |
| Abstract: | Yes. We construct a measure of aggregate technology change, controlling for varying utilization of capital and labor, non- constant returns and imperfect competition, and aggregation effects. On impact, when technology improves, input use and non- residential investment fall sharply. Output changes little. With a lag of several years, inputs and investment return to normal and output rises strongly. We discuss what models could be consistent with this evidence. For example, standard one-sector real-business-cycle models are not, since they generally predict that technology improvements are expansionary, with inputs and (especially) output rising immediately. However, the evidence is consistent with simple sticky-price models, which predict the results we find: When technology improves, input use and investment demand generally fall in the short run, and output itself may also fall. |
| Keywords: | Technology - Economic aspects |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedhwp:wp-04-20&r=dge |
| By: | Jeffrey R. Campbell; Zvi Hercowitz |
| Abstract: | Market innovations following the financial reforms of the early 1980's relaxed collateral constraints on households' borrowing. This paper examines the implications of this development for macroeconomic volatility. We combine collateral constraints on households with heterogeneity of thrift in a calibrated general equilibrium model, and we use this tool to characterize the business cycle implications of realistically lowering minimum down payments and rates of amortization for durable goods purchases. The model predicts that this relaxation of collateral constraints can explain a large fraction of the volatility decline in hours worked, output, household debt, and household durable goods purchases. |
| Keywords: | Households - Economic aspects ; Macroeconomics ; Labor supply |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedhwp:wp-04-24&r=dge |
| By: | Bernardino Adão; Isabel Correia; Pedro Teles |
| Abstract: | We consider a standard cash in advance monetary model with flexible prices or prices set in advance and show that there are interest rate or money supply rules such that equilibria are unique. The existence of these single instrument rules depends on whether the economy has an infinite horizon or an arbitrarily large but finite horizon. |
| Keywords: | Monetary policy ; Prices |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedhwp:wp-04-30&r=dge |
| By: | Huberto M. Ennis |
| Abstract: | I study a version of the Lagos-Wright (2003) model of monetary exchange in which buyers have private information about their tastes and sellers make take-it-or-leave-it-offers (i.e., have the power to set prices and quantities). The introduction of imperfect information makes the existence of monetary equilibrium a more robust feature of the environment. In general, the model has a monetary steady state in which only a proportion of the agents hold money. Agents who do not hold money cannot participate in trade in the decentralized market. The proportion of agents holding money is endogenous and depends (negatively) on the level of expected inflation. As in Lagos and Wright’s model, in equilibrium there is a positive welfare cost of expected inflation, but the origins of this cost are very different. |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmem:142&r=dge |
| By: | Ellen R. McGrattan; Edward C. Prescott |
| Abstract: | In this paper, we show that ignoring corporate intangible investments gives a distorted picture of the post-1990 U.S. economy. In particular, ignoring intangible investments in the late 1990s leads one to conclude that productivity growth was modest, corporate profits were low, and corporate investment was at moderate levels. In fact, the late 1990s was a boom period for productivity growth, corporate profits, and corporate investment. |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmsr:350&r=dge |
| By: | Aubhik Khan; Julia Thomas |
| Abstract: | We solve equilibrium models of lumpy investment wherein establishments face persistent shocks to common and plant-specific productivity. Nonconvex adjustment costs lead plants to pursue generalized (S, s) rules with respect to capital; thus, their investments are lumpy. In partial equilibrium, this yields substantial skewness and kurtosis in aggregate investment, though, with differences in plant-level productivity, these nonlinearities are far less pronounced. Moreover, nonconvex costs, like quadratic adjustment costs, increase the persistence of aggregate investment, yielding a better match with the data. In general equilibrium, aggregate nonlinearities disappear, and investment rates are very persistent, regardless of adjustment costs. While the aggregate implications of lumpy investment change substantially in equilibrium, the inclusion of fixed costs or idiosyncratic shocks makes the average distribution of plant investment rates largely invariant to market-clearing movements in real wages and interest rates. Nonetheless, we find that understanding the dynamics of plant-level investment requires general equilibrium analysis. |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmsr:352&r=dge |
| By: | Matthias Doepke; Fabrizio Zilibotti |
| Abstract: | We develop a positive theory of the adoption of child labor laws. Workers who compete with children in the labor market support the introduction of a child labor ban, unless their own working children provide a large fraction of family income. Since child labor income depends on family size, fertility decisions lock agents into specific political preferences, and multiple steady states can arise. The introduction of child labor laws can be triggered by skill-biased technological change that induces parents to choose smaller families. The model replicates features of the history of the U.K. in the nineteenth century, when regulations were introduced after a period of rising wage inequality, and coincided with rapidly declining fertility rates. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmsr:354&r=dge |
| By: | Matthias Doepke; Martin Schneider |
| Abstract: | This paper provides a quantitative assessment of the effects of inflation through changes in the value of nominal assets. We document nominal positions in the U.S. across sectors as well as different groups of households, and estimate the redistribution brought about by a moderate inflation episode. Redistribution takes the form of “ends-against-the-middle:” the middle class gains at the cost of the rich and poor. In addition, inflation favors the young over the old, and hurts foreigners. A calibrated OLG model is used to assess the macroeconomic implications of this redistribution under alternative fiscal policy rules. We show that inflation-induced redistribution has a persistent negative effect on output, but improves the weighted welfare of domestic households. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmsr:355&r=dge |
| By: | Harold L. Cole; Lee E. Ohanian; Ron Leung |
| Abstract: | This paper presents a dynamic, stochastic general equilibrium study of the causes of the international Great Depression. We use a fully articulated model to assess the relative contributions of deflation/monetary shocks, which are the most commonly cited shocks for the Depression, and productivity shocks. We find that productivity is the dominant shock, accounting for about 2/3 of the Depression, with the monetary shock accounting for about 1/3. The main reason deflation doesn’t account for more of the Depression is because there is no systematic relationship between deflation and output during this period. Our finding that a persistent productivity shock is the key factor stands in contrast to the conventional view that a continuing sequence of unexpected deflation shocks was the major cause of the Depression. We also explore what factors might be causing the productivity shocks. We find some evidence that they are largely related to industrial activity, rather than agricultural activity, and that they are correlated with real exchange rates and non-deflationary shocks to the financial sector. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmsr:356&r=dge |
| By: | Nobuhiro Kiyotaki; Ricardo Lagos |
| Abstract: | We develop a model of gross job and worker flows and use it to study how the wages, permanent incomes, and employment status of individual workers evolve over time. Our model helps explain various features of labor markets, such as the size and persistence of the changes in income that workers experience due to displacements or job-to-job transitions, the length of job tenures and unemployment duration, and the amount of worker turnover in excess of job reallocation. We also examine the effects that labor market institutions and public policy have on the gross flows, as well as on the resulting wage distribution, employment, and aggregate output in the equilibrium. From a theoretical standpoint, we study the extent to which the competitive equilibrium achieves an efficient allocation of resources. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmsr:358&r=dge |
| By: | Michele Boldrin; Mariacristina De Nardi; Larry E. Jones |
| Abstract: | The data show that an increase in government provided old-age pensions is strongly correlated with a reduction in fertility. What type of model is consistent with this finding? We explore this question using two models of fertility: one by Barro and Becker (1989), and one inspired by Caldwell (1978, 1982) and developed by Boldrin and Jones (2002). In Barro and Becker’s model parents have children because they perceive their children’s lives as a continuation of their own. In Boldrin and Jones’ framework parents procreate because children care about their parents’ utility, and thus provide them with old-age transfers. The effect of increases in government provided pensions on fertility in the Barro and Becker model is very small, whereas the effect on fertility in the Boldrin and Jones model is sizeable and accounts for between 55 and 65% of the observed Europe-U.S. fertility differences both across countries and across time. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmsr:359&r=dge |
| By: | V. V. Chari; Patrick J. Kehoe; Ellen R. McGrattan |
| Abstract: | The main substantive finding of the recent structural vector autoregression literature with a differenced specification of hours (DSVAR) is that technology shocks lead to a fall in hours. Researchers have used these results to argue that standard business cycle models in which technology shocks leads to a rise in hours should be discarded. We evaluate the DSVAR approach by asking the following: Is the specification derived from this approach misspecified when the data is generated by the very model the literature is trying to discard, namely the standard business cycle model? We find that it is misspecified. Moreover, this misspecification is so great that it leads to mistaken inferences that are quantitatively large. We show that the other popular specification which uses the level of hours (LSVAR) is also misspecified with respect to the standard business cycle model. We argue that an alternative approach, the business cycle accounting approach, is a more fruitful technique for guiding the development of business cycle theory. |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmwp:631&r=dge |
| By: | Marco Cagetti; Mariacristina De Nardi |
| Abstract: | Entrepreneurship is a key determinant of investment, saving, wealth holdings, and wealth inequality. We study the aggregate and the distributional effects of several tax reforms in a model that recognizes the key role played by the entrepreneurs, and that matches very well the extreme degree of wealth inequality observed in the U.S. data. We find that the effects of tax reforms on output and capital formation can be particularly large when they affect the majority of small and medium-size businesses, which face the most severe financial constraints, rather than a small number of big businesses. We show that the consequences of changes in the estate tax depend heavily on the size of its exemption level. The current effective estate tax system seems to insulate most of the businesses from the negative effects of estate taxation thus minimizing the aggregate costs of redistribution. Abolishing the current estate tax would generate a modest increase in wealth inequality and slightly reduce aggregate output. Decreasing progressivity of the income tax can generate large increases in output, as this stimulates entrepreneurial savings and capital formation, but at the cost of large increases in wealth concentration. |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmwp:632&r=dge |
| By: | Stefano Eusepi |
| Abstract: | This paper examines the performance of forecast-based nonlinear Taylor rules in a class of simple microfunded models. The paper shows that even if the policy rule leads to a locally determinate (and stable) inflation target, there exist other learnable "global" equilibria such as cycles and sunspots. Moreover, under learning dynamics, the economy can fall into a liquidity trap. By contrast, more backward-looking and "active" Taylor rules guarantee that the unique learnable equilibrium is the inflation target. This result is robust to different specifications of the role of money, price stickiness, and the trading environment. |
| Keywords: | Econometric models ; Monetary policy ; Uncertainty ; Business cycles ; Banks and banking, Central |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:198&r=dge |
| By: | Stefano Eusepi |
| Abstract: | This paper explores the effects of central bank transparency on the performance of optimal inflation targeting rules. I assume that both the central bank and the private sector face uncertainty about the "correct" model of the economy and have to learn. A transparent central bank can reduce one source of uncertainty for private agents by communicating its policy rule to the public. ; The paper shows that central bank transparency plays a crucial role in stabilizing the agents' learning process and expectations. By contrast, lack of transparency can lead to expectations-driven fluctuations that have destabilizing effects on the economy, even when the central bank has adopted optimal policies. |
| Keywords: | Monetary policy ; Inflation (Finance) ; Banks and banking, Central ; Uncertainty |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:199&r=dge |
| By: | Falko Fecht; Kevin X. D. Huang; Antoine Martin |
| Abstract: | We build a model in which financial intermediaries provide insurance to households against a liquidity shock. Households can also invest directly on a financial market if they pay a cost. In equilibrium, the ability of intermediaries to share risk is constrained by the market. This can be beneficial because intermediaries invest less in the productive technology when they provide more risk-sharing. Our model predicts that bank-oriented economies should grow slower than more market-oriented economies, which is consistent with some recent empirical evidence. We show that the mix of intermediaries and market that maximizes welfare under a given level of financial development depends on economic fundamentals. We also show the optimal mix of two structurally very similar economies can be very different. |
| Keywords: | Intermediation (Finance) ; Financial markets ; Risk |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:04-24&r=dge |
| By: | M. Ayhan Kose; Kei-Mu Yi |
| Abstract: | Recent empirical research finds that pairs of countries with stronger trade linkages tend to have more highly correlated business cycles. We assess whether the standard international business cycle framework can replicate this intuitive result. We employ a three-country model with transportation costs. We simulate the effects of increased goods market integration under two asset market structures: complete markets and international financial autarky. Our main finding is that under both asset market structures the model can generate stronger correlations for pairs of countries that trade more, but the increased correlation falls far short of the empirical findings. Even when we control for the fact that most country pairs are small with respect to the rest of the world, the model continues to fall short. We also conduct additional simulations that allow for increased trade with the third country or increased TFP shock comovement to affect the country pair’s business cycle comovement. These simulations are helpful in highlighting channels that could narrow the gap between the empirical findings and the predictions of the model. |
| Keywords: | Business cycles ; International trade |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:05-3&r=dge |
| By: | Michael Dotsey; Robert G. King |
| Abstract: | Though built with increasingly precise microfoundations, modern optimizing sticky price models have displayed a chronic inability to generate large and persistent real responses to monetary shocks, as recently stressed by Chari, Kehoe, and McGrattan [2000]. This is an ironic finding, since Taylor [1980] and other researchers were motivated to study sticky price models in part by the objective of generating large and persistent business fluctuations. ; The authors trace this lack of persistence to a standard view of the cyclical behavior of real marginal cost built into current sticky price macro models. Using a fully-articulated general equilibrium model, they show how an alternative view of real marginal cost can lead to substantial persistence. This alternative view is based on three features of the "supply side" of the economy that we believe are realistic: an important role for produced inputs, variable capacity utilization, and labor supply variability through changes in employment. Importantly, these "real flexibilities" work together to dramatically reduce the elasticity of marginal cost with respect to output, from levels much larger than unity in CKM to values much smaller than unity in this analysis. These "real flexibilities" consequently reduce the extent of price adjustments by firms in time-dependent pricing economies and the incentives for paying fixed costs of adjustment in state-dependent pricing economies. The structural features also lead the sticky price model to display volatility and comovement of factor inputs and factor prices that are more closely in line with conventional wisdom about business cycles and various empirical studies of the dynamic effects of monetary shocks. |
| Keywords: | Prices ; Production (Economic theory) |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:05-4&r=dge |
| By: | Wenli Li; Rui Yao |
| Abstract: | The authors develop a life-cycle model to study the effects of house price changes on household consumption and welfare. The model explicitly incorporates the dual feature of housing as both a consumption good and an investment asset and allows for costly adjustments in housing and mortgage positions. Li and Yao's analysis indicates that although house price changes have small aggregate effects, their consumption and welfare consequences on individual households vary significantly. In particular, the non-housing consumption of young and old homeowners is much more sensitive to house price changes than that of middle-aged homeowners. More importantly, while house price appreciation increases the net worth and consumption of all homeowners, it only improves the welfare of middle-aged and old homeowners. Young homeowners and renters are worse off due to higher life-cycle housing consumption costs. |
| Keywords: | Consumption (Economics) ; Saving and investment ; Housing ; Mortgages |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:05-7&r=dge |
| By: | Oviedo, P. Marcelo |
| Abstract: | The consensus about the ability of the standard open-economy neoclassical growth model to account for interest-rate driven business cycles has changed over time: whereas early research concluded that business cycles are neutral to interest-rate shocks, more recent investigations suggest that these shocks can explain a large extent of the business cycles of a small open economy when firms borrow to pay for their labor cost before cashing their sales. The first goal of this paper is to show that the recently found effectiveness of interest-rate shocks to cause business cycles rests more on the statistical properties of the shocks than on the working-capital constraint; in particular, recent results are only valid when the level and volatility of the interest rate are high and when the interest rate is negatively correlated with total factor productivity. The paper also shows that interest-rate shocks cannot be the sole driving force of business cycles even when the canonical model is augmented to include a working-capital constraint. The second goal of the paper is to quantitatively explore the dynamic properties of the neoclassical growth model extended to include financial intermediation. It is shown that the extended model with external effects in financial intermediation can match the negative correlation between GDP and a domestic borrowing-lending spread in emerging countries if the economy is subject to productivity shocks but not when the model is subject to both productivity and interest-rate shocks. |
| JEL: | F3 |
| Date: | 2005–05–17 |
| URL: | http://d.repec.org/n?u=RePEc:isu:genres:12360&r=dge |
| By: | Yulei Luo (Princeton University) |
| Abstract: | This paper studies consumption dynamics and welfare losses under information processing constraints (it is also called 'rational inattention' (RI) in Sims (2003)) in the permanent income hypothesis (PIH) model. It is shown that incorporating RI into the otherwise standard PIH model can substantially affect the intertemporal allocation of consumption, which makes the models better explain the data in some important aspects. Specifically, the main contributions of this paper are: first, we propose a tractable analytical approach to solve the multivariate state PIH model with RI and show that consumption reacts to the shocks to wealth gradually and with delay; second, after aggregating, we show that incorporating RI into the model can help resolve the excess sensitivity puzzle and the excess smoothness in; third, we also find that the utility costs due to RI are very trivial, which can rationalize a key assumption in Sims (2003) that consumers only devote low channel capacity in observing and processing information; fourth, we investigate which factors determine optimal channel capacity endogeneously; finally, we compare our RI model with the standard internal habit formation model and the Campbell-Mankiw's rule-of-thumb model. |
| JEL: | C61 D81 |
| Date: | 2005–05–13 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpma:0505011&r=dge |
| By: | Kenneth Burdett (Department of Economics, University of Pennsylvania); Ricardo Lagos (New York University); Randall Wright (Department of Economics, University of Pennsylvania) |
| Abstract: | There is much discussion of the relationships between crime, inequality, and unemployment. We construct a model where all three are endogenous. We find that introducing crime into otherwise standard models of labor markets has several interesting implications. For example, it can lead to wage inequality among homogeneous workers. Also, it can generate multiple equilibria in natural but previously unexplored ways; hence two identical neighborhoods can end up with different levels of crime, inequality, and unemployment. We discuss the effects of anti-crime policies like changing jail sentences, as well as more traditional labor market policies like changing unemployment insurance. |
| Keywords: | Crime, Inequality, Unemployment, Search |
| JEL: | D83 J64 |
| Date: | 2002–05–03 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:03-029&r=dge |
| By: | Kenneth Burdett (Department of Economics, University of Pennsylvania); Ricardo Lagos (Department of Economics, New York University); Randall Wright (Department of Economics, University of Pennsylvania) |
| Abstract: | We extend simple search-theoretic models of crime, unemployment and inequality to incorporate on-the-job search. This is valuable because, although the simple models can be used to illustrate some important points concerning the economics of crime, on-the-job search models are more relevant empirically as well as more interesting in terms of the types of equilibria they generate. We characterize crime decisions, unemployment, and the equilibrium wage distribution. We use quantitative methods to illustrate key results, including a multiplicity of equilibria with different unemployment and crime rates, and to discuss the effects of changes in labor market and anti-crime policies. |
| Keywords: | Crime, Inequality, Unemployment, Search, Turnov |
| JEL: | D83 J31 |
| Date: | 2003–09–04 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:03-030&r=dge |
| By: | Guillaume Rocheteau (Department of Research,Federal Reserve Bank of Cleveland); Randall Wright (Department of Economics, University of Pennsylvania) |
| Abstract: | We compare three pricing mechanisms for monetary economies: bargaining (search equilibrium); price taking (competitive equilibrium); and price posting (competitive search equilibrium). We do this in a framework that, in addition to considering different mechanisms, extends existing work on the microfoundations of money by allowing a general matching technology and endogenous entry. We study how the nature of equilibrium and effects of policy depend on the mechanism. Under bargaining, trades and entry are both inefficient, and inflation implies a first-order welfare loss. Under price taking, the Friedman rule solves the first inefficiency but not the second, and inflation can actually improve welfare. Under posting, the Friedman rule implies first best, and inflation reduces welfare but the effect is second order. |
| Keywords: | Money, Search |
| JEL: | D83 E31 |
| Date: | 2003–09–01 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:03-031&r=dge |
| By: | Guillaume Rocheteau (Department of Research,Federal Reserve Bank of Cleveland); Randall Wright (Department of Economics, University of Pennsylvania) |
| Abstract: | We study the effects of inflation in models with various trading frictions. The framework is related to recent search-based monetary theory, in that trade takes place periodically in centralized and decentralized markets, but we consider three alternative mechanisms for price formation: bargaining, price taking, and posting. Both the value of money per transaction and market composition are endogenous, allowing us to characterize intensive and extensive margin effects. In the calibrated model, under posting the cost of inflation is similar to previous estimates, around 1% of consumption. Under bargaining, it is considerably bigger, between 3% and 5%. Under price taking, the cost of inflation depends on parameters, but tends to be between the bargaining and posting models. In some cases, moderate inflation may increase output or welfare. |
| Keywords: | Money, Search, Frictions, Inflation |
| JEL: | D83 E31 |
| Date: | 2003–11–12 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:03-032&r=dge |