nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2005‒07‒11
ten papers chosen by
Christian Zimmermann
University of Connecticut

  2. Does income inequality lead to consumption equality? evidence and theory By Dirk Krueger; Fabrizio Perri
  3. A critique of structural VARs using business cycle theory By V. V. Chari; Patrick J. Kehoe; Ellen R. McGrattan
  4. Consumption along the life cycle: how different is housing? By Fang Yang
  5. Sweat equity By Ellen R. McGrattan; Edward C. Prescott
  6. Consumer search, price dispersion, and international relative price volatility By George Alessandria
  7. A Parsimonious Macroeconomic Model for Asset Pricing: Habit Formation of Cross-sectional Heterogeneity? By Fatih Guvenen
  8. Tax Policy and Human Capital Formation with Public Investment in Education By Simone Valente
  9. Learning Your Earning: Are Labor Income Shocks Really Very Persistent? By Fatih Guvenen
  10. Reconciling Conflicting Evidence on the Elasticity of Intertemporal Substitution: A Macroeconomic Perspective By Fatih Guvenen

  1. By: Andrés Arias
    Abstract: The Kiyotaki-Moore (1997) framework is a prominent macro model that features credit constraints as an important factor that propagates and magnifies the effects of shocks. However, the quantitative importance of these constraints in this setup remains an open question. This paper introduces the Kiyotaki-Moore (1997) setup into an otherwise standard dynamic general equilibrium model to explore the quantitative properties of credit constraints. I take a Hansen (1985)- type RBC model and introduce a banking sector that intermediates savings and investment. After calibrating the model to post-1959 U.S. data, I evaluate the propagation and magnification effects of a standard TFP shock to the aggregate economy. I find that the quantitative importance is very small. I then ask if the propagation and magnification effects are stronger if the shock originates in the banking sector. I therefore introduce TFP shocks into financial intermediation. I find that the constraints are also quantitatively unimportant. I conclude that the quantitative significance of the credit constraint in the Kiyotaki-Moore setup is small. The reason underlying this result has to do, theoretically, with asset market dynamics and, empirically, with the low participation of loans in economic activity in the U.S.
    Keywords: credit constraint
    JEL: E32
    Date: 2003–11–15
  2. By: Dirk Krueger; Fabrizio Perri
    Abstract: Using data from the Consumer Expenditure Survey, we first document that the recent increase in income inequality in the United States has not been accompanied by a corresponding rise in consumption inequality. Much of this divergence is due to different trends in within-group inequality, which has increased significantly for income but little for consumption. We then develop a simple framework that allows us to analytically characterize how within-group income inequality affects consumption inequality in a world in which agents can trade a full set of contingent consumption claims, subject to endogenous constraints emanating from the limited enforcement of intertemporal contracts (as in Kehoe and Levine, 1993). Finally, we quantitatively evaluate, in the context of a calibrated general equilibrium production economy, whether this setup, or alternatively a standard incomplete markets model (as in Aiyagari, 1994), can account for the documented stylized consumption inequality facts from the U.S. data.
    Date: 2005
  3. 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 business cycle models in which technology shocks lead to a rise in hours should be discarded. We evaluate the DSVAR approach by asking, is the specification derived from this approach misspecified when the data are generated by the very model the literature is trying to discard? 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 that uses the level of hours (LSVAR) is also misspecified. We argue that alternative state space approaches, including the business cycle accounting approach, are more fruitful techniques for guiding the development of business cycle theory.
    Date: 2005
  4. By: Fang Yang
    Abstract: Micro data over the life cycle shows two different patterns of consumption of housing and non-housing goods: the consumption profile of non-housing goods is hump-shaped while the consumption profile for housing first increases monotonically and then flattens out. This paper develops a rich, quantitative, dynamic general equilibrium model of life cycle behavior, which generates consumption profiles consistent with the observed data. Borrowing constraints are essential in explaining the accumulation of housing assets early in life, while transaction costs are crucial in generating the slow downsizing of the housing later in life. The bequest motives play a role in determining total life time wealth, but not the housing profile.
    Date: 2005
  5. By: Ellen R. McGrattan; Edward C. Prescott
    Abstract: Sweat equity is investment in a business that is financed by owner-workers being compensated at less than their market rate. Taking into account the hours spent building sweat equity while ignoring the output introduces an error in measured productivity and distorts the picture of what is happening in the economy. In this paper, we incorporate sweat equity in an otherwise standard business cycle model. We use the model to analyze productivity in the United States during the 1990s boom. We find that sweat investment was large during this period and critical for understanding the dramatic rise in hours and the modest growth in productivity.
    Keywords: Productivity
    Date: 2005
  6. By: George Alessandria
    Abstract: This paper develops a model of consumer search consistent with the evidence of substantial price dispersion within countries. This model is used to study international relative price fluctuations. Consumer search frictions permit firms to price discriminate across markets based on the local wage of consumers. With price dispersion, the market price of a good does not measure its resource cost. This breaks the tight link between relative quantities and relative prices implied by most models. We show that volatile and persistent fluctuations in relative wages lead to volatile and persistent fluctuations in relative prices at the disaggregate level. These deviations from the law of one price substantially increase international relative price volatility. With productivity and taste shocks, the model generates international business cycles that closely match the data
    Keywords: Prices ; Consumers
    Date: 2005
  7. By: Fatih Guvenen (University of Rochester)
    Abstract: In this paper we study asset prices in a parsimonious two-agent macroeconomic model with two key features: limited participation in the stock market and heterogeneity in the elasticity of intertemporal substitution in consumption. The parameter values for the model are taken from the business cycle literature, and in particular, are not calibrated to match financial statistics. The model generates a number of asset pricing phenomena that have been documented in the literature, including a high equity premium and a low risk-free rate; procyclical variation in the price-dividend ratio; countercyclical variation in the equity premium, in its volatility, and in the Sharpe ratio; and long- horizon predictability of returns with high R2 values. We also show that the similarity of our results to those from an external habit model is not a coincidence: the model has a reduced form representation that is similar to Campbell and Cochrane’s (1999) framework for asset pricing. However, the implications of the two models for macroeconomic questions and policy analyses are different.
    Keywords: Limited stock market participation, the equity premium puzzle, incomplete markets, habit formation, elasticity of intertemporal substitution.
    JEL: E32 E44 G12
    Date: 2005–07–08
  8. By: Simone Valente (Institute of Economic Research WIF , Swiss Federal Institute of Technology Zurich ETH)
    Abstract: This paper studies the effects of distortionary taxes and public investment in an endogenous growth OLG model with knowledge transmission. Fiscal policy affects growth in two respects: First, work time reacts to variations of prospective tax rates and modifies knowledge formation; second, public spending enhances labour efficiency but also stimulates physical capital through increased savings. It is shown that Ramsey-optimal policies reduce savings due to high tax rates on young generations, and are not necessarily growth-improving with respect to a pure private system. Non-Ramsey policies that shift the burden on adults are always growth-improving due to crowding-in effects: the welfare of all generations is unambiguously higher with respect to a private system, and there generally exists a continuum of non-optimal tax rates under which long-run growth and welfare are higher than with the Ramsey-optimal policy.
    Keywords: Endogenous growth, Human capital, Overlapping generations, Tax policy, Public investment.
    JEL: E62 O41 O11
    Date: 2005–07–07
  9. By: Fatih Guvenen (University of Rochester)
    Abstract: The current literature offers two views on the nature of the income process. According to the first view, which we call the “restricted income profiles” (RIP) model (MaCurdy, 1982), individuals are subject to large and very persistent shocks, while facing similar life-cycle income profiles (conditional on a few characteristics). According to the alternative view, which we call the “heterogeneous income profiles” (HIP) model (Lillard and Weiss, 1979), individuals are subject to income shocks with modest persistence, while facing individual-specific income profiles. While labor income data does not seem to distinguish between the two hypotheses in a definitive way, the RIP model is overwhelmingly used to specify the income process in economic models, because it delivers implications consistent with certain features of consumption data. In this paper we study the consumption-savings behavior under the HIP model, which so far has not been investigated. In a life-cycle model, we assume that individuals enter the labor market with a prior belief about their individual-specific profile and learn over time in a Bayesian fashion. We find that learning is slow, and thus initial uncertainty affects decisions throughout the life-cycle allowing us to estimate the prior uncertainty from consumption behavior later in life. This procedure implies that 40 percent of variation in income growth rates is forecastable by individuals at time zero. The resulting model is consistent with several features of consumption data including (i) the substantial rise in within-cohort consumption inequality (Deaton and Paxson 1994), (ii) the non-concave shape of the age-inequality profile (which the RIP model is not consistent with), and (iii) the fact that consumption profiles are steeper for higher educated individuals (Carroll and Summers 1991). These results bring new evidence from consumption data on the nature of labor income risk.
    Keywords: Labor income risk, Incomplete markets, Inequality, Consumption-savings decision, Kalman filter.
    JEL: D52 D91 E21
    Date: 2005–07–07
  10. By: Fatih Guvenen (University of Rochester)
    Abstract: In this paper we reconcile two opposing views about the elasticity of intertemporal substitution in consumption (EIS). Empirical studies using aggregate consumption data typically find that the EIS is close to zero (Hall, 1988). Calibrated models designed to match growth and fluctuations facts typically require that the EIS be close to one (Lucas, 1990). This apparent contradiction is resolved when two kinds of heterogeneity are acknowledged: One, the majority of households do not participate in stock markets; and two, empirical evidence indicates that the EIS increases with wealth. We introduce these two features into a standard real business cycle model. First, limited participation creates substantial wealth inequality as in the U.S. data. Consequently, the properties of aggregates directly linked to wealth (e.g., investment and output) are mainly determined by the (high-EIS) stockholders. At the same time, since consumption is much more evenly distributed in the population, estimation from aggregate consumption uncovers the low EIS of the majority (i.e., the poor).
    Keywords: The elasticity of intertemporal substitution, limited stock market participation, business cycle fluctuations, incomplete markets, wealth inequality.
    JEL: E32 E44 E62
    Date: 2005–07–07

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