nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2005‒09‒29
forty papers chosen by
Christian Zimmermann
University of Connecticut

  1. Trends in Hours, Balanced Growth and the Role of Technology in the Business Cycle By Jordi Galí
  2. Comovement: it's not a puzzle By Riccardo DiCecio
  3. Non-stationary Hours in a DSGE Model By Chang, Yongsung; Doh, Taeyoung; Schorfheide, Frank
  4. Business Cycles, Unemployment Insurance, and the Calibration of Matching Models By James S. Costain; Michael Reiter
  5. Bayesian Analysis of DSGE Models By An, Sungbae; Schorfheide, Frank
  6. Granger causality and equilibrium business cycle theory By Yi Wen
  7. Is Lumpy Investment really Irrelevant for the Business Cycle? By Tommy Sveen; Lutz Weinke
  8. The Tobin effect and the Friedman rule By Bhattacharya, Joydeep; Haslag, J; Martin, A
  9. By force of demand: explaining international comovements and the saving-investment correlation puzzle By Yi Wen
  10. On-the-Job Search and Sorting By Pieter A. Gautier; Coenraad N. Teulings; Aico van Vuuren
  11. Housing and the macroeconomy: the role of implicit guarantees for government-sponsored enterprises By Karsten Jeske; Dirk Krueger
  12. A quantitative theory of unsecured consumer credit with risk of default By Satyajit Chatterjee; Dean Corbae; Makoto Nakajima; Jose-Victor Rios-Rull
  13. Real Effects of Inflation Through the Redistribution of Nominal Wealth By Doepke, Matthias; Schneider, Martin
  14. The cost of business cycles for unskilled workers By Toshihiko Mukoyama; Aysegul Sahin
  15. Availability of Higher Education and Long-Term Economic Growth By Ryo Horii; Akiomi Kitagawa; Koichi Futagami
  16. Understanding the Effects of Government Spending on Consumption By Galí, Jordi; López-Salido, J David; Vallés Liberal, Javier
  17. Wealth, Financial Intermediation and Growth By Alejandro Gaytan; Romain Rancière
  18. Housing, portfolio choice, and the macroeconomy By Pedro Silos
  19. Indeterminacy in Dynamic Models: When Diamond Meets Ramsey By Lloyd-Braga, Teresa; Nourry, Carine; Venditti, Alain
  20. Insurance and Opportunities: The Welfare Implications of Rising Wage Dispersion By Heathcote, Jonathan; Storesletten, Kjetil; Violante, Giovanni L
  21. Aggregate Consequences of Limited Contract Enforceability By Thomas Cooley; Ramon Marimon; Vicenzo Quadrini
  22. Markups, Gaps, and the Welfare Costs of Business Fluctuations By Jordi Galí; Mark Gertler; J. David López-Salido
  23. Bank Finance versus Bond Finance: What Explains the Differences Between the US and Europe? By De Fiore, Fiorella; Uhlig, Harald
  24. Does Social Security Privatization Produce Efficiency Gains? By Shinichi Nishiyama; Kent Smetters
  25. Banks, markets, and efficiency By Falko Fecht; Antoine Martin
  26. Euler Equation Errors By Martin Lettau; Sydney C. Ludvigson
  27. An Empirical Note on the Relationship between Unemployment and Risk-Aversion By Luis Diaz-Serrano; Donal O'Neill
  28. Durable good inventories and the volatility of production: explaining the less volatile U.S. economy By Yi Wen
  29. The multiplier: a general equilibrium analysis of multi-stage-fabrication economy with inventories By Yi Wen
  30. Inequality, Incomplete Contracts, and the Size Distribution of Business Firms By Thomas Gall
  31. Modeling Exchange-Rate Passthrough After Large Devaluations By Ariel Burstein; Martin Eichenbaum; Sergio Rebelo
  32. Health insurance and tax policy By Karsten Jeske; Sagiri Kitao
  33. Monetary Equilibria in a Cash-in-Advance Economy with Incomplete Financial Markets By Ingolf Schwarz; Jinhui H. Bai
  34. The 'News' View of Economic Fluctuations: Evidence from Aggregate Japanese Data and Sectoral US Data By Beaudry, Paul; Portier, Franck
  35. Nominal Debt as a Burden on Monetary Policy By Javier Díaz-Giménez; Giorgia Giovannetti; Ramon Marimon; Pedro Teles
  36. Habits in Consumption, Transactions Learning And Economic Growth. By Constantin Gurdgiev;
  37. Stable Sunspot Equilibria in a Cash-in-Advance Economy By George W. Evans; Seppo Honkapohja; Ramon Marimon
  38. Turbulence and Unemployment in a Job Matching Model By Wouter J. Den Haan; Christian Haefke; Garey Ramey
  39. Public Pensions and Capital Accumulation: The Case of Brazil By Gerhard Glomm; Jürgen Jung; Changmin Lee; Chung Tran
  40. What Do Endogenous Growth Models Contribute? By David C. Maré

  1. By: Jordi Galí
    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 fl uctuations in the G7 countries.
    Keywords: real business cycles, technology shocks, market frictions, balanced growth path, stationarity of hours
    JEL: E32
    Date: 2005–01
  2. By: Riccardo DiCecio
    Abstract: A defining feature of business cycles is the comovement of inputs at the sectoral level with aggregate activity. Standard models can- not account for this phenomenon. This paper develops and estimates a two-sector dynamic general equilibrium model that can account for this key regularity. My model incorporates three shocks to the economy: monetary policy shocks, neutral technology shocks, and embodied technology shocks in the capital-producing sector. The estimated model is able to account for the response of the US economy to all three shocks. Using this model, I argue that the key friction underlying sectoral comovement is rigidity in nominal wages.
    Keywords: Business cycles ; Wages
    Date: 2005
  3. By: Chang, Yongsung; Doh, Taeyoung; Schorfheide, Frank
    Abstract: The time series fit of dynamic stochastic general equilibrium (DSGE) models often suffers from restrictions on the long-run dynamics that are at odds with the data. Relaxing these restrictions can close the gap between DSGE models and vector autoregressions. This paper modifies a simple stochastic growth model by incorporating permanent labor supply shocks that can generate a unit root in hours worked. Using Bayesian methods we estimate two versions of the DSGE model: the standard specification in which hours worked are stationary and the modified version with permanent labor supply shocks. We find that the data support the latter specification.
    Keywords: Bayesian econometrics; DSGE models; non-stationary hours
    JEL: C32 E52 F41
    Date: 2005–09
  4. By: James S. Costain; Michael Reiter
    Abstract: This paper points out an empirical puzzle that arises when an RBC economy with a job matching function is used to model unemployment. The standard model can generate sufficiently large cyclical fluctuations in unemployment, or a sufficiently small response of unemployment to labor market policies, but it cannot do both. Variable search and separation, finite UI benefit duration, efficiency wages, and capital all fail to resolve this puzzle. However, both sticky wages and match-specific productivity shocks help the model reproduce the stylized facts: both make the firm's flow of surplus more procyclical, thus making hiring more procyclical too.
    Keywords: Real business cycles, matching function, unemployment insurance
    JEL: C78 E24 E32 I38 J64
    Date: 2003–06
  5. By: An, Sungbae; Schorfheide, Frank
    Abstract: This paper reviews Bayesian methods that have been developed in recent years to estimate and evaluate dynamic stochastic general equilibrium (DSGE) models. We consider the estimation of linearized DSGE models, the evaluation of models based on Bayesian model checking, posterior odds comparisons, and comparisons to a reference model, as well as the estimation of second-order accurate solutions of DSGE models. These methods are applied to data generated from a linearized DSGE model, a vector autoregression that violates the cross-coefficient restrictions implied by the linearized DSGE model, and a DSGE model that was solved with a second-order perturbation method.
    Keywords: Bayesian analysis; DSGE models; model evaluation; vector autoregressions
    JEL: C11 C32 C51 C52
    Date: 2005–09
  6. By: Yi Wen
    Abstract: Post war US data show that consumption growth causes output and investment growth. This is puzzling if technology is the driving force of the business cycle. I ask whether general equilibrium models driven by demand shocks can rationalize the observed causal relations. My conclusion is that business cycle theory remains behind business cycle measurement.
    Keywords: Business cycles
    Date: 2005
  7. By: Tommy Sveen; Lutz Weinke
    Abstract: New-Keynesian (NK) models can only account for the dynamic effects of monetary policy shocks if it is assumed that aggregate capital accumulation is much smoother than it would be the case under frictionless firm-level investment, as discussed in Woodford (2003, Ch. 5). We find that lumpy investment, when combined with price stickiness and market power of firms, can rationalize this assumption. Our main result is in stark contrast with the conclusions obtained by Thomas (2002) in the context of a real business cycle (RBC) model. We use our model to explain the economic mechanism behind this difference in the predictions of RBC and NK theory.
    Keywords: Lumpy Investment, Sticky Prices
    JEL: E22 E31 E32
    Date: 2005–06
  8. By: Bhattacharya, Joydeep; Haslag, J; Martin, A
    Abstract: This paper studies a overlapping generations economy with capital where limited communication and stochastic relocation create an endogenous transactions role for fiat money. We assume a production function with a knowledge-externality (Romer-style) that nests economies with endogenous growth (AK form) and those with no long run growth (the Diamond model). With logarithmic utility, the Friedman rule is optimal (stationary welfare maximizing) irrespective of whether there is long run growth or not. Under the more general CRRA form of preferences, we find that a sufficient condition for the Friedman rule to be optimal is that the ‘anti-Tobin effect’ is operative. Also, contrary to models with a storage technology, zero inflation is not optimal (except for a set of parameters which has measure zero in the parameter space). These results are in sharp contrast to the received wisdom about the suboptimality of the Friedman rule in overlapping generation models.
    Keywords: Friedman rule, Tobin effect, monetary policy
    JEL: E4
    Date: 2005–09–15
  9. By: Yi Wen
    Abstract: This paper shows that economic fluctuations can be largely demand-driven. In particular, the stylized open-economy business cycle regularities documented by Feldstein and Horioka (1980) and Backus, Kehoe and Kydland (JPE 1992) can be explained by the standard general equilibrium theory if consumption demand is treated as the primary source of aggregate uncertainty. Frictions such as market incompleteness, increasing returns to scale, and sticky prices are not needed for resolving these longstanding puzzles.
    Keywords: Business cycles ; Saving and investment
    Date: 2005
  10. By: Pieter A. Gautier; Coenraad N. Teulings; Aico van Vuuren
    Abstract: We characterize the equilibrium of a search model with a continuum of job and worker types, wage bargaining, free entry of vacancies and on-the-job search. The decentralized economy with monopsonistic wage setting yields too many vacancies and hence too low unemployment compared to first best. This is due to a business-stealing externality. Raising workers’ bargaining power resolves this inefficiency. Unemployment benefits are a second best alternative to this policy. We establish simple relations between the losses in production due to search frictions and wage differentials on the one hand and unemployment on the other hand. Both can be used for empirical testing.
    JEL: J30 J60
    Date: 2005
  11. By: Karsten Jeske; Dirk Krueger
    Abstract: This paper studies the macroeconomic effects of implicit government guarantees of the obligations of government-sponsored enterprises. We construct a model with competitive housing and mortgage markets in which the government provides banks with insurance against aggregate shocks to mortgage default risk. We use this model to evaluate aggregate and distributional impacts of this government subsidy of owner-occupied housing. Preliminary findings indicate that the subsidy leads to higher equilibrium housing investment, higher mortgage default rates, and lower welfare. The welfare effects of this policy vary substantially across members of the population with different economic characteristics.
    Date: 2005
  12. By: Satyajit Chatterjee; Dean Corbae; Makoto Nakajima; Jose-Victor Rios-Rull
    Abstract: The authors study, theoretically and quantitatively, the general equilibrium of an economy in which households smooth consumption by means of both a riskless asset and unsecured loans with the option to default. The default option resembles a bankruptcy filing under Chapter 7 of the U.S. Bankruptcy Code. Competitive financial intermediaries offer a menu of loan sizes and interest rates wherein each loan makes zero profits. They prove existence of a steady state equilibrium and characterize the circumstances under which a household defaults on its loans. The authors show that their model accounts for the main statistics regarding bankruptcy and unsecured credit while matching key macroeconomic aggregates and the earnings and wealth distributions. They use this model to address the implications of a recent policy change that introduces a form of "means-testing" for households contemplating a Chapter 7 bankruptcy filing. The authors find that this policy change yields large welfare gains.
    Keywords: Consumer credit ; Risk ; Default (Finance)
    Date: 2005
  13. By: Doepke, Matthias; Schneider, Martin
    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 US 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 favours 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.
    Keywords: inflation; redistribution; welfare
    JEL: D31 D58 E31 E50
    Date: 2005–08
  14. By: Toshihiko Mukoyama; Aysegul Sahin
    Abstract: This paper reconsiders the cost of business cycles under incomplete markets. Primarily, we focus on the heterogeneity in the cost of business cycles among agents with different skill levels. Unskilled workers are subject to a much larger risk of unemployment during recessions than are skilled workers. Moreover, unskilled workers earn less income, which limits their ability to self-insure. We examine how this heterogeneity in unemployment risk and income translates into heterogeneity in the cost of business cycles. We set up a dynamic general equilibrium model with incomplete markets, in which there is heterogeneity in skills, employment status, asset holding, and the discount factor. We find that the welfare cost of business cycles for unskilled workers is substantially higher than that for skilled workers.
    Keywords: Unemployment ; Business cycles ; Labor market
    Date: 2005
  15. By: Ryo Horii (Graduate School of Economics, Osaka University); Akiomi Kitagawa (Graduate School of Economics and Management, Tohoku University); Koichi Futagami (Graduate School of Economics, Osaka University)
    Abstract: This paper examines the economic growth effects of limited availability of higher education in a simple endogenous growth model with overlapping generations. With limited availability, the scarcity of human capital keeps its price high and distributes a larger share of the aggregate output to young households. Under certain conditions, it leads to greater aggregate savings in each period, thereby enabling the economy to grow faster than without any limitation. In such cases, an excessive expansion in the availability causes a temporary boom followed by a serious deficiency in investible funds, resulting in a substantial slowdown in economic growth.
    Keywords: Endogenous Growth; Human Capital; Slowdown; Intergenerational Income Distribution.
    JEL: O41
    Date: 2003–11
  16. By: Galí, Jordi; López-Salido, J David; Vallés Liberal, Javier
    Abstract: Recent evidence suggests that consumption rises in response to an increase in government spending. That finding cannot be easily reconciled with existing optimizing business cycle models. We extend the standard new Keynesian model to allow for the presence of rule-of-thumb consumers. We show how the interaction of the latter with sticky prices and deficit financing can account for the existing evidence on the effects of government spending.
    Keywords: fiscal multiplier; government spending; non-Ricardian households; rule-of-thumb consumers; Taylor rules
    JEL: E32 E62
    Date: 2005–09
  17. By: Alejandro Gaytan; Romain Rancière
    Abstract: This paper presents empirical support for the existence of wealth effects in the contribution of financial intermediation to economic growth, and offers a theoretical explanation for these effects. Using GMM dynamic panel data techniques applied to study the growth-promoting effects of financial intermediation, we show that the exogenous contribution of financial development on economic growth has different effects for different levels of income per capita. We find that this contribution is generally increasing with the level of income per capita of the economy, up to a relatively high level of income. This contribution is consistently lower for poor countries; and for some low levels of income per capita it can be negative. We provide a model to account for these wealth effects. The model is a overlapping generations growth model where financial intermediaries implement liquidity risk sharing among depositors. We show that at early stages of economic development, a bank can increase welfare of its depositors only at the cost of lowering investment and growth. However, once the economy has crossed certain wealth threshold, the liquidity role of banks becomes unambiguously growth enhancing. As wealth increases, banks offer improving liquidity insurance, and higher growth; however, for high levels of wealth, growth generated by financial intermediation declines as the economy attains the optimal level of consumption risk sharing.
    Keywords: Financial development, economic growth, OLG growth models, liquidity, financial intermediation
    JEL: E44 G21 O16 O40
    Date: 2004–01
  18. By: Pedro Silos
    Abstract: Much of the macroeconomics literature dealing with wealth distribution has become abstracted from modeling housing explicitly. This paper investigates the properties of the wealth distribution and the portfolio composition regarding housing and equity holdings and their relationship to macroeconomic shocks. To this end, I construct a business cycle model in which agents differ in age, income, and wealth and derive utility from housing services. The model is consistent with several facts such as the life-cycle pattern of housing-to-wealth ratios, the larger degree of concentration for nonhousing wealth, and the smaller weight of housing in richer households’ portfolios as well as the larger housing-to-wealth ratios in recessions. In addition, the model delivers the familiar business-cycle moments regarding relative standard deviations and procyclicality of consumption, investment, and employment.
    Date: 2005
  19. By: Lloyd-Braga, Teresa; Nourry, Carine; Venditti, Alain
    Abstract: In this paper, we consider an aggregate overlapping generations model with endogenous labour, consumption in both periods of life, homothetic preferences and productive external effects coming from the average capital and labour. We show that under realistic calibrations of the parameters, in particular a large enough share of first period consumption over the wage income, local indeterminacy of equilibria cannot occur with capital externalities alone but that it can occur when there are only, however small, labour externalities. More precisely, under gross substitutability, the existence of multiple equilibria requires a large enough elasticity of capital-labour substitution and a large enough elasticity of the labour supply. We also show that if labour externalities are slightly stronger and the elasticity of labour supply is larger, local indeterminacy occurs in a Cobb-Douglas economy. Finally, we show that, as a consequence of our restriction on first period consumption, a locally indeterminate steady state is generically characterized by an under-accumulation of capital. It follows therefore that while agents live over a finite number of periods, the conditions for the existence of locally indeterminate equilibria are very similar to those obtained within infinite horizon models and that from this point of view, Diamond meets Ramsey.
    Keywords: capital and labour externalities; endogenous cycles; endogenous labour supply; indeterminacy; overlapping generations; under-accumulation
    JEL: C62 E32 O41
    Date: 2005–09
  20. By: Heathcote, Jonathan; Storesletten, Kjetil; Violante, Giovanni L
    Abstract: This paper analyses the welfare effects of changes in cross-sectional wage dispersion, using a class of tractable heterogeneous-agent economies. We emphasize a trade-off in the welfare calculation that arises when labour supply is endogenous. On the one hand, as wage uncertainty rises, so does the cost associated with missing insurance markets. On the other hand, greater wage inequality presents opportunities to increase aggregate productivity by concentrating market work among more productive workers. We find that the observed rise in wage dispersion in the United States over the past three decades implies a welfare loss roughly equivalent to a 2.5% decline in lifetime consumption. Assuming Cobb-Douglas preferences, this number is the result of a welfare gain of around 5% from the endogenous increase in productivity coupled with a loss of around 7.5% associated with greater volatility in consumption and leisure.
    Keywords: insurance; labour supply; productivity; wage dispersion; welfare
    JEL: D31 D58 D91 E21 J22 J31
    Date: 2005–08
  21. By: Thomas Cooley; Ramon Marimon; Vicenzo Quadrini
    Abstract: We study a general equilibrium model in which entrepreneurs finance investment with optimal financial contracts. Because of enforceability problems, contracts are constrained efficient. We show that limited enforceability amplifies the impact of technological innovations on aggregate output. More generally, we show that lower enforceability of contracts will be associated with greater aggregate volatility. A key assumption for this result is that defaulting entrepreneurs are not excluded from the market.
    Keywords: Innovation, enforcement, aggregate fluctuations, development, financing innovation
    JEL: E10 O11 O16 O40
    Date: 1999–06
  22. By: Jordi Galí; Mark Gertler; J. David López-Salido
    Abstract: In this paper we present a simple theory-based measure of the variations in aggregate economic efficiency: the gap between the marginal product of labor and the household’s consumption/leisure tradeoff. We show that this indicator corresponds to the inverse of the markup of price over social marginal cost, and give some evidence in support of this interpretation. We then show that, with some auxilliary assumptions our gap variable may be used to measure the efficiency costs of business fluctuations. We find that the latter costs are modest on average. However, to the extent the flexible price equilibrium is distorted, the gross efficiency losses from recessions and gains from booms may be large. Indeed, we find that the major recessions involved large efficiency losses. These results hold for reasonable parameterizations of the Frisch elasticity of labor supply, the coefficient of relative risk aversion, and steady state distortions.
    Keywords: Business Cycles, Countercyclical Markups, Welfare Costs
    JEL: E32
    Date: 2005–05
  23. By: De Fiore, Fiorella; Uhlig, Harald
    Abstract: We present a dynamic general equilibrium model with agency costs, where heterogeneous firms choose between two alternative instruments of external finance - corporate bonds and bank loans. We characterize the financing choice of firms and the endogenous financial structure of the economy. The calibrated model is used to address questions such as: What explains differences in the financial structure of the US and the euro area? What are the implications of these differences for allocations? We find that a higher share of bank finance in the euro area relative to the US is due to lower availability of public information about firms' credit worthiness and to higher efficiency of banks in acquiring this information. We also quantify the effect of differences in the financial structure on per-capita GDP.
    Keywords: agency costs; financial structure; heterogeneity
    JEL: C68 E20
    Date: 2005–09
  24. By: Shinichi Nishiyama; Kent Smetters
    Abstract: While privatizing Social Security can improve labor supply incentives, it can also reduce risk sharing when households face uninsurable risks. We simulate a stylized 50-percent privatization using an overlapping-generations model where heterogenous agents with elastic labor supply face idiosyncratic earnings shocks and longevity uncertainty. When wage shocks are insurable, privatization produces about $21,900 of new resources for each future household (growth adjusted over time) after all households have been fully compensated for their possible transitional losses. However, when wages are not insurable, privatization reduces efficiency by about $5,600 per future household despite improved labor supply incentives. We check the robustness of these results to different model specications and arrive at several surprising conclusions. First, privatization actually performs relatively better in a closed economy, where interest rates decline with capital accumulation, than in an open economy where capital can be accumulated without reducing interest rates. Second, privatization also performs relatively better when an actuarially-fair private annuity market does not exist than when it does exist. Third, introducing progressivity into the privatized system to restore risk sharing must be done carefully. In particular, having the government match private contributions on a progressive basis is not very effective at restoring risk sharing -- too much matching actually harms efficiency. However, increasing the progressivity of the remaining traditional system is very effective at restoring risk sharing, thereby allowing partial privatization to produce efficiency gains of $2,700 per future household.
    JEL: H0 H2 H3
    Date: 2005–09
  25. By: Falko Fecht; Antoine Martin
    Abstract: In this paper, we address the question whether increasing households' financial market access improves welfare in a financial system in which there is intense competition among banks for private households' funds. Following earlier work by Diamond and by Fecht, we use a model in which the degree of liquidity insurance offered to households through banks' deposit contracts is restrained by households' financial market access. However, we also assume spatial monopolistic competition among banks. Because monopoly rents are assumed to bring about inefficiencies, improved financial market access that limits monopoly rents also entails a positive effect; however, this beneficial effect is only relevant if competition among banks does not sufficiently restrain monopoly rents already. ; Thus, our results suggest that in Germany's bank-dominated financial system, which is characterized by intense competition for households' deposits, improved financial market access might reduce welfare because it only reduces risk sharing. In contrast, in the U.S. banking system, where there is less competition for households' deposits, a high level of household financial market participation might be beneficial.
    Keywords: Households ; Bank competition ; Bank deposits
    Date: 2005
  26. By: Martin Lettau; Sydney C. Ludvigson
    Abstract: Among the most important pieces of empirical evidence against the standard representative agent, consumption-based asset pricing paradigm are the formidable unconditional Euler equation errors the model produces for cross-sections of asset returns. Here we ask whether calibrated leading asset pricing models — specifically developed to address empirical puzzles associated with the standard paradigm — explain the mispricing of the standard consumption-based model when evaluated on cross-sections of asset returns. We find that, in many cases, they do not. We present several results. First, we show that if the true pricing kernel that sets the unconditional Euler equation errors to zero is jointly lognormally distributed with aggregate consumption and returns, such a kernel will not rationalize the magnitude of the pricing errors generated by the standard model, particularly when the curvature of utility is high. Second, we show that leading asset pricing models also do not explain the significant mispricing of the standard paradigm for plausibly calibrated sets of asset returns, even though in those models the pricing kernel, returns, and consumption are not jointly lognormally distributed. Third, in contrast to the above results, we provide one example of a limited participation/incomplete markets model capable of explaining larger pricing errors for the standard model; but we also find many examples of such models, in which the consumption of marginal assetholders behaves quite differently from per capita aggregate consumption, that do not explain the large Euler equation errors of the standard representative agent model.
    JEL: G10 G12
    Date: 2005–09
  27. By: Luis Diaz-Serrano (National University of Ireland Maynooth, Department of Economics); Donal O'Neill (National University of Ireland Maynooth, Department of Economics)
    Abstract: In this paper we use a direct measure of individual risk-aversion to examine the relationship between risk-aversion and unemployment. Contrary to what the simple search model predicts, we observe that more risk-averse individuals are more likely to be unemployed. We present extensions of the search model that can reconcile the theory with the relationships observed in the data.
    Keywords: Unemployment,job-search,risk-aversion
    JEL: D81 J64
    Date: 2004–08
  28. By: Yi Wen
    Abstract: This paper provides a simple dynamic optimization model of durable goods inventories. Closed-form solutions are derived in a general equilibrium environment with imperfect information and serially correlated shocks. The model is then applied to scrutinize some popular conjectures regarding the causes of the volatility reduction of GDP since 1984.
    Keywords: Investments ; Production (Economic theory)
    Date: 2005
  29. By: Yi Wen
    Abstract: This paper provides a general equilibrium multi-stage production model to explain the co-existence and co-movement of output- and input-inventories. The model offers a neoclassical perspective on the propagation mechanism of demand uncertainty. It reveals that uncertainty in demand at downstream can be transmitted and amplified towards upstream by inventory investment at all stages of production via input-output linkages, leading to a chain-multiplier effect on aggregate output and employment. The model is capable of explaining several long-standing puzzles of the business cycle associated with inventories.
    Keywords: Business cycles ; Production (Economic theory) ; Investments
    Date: 2005
  30. By: Thomas Gall (Economic Theory II, University of Bonn)
    Abstract: This paper analyzes the effects of intrafirm bargaining on the formation of firms in an economy with imperfect capital markets and contracting constraints. In equilibrium wealth inequality induces a heterogenous distribution of firm sizes allowing for firms both too small and too large in terms of technical efficiency. The findings connect well to empirical facts such as the missing middle of size distributions in developing countries. The model identifies a number of properties of the firm size distribution with respect to the wealth distribution and can encompass a non-monotonic relationship between aggregate wealth and inequality.
    Keywords: Intrafirm bargaining, matching, firm size distribution
    JEL: O12 C78 D31
    Date: 2005–07
  31. By: Ariel Burstein; Martin Eichenbaum; Sergio Rebelo
    Abstract: Large devaluations are generally associated with large declines in real exchange rates. We develop a model which embodies two complementary forces that account for the large declines in the real exchange rate that occur in the aftermath of large devaluations. The first force is sticky nontradable-goods prices. The second force is the impact of real shocks that often accompany large devaluations. We argue that sticky nontradable goods prices generally play an important role in explaining post-devaluation movements in real exchange rates. However, real shocks can sometimes be primary drivers of real exchange-rate movements.
    JEL: F31
    Date: 2005–09
  32. By: Karsten Jeske; Sagiri Kitao
    Abstract: The U.S. tax policy on health insurance favors only those offered a group insurance through their employers. This policy is highly regressive since the subsidy takes the form of deductions from the progressive tax system. The paper investigates alternatives to the current policy. We find that the complete removal of the subsidy results in a significant reduction in the insurance coverage and serious welfare deterioration. However, eliminating regressiveness in the group insurance subsidy and extending benefits to the private insurance market improve welfare and raise the coverage. Our work is the first in highlighting the importance of studying health policy in a general equilibrium framework with an endogenous demand for the health insurance. We use the Medical Expenditure Panel Survey (MEPS) to calibrate the process for income, health expenditure shocks, and health insurance offer status and succeed in producing the pattern of insurance demand as observed in the data, which serve as a solid benchmark for the policy experiments.
    Date: 2005
  33. By: Ingolf Schwarz (Max-Planck-Institute for Research on Collective Goods); Jinhui H. Bai (Yale University, Department of Economics)
    Abstract: The general equilibrium model with incomplete financial markets (GEI) is extended by adding fiat money, fiscal and monetary policy and a cash-in-advance constraint. The central bank either pegs the interest rate or money supply while the fiscal authority sets a Ricardian or a non-Ricardian fiscal plan. We prove the existence of equilibria in all four scenarios. In Ricardian economies, the conditions required for existence are not more restrictive than in standard GEI. In non-Ricardian economies, the sufficient conditions for existence are more demanding. In the Ricardian economy, neither the price level nor the equivalent martingale measure are determinate.
    Keywords: Money, Incomplete Markets, Fiscal Policy, Indeterminacy
    JEL: D52 E40 E50
    Date: 2005–09
  34. By: Beaudry, Paul; Portier, Franck
    Abstract: This paper uses aggregate Japanese data and sectoral US data to explore the properties of the joint behaviour of stock prices and total factor productivity (TFP) with the aim of highlighting data patterns that are useful for evaluating business cycle theories. The approach used follows that presented in Beaudry and Portier (2004b). The main findings are that (i) in both Japan and the US, innovations in stock prices that are contemporaneously orthogonal to TFP precede most of the long run movements in total factor productivity, and (ii) such stock prices innovations do not affect US sectoral TFPs contemporaneously, but do precede TFP increases in those sectors that are driving US TFP growth, namely durable goods, and among them equipment sectors.
    Keywords: business cycle; productivity shocks; stock prices
    JEL: E3
    Date: 2005–08
  35. By: Javier Díaz-Giménez; Giorgia Giovannetti; Ramon Marimon; Pedro Teles
    Abstract: We study the effects of nominal debt on the optimal sequential choice of monetary policy. When the stock of debt is nominal, the incentive to generate unanticipated inflation increases the cost of the outstanding debt even if no unanticipated inflation episodes occur in equilibrium. Without full commitment, the optimal sequential policy is to deplete the outstanding stock of debt progressively until these extra costs disappear. Nominal debt is therefore a burden on monetary policy, not only because it must be serviced, but also because it creates a time inconsistency problem that distorts interest rates. The introduction of alternative forms of taxation may lessen this burden, if there is enough commtiment to fiscal policy. If there is full commitment to an optimal fiscal policy, then the resulting monetary policy is the Friedman rule of zero nominal interest rates.
    Keywords: Time-consistency, monetary policy, debt, recursive equilibrium
    JEL: E40 E52 E61
    Date: 2004–07
  36. By: Constantin Gurdgiev; (Department of Economics, Trinity College)
    Abstract: This paper presents a model of endogenous growth in the presence of habit formation in consumption. We argue that in addition to the traditional disutility effects of habitual consumption, the past history of consumption represents a past record of transactions as well. As a result, the knowledge acquired in the process of past consumption leads to efficiency gains in allocating time to other activities. In particular, the investment technology in broad household capital can be seen as benefiting from the habitual consumption knowledge, while being subject to the costly new consumption pathways learning. These learning-by-consuming effects imply a faster speed of convergence to the steady state growth rate in consumption and a higher steady state ratio of capital to habits. Alternatively our model allows for the case where new consumption is associated with the accumulation of broad capital, as is consistent with the case where consumption goods can also be used in production. In this case convergence to steady state growth rate is slower.
    JEL: D13 E21 E22 O40
    Date: 2005–08
  37. By: George W. Evans; Seppo Honkapohja; Ramon Marimon
    Abstract: We analyze a monetary model with flexible labor supply, cash-inadvance constraints and seigniorage-financed government deficits. If the intertemporal elasticity of substitution of labor is greater than one, there are two steady states, one determinate and the other indeterminate. If the elasticity is less than one, there is a unique steady state, which can be indeterminate. Only in the latter case do there exist sunspot equilibria that are stable under adaptive learning. A sufficient reduction in government purchases can in many cases eliminate the sunspot equilibria while raising consumption/labor taxes even enough to balance the budget may fail to achieve determinacy.
    Keywords: Indeterminacy, learnability, expectational stability, endogenous fluctuations, seigniorage
    JEL: C62 D83 D84 E31 E32
    Date: 2004–02
  38. By: Wouter J. Den Haan; Christian Haefke; Garey Ramey
    Abstract: According to Ljungqvist and Sargent (1998), high European unemployment since the 1980s can be explained by a rise in economic turbulence, leading to greater numbers of unemployed workers with obsolete skills. These workers refuse new jobs due to high unemployment benefits. In this paper we reassess the turbulence-unemployment relationship using a matching model with endogenous job destruction. In our model, higher turbulence reduces the incentives of employed workers to leave their jobs. If turbulence has only a tiny effect on the skills of workers experiencing endogenous separation, then the results of Lungqvist and Sargent (1998, 2004) are reversed, and higher turbulence leads to a reduction in unemployment. Thus, changes in turbulence cannot provide an explanation for European unemployment that reconciles the incentives of both unemployed and employed workers.
    Keywords: Skill loss, European unemployment puzzle
    JEL: E24 J64
    Date: 2004–11
  39. By: Gerhard Glomm; Jürgen Jung; Changmin Lee; Chung Tran
    Abstract: We use an OLG model to study the effects of the generous public sector pension system in Brazil. In our model there are two types of workers, one working in the private sector, the other working in the public sector. Public workers produce infrastructure or education services. We find that reducing generosity of the public sector pensions has large effects on capital accumulation and steady state income.
    Keywords: pension reform, capital accumulation
    JEL: E62 H41 H55
    Date: 2005
  40. By: David C. Maré (Motu Economic & Public Policy Research)
    Abstract: Endogenous growth theory is one of the mainstream economics approaches to modelling economic growth. This paper provides a non-technical overview of some key strands of the endogenous growth theory (EGT) literature, providing references to key articles and texts. The intended audience is policy analysts who want to understand the intuition behind EGT models. The paper should be accessible to someone without much economics training.
    Keywords: Endogenous Growth, Innovation
    JEL: O31 O40
    Date: 2005–09–12

This nep-dge issue is ©2005 by Christian Zimmermann. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.