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on Dynamic General Equilibrium |
| By: | Frank Smets (European Central Bank, Kaiserstrasse 29, D-60311, Frankfurt am Main, Germany.); Raf Wouters (National Bank of Belgium.) |
| Abstract: | This paper estimates a DSGE model with many types of shocks and frictions for both the US and the euro area economy over a common sample period (1974-2002). The structural estimation methodology allows us to investigate whether differences in business cycle behaviour are due to differences in the type of shocks that affect the two economies, differences in the propagation mechanism of those shocks or differences in the way the central bank responds to those economic developments. Our main conclusion is that each of those characteristics is remarkably similar across both currency areas. |
| Keywords: | DSGE models; business cycle fluctuations. |
| JEL: | E1 E2 E3 |
| Date: | 2004–09 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20040391&r=dge |
| By: | Gert Peersman (Department of Financial economics, Ghent University); Roland Straub (European University Institute) |
| Abstract: | This paper provides evidence for the impact of technology, labor supply, monetary policy and aggregate spending shocks on hours worked in the Euro area. The evidence is based on a vector autoregression identified using sign restrictions that are consistent with both sticky price and real business cycle models. In contrast to most of the existing literature for the US, evidence of a positive response of hours to technology shocks is found, which is consistent with the conventional real business cycle interpretation and at odds with sticky price models. In addition, an important role for technology shocks in explaining business cycle fluctuations is found. |
| Keywords: | Technology shocks; Real business cycle models; Sticky price models; Vector autoregressions. |
| JEL: | E32 E24 |
| Date: | 2004–07 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20040373&r=dge |
| By: | Marco Del Negro (Federal Reserve Bank of Atlanta, Research Department, 1000 Peachtree Street N.E., Atlanta, GA 30309-4470, USA); Frank Schorfheide (University of Pennsylvania, Department of Economics, 3718 Locust Walk, Philadelphia, PA 19 104, USA); Frank Smets (European Central Bank and CEPR); Raf Wouters (National Bank of Belgium, B-1000 Brussels, Belgium) |
| Abstract: | The paper provides new tools for the evaluation of DSGE models, and applies it 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 Lambda 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 Lambda. 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 DSGEVAR. We find that the degree of misspecification in large-scale DSGE models is no longer so large to prevent their use in day-to-day policy analysis, yet it is not small enough that it cannot be ignored. |
| Keywords: | Bayesian Analysis; DSGE Models; Model Evaluation; Vector Autoregressions. |
| JEL: | C11 C32 C53 |
| Date: | 2005–06 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20050491&r=dge |
| By: | Shigeru Fujita (Federal Reserve Bank of Philadelphia); Garey Ramey (University of California, San Diego) |
| Abstract: | In aggregate U.S. data, exogenous shocks to labor productivity induce highly persistent and hump-shaped responses to both the vacancy- unemployment ratio and employment. We show that the standard version of the Mortensen-Pissarides matching model fails to replicate this dynamic pattern due to the rapid responses of vacancies. We extend the model by introducing a sunk cost for creating new job positions, motivated by the well-known fact that worker turnover exceeds job turnover. In the matching model with sunk costs, vacancies react sluggishly to shocks, leading to highly realistic dynamics. |
| Keywords: | Unemployment, Vacancies, Labor Adjustment, Matching |
| JEL: | E32 J63 J64 |
| Date: | 2005–09–26 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpma:0509026&r=dge |
| By: | Frank Smets (European Central Bank, CEPR and University of Ghent.); Raf Wouters (National Bank of Belgium.) |
| Abstract: | In monetary policy strategies geared towards maintaining price stability conditional and unconditional forecasts of inflation and output play an important role. This paper illustrates how modern sticky-price dynamic stochastic general equilibrium models, estimated using Bayesian techniques, can become an additional useful tool in the forecasting kit of central banks. First, we show that the forecasting performance of such models compares well with a-theoretical vector autoregressions. Moreover, we illustrate how the posterior distribution of the model can be used to calculate the complete distribution of the forecast, as well as various inflation risk measures that have been proposed in the literature. Finally, the structural nature of the model allows computing forecasts conditional on a policy path. It also allows examining the structural sources of the forecast errors and their implications for monetary policy. Using those tools, we analyse macroeconomic developments in the euro area since the start of EMU. |
| Keywords: | Forecasting; DSGE models; monetary policy; euro area. |
| JEL: | E4 E5 |
| Date: | 2004–09 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20040389&r=dge |
| By: | Günter Coenen (Directorate General Research, European Central Bank); Roland Straub (Monetary and Financial Systems Department, International Monetary Fund) |
| Abstract: | In this paper, we revisit the effects of government spending shocks on private consumption within an estimated New-Keynesian DSGE model of the euro area featuring non-Ricardian households. Employing Bayesian inference methods, we show that the presence of non-Ricardian households is in general conducive to raising the level of consumption in response to government spending shocks when compared with the benchmark specification without non-Ricardian households. However, we find that there is only a fairly small chance that government spending shocks crowd in consumption, mainly because the estimated share of non-Ricardian households is relatively low, but also due to the large negative wealth effect induced by the highly persistent nature of government spending shocks. |
| Keywords: | non-Ricardian households; fiscal policy; DSGE modelling; euro area. |
| JEL: | E32 E62 |
| Date: | 2005–08 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20050513&r=dge |
| By: | Lawrence Christiano (Department of Economics, Northwestern University, 2001 Sheridan Road, Evanston, Illinois 60208, USA); Roberto Motto (European Central Bank, Kaiserstr. 29, D-60311 Frankfurt am Main, Germany); Massimo Rostagno (European Central Bank, Kaiserstr. 29, D-60311 Frankfurt am Main, Germany) |
| Abstract: | We evaluate the Friedman-Schwartz hypothesis that a more accommodative monetary policy could have greatly reduced the severity of the Great Depression. To do this, we first estimate a dynamic, general equilibrium model using data from the 1920s and 1930s. Although the model includes eight shocks, the story it tells about the Great Depression turns out to be a simple and familiar one. The contraction phase was primarily a consequence of a shock that induced a shift away from privately intermediated liabilities, such as demand deposits and liabilities that resemble equity, and towards currency. The slowness of the recovery from the Depression was due to a shock that increased the market power of workers. We identify a monetary base rule which responds only to the money demand shocks in the model. We solve the model with this counterfactual monetary policy rule. We then simulate the dynamic response of this model to all the estimated shocks. Based on the model analysis, we conclude that if the counterfactual policy rule had been in place in the 1930s, the Great Depression would have been relatively mild. |
| Keywords: | General equilibrium; Lower bound; Deflation; Shocks |
| JEL: | E31 E40 E51 E52 E58 N12 |
| Date: | 2004–03 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20040326&r=dge |
| By: | Liam Graham (Corresponding author : Department of Economics, University of Warwick, Coventry, CV4 7AL, UK.); Dennis J. Snower (Department of Economics, Birkbeck College, University of London, 7 Gresse Street, London W1P 2LL, UK.) |
| Abstract: | We analyse the effects of money growth within a standard New Keynesian framework and show that the interaction between staggered nominal contracts and money growth leads to a long-run trade-off between output and money growth. We explore the microeconomic mechanisms that lead to this trade-off, and show that it remains even when the contract length is endogenised. |
| Keywords: | Inflation; unemployment; Phillips curve; nominal inertia; monetary policy; dynamic general equilibrium. |
| JEL: | E20 E40 E50 |
| Date: | 2004–11 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20040412&r=dge |
| By: | Antonella Trigari (IGIER, Bocconi University, Italy) |
| Abstract: | In order to explain the joint fluctuations of output, inflation and the labor market, this paper first develops a general equilibrium model that integrates a theory of equilibrium unemployment into a monetary model with nominal price rigidities. Then, it estimates a set of structural parameters characterizing the dynamics of the labor market using an application of the minimum distance estimation. The estimated model can explain the cyclical behavior of employment, hours per worker, job creation and job destruction conditional on a shock to monetary policy. Moreover, allowing for variation of the labor input at the extensive margin leads to a significantly lower elasticity of marginal costs with respect to output. This helps to explain the sluggishness of inflation and the persistence of output after a monetary policy shock. The ability of the model to account for the joint dynamics of output and inflation rely on its ability to explain the dynamics in the labor market. |
| Keywords: | Business Cycles, Search and Matching Models, Monetary Policy, Inflation. |
| JEL: | E32 J41 J64 E52 E31 |
| Date: | 2004–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20040304&r=dge |
| By: | Marco Del Negro (Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree St NE, Atlanta GA 30309-4470, USA); Frank Schorfheide (Department of Economics, 3718 Locust Walk, University of Pennsylvania, Philadelphia, PA 19104-6297, USA) |
| Abstract: | This paper proposes a novel method for conducting policy analysis with potentially misspecified dynamic stochastic general equilibrium (DSGE) models and applies it to a New Keynesian DSGE model along the lines of Christiano, Eichenbaum, and Evans (JPE 2005) and Smets and Wouters (JEEA 2003). Specifically, we are studying the effects of coefficient changes in interest-rate feedback rules on the volatility of output growth, inflation, and nominal rates. The paper illustrates the sensitivity of the results to assumptions on the policy invariance of model misspecifications. |
| Keywords: | Bayesian Analysis; DSGE Models; Model Misspecification. |
| JEL: | C32 |
| Date: | 2005–04 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20050475&r=dge |
| By: | Matthias Mohr (European Central Bank, Kaiserstraße 29, D-60311 Frankfurt am Main, Germany) |
| Abstract: | This paper proposes a new univariate method to decompose a time series into a trend, a cyclical and a seasonal component: the Trend-Cycle filter (TC filter) and its extension, the Trend-Cycle-Season filter (TCS filter). They can be regarded as extensions of the Hodrick-Prescott filter (HP filter). In particular, the stochastic model of the HP filter is extended by explicit models for the cyclical and the seasonal component. The introduction of a stochastic cycle improves the filter in three respects - first, trend and cyclical components are more consistent with the underlying theoretical model of the filter. Second, the end-of-sample reliability of the trend estimates and the cyclical component is improved compared to the HP filter since the pro-cyclical bias in end-of-sample trend estimates is virtually removed. Finally, structural breaks in the original time series can be easily accounted for. |
| Keywords: | Economic cycles; time series; filtering; trend-cycle decomposition; seasonality. |
| JEL: | C13 C22 E32 |
| Date: | 2005–07 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20050499&r=dge |
| By: | Yi Wen |
| Abstract: | The extremely weak propagation mechanisms of real business cycle (RBC) models are well acknowledged, and some effort has been devoted to improving the models on this dimension. This paper builds on these efforts to provide an explicit explanation of why various existing RBC models do not replicate real world business cycles, and discusses modifications necessary to bring real business cycle theory into closer conformity with the data. |
| Keywords: | Business cycles |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2005-039&r=dge |
| By: | Michael Dueker |
| Abstract: | A pair of simple modifications to the Kalman filter recursions makes possible the filtering of models in which one or more state variables is truncated normal. Such recursions are broadly applicable to macroeconometric models that have one or more probit-type equation, such as vector autoregressions and estimated dynamic stochastic general equilibrium models. |
| Keywords: | Macroeconomics - Econometric models |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2005-057&r=dge |
| By: | George Alexandria; Horag Choi |
| Abstract: | Not all firms export every period. Firms enter and exit foreign markets. Previous research has suggested that these export participation decisions have significant aggregate implications. In particular, it has been argued that these export decisions are important for the comovements of net exports and the real exchange rate. In this paper, the authors evaluate these predictions in a general equilibrium environment. Specifically, assuming that firms face an up-front, sunk cost of entering foreign markets and a smaller period-by-period continuation cost, they derive the discrete entry and exit decisions yielding exporter dynamics in an otherwise standard equilibrium open economy business cycle model. The authors show that the export decisions of firms in the model are infuenced by the business cycle in a manner consistent with evidence presented for U.S. exporters. However, in contrast to previous partial equilibrium analyses, model results reveal that the aggregate effects of these export decisions are negligible |
| Keywords: | Exports ; Foreign exchange rates |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:05-20&r=dge |
| By: | Christopher J. Erceg; Luca Guerrieri; Christopher Gust |
| Abstract: | In this paper, we describe a new multi-country open economy SDGE model named "SIGMA" that we have developed as a quantitative tool for policy analysis. We compare SIGMA's implications to those of an estimated large-scale econometric policy model (the FRB/Global model) for an array of shocks that are often examined in open-economy policy simulations. We show that SIGMA's implications for the near-term (2-3 year) responses of key variables are generally similar to those of FRB/Global. Two features of our modeling framework, including rational expectations with learning, and the inclusion of some non-Ricardian agents, play an important role in giving SIGMA more flexibility to generate responses akin to the econometric policy model; nevertheless, some quantitative disparities between the two models remain due to certain restrictive aspects of SIGMA's optimization-based framework. We conclude by using long-term simulations to illustrate some areas of comparative advantage of our SDGE modeling framework. These include linking model responses to underlying structural features of the economy, and fully articulating the endogenous channels through which "imbalances" arising from various shocks are alleviated. |
| Keywords: | Macroeconomics - Econometric models ; Business cycles - Econometric models |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:835&r=dge |
| By: | Ester Faia (Universitat Pompeu Fabra, Ramon Trias Fargas 25, Barcelona, Spain.); Tommaso Monacelli (IGIER Universita’ Bocconi,Via Salasco 3/5, 20136 Milan, Italy.) |
| Abstract: | We analyze welfare maximizing monetary policy in a dynamic two-country model with price stickiness and imperfect competition. In this context, a typical terms of trade externality affects policy interaction between independent monetary authorities. Unlike the existing literature, we remain consistent to a public finance approach by an explicit consideration of all the distortions that are relevant to the Ramsey planner. This strategy entails two main advantages. First, it allows an accurate characterization of optimal policy in an economy that evolves around a steady-state which is not necessarily efficient. Second, it allows to describe a full range of alternative dynamic equilibria when price setters in both countries are completely forwardlooking and households’ preferences are not restricted. In this context, we study optimal policy both in the long-run and along a dynamic path, and we compare optimal commitment policy under Nash competition and under cooperation. By deriving a second order accurate solution to the policy functions, we also characterize the welfare gains from international policy cooperation. |
| Keywords: | Optimal Monetary Policy; Ramsey planner; Nash equilibrium; Cooperation; sticky prices; imperfect competition. |
| JEL: | E52 F41 |
| Date: | 2004–04 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20040344&r=dge |
| By: | Cyril Monnet (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Erwan Quintin (Federal Reserve Bank of Dallas, 2200 N. Pearl St., Dallas,TX 75201, USA.) |
| Abstract: | We describe a dynamic model of financial intermediation in which fundamental characteristics of the economy imply a unique equilibrium path of bank and financial market lending. Yet we also show that economies whose fundamental characteristics have converged may continue to have very different financial structures. Because setting up financial markets is costly in our model, economies that emphasize financial market lending are more likely to continue doing so in the future, all else equal. |
| Keywords: | Financial Systems; Financial Markets; Financial Institutions; Banks; Convergence. |
| JEL: | L16 G10 G20 N20 |
| Date: | 2005–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20050442&r=dge |
| By: | Jesús Fernández-Huertas Moraga (Columbia University, Department of Economics, 420 West 118th Street, New York, NY 10027, USA.); Jean-Pierre Vidal (European Central Bank, Kaiserstrasse 29, D-60311, Frankfurt am Main, Germany.) |
| Abstract: | This paper investigates fiscal sustainability in an overlapping generations economy with endogenous growth coming from human capital formation through educational spending. We assess how budgetary imbalances affect economic dynamics and the outlook for economic growth, thereby providing a rationale for fiscal rules ensuring sustainability. Our results show that the appropriate response of fiscal policy to temporary shocks is not trivial in the absence of fiscal rules. Fiscal rules allow for a timely reaction, thereby avoiding possibly disruptive fiscal adjustment in the future: the more adjustment is delayed, the larger is its necessary scale. We perform a rough calibration of the model to simulate the effects of a demographic shock (change in the population growth rate) under different fiscal policy scenarios. |
| Keywords: | Fiscal sustainability; public debt; overlapping generations. |
| JEL: | E62 H63 H55 O41 E17 |
| Date: | 2004–10 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20040395&r=dge |
| By: | André Meier (European University Institute,Via della Piazzuola 43, 50133 Firenze, Italy); Gernot J. Müller (Goethe University Frankfurt, Mertonstr. 17, 60054 Frankfurt am Main, Germany) |
| Abstract: | Financial frictions affect the way in which different components of GDP respond to a monetary policy shock. We embed the financial accelerator of Bernanke, Gertler and Gilchrist (1999) into a medium-scale Dynamic General Equilibrium model and evaluate the relative importance of financial frictions in explaining monetary transmission. Specifically, we match the impulse responses generated by the model with empirical impulse response functions obtained from a vector autoregression on US time series data. This allows us to provide estimates for the structural parameters of our model and judge the relevance of different model features. In addition, we propose a set of simple and instructive specification tests that can be used to assess the relative fit of various restricted models. Although our point estimates suggest some role for financial accelerator effects, they are actually of minor importance for the descriptive success of the model. |
| Keywords: | Monetary Policy; Output Composition; Financial Frictions; Minimum Distance Estimation. |
| JEL: | E32 E44 E51 |
| Date: | 2005–07 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20050500&r=dge |
| By: | Guido Ascari (Dipartimento di Economia Politica e Metodi Quantitativi, University degli Studi di Pavia,Via S. Felice, 5, 27100 Pavia, Italy.); Neil Rankin (Department of Economics, University of Warwick, Coventry CV4 7AL, UK.) |
| Abstract: | In the “perpetual youth” overlapping-generations model of Blanchard and Yaari, if leisure is a “normal” good then some agents will have negative labour supply. We suggest a solution to this problem by using a modified version of Greenwood, Hercowitz and Huffman’s utility function. The modification incorporates real money balances, so that the model may be used to analyse monetary as well as fiscal policy. In a Walrasian version of the economy, we show that increased government debt and increased government spending raise the interest rate and lower output, while an open-market operation to increase the money supply lowers the interest rate and raises output. |
| Keywords: | Blanchard-Yaari overlapping generations, endogenous labour supply. |
| JEL: | D91 E63 |
| Date: | 2004–04 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20040346&r=dge |
| By: | Cyril Monnet (DG-Research, European Central Bank) |
| Abstract: | In this paper I show that a lax anti-counterfeiting policy is inconsistent with price stability. I use a deterministic matching model with no commitment and no enforcement. An intrinsically worthless but perfectly durable object called a ‘note’ can be produced by banks at a given cost, but also by nonbanks at a (possibly) higher cost. Counterfeiting occurs when nonbanks produce notes in equilibrium. When it is cheap for nonbanks to produce notes, or the technology used to detect counterfeits is poor, counterfeits are circulating in equilibrium and trade is only implemented with a growing stock of notes (thus creating inflation). Finally, I show that the highest welfare level is achieved when counterfeiting is costly, or when the detection of counterfeits is of high quality. |
| Keywords: | Counterfeiting; Inflation; Money; Limited Commitment. |
| JEL: | D8 E5 |
| Date: | 2005–08 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20050512&r=dge |
| By: | Giovanni Lombardo (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany); Alan Sutherland (School of Economics and Finance, University of St Andrews, St Andrews, KY16 9AL, United Kingdom) |
| Abstract: | This paper shows how to compute a second-order accurate solution of a non-linear rational expectation model using algorithms developed for the solution of linear rational expectation models. The result is a state-space representation for the realized values of the variables of the model. This state-space representation can easily be used to compute impulse responses as well as conditional and unconditional forecasts. |
| Keywords: | Second order approximation; Solution method for rational expectation models. |
| JEL: | C63 E0 |
| Date: | 2005–05 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20050487&r=dge |
| By: | Philippe Michel (National Center for Scientific Research (CNRS)); Emmanuel Thibault (University of Perpignan (GEREM)); Jean-Pierre Vidal (European Central Bank, DG Economics) |
| Abstract: | This paper surveys intergenerational altruism in neoclassical growth models. It first examines Barro's approach to intergenerational altruism, whereby successive generations are linked by recursive altruistic preferences. Individuals have an altruistic concern only for their children, who in turn also have altruistic feelings for their own children. The conditions under which the Ricardian equivalence (debt neutrality) theorem applies are specified. The effectiveness of fiscal policy is further analysed in the context of an economy populated by heterogeneous families differing with respect to their degree of intergenerational altruism. Other forms of altruism, referred to as ad hoc altruism, are also examined, along with their implications for fiscal policy. |
| Keywords: | Neoclassical general aggregative models, Altruism, Fiscal Policy. |
| JEL: | E13 D64 E62 C60 |
| Date: | 2004–08 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20040386&r=dge |
| By: | Barbara Annicchiarico (Ceis, Facoltà di Economia, Università di Roma “Tor Vergata”,Via Columbia 2, 00133 Rome, Italy.) |
| Abstract: | This paper investigates the inflationary effects of fiscal policy in an optimising general equilibrium monetary model with capital accumulation, flexible prices and wealth effects. The model is calibrated to Euro Area quarterly data. Simulation results show that government deficits, high debt level and slow fiscal adjustment adversely affect price stability in the presence of an independent monetary authority adopting a monetary targeting regime. The mechanism through which fiscal policy affects the dynamics of the price level presents monetarist properties, since the price level is determined in the monetary market. The effects produced by fiscal expansions on price dynamics are due to the behaviour of consumers, sharing the burden of fiscal adjustment with future generations. Fiscal variables are shown to influence the consumption plan of individuals and the demand for real money balances, thus affecting the equilibrium conditions in the money market where the price level is determined. |
| Keywords: | Price Stability; Fiscal Policy and Government Debt. |
| JEL: | E31 E62 |
| Date: | 2003–11 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20030285&r=dge |
| By: | Tamim Bayoumi (International Monetary Fund, NY, USA.); Douglas Laxton (International Monetary Fund, NY, USA.); Paolo Pesenti (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.) |
| Abstract: | Using a general-equilibrium simulation model featuring nominal rigidities and monopolistic competition in product and labor markets, this paper estimates the macroeconomic benefits and international spillovers of an increase in competition. After calibrating the model to the euro area vs. the rest of the industrial world, the paper draws three conclusions. First, greater competition produces large effects on macroeconomic performance, as measured by standard indicators. In particular, we show that differences in competition can account for over half of the current gap in GDP per capita between the euro area and the US. Second, it may improve macroeconomic management by increasing the responsiveness of wages and prices to market conditions. Third, greater competition can generate positive spillovers to the rest of the world through its impact on the terms of trade. |
| Keywords: | Competition; Markups; Monetary Policy; Taylor Rule. |
| JEL: | C51 E31 E52 |
| Date: | 2004–04 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20040341&r=dge |
| By: | Susan Athey (Stanford University and National Bureau of Economic Research,Stanford University, Stanford, CA 94305-6072, USA.); Andrew Atkeson (University of California, Los Angeles,CA, USA. Federal Reserve Bank of Minneapolis, and National Bureau of Economic Research.); Patrick J. Kehoe (Federal Reserve Bank of Minneapolis, University of Minnesota, and National Bureau of Economic Research) |
| Abstract: | How much discretion should the monetary authority have in setting its policy? This question is analyzed in an economy with an agreed-upon social welfare function that depends on the randomly fluctuating state of the economy. The monetary authority has private information about that state. In the model, well-designed rules trade off society’s desire to give the monetary authority discretion to react to its private information against society’s need to guard against the time inconsistency problem arising from the temptation to stimulate the economy with unexpected inflation. Although this dynamic mechanism design problem seems complex, society can implement the optimal policy simply by legislating an inflation cap that specifies the highest allowable inflation rate. The more severe the time inconsistency problem, the more tightly the cap constrains policy and the smaller is the degree of discretion. As this problem becomes sufficiently severe, the optimal degree of discretion is none. |
| Keywords: | Rules vs. discretion; time inconsistency; optimal monetary policy; inflation targets; inflation caps. |
| JEL: | E5 E6 E52 E58 E61 |
| Date: | 2004–04 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20040338&r=dge |
| By: | Pierpaolo Benigno (New York University, Department of Economics, 269 Mercer Street, New York, NY 10003, USA.); Michael Woodford (Columbia University, Department of Economics, 420 W. 118th Street, New York, NY 10027, USA.) |
| Abstract: | We propose an integrated treatment of the problems of optimal monetary and fiscal policy, for an economy in which prices are sticky and the only available sources of government revenue are distorting taxes. Our linear-quadratic approach allows us to nest both conventional analyses of optimal monetary stabilization policy and analyses of optimal tax-smoothing as special cases of our more general framework. We show how a linear-quadratic policy problem can be derived which yields a correct linear approximation to the optimal policy rules from the point of view of the maximization of expected discounted utility in a dynamic stochastic general-equilibrium model. Finally, we derive targeting rules through which the monetary and fiscal authorities may implement the optimal equilibrium. |
| Keywords: | Loss function, output gap, tax smoothing, targeting rules. |
| JEL: | E52 E61 E63 |
| Date: | 2004–04 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20040345&r=dge |
| By: | Cahuc, Pierre; Zylberberg, Andre |
| Abstract: | This paper analyses optimum income taxation in a model with endogenous job destruction that gives rise to unemployment. It is shown that optimal tax schemes comprise both payroll and layoff taxes when the state provides public unemployment insurance and aims at redistributing income. The optimal layoff tax is equal to the social cost of job destruction, which amounts to the discounted value of the sum of unemployment benefits (that the state pays to unemployed workers) and payroll taxes (that the state does not get when workers are unemployed). Our quantitative analysis suggests that the introduction of layoff taxes, that are usually absent from actual tax schemes, could lead to significant increases in employment and GDP. |
| Keywords: | job destruction; layoff taxes; optimal taxation |
| JEL: | H21 H32 J38 J65 |
| Date: | 2005–08 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:5170&r=dge |
| By: | Andrea Ferrero (Department of Economics, New York University, 269 Mercer Street – 7th floor, New York, NY 10003, USA) |
| Abstract: | This paper addresses the question of the joint conduct of fiscal and monetary policy in a currency union. The problem is studied using a two-country DSGE framework with staggered price setting, monopolistic competition in the goods market, distortionary taxation and nominal debt. The two countries form a currency union but retain fiscal policy independence. The policy problem can be cast in terms of a tractable linear-quadratic setup. The stabilization properties and the welfare implications of the optimal commitment plan are compared with the outcome obtained under simple implementable rules. The central result is that fiscal policy plays a key role to smooth appropriately the impact of idiosyncratic exogenous shocks. Fiscal rules that respond to a measure of real activity have the potential to approximate accurately the optimal plan and lead to large welfare gains as compared to balanced budget rules. Monetary policy shall focus on maintaining price stability. |
| Keywords: | Currency Union; Optimal Policy; Flexibility; Welfare. |
| JEL: | E63 F33 F42 |
| Date: | 2005–07 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20050502&r=dge |
| By: | Volker Grossmann; Panu Poutvaara |
| Abstract: | Altruistic parents may transfer resources to their offspring by providing education, and by leaving bequests. We show that in the presence of wage taxation, a small bequest tax may improve efficiency in an overlapping-generations framework with only intended bequests, by enhancing incentives of parents to invest in their children’s education. This result holds even if the wage tax rate is held constant when introducing bequest taxation. We also calculate an optimal mix of wage and bequest taxes with alternative parameter combinations. In all cases, the optimal wage tax rate is clearly higher than the optimal bequest tax rate, but the latter is generally positive when the required government revenue in the economy is sufficiently high. |
| Keywords: | bequest taxation, bequests, education, Pareto improvement |
| JEL: | D64 H21 H31 I21 |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_1515&r=dge |
| By: | Barbara Annicchiarico (School of Economics, Finance and Management, University of Bristol); Nicola Giammarioli (European Central Bank, DG Economics) |
| Abstract: | This paper presents a two period overlapping generations model with endogenous growth in the presence of a public sector with objectives of convergence for public debt and primary balance to GDP ratios. In order to ensure the existence of converging paths towards the target values of fiscal variables, we introduce a simple fiscal policy rule. According to this rule, the primary balance ratio is adjusted in function of the distance between the current and the target levels of the public debt and the primary surplus to GDP ratios. It is shown that the fiscal rule displaying time invariant parameters may produce non linear dynamic processes of adjustment of the fiscal ratios as well as endogenous fluctuations in the rate of growth of the economy. In addition the transitional process towards fiscal targets critically depends on the adjustment tool chosen by the fiscal authorities to implement the rule. |
| Keywords: | Fiscal Policy; Sustainability of Public Finances; Endogenous Growth. |
| JEL: | H62 H63 O41 |
| Date: | 2004–08 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20040381&r=dge |
| By: | K Blackburn; G Forgues-Puccio |
| Abstract: | This paper presents a dynamic general equilibrium analysis of public sector corruption and economic growth. In an economy with government intervention and capital accumulation, state-appointed bureaucrats are charged with the responsibility for procuring public goods which contribute to productive efficiency. Corruption arises because of an opportunity for bureaucrats to appropriate public funds by misinforming the government about the cost and quality of public goods provision. The incentive for each bureaucrat to do this depends on economy-wide outcomes which, in turn, depend on the behaviour of all bureaucrats. We establish the existence of multiple development regimes, together with the possibility of multiple, frequency-dependent equilibria. The predictions of our analysis accord strongly with recent empirical evidence on the causes and consequences of corruption in public office.We study the effect of international financial integration on economic development when the quality of governance may be compromised by corruption. Our analysis is based on a dynamic general equilibrium model of a small economy in which growth is driven by capital accumulation and public policy is administered by government appointed bureaucrats. Corruption may arise due to the opportunity for bureaucrats to embezzle public funds, an opportunity that is made more attractive by financial liberalisation which, at the same time, raises efficiency in capital production. Our main results may be summarised as follows: (1) corruption is always bad for economic development, but its e¤ect is worse if the economy is open than if it is closed; (2) the incidence of corruption may, itself, be affected by both the development and openness of the economy; (3) financial liberalisation is good for development when governance is good, but may be bad for development when governance is bad; and (4) corruption and poverty may co-exist as permanent, rather than just transitory, fixtures of an economy. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:man:cgbcrp:54&r=dge |