nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2005‒10‒29
nineteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Competitive Risk Sharing Contracts with One-Sided Commitment By Dirk Krueger; Harald Uhlig
  2. Real Exchange Rate Overshooting RBC Style By Patrick Minford; Prakriti Sofat; Eric Nowell; David Meenagh
  3. Skill mismatch in equilibrium unemployment By Ronald Bachmann
  4. Equilibrium Implications of Fiscal Policy with Tax Evasion By Francesco Busato; Bruno Chiarini; Vincenzo di Maro
  5. Introducing Time-to-Educate in a Job Search Model By Sascha O. Becker
  6. The relevance of Post-Match LTC: Why has the Spanish labor market become as volatile as the US one? By Hector Sala Lorda
  7. Bank finance versus bond finance: what explains the differences between US and Europe? By Fiorella De Fiore; Harald Uhlig
  8. Growing Old and Staying Young: Population Policy in an Ageing Closed Economy By Bas van Groezen; Lex Meijdam
  9. Housing Market Dynamics: On the Contribution of Income Shocks and Credit Constraint By François Ortalo-Magné; Sven Rady
  10. Job Matching with Multiple-Hiring Firms and Heterogeneous Workers: A Microfoundation By Kenjiro Hori
  11. Optimal Sticky Prices under Rational Inattention By Bartosz Mackowiak; Mirko Wiederholt
  12. Expectations, Learning and Macroeconomic Persistence By Fabio Milani
  13. Estimating a Life Cycle Model with Unemployment and Human Capital Depreciation By Andreas Pollak
  14. Notes on an Endogenous Growth Model with two Capital Stocks II: The Stochastic Case By Dirk Bethmann
  15. Heterogeneity within Communities: A Stochastic Model with Tenure Choice By François Ortalo-Magné; Sven Rady
  16. Structural Change in a Multi-Sector Model of Growth By L. Rachel Ngai; Christopher A. Pissarides
  17. Near-Rational Exuberance By James Bullard; George W. Evans; Seppo Honkapohja
  18. Some Benets of Cyclical Monetary Policy By Ricardo de Oliveira Cavalcanti; Ed Nosal
  19. Advances in Dynamic Optimal Taxation By Narayana R Kocherlakota

  1. By: Dirk Krueger; Harald Uhlig
    Abstract: This paper analyzes dynamic equilibrium risk sharing contracts between profit-maximizing intermediaries and a large pool of ex-ante identical agents that face idiosyncratic income uncertainty that makes them heterogeneous ex-post. In any given period, after having observed her income, the agent can walk away from the contract, while the intermediary cannot, i.e. there is one-sided commitment. We consider the extreme scenario that the agents face no costs to walking away, and can sign up with any competing intermediary without any reputational losses. We demonstrate that not only autarky, but also partial and full insurance can obtain, depending on the relative patience of agents and financial intermediaries. Insurance can be provided because in an equilibrium contract an up-front payment effectively locks in the agent with an intermediary. We then show that our contract economy is equivalent to a consumption-savings economy with one-period Arrow securities and a short-sale constraint, similar to Bulow and Rogoff (1989). From this equivalence and our characterization of dynamic contracts it immediately follows that without cost of switching financial intermediaries debt contracts are not sustainable, even though a risk allocation superior to autarky can be achieved.
    Keywords: Long-term contracts, Risk Sharing, Limited Commitment, Competition
    JEL: G22 E21 D11 D91
    Date: 2005–02
  2. By: Patrick Minford (Cardiff Business School); Prakriti Sofat (Cardiff Business School); Eric Nowell; David Meenagh (Cardiff Business School)
    Abstract: The objective of this paper is to establish the ability of a Real Business Cycle model to account for the behaviour of the real exchange rate (RXR), using UK experience as our empirical focus. We specify a dynamic general equilibrium open economy model based on optimising decisions of rational agents; the first order conditions from the households. and firms' optimisation problems are used to derive the behavioural equations of the model. As we model the UK, a medium-sized open economy, we take the world economy as given. We keep the model in its non- linear form and hence solve it numerically. The interaction with the rest of the world comes in the form of uncovered real interest rate parity and current account both of which are explicitly micro-founded. The paper discusses simulation results of a 1 percent productivity shock, which shows clearly that on impact RXR appreciates and then goes back to a new depreciated equilibrium, producing a business cycle. This deterministic simulation is very encouraging to the idea that the behaviour of RXR may be explicable within an RBC context. Ultimately to test whether our model is consistent with the facts, we bootstrap our model to generate pseudo RXR series and check if the ARIMA parameters estimated for the data lie within 95% confidence limits implied by our model. We find that our model tells quite a good story, the gyrations of the RXR can be explained within an RBC framework.
    Date: 2005
  3. By: Ronald Bachmann
    Abstract: We analyse the effect of skill mismatch in a search model of equilibrium unemployment with risk-neutral agents, endogenous job destruction, and two-sided ex-ante heterogeneity. First, we examine the interaction of labour market institutions and skill mismatch. We find that skill mismatch changes the results obtained in a model with ex-ante homogeneity. Second, we analyse the interaction of skill mismatch and labour market institutions for the difference in the labour market experience of continental Europe on the one hand and the US on the other hand. We find that within-group skill mismatch cannot explain the rise in unemployment in Europe relative to the US. This result is due to the endogeneity of job destruction and stands at odds with previous findings in the literature. We can, however, confirm the fact that unemployment benefits potentially play a beneficial role by providing a subsidy to search. Generally, we argue that in search models with fixed match characteristics, job destruction should be endogenised in order to take account of heterogeneous decision rules.
    Keywords: Unemployment, mismatch, ex-ante heterogeneity, search, endogenous job destruction, Nash bargaining
    JEL: J64 J65 D33
    Date: 2005–06
  4. By: Francesco Busato; Bruno Chiarini; Vincenzo di Maro (Department of Economics, University of Aarhus, Denmark)
    Abstract: This paper generates high frequency data for the underground labor and the underground production using a theoretical general equilibrium model, over the sample 1970:01-1992:04 (32 years; 128 observations). We compare selected time series properties of the generated series with those of the corresponding series estimated with classical methodologies. The generated series for underground labor and underground production present a wider range and are more volatile than all other series estimated with classical methodologies. The analysis, next, suggests that the underground labor is pro-cyclical with respect to the GDP, that is lagging it by approximately one quarter, and that underground labor series generated from the theoretical model are highly persistent. Finally, the estimated correlation between the cyclical component of our generated-from-theory underground labor productivity and the actual series of aggregate GDP is negative (-0.34), while official yearly estimates present a positive (but very low) correlation with the cyclical component of GDP (0.12). This suggests that the underground sector has a positive impact over the productivity at the business cycle frequency, while it dampens productivity fluctuations at a lower frequency.
    Keywords: Real Business Cycle Models, Underground Economy
    JEL: E32
    Date: 2005–10–27
  5. By: Sascha O. Becker (CES, CESifo and IZA Bonn)
    Abstract: Transition patterns from school to work differ considerably across OECD countries. Some countries exhibit high youth unemployment rates, which can be considered an indicator of the difficulty facing young people trying to integrate into the labor market. At the same time, education is a time-consuming process, and enrolment and dropout decisions depend on expected duration of studies, as well as on job prospects with and without completed degrees. One way to model entry into the labor market is by means of job search models, where the job arrival hazard is a key parameter in capturing the ease or difficulty in finding a job. Standard models of job search and education assume that skills can be upgraded instantaneously (and mostly in the form of on-the-job training) at a fixed cost. This paper models education as a time-consuming process, a concept which we call time-to-educate, during which an individual faces the trade-off between continuing education and taking up a job.
    Keywords: job search, education, enrollment, dropouts
    JEL: E24 J31 J41 J64
    Date: 2005–10
  6. By: Hector Sala Lorda (Departament d'Economia Aplicada, Universitat Autonoma de Barcelona)
    Abstract: We present a Search and Matching model with heterogeneous workers (entrants and incumbents) that replicates the stylized facts characterizing the US and the Spanish labor markets. Under this benchmark, we find the Post-Match Labor Turnover Costs (PMLTC) to be the centerpiece to explain why the Spanish labor market is as volatile as the US one. The two driving forces governing this volatility are the gaps between entrants and incumbents in terms of separation costs and productivity. We use the model to analyze the cyclical implications of changes in labor market institutions affecting these two gaps. The scenario with a low degree of workers’ heterogeneity illustrates its suitability to understand why the Spanish labor market has become as volatile as the US one.
    Keywords: Search, Matching, Training, Firing costs, Productivity Differentials.
    JEL: J23 J24 J31 J41 J63 J64
    Date: 2005–10
  7. By: Fiorella De Fiore; Harald Uhlig
    Abstract: We present a dynamic general equilibrium model with agency costs, where heterogeneous firms choose among 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 effciency of banks in acquiring this information. We also quantify the effect of differences in the financial structure on per-capita GDP.
    Keywords: Financial structure, agency costs, heterogeneity
    JEL: E20 E44 C68
    Date: 2005–08
  8. By: Bas van Groezen; Lex Meijdam
    Abstract: This paper analyses the relation between public pensions, fertility and child care in a closed economy OLG-model with endogenous fertility. It it shown that it is optimal to introduce child allowances if the government redistributes income from the young to the old, and rises when longevity increases.
    Keywords: ageing, child allowances, closed economy, endogenous fertility, overlapping generations, pensions, social security
    JEL: D10 H55 J13 J14 J18 J26
    Date: 2004–11
  9. By: François Ortalo-Magné (Department of Real Estate and Urban Land Economics, University of Wisconsin-Madison, 975 University Avenue, Madison, WI 53706, USA); Sven Rady (Department of Economics, University of Munich, Kaulbachstr. 45, D-80539 Munich, Germany)
    Abstract: We propose a life-cycle model of the housing market with a property ladder and a credit constraint. We focus on equilibria which replicate the facts that credit constraints delay some households' first home purchase and force other households to buy a home smaller than they would like. The model helps us identify a powerful driver of the housing market: the ability of young households to afford the down payment on a starter home, and in particular their income. The model also highlights a channel whereby changes in income may yield housing price overshooting, with prices of trade-up homes displaying the most volatility, and a positive correlation between housing prices and transactions. This channel relies on the capital gains or losses on starter homes incurred by credit-constrained owners. We provide empirical support for our arguments with evidence from both the U.K. and the U.S.
    Keywords: Housing Demand, Income Fluctuations, Overlapping Generations, Collateral Constraint
    JEL: E32 G12 G21 R21
    Date: 2005–05
  10. By: Kenjiro Hori (School of Economics, Mathematics & Statistics, Birkbeck College)
    Abstract: The traditional search models that consider coordination failure of firms consisting of single jobs, are inadequate when applied to large firms. In this paper a firm-level matching function is derived for firms with multiple vacancies, by introducing heterogeneity in jobs and workers. Firms face diminishing returns to hiring success, which allows us to determine firm-size endogenously. The derived aggregate matching function exhibits constant returns to scale. The main macroeconomic results of the traditional search models are also shown to survive in this model of large firms. The paper thus provides a microfoundation to the macroeconomic job-matching literature.
    Keywords: frictional labour market, matching function, heterogeneity
    JEL: J41 J64
    Date: 2005–10
  11. By: Bartosz Mackowiak; Mirko Wiederholt
    Abstract: In the data, individual prices change frequently and by large amounts. In standard sticky price models, frequent and large price changes imply a fast response of the aggregate price level to nominal shocks. This paper presents a model in which price setting firms optimally decide what to observe, subject to a constraint on information flow. When idiosyncratic conditions are more variable or more important than aggregate conditions, firms pay more attention to idiosyncratic conditions than to aggregate conditions. When we calibrate the model to match the large average absolute size of price changes observed in the data, prices react fast and by large amounts to idiosyncratic shocks, but prices react only slowly and by small amounts to nominal shocks. Nominal shocks have persistent real effects. We use the model to investigate how the optimal allocation of attention and the dynamics of prices depend on the firms’ environment.
    Keywords: rational inattention, sticky prices, real effects of nominal shocks
    JEL: E3 E5 D8
    Date: 2004–06
  12. By: Fabio Milani (Princeton University & University of California, Irvine)
    Abstract: This paper presents an estimated model with learning and provides evidence that learning can improve the fit of popular monetary DSGE models and endogenously generate realistic levels of persistence. The paper starts with an agnostic view, developing a model that nests learning and some of the structural sources of persistence, such as habit formation in consumption and inflation indexation, that are typically needed in monetary models with rational expectations to match the persistence of macroeconomic variables. I estimate the model by likelihood-based Bayesian methods, which allow the estimation of the learning gain coefficient jointly with the `deep' parameters of the economy. The empirical results show that when learning replaces rational expectations, the estimated degrees of habits and indexation drop near zero. This finding suggests that persistence arises in the model economy mainly from expectations and learning. The posterior model probabilities show that the specification with learning fits significantly better than does the specification with rational expectations. Finally, if learning rather than mechanical sources of persistence provides a more appropriate representation of the economy, the implied optimal policy will be different. The policymaker will also incur substantial costs from misspecifying private expectations formation.
    Keywords: persistence, constant-gain learning, expectations, habit formation in consumption, inflation inertia, Phillips curve, Bayesian econometrics, New-Keynesian model.
    JEL: C11 D84 E30 E50 E52
    Date: 2005–10–22
  13. By: Andreas Pollak (University of Freiburg)
    Abstract: I estimate a life cycle model of consumption choice with unemployment risk. Employed individuals face the risk of losing their job. Unemployed agents receive job random offers of different quality, which they can accept or reject. Following the loss of a job and during unemployment, an agent’s productivity declines. Using micro data, I estimate the structural model for Germany, the UK, and the US following the method of simulated moments approach of Duffie and Singleton. The estimated model is used to perform policy simulations that highlight the relationship between the unemployment insurance scheme and the unemployment rates of different age groups.
    Keywords: Method of Simulated Moments, Unemployment Insurance, Life- Cycle Models, Human Capital
    JEL: C51 D1 E2 J24 J31 J38 J64
    Date: 2005–10–23
  14. By: Dirk Bethmann
    Abstract: This paper extends the class of stochastic AK growth models with a closed-form solution to the case where there are two capital goods in the model. To be precise, we consider the Uzawa-Lucas model of endogenous growth with human and physical capital. The extension holds, even if an external effect in the use of human capital in goods production occurs. Using the “guess and verify” method, we determine the value function of the social planner in the centralized economy and the value function of the representative agent in the decentralized case. We show that the introduction of income taxes on wages and of a subsidy on physical capital earnings is able to help the decentralized economy in reaching the social optimum, while keeping the policy maker’s budget balanced. Then the time series implications of the model’s solution are derived. In Appendix to the paper the uniqueness of the value functions is proved by using an alternative method.
    Keywords: closed-form solution, value function, saddle path stability, endogenous growth
    JEL: C61 C62
    Date: 2005–06
  15. By: François Ortalo-Magné (Department of Real Estate and Urban Land Economics, University of Wisconsin-Madison, 975 University Avenue, Madison, WI 53706, USA); Sven Rady (Department of Economics, University of Munich, Kaulbachstr. 45, D-80539 Munich, Germany)
    Abstract: Standard explanations for the income heterogeneity within neighborhoods rely on differences of preferences across households and heterogeneity of the housing stock. We propose an alternative and complementary explanation. We construct a stochastic equilibrium sorting model where (1) income is the sole dimension of household heterogeneity, (2) households form state-contingent housing location plans that may involve moves over their lifetimes, (3) households choose whether to own or rent depending on the housing expenditure risk associated with each tenure mode, and (4) there is a probability that newcomer households move in and compete for homes with native households. Income mixing within neighborhood arises for two reasons. First, allowing natives to form state-contingent housing location plans breaks the indivisibility of housing consumption implicit in the literature where households choose their location once and for all. Second, natives can insure themselves against rent fluctuations by buying their home prior to the realization of the population shock; newcomers cannot. As a result, poorer natives stay in the more desirable communities and only richer newcomers move in these communities. Evidence from U.S. metropolitan areas supports the effects predicted by the model.
    Keywords: Equilibrium Sorting, Income Mixing, Housing Demand, Tenure Choice
    JEL: D31 R12 R21
    Date: 2005–05
  16. By: L. Rachel Ngai (CEP, London School of Economics and CEPR); Christopher A. Pissarides (CEP, London School of Economics, CEPR and IZA Bonn)
    Abstract: We study a multi-sector model of growth with differences in TFP growth rates across sectors and derive sufficient conditions for the coexistence of structural change, characterized by sectoral labor reallocation, and balanced aggregate growth. The conditions are weak restrictions on the utility and production functions commonly applied by macroeconomists. Per capita output grows at the rate of labor-augmenting technological progress in the capitalproducing sector and employment moves to low-growth sectors. In the limit all employment converges to two sectors, the slowest-growing consumption-goods sector and the capitalgoods sector.
    Keywords: multi-sector growth, structural change, balanced growth, sectoral employment, unbalanced growth
    JEL: O41 O14
    Date: 2005–10
  17. By: James Bullard; George W. Evans; Seppo Honkapohja
    Abstract: We study how the use of judgement or “add-factors” in macroeconomic forecasting may disturb the set of equilibrium outcomes when agents learn using recursive methods. We isolate conditions under which new phenomena, which we call exuberance equilibria, can exist in standard macroeconomic environments. Examples include a simple asset pricing model and the New Keynesian monetary policy framework. Inclusion of judgement in forecasts can lead to self-fulfilling fluctuations, but without the requirement that the underlying rational expectations equilibrium is locally indeterminate. We suggest ways in which policymakers might avoid unintended outcomes by adjusting policy to minimize the risk of exuberance equilibria. Key words: Learning, expectations, excess volatility, bounded rationality, monetary policy
    JEL: E52 E61
    Date: 2005–10
  18. By: Ricardo de Oliveira Cavalcanti (EPGE/FGV); Ed Nosal
    Date: 2005–10
  19. By: Narayana R Kocherlakota
    Date: 2005–10–26

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