nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2005‒11‒05
eighteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. The dynamic Beveridge curve By Shigeru Fujita; Garey Ramey
  2. The Tobin effect and the Friedman rule By Joydeep Bhattacharya; Joseph Haslag; Antoine Martin
  3. Optimality of the Friedman rule in an overlapping generations model with spatial separation By Joseph H. Haslag; Antoine Martin
  4. The Relevance of Post-Match LTC: Why Has the Spanish Labor Market Become as Volatile as the US One? By Hector Sala; José I. Silva
  5. How Important are Financial Frictions in the U.S. and Euro Area? By Queijo, Virginia
  6. Accounting for the heterogeneity in retirement wealth By Fang Yang
  7. Is it is or is it ain't my obligation? Regional debt in a fiscal federation By Russell Cooper; Hubert Kempf; Dan Peled
  8. Robust control with commitment: a modification to Hansen-Sargent By Richard Dennis
  9. Evaluating Approximate Equilibria of Dynamic Economic Models By Paul Pichler; Uwe Dulleck
  10. An Estimated DSGE Model for Sweden with a Monetary Regime Change By Cúrdia, Vasco; Finocchiaro, Daria
  11. How biased are measures of cyclical movements in productivity and hours? By Stephanie Aaronson; Andrew Figura
  12. Financial crises and total factor productivity By Felipe Meza; Erwan Quintin
  13. International Capital Flows, Returns and World Financial Integration By Martin D. D. Evans; Viktoria Hnatkovska
  14. Politics and efficiency of separating capital and ordinary government budgets By Marco Bassetto; Thomas J. Sargent
  15. Monopoly Power and Optimal Taxation of Labor Income By Sheikh Tareq Selim
  16. Unexploited Connections Between Intra- and Inter-temporal Allocation By Thomas F. Crossley; Hamish W. Low
  17. The Information Technology Revolution and the Puzzling Trends in Tobin’s average q By Adrian Peralta-Alva
  18. "A Dynamic General Equilibrium Analysis of the Political Economy of Public Education." By Jorge Soares

  1. By: Shigeru Fujita; Garey Ramey
    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. The authors show that the standard version of the Mortensen-Pissarides matching model fails to replicate this dynamic pattern due to the rapid responses of vacancies. They 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: Employment ; Unemployment
    Date: 2005
  2. By: Joydeep Bhattacharya; Joseph Haslag; Antoine Martin
    Abstract: This paper addresses whether the Friedman rule can be optimal in an economy in which the Tobin effect is operative. We present an overlapping generations economy with capital in which limited communication and stochastic relocation create an endogenous transaction 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 "anti-Tobin effect" is operative, and the Friedman rule is optimal (that is, stationary-welfare-maximizing) regardless of whether or not there is long-run growth. Under the more general CRRA (constant relative risk aversion) form of preferences, we show that an operative anti-Tobin effect is a sufficient condition for the Friedman rule to be optimal. Also, contrary to models with linear storage technologies, our model shows that zero inflation is not optimal.
    Keywords: Inflation (Finance) ; Money supply ; Monetary policy ; Friedman, Milton
    Date: 2005
  3. By: Joseph H. Haslag; Antoine Martin
    Abstract: We examine models with spatial separation and limited communication that have shown some promise toward resolving the disparity between theory and practice concerning optimal monetary policy; these models suggest that the Friedman rule may not be optimal. We show that intergenerational transfers play a key role in this result, the Friedman rule is a necessary condition for an efficient allocation in equilibrium, and the Friedman rule is chosen whenever agents can implement mutually beneficial arrangements. We conclude that in order for these models to resolve the aforementioned disparity, they must answer the following question: Where do the frictions that prevent agents from implementing mutually beneficial arrangements come from?
    Keywords: Monetary policy ; Friedman, Milton ; Econometric models ; Equilibrium (Economics)
    Date: 2005
  4. By: Hector Sala (Universitat Autònoma de Barcelona and IZA Bonn); José I. Silva (Universitat Autònoma de Barcelona and Central Bank of Venezuela)
    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
  5. By: Queijo, Virginia (Institute for International Economic Studies, Stockholm University)
    Abstract: This paper aims to evaluate the importance of frictions in credit markets for business cycles in the U.S. and the Euro area. For this purpose, I modify the DSGE financial accelerator model developed by Bernanke, Gertler and Gilchrist (1999) and estimate it using Bayesian methods. The model is augmented with frictions such as price indexation to past inflation, sticky wages, consumption habits and variable capital utilization. My results indicate that financial frictions are relevant in both areas. Using the Bayes factor as criterion, the data favors the model with financial frictions both in the U.S. and the Euro area in five different specifications of the model. Moreover, the size of the financial frictions is larger in the Euro area.
    Keywords: DSGE models; Bayesian estimation; financial accelerator
    JEL: C11 C15 E32 E40 E50 G10
    Date: 2005–08–01
  6. By: Fang Yang
    Abstract: This paper studies a quantitative dynamic general equilibrium life-cycle model where parents and their children are linked by bequests, both voluntary and accidental, and by the transmission of earnings ability. This model is able to match very well the empirical observation that households with similar lifetime incomes hold very different amounts of wealth at retirement. Income heterogeneity and borrowing constraints are essential in generating the variation in retirement wealth among low lifetime income households, while the existence of intergenerational links is crucial in explaining the heterogeneity in retirement wealth among high lifetime income households.
    Date: 2005
  7. By: Russell Cooper; Hubert Kempf; Dan Peled
    Abstract: This paper studies the repayment of regional debt in a multiregion economy with a central authority: Who pays the obligation issued by a region? With commitment, a central government will use its taxation power to smooth distortionary taxes across regions. Absent commitment, the central government may be induced to bail out the regional government in order to smooth consumption and distortionary taxes across the regions. We characterize the conditions under which bailouts occur and their welfare implications. The gains to creating a federation are higher when the (government spending) shocks across regions are negatively correlated and volatile. We use these insights to comment on actual fiscal relations in three quite different federations: the U.S., the European Union and Argentina.
    Keywords: Taxation
    Date: 2005
  8. By: Richard Dennis
    Abstract: This paper studies robust control problems when policy is set with commitment. One contribution of the paper is to articulate an approximating equilibrium that differs importantly from that developed in Hansen and Sargent (2003). The paper illustrates how the proposed approximating equilibrium differs from Hansen-Sargent in the context of two New Keynesian business cycle models. A further contribution of the paper is to show that once misspecification is acknowledged commitment is no longer necessarily superior to discretion.
    Keywords: Monetary policy ; Econometric models
    Date: 2005
  9. By: Paul Pichler; Uwe Dulleck
    Abstract: This paper evaluates the performances of Perturbation Methods, the Parameterized Expectations Algorithm and Projection Methods in finding approximate decision rules of the basic neoclassical stochastic growth model. In contrast to the existing literature, we focus on comparing numerical methods for a given functional form of the approximate decision rules, and we repeat the evaluation for many di®erent parameter sets. We ¯nd that signi¯cant gains in accuracy can be achieved by moving from linear to higher-order approximations. Our results show further that among linear and quadratic approximations, Perturbation Methods yield particularly good results, whereas Projection Methods are well suited to derive higher-order approximations. Finally we show that although the structural parameters of the model economy have a large e®ect on the accuracy of numerical approximations, the ranking of competing methods is largely independent from the calibration.
    JEL: C63 C68
    Date: 2005–12
  10. By: Cúrdia, Vasco (Princeton University); Finocchiaro, Daria (Institute for International Economic Studies, Stockholm University)
    Abstract: Using Bayesian methods, we estimate a small open economy model for Sweden. We explicitly account for a monetary regime change from an exchange rate target zone to flexible exchange rates with explicit inflation targeting. In each of these regimes, we analyze the behavior of the monetary authority and the relative contribution to the business cycle of structural shocks in detail. Our results can be summarized as follows. Monetary policy is mainly concerned with stabilizing the exchange rate in the target zone and with price stability in the inflation targeting regime. Expectations of realignment and the risk premium are the main sources of volatility in the target zone period. In the inflation targeting period, monetary shocks are important sources of volatility in the short run, but in the long run, labor supply and preference shocks become relatively more important. Foreign shocks are much more destabilizing under the target zone than under inflation targeting.
    Keywords: Bayesian estimation; DSGE models; target zone; inflation targeting; regime change
    JEL: C10 C30 E50
    Date: 2005–10–01
  11. By: Stephanie Aaronson; Andrew Figura
    Abstract: The movement of hours worked over the business cycle is an important input into the estimation of many key parameters in macroeconomics. Unfortunately, the available data on hours do not correspond precisely to the concept required for accurate inference. We study one source of mismeasurement--that the most commonly used source data measure hours paid instead of hours worked--focusing our attention on salaried workers, a group for whom the gap between hours paid and hours worked is likely particularly large. We show that the measurement gap varies significantly and positively with changes in labor demand. As a result, we estimate that the standard deviations of the workweek and of total hours worked are 25 and 6 percent larger, respectively, than standard measures of hours suggest. We also find that this measurement gap is an unlikely source of the acceleration in published measures of productivity since 2000.
    Date: 2005
  12. By: Felipe Meza; Erwan Quintin
    Abstract: Total factor productivity (TFP) falls markedly during financial crises, as we document with recent evidence from Mexico and Asia. These falls are unusual in magnitude and present a difficult challenge for the standard small open economy neoclassical model. We show in the case of Mexico’s 1994-95 crisis that the model predicts that inputs and output should have fallen much more than they did. Using models with endogenous factor utilization, we find that capital utilization and labor hoarding can account for a large fraction of the TFP fall during the crisis. However, these models also predict that output should fall significantly more than in the data. Given the behavior of TFP, the biggest challenge may not be explaining why output falls so much following financial crises, but rather why it falls so little.
    Keywords: Financial crises - Mexico
    Date: 2005
  13. By: Martin D. D. Evans; Viktoria Hnatkovska
    Abstract: International capital flows have increased dramatically since the 1980s, with much of the increase being due to trade in equity and debt markets. Such developments are often attributed to the increased integration of world financial markets. We present a model that allows us to examine how greater integration in world financial markets affects the behavior of international capital flows and financial returns. Our model predicts that international capital flows are large (in absolute value) and very volatile during the early stages of financial integration when international asset trading is concentrated in bonds. As integration progresses and households gain access to world equity markets, the size and volatility of international bond flows fall dramatically but continue to exceed the size and volatility of international equity flows. This is the natural outcome of greater risk sharing facilitated by increased integration. We find that the equilibrium flows in bonds and stocks are larger than their empirical counterparts, and are largely driven by variations in equity risk premia. The paper also makes a methodological contribution to the literature on dynamic general equilibrium asset-pricing. We implement a new technique for solving a dynamic general equilibrium model with production, portfolio choice and incomplete markets.
    JEL: D52 F36 G11
    Date: 2005–10
  14. By: Marco Bassetto; Thomas J. Sargent
    Abstract: We analyze the democratic politics and competitive economics of a ‘golden rule’ that separates capital and ordinary account budgets and allows a government to issue debt to finance only capital items. Many national governments followed this rule in the 18th and 19th centuries and most U.S. states do today. We study an economy with a growing population of overlapping generations of long-lived but mortal agents. Each period, majorities choose durable and nondurable public goods. In a special limiting case with demographics that make Ricardian equivalence prevail, the golden rule does nothing to promote efficiency. But when the demographics imply even moderate departures from Ricardian equivalence, imposing the golden rule substantially improves the efficiency of democratically chosen allocations of public goods. We use some examples calibrated to U.S. demographic data and find greater benefits from adopting the golden rule at the state level or with 19th century demographics than under current national demographics.
    Date: 2005
  15. By: Sheikh Tareq Selim (Cardiff Business School)
    Abstract: This paper studies the Ramsey problem of optimal labor income taxation in a simple model economy which deviates from a first best representative agent economy in three important aspects, namely, flat rate second best tax, monopoly power in intermediate product market, and monopolistic wage setting. There are three key findings: (1) In order to correct for monopoly distortion the Ramsey tax prescription is to set the labor income tax rate lower than its competitive market analogue; (2) Government's optimal tax policy is independent of its fiscal treatment of distributed pure profits; and (3) For higher levels of monopoly distortions Ramsey policy is more desirable than the first best policy. The key analytical results are verified by a calibration which fits the model to the stylized facts of the US economy.
    Keywords: Optimal taxation; Monopoly power; Ramsey policy
    JEL: D42 E62 H21 H30
    Date: 2005
  16. By: Thomas F. Crossley; Hamish W. Low
    Abstract: This paper shows that a power utility specification of preferences over total expenditure (ie. CRRA preferences) implies that intratemporal demands are in the PIGL/PIGLOG class. This class generates (at most) rank two demand systems and we can test the validity of power utility on cross-section data. Further, if we maintain the assumption of power utility, and within period preferences are not homothetic, then the intertemporal preference parameter is identified by the curvature of Engel curves. Under the power utility assumption, neither Euler equation estimation nor structural consumption function estimation is necessary to identify the power parameter. In our empirical work, we use demand data to estimate the power utility parameter and to test the assumption of the power utility representation. We find estimates of the power parameter larger than obtained from Euler equation estimation, but we reject the power specification of within period utility.
    Keywords: elasticity of intertemporal substitution, Euler equation estimation, demand systems
    JEL: D91 E21 D12
    Date: 2005–09
  17. By: Adrian Peralta-Alva (University of Miami)
    Abstract: A growing literature argues that the Information Technology rev- olution caused the stock market crash of 1973-1974, its subsequent stagnation and eventual recovery. This paper employs general equi- librium theory to test whether this good news hypothesis is consistent with the behavior of US equity prices and with the trends in corpo- rate output, investment and consumption. I …nd it is not. A model based exclusively on good news can make equity prices fall as much as in the data but it must also imply a strong economic expansion right when the US economy stagnated. However, when the observed productivity slowdown in old production methods is incorporated into the model consistency with major macroeconomic aggregates can be achieved and a 20% drop in equity values can be accounted for. (JEL E44, O33, O41)
    Keywords: Information Technology Revolution, Stock Market, Productivity Slowdown, Tobin's q, 1974, Crash
    JEL: E44 O33 O41
    Date: 2005–11–03
  18. By: Jorge Soares (Department of Economics,University of Delaware)
    Abstract: The primary objective of this paper is to highlight the distinct roles of altruism and of self-interest in the political determination of a public education policy. I assess the relative importance of three factors in the determination of the equilibrium level of this policy: altruism, the impact of public funding of education on social security benefits and its impact on factor prices. I then focus on the impact of implementing a social security system on the equilibrium levels of education funding and on welfare. I find that although, in the benchmark economy, the presence of social security might generate support for public funding of education, its overall effect on the well-being of individuals is negative for any level of social security taxation. are particularly well-suited for analyzing the dynamics going forward in time even though the dynamics are ill-defined in this direction. In particular, we analyze the inverse limit of the cash-in-advance model of money and illustrate how information about the inverse limit is useful for detecting or ruling out complex dynamics.
    Keywords: Public Education, Voting, General Equilibrium.
    JEL: D78 E62 I22
    Date: 2005

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