nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2005‒11‒19
thirty-six papers chosen by
Christian Zimmermann
University of Connecticut

  1. Non-Ricardian Households and Fiscal Policy in an Estimated DSGE Model of the Euro Area By Roland Straub; Günter Coenen
  2. Bayesian Estimation of a DSGE Model with Financial Frictions for the U.S. and the Euro Area By Virginia Queijo
  3. Optimal Inflation Persistence: Ramsey Taxation with Capital and Habits By Sanjay K. Chugh
  4. Bank finance versus bond finance - what explains the differences between US and Europe? By Fiorella De Fiore; Harald Uhlig
  5. Monetary Policy in an Estimated DSGE Model with a Financial Accelerator By Ali Dib; Ian Christensen
  6. Distributional Effects of Monetary Policies in a New Neoclassical Model with Progressive Income Taxation By Burkhard Heer; Alfred Maussner
  7. Quantifying the Inefficiency of the US Social Security System By J. C. Parra; M. Huggett
  8. Expansionary Fiscal Shocks and the Trade Deficit By Christopher Erceg; Luca Guerrieri
  9. An Interpretation of Fluctuating Macro Policies By Eric Leeper; Troy Davig
  10. Income Inequality, Monetary Policy, and the Business Cycle By Stuart J. Fowler
  11. Limited Participation, Income Distribution and Capital Account Liberalization By Eva de Francisco
  12. International Capital Flows in a World of Greater Financial Integration By Viktoria Hnatkovska; Martin Evans
  13. Welfare Effects of Tax Policy in Open Economies: Stabilization and Cooperation By Sunghyun Henry Kim; Jinill Kim
  14. Heterogeneity and Learning in Labor Markets By Simon D. Woodcock
  15. DSGE Models in a Data-Rich Environment By Marc P. Giannoni; Jean Boivin
  16. An estimated open-economy model for the EURO area By Marco Ratto; Werner Roeger
  17. Learning and Endogenous Business Cycles in a Standard Growth Model By Laurent Cellarier
  18. Expectation Formation and Endogenous Fluctuations in Aggregate Demand By Maciej K. Dudek
  19. Multiplicity of Dynamic Equilibria and Global Efficiency By Giancarlo Marini; Pietro Senesi
  20. The Mundell-Fleming-Dornbusch Model in a New Bottle By Anthony Landry
  21. An Estimated DSGE Model for The German Economy By Ernest Pytlarczyk
  22. Capital Accumulation in the Presence of Informal Credit Contract: Does Incentive Mechanism Work Better than Credit Rationing Under Asymmetric Information? By basab dasgupta
  23. Aging, pension reform, and capital flows: A multi-country simulation model By Axel Boersch-Supan; Alexander Ludwig
  24. Pension benefit default risk and welfare effects of funding regulation By Thomas Steinberger
  25. A Rational Expectations Model of Optimal Inflation Inertia By Michael Kumhof; Douglas Laxton
  26. Optimal Unemployment Insurance in a Search Model with Variable Human Capital By Andreas Pollak
  27. Interest Rate Pegs, Wealth Effects and Price Level Determinacy By Barbara Annicchiarico; Giancarlo Marini
  28. Time Consistent Control in Non-Linear Models By Steven Ambler; Florian Pelgrin
  29. Why are More Redistributive Social Security Systems Smaller? A Median Voter Approach By Marko Köthenbürger; Panu Poutvaara; Paola Profeta
  30. Credit Card Debt Puzzles By Michael Haliassos; Michael Reiter
  31. On the Distributional Effects of Trade Policy: A Macroeconomic Perspective By Luis San Vicente Portes
  32. Uncertainty, Learning, and Optimal Technological Portfolios: A Dynamic General Equilibrium Approach to Climate Change By Seung-Rae Kim
  33. Making a match: combining theory and evidence in policy-oriented macroeconomic modelling By Alasdair Scott; George Kapetanios; Adrian Pagan
  34. Endogenous Tax Evasion and Reserve Requirements: A Comparative Study in the Context of European Economies By Rangan Gupta
  35. General Equilibrium Analysis of the Eaton-Kortum Model of International Trade By Fernando Alvarez; Robert E. Lucas
  36. Optimal Interest Rate Rules, Asset Prices and Credit Frictions By Tommaso Monacelli; Ester Faia

  1. By: Roland Straub; Günter Coenen (IMF public)
    Abstract: In this paper, we revisit the effects of government spending shocks on private aggregate consumption within an estimated New-Keynesian DSGE model of the euro area featuring non-Ricardian households and a relatively detailed fiscal policy set up. Employing Bayesian inference methods, we show that the presence of non-Ricardian households is in general conducive to raising the level of aggregate consumption in response to government spending shocks when compared with the benchmark specification without non-Ricardian households. As a practical matter, however, we find that there is only a fairly small chance that government spending shocks crowd in aggregate 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: fiscal policy, DSGE models, non-Ricardian households.
    JEL: E32 E62
    Date: 2005–11–11
  2. By: Virginia Queijo
    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: E3 E4 E5
    Date: 2005–11–11
  3. By: Sanjay K. Chugh
    Abstract: Ramsey models of fiscal and monetary policy with perfectly-competitive product markets and a fixed supply of capital predict highly volatile inflation with no serial correlation. In this paper, we show that an otherwise-standard Ramsey model that incorporates capital accumulation and habit persistence predicts highly persistent inflation. The result depends on increases in either the ability to smooth consumption or the preference for doing so. The effect operates through the Fisher relationship: a smoother profile of consumption implies a more persistent real interest rate, which in turn implies persistent optimal inflation. Our work complements a recent strand of the Ramsey literature based on models with nominal rigidities. In these models, inflation volatility is lower but continues to exhibit very little persistence. We quantify the effects of habit and capital on inflation persistence and also relate our findings to recent work on optimal fiscal policy with incomplete markets
    Keywords: Optimal fiscal and monetary policy, inflation persistence, Ramsey model, habit formation
    JEL: E50 E61 E63
    Date: 2005–11–11
  4. By: Fiorella De Fiore (Directorate General Research, European Central Bank, Postfach 160319, 60066 Frankfurt am Main, Germany); Harald Uhlig (School of Business and Economics,WiPol 1, Humboldt University, Spandauer Str. 1, 10178 Berlin, Germany)
    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 efficiency 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: 2005–11
  5. By: Ali Dib; Ian Christensen
    Abstract: This paper estimates a sticky-price DSGE model with a financial accelerator to assess the importance of financial frictions in the amplification and propagation of the effects of transitory shocks. Structural parameters of two models, one with and one without a financial accelerator, are estimated using a maximum-likelihood procedure and post-war US data. The estimation and simulation results provide some quantitative evidence in favour of the financial accelerator model. The financial accelerator appears to play an important role in investment fluctuations, but its importance for output depends on the nature of the initial shock
    Keywords: Monetary policy, Financial accelerator, DSGE estimation
    JEL: E31 E44 E51
    Date: 2005–11–11
  6. By: Burkhard Heer; Alfred Maussner (School of Economics and Management Free University of Bolzano-Bozen)
    Abstract: In our dynamic optimizing sticky price model, agents are heterogenous with regard to their assets and their income. Unanticipated inflation redistributes income and wealth. In order to model the wealth distribution, we study a 60-period OLG model with aggregate uncertainty. A positive technology shock increases the concentration of wealth as measured by the Gini coefficient considerably. In particular, a one percent increase of the technology level results in a one percent increase of the Gini coefficient. An unexpected expansionary monetary policy is found to reduce the inequality of the wealth distribution. In addition, we find that the business cycle dynamics in the OLG model in response to both a technology shock and a monetary shock are different from those in the corresponding representative-agent model
    Keywords: Distribution Effects, Unanticipated Inflation, Heterogeneous Agents
    JEL: E31 E32 E52
    Date: 2005–11–11
  7. By: J. C. Parra; M. Huggett
    Abstract: We quantify the inefficiency of the retirement component of the US social security system within a model where agents receive idiosyncratic labor-productivity shocks that are privately observed
    Keywords: social security, efficient allocations, idiosyncratic shocks
    JEL: D80 D90 E21
    Date: 2005–11–11
  8. By: Christopher Erceg; Luca Guerrieri
    Abstract: In this paper, we use an open economy DGE model (SIGMA) to assess the quantitative effects of fiscal shocks on the trade balance in the United States. We examine the effects of two alternative fiscal shocks: a rise in government consumption, and a reduction in the labor income tax rate. Our salient finding is that a fiscal deficit has a relatively small effect on the U.S. trade balance, irrespective of whether the source is a spending increase or tax cut. In our benchmark calibration, we find that a rise in the fiscal deficit of one percentage point of GDP induces the trade balance to deteriorate by less than 0.2 percentage point of GDP. Noticeably larger effects are only likely to be elicited under implausibly high values of the short-run trade price elasticity
    Keywords: DGE Models, Open-Economy Macroeconomics
    JEL: F32 F41 E62
    Date: 2005–11–11
  9. By: Eric Leeper; Troy Davig (Department of Economics College of William and Mary)
    Abstract: This paper estimates simple regime-switching rules for monetary policy and tax policy over the post-war period in the United States and imposes the estimated policy process on a standard dynamic stochastic general equilibrium model with nominal rigidities. The estimated joint policy process produces a unique stationary rational expectations equilibrium in a simple New Keynesian model. We characterize policy impacts across regimes
    Keywords: Policy rules, Markov-switching, DSGE models
    JEL: E42 E51 E52
    Date: 2005–11–11
  10. By: Stuart J. Fowler
    Abstract: The effects of changes in monetary policy are studied in a general equilibrium model where money facilitates transactions. Because there are two types of agents, workers and capitalists, different elasticities of money demand exist, implying that monetary policy influences the distribution of income. Only when earnings inequality is incorporated into monetary policy rule is the model able to replicate cyclical fluctuations of both real and nominal aggregates as well as the inequality measure. Additionally, monetary policy becomes more countercyclical when the fraction of transfers received by the workers increases. These results can support a theory that the distribution of seigniorage revenues between the workers and capitalists changed in 1979
    Keywords: Inflation, Income Distribution, Heterogenous Agents, Perturbation
    JEL: E32 E42 E50
    Date: 2005–11–11
  11. By: Eva de Francisco (Macroanalysis CBO)
    Abstract: This paper examines theoretically, using a two-country real-business-cycle model, the effects of capital-market liberalization when there is limited participation in national financial markets. It is assumed that workers cannot smooth consumption as well as do stockholders, and therefore, liberalization may hurt workers. This dynamic model evaluates some claims---made particularly by the "anti-globalization" movement---that capital movements hurt workers, while benefitting stockholders. Quantitatively, liberalization makes workers better off in the long run, since the new capital allocation and increased insurance foster capital accumulation, raising wages that offset the output fluctuations due to capital flows. However, transitional effects may overturn these long-run benefits
    Keywords: Capital Account Liberalization, Globalization and Limited Participation
    JEL: E20 F20 F30
    Date: 2005–11–11
  12. By: Viktoria Hnatkovska; Martin Evans (Economics Georgetown University)
    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 structure of asset ownership and the behavior of international capital flows. 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. We also find that variations in the equity risk premia account for almost all of the international portfolio flows in bonds and equities. We argue that both effects arise naturally as a result of increased risk sharing facilitated by greater financial integration. The paper also makes a methodological contribution to the literature on dynamic general equilibrium asset-pricing. We present a new technique for solving a dynamic general equilibrium model with production, portfolio choice and incomplete markets
    Keywords: Portfolio Choice; Financial Integration; Incomplete Markets
    JEL: D52 F36 G11
    Date: 2005–11–11
  13. By: Sunghyun Henry Kim; Jinill Kim
    Abstract: This paper studies optimal tax policy problem by employing a two-country dynamic general equilibrium model with incomplete asset markets. We investigate the possibility of welfare-improving active, contingent tax policies (under which tax rates respond to changes in productivity) on capital and labor income and consumption. Unlike the conventional wisdom regarding stabilization policies, procyclical factor-income tax policies in general improves welfare in open economies. Procyclical tax policies generate efficiency gains by correcting asset market incompleteness. Optimal tax policy under cooperative equilibrium is similar to that under the Nash equilibrium, and welfare gains from tax policy coordination is quite small
    Keywords: optimal tax, procyclical, countercyclical, stabilization, cooperation
    JEL: F4 E6
    Date: 2005–11–11
  14. By: Simon D. Woodcock (Simon Fraser University)
    Abstract: This paper examines the role of agent heterogeneity and learning on wage dispersion and employment dynamics. In the first half of the paper, I present an equilibrium matching model where heterogeneous workers and firms learn about match quality and bargain over wages. The model generalizes Jovanovic (1979) to the case of heterogeneous workers and firms. Equilibrium wage dispersion arises due to productivity differences across workers, technological differences across firms, and heterogeneity in beliefs about match quality. Under a simple CRS technology, the equilibrium wage is additively separable in worker- and firm-specific components, and in the posterior mean of beliefs about match quality. This parallels the 'person and firm effects' empirical specification of Abowd et. al. (1999, AKM) and others. It consequently provides a theoretical context for the AKM model, and a formal economic interpretation of their empirical person and firm effects. The model also yields an assortative matching result that predicts a negative correlation between estimated person and firm effects, which is consistent with most empirical evidence. Finally, the model makes novel predictions about the relationship between the person and firm effects and separation behavior, job duration, and firm size. In the second half of the paper, I test the model's empirical predictions. I estimate fixed and mixed effects specifications of the equilibrium wage function on the LEHD database. The mixed effect specifications generalize the earlier work of AKM and others. The learning component of the matching model implies a specific structure for the error covariance. I exploit this structure to test whether earnings residuals are consistent with Bayesian learning, and to estimate structural parameters of the matching model. I find considerable support for the matching model in these data.
    Keywords: matching, learning, heterogeneity, longitudinal linked data, mixed model
    JEL: J31 D83 C23
    Date: 2005–11–15
  15. By: Marc P. Giannoni; Jean Boivin
    Abstract: Standard practice for the estimation of dynamic stochastic general equilibrium (DSGE) models maintains the assumption that economic variables are properly measured by a single indicator, and that all relevant information for the estimation is adequately summarized by a small number of data series, whether or not measurement error is allowed for. However, recent empirical research on factor models has shown that information contained in large data sets is relevant for the evolution of important macroeconomic series. This suggests that conventional model estimates and inference based on estimated DSGE models are likely to be distorted. In this paper, we propose an empirical framework for the estimation of DSGE models that exploits the relevant information from a data-rich environment. This framework provides an interpretation of all information contained in a large data set through the lenses of a DSGE model. The estimation involves Bayesian Markov-Chain Monte-Carlo (MCMC) methods extended so that the estimates can, in some cases, inherit the properties of classical maximum likelihood estimation. We apply this estimation approach to a state-of-the-art DSGE monetary model. Treating theoretical concepts of the model --- such as output, inflation and employment --- as partially observed, we show that the information from a large set of macroeconomic indicators is important for accurate estimation of the model. It also allows us to improve the forecasts of important economic variables
    Keywords: DSGE models, model estimation, measurement error, large data sets, factor models, MCMC techniques, Bayesian estimation
    JEL: E52 E3 C32
    Date: 2005–11–11
  16. By: Marco Ratto; Werner Roeger
    Abstract: We estimate a small open economy DSGE model for the euro area. The household sector optimises an intertemporal utility function with habit persistence. Households decide about asset accumulation, consumption and sets wages in a monopolistically competitive labour market. Households trade bonds internationally and there is a risk premium determined by the degree of foreign indebtedness. Firms are owned by domestic households. Consistent with the household objective function they determine labour demand, capacity, investment and they set prices in a monopolistically competitive goods market by maximising the market value of the corporate sector. Apart from technological constraints, decisions are subject to convex adjustment costs. Monetary policy is modelled via a Taylor rule. A Bayesian estimation approach is applied, using the Dynare code, by Michel Juillard, via the log-linearisation of the model around the steady state, solution of the forward looking log-linear model and computation of the likelihood via Kalman filter. After estimating the posterior mode via standard optimisation routines, the posterior distribution of model parameters is estimated with a Metropolis Markov Chain Monte Carlo approach. Unobserved components are also derived, such as technology, target inflation, capital utilisation. A full Bayesian impulse response analysis is then performed, comprising a detailed sensitivity analysis of the main dynamical features of the model simulations versus changes in model parameters.
    JEL: C13 C15 E12 E17
    Date: 2005–11–11
  17. By: Laurent Cellarier
    Abstract: Cyclical or chaotic competitive equilibria that do not exist under perfect foresight are shown to occur in a decentralized growth model under constant gain adaptive learning. This paper considers an economy populated by boundedly rational households making one-period ahead constant gain adaptive input price forecasts, and using simple expectation rules to predict long-run physical capital holdings and consumption. Under these hypotheses, lifetime decisions are derived as time unfolds, and analytical solutions to the representative household's problem exist for a standard class of preferences. Under various characteristics of the model's functional forms, competitive equilibrium trajectories under learning may exhibit opposite local stability properties depending whether the underlying information set accommodates all contemporary data. Calibrated to the U.S. economy, the model with boundedly rational households may exhibit endogenous business cycles around the permanent regime which is a saddle point under perfect foresight
    Keywords: bounded rationality, constant gain adaptive learning, endogenous business cycles
    JEL: C61 D83 E32
    Date: 2005–11–11
  18. By: Maciej K. Dudek
    Abstract: The paper recognizes that expectations and the process of their formation are subject to standard decision making and are determined as a part of equilibrium. Accordingly, the paper presents a basic framework in which the form of expectation formation is a choice variable. At any point in time rational economic agents decide on the basis of the level of utility what expectation formation technology to use and as a consequence what expectations to hold. As economic decisions are conditioned on expectations holding proper or rational expectations eliminates the possibility of ex ante inefficiencies. The choice of expectation formation technology is not trivial as the paper assumes that information gathering and processing are costly. Consequently, economic agents must make informed decisions with the regard to the quality of expectation formation technologies they wish to use. The paper shows that agents' optimization over expectations not only adds on to realism, but also can carry non trivial implications for the behavior of macroeconomic variables. Specifically, the paper illustrates that endogenous expectation revisions can be a source of permanent oscillations in aggregate demand and can prevent an economy from settling into a steady state. In addition, the paper quantifies intangible notions such as overheating, overborrowing, and output gap. Finally, the paper shows that active policy measures can limit inefficiencies resulting from output fluctuations
    Keywords: Business Cycles, Expectation Formation, Costly Information Acquisition.
    JEL: D84 E32
    Date: 2005–11–11
  19. By: Giancarlo Marini (University of Rome II - Faculty of Economics); Pietro Senesi (University of Rome II - Faculty of Economics)
    Abstract: Within a one-sector, infinite-horizon representative agent model with technological externalities and a convex-concave production function, this paper derives a capital subsidy policy that simultaneously eliminates the wedge between private and social marginal products of capital, and achieves a globally efficient allocation.
    Keywords: nonconvexities, technological externalities, dynamic equilibrium allocations
    JEL: C61 D62 H21
    Date: 2004–06–10
  20. By: Anthony Landry (Economics Boston University)
    Abstract: We introduce elements of state-dependent pricing and strategic complementarity within an otherwise standard "New Open Economy Macroeconomics" model, and develop its implications for the dynamics of real and nominal economic activity. Under a traditional Producer-Currency-Pricing environment, our framework replicates key international features following a domestic monetary shock. In contrast with its time-dependent counterpart, our approach delivers (i) a high international output correlation relative to consumption correlation, (ii) a delayed surge in inflation across countries, (iii) a delayed overshooting of exchange rates, and (iv) a J-curve dynamic in the domestic trade balance. Moreover, our model emphasizes the expenditure-switching effect as an important channel of monetary policy transmission, and consequently keeps the spirit of the Mundell-Fleming-Dornbusch model within the confines of the microfounded dynamic general equilibrium approach
    Keywords: international monetary policy transmission, international comovements, state-dependent pricing, strategic complementarity.
    JEL: F41 F42
    Date: 2005–11–11
  21. By: Ernest Pytlarczyk
    Abstract: This paper presents an estimated DSGE model for the European Monetary Union. Our approach, contrary to the previous studies, accounts for heterogeneity within the euro area. In the estimation we utilize disaggregated information, employing single country data, along with the aggregated EMU by Fagan et. al (2001). We also contribute to the literature by proposing a strategy for consistent estimation of the currency union model, using information available prior to the adoption of the single currency and afterwards. This approach requires the determination of two separate data generating processes - here these are theoretical DSGE models - corresponding to both current and historical monetary regimes. We emphasize the use of regime-switching models in the DSGE framework (in our case the threshold is known exactly and the switch is permanent). The approach is illustrated by developing a simple two-region DSGE model, with a particular focus on analyzing the German economy within EMU, and its Bayesian estimation on the sample 1980:q1- 2003:q4. Moreover, the paper offers: (i) a robustness check of the estimation results with respect to the alternative data approaches and various restrictions imposed on the model's structure (ii) assesments of the relative importance of various shocks and frictions for explaining the model dynamics (iii) an evaluation of the model's empirical properties
    Keywords: Bayesian econometrics, DSGE models, Euro area
    JEL: E4 E5
    Date: 2005–11–11
  22. By: basab dasgupta (economics university of connecticut)
    Abstract: Credit markets with asymmetric information often prefer credit rationing as a profit maximizing device. This paper asks whether the presence of informal credit markets reduces the cost of credit rationing, that is, whether it can alleviate the impact of asymmetric information based on the available information. We used a dynamic general equilibrium model with heterogenous agents to assess this. Using Indian credit market data our study shows that the presence of informal credit market can reduce the cost of credit rationing by separating high risk firms from the low risk firms in the informal market. But even after this improvement, the steady state capital accumulation is still much lower as compared to incentive based market clearing rates. Through self revelation of each firm's type, based on the incentive mechanism, banks can diversify their risk by achieving a separating equilibrium in the loan market. Incentive mechanism helps banks to increase capital accumulation in the long run by charging lower rates and lending relatively higher amount to the less risky firms. Another important finding of this study is that self revelation leads to very significant welfare improvement, as measured by consumption equivalence
    Keywords: informal credit and capital accumulation
    JEL: O16 O17
    Date: 2005–11–11
  23. By: Axel Boersch-Supan; Alexander Ludwig
    Abstract: We present a quantitative analysis of the effects of population aging and pension reform on international capital markets. First, demographic change alters the time path of aggregate savings within each country. Second, this process may be amplified when a pension reform shifts old-age provision towards more pre-funding. Third, while the patterns of population aging are similar in most countries, timing and initial conditions differ substantially. Hence, to the extent that capital is internationally mobile, population aging will induce capital flows between countries. All three effects influence the rate of return to capital and interact with the demand for capital in production and with labor supply. In order to quantify these effects, we develop a computational general equilibrium model. We feed this multi-country overlapping generations model with detailed long-term demographic projections for seven world regions. Our simulations indicate that capital flows from fast-aging regions to the rest of the world will initially be substantial but that trends are reversed when households decumulate savings. We also conclude that closed-economy models of pension reform miss quantitatively important effects of international capital mobility
    Keywords: aging; pension reform; capital mobility
    JEL: E27 F21 G15
    Date: 2005–11–11
  24. By: Thomas Steinberger (CSEF, University of Salerno)
    Abstract: This paper analyzes the welfare effects of funding regulation for defined benefit pension plans subject to pension benefit default risk in an incomplete financial markets OLG-setting with aggregate uncertainty and idiosyncratic pension default risk. The financial market incompleteness arises from the inability to trade human capital claims. Using numerical methods to solve for equilibrium, we show first that default-free defined benefit pension plans are welfare-improving even in a dynamically efficient economy. Second, we show that in the presence of default risk funding regulations improve aggregate welfare by making larger size plans more attractive and that full funding is not necessarily the optimal policy. Our results provide a rationale for the widespread underfunding of defined benefit pension plans and might explain the decline of these plans after the introduction of stringent funding regulation in the US
    Keywords: generations, pension default, funding regulation
    JEL: H21 H31 H55
    Date: 2005–11–01
  25. By: Michael Kumhof (Modeling Division, Research Department International Monetary Fund); Douglas Laxton
    Abstract: This paper presents a monetary model with nominal rigidities and maximizing, rational, forward-looking households, intermediaries and firms. It differs from conventional models in this class in two key respects. First, price (and wage) setters set pricing policies, including an updating rate for future prices, instead of price levels. Second, output fluctuations during the period of a pricing policy are costly to firms. The paper is motivated by some important shortcomings of conventional models, namely their inability to generate inflation inertia, inflation persistence and recessionary disinflations without introducing either an ad-hoc updating rule or learning. While learning is clearly important, we are interested in the contribution that structural rigidities can make in a forward-looking and optimizing model. The model does generate all of the above effects in response to monetary policy shocks. The channel for these effects in the model is the long-run or inflation updating component of firms' pricing policies. This is distinct from another frequently stressed reason for inflation inertia and persistence, a slow response of marginal cost to shocks, which is also present in our model because all components of marginal cost, not just wages, are sticky. In work in progress, we are estimating the model using Bayesian techniques.
    Keywords: Inflation inertia, price setting behavior, output volatility
    JEL: E31 E32
    Date: 2005–11–11
  26. By: Andreas Pollak
    Abstract: The framework of a general equilibrium heterogeneous agents model is used to study the optimal design of an unemployment insurance scheme and the voting behaviour on unemployment policy reforms. Agents, who have a limited lifetime and participate in the labour market until they reach the retirement age, can either be employed or unemployed in each period of their working life. Unemployed agents receive job offers of different (match) qualities. Moreover, unemployed agents suffer a decline of their individual productivity during unemployment, whereas the productivity of employed agents increases over time. Any form of unemployment insurance must take into account an important trade-off. On the one hand, generous benefits are desirable as they provide good insurance of the risk-averse agents against unforeseen income fluctuations (caused by layoffs and the randomness of individual job offers). On the other hand, high benefits induce a moral-hazard problem, as certain groups of agents choose to decline job offers that, while not being as attractive as the unemployment benefit from an individual point of view, a central planner would make them accept. An optimal unemployment insurance scheme is one that maximizes the expected lifetime utility of a newly born agent. Two types of unemployment insurance are considered, one with defined benefits and one with defined replacement ratios. A numerical version of the model is calibrated to the West German economy and simulated at ½-monthly frequency, resulting in an agent’s life-span of 1440 periods. The welfare maximising unemployment insurance scheme is determined in simulations. Under this optimal system, no payments are made to short-term unemployed agents. Long-term unemployed receive rather low (social assistance level) benefits, the optimal level of which depends on the assumed degree of risk aversion. Defined benefit systems provide a higher welfare than defined replacement ratios. I then address the question whether the majority of population would support the optimal system given the status quo. It turns out that older or unemployed agents tend vote in favour of the status quo, whereas young employed agents would approve the reform. If voters can choose between keeping their current unemployment system and jumping to the equilibrium associated with the optimal policy, there is a slight majority of just above 50% for the optimal policy. Finally, a more realistic case is considered, in which voters do not choose between the long-rung equilibria associated with policy changes, but take into account the transition process to the new equilibrium. The adjustment process of the macro environment after the policy reform is computed for a time span of sixty years. As some of the relevant variables adjust very slowly to their new long-run equilibrium values, the effect of the transition process on voting behaviour cannot be neglected
    JEL: C61 J64 J65
    Date: 2005–11–11
  27. By: Barbara Annicchiarico (University of Bristol - Department of Economics); Giancarlo Marini (University of Rome II - Faculty of Economics)
    Abstract: This paper analyses the issue of price level determinacy in an optimising general equilibrium model with overlapping generations. It is shown that under a pure interest rate peg, wealth effects rule out nominal indeterminacy but give rise to multiple equilibria.
    Keywords: Price Level Determination, Interest Rate Pegging, Multiple Equilibria
    JEL: E31 E63
    Date: 2005–02–04
  28. By: Steven Ambler (Université du Québec à Montréal public); Florian Pelgrin
    Abstract: This paper shows how to use optimal control theory to derive time-consistent optimal government policies in nonlinear dynamic general equilibrium models. It extends the insight of Cohen and Michel (1988), who showed that in _linear_ models time-consistent policies can be found by imposing a linear relationship between predetermined state variables and the costate variables from private agents' maximization problems. We use an analogous procedure based on the Den Haan and Marcet (1990) technique of parameterized expectations, which replaces nonlinear functions of expected future costates by flexible functions of current states. This leads to a nonlinear relationship between current state and costate variables, which is verified in equilibrium to an arbitrarily close degree of approximation. The optimal control problem of the government is recursive, unlike the Ramsey (1927) problem which is common in the optimal taxation literature. We use a model of public investment to illustrate the technique
    Keywords: Optimal government policy; Time consistent control
    JEL: E61 E62 C63
    Date: 2005–11–11
  29. By: Marko Köthenbürger (CES, University of Munich and CESifo); Panu Poutvaara (University of Helsinki, CEBR, CESifo, HECER and IZA Bonn); Paola Profeta (Bocconi University)
    Abstract: We suggest a political economy explanation for the stylized fact that intragenerationally more redistributive social security systems are smaller. We relate the stylized fact to an "efficiencyredistribution" trade-off to be resolved by political process. The inefficiency of social security financing is due to endogenous labor supply. Using data on eight European countries, we find that the stylized fact and a considerable degree of cross-country variation in contribution rates can be explained by the median voter model.
    Keywords: earnings-related and flat-rate benefits, applied political economy, public pensions, labor supply
    JEL: H55 D72
    Date: 2005–11
  30. By: Michael Haliassos; Michael Reiter
    Abstract: Most US credit card holders revolve high-interest debt, often combined with substantial (i) asset accumulation by retirement, and (ii) low-rate liquid assets. Hyperbolic discounting can resolve only the former puzzle (Laibson et al., 2003). Bertaut and Haliassos (2002) proposed an 'accountant-shopper'framework for the latter. The current paper builds, solves, and simulates a fully-specified accountant-shopper model, to show that this framework can actually generate both types of co-existence, as well as target credit card utilization rates consistent with Gross and Souleles (2002). The benchmark model is compared to setups without self-control problems, with alternative mechanisms, and with impatient but fully rational shoppers.
    Keywords: Credit cards, debt, self control, household portfolios
    JEL: E21 G11
    Date: 2005–11
  31. By: Luis San Vicente Portes (Economics Georgetown University)
    Abstract: This paper develops a theoretical model to explore the relationship between openness to trade and long-term income inequality. Empirical evidence on the issue is mixed, though greater inequality is often cited as a possible cost of trade liberalization. To quantify the effect of liberalization on inequality I calibrate a two-sector (agriculture and non-agriculture) open-economy macroeconomic model to the Mexican economy. Agents in the model are subject to idiosyncratic, uninsurable labor income risk, and precautionary saving generates endogenous distributions of wealth and income. When preferences are characterized by subsistence floor for food consumption, trade liberalization implies large welfare gains for low wealth agents. At the same time, liberalization increases long-run wealth and income inequality. After liberalization land-owners are worse off since the price of land falls along with the relative price of the agricultural commodity. When tariff revenue must be replaced by an alternative instrument, higher labor taxes are preferred to higher taxes on consumption or capital
    Keywords: Free trade; inequality; agriculture
    JEL: E60 F13 F40 O13
    Date: 2005–11–11
  32. By: Seung-Rae Kim (Woodrow Wilson School Princeton University)
    Abstract: How is the design of efficient climate policies affected by the potentials for induced technological change and for future learning about key parameter uncertainties? We address this question using a new integrated climate-economy model incorporating endogenous technological change to explore optimal technological portfolios against global warming in the presence of uncertainty and learning. We explicitly consider the interplays between induced innovation, the stringency of environmental policies, and possible environmental risks within the general equilibrium framework of probabilistic integrated assessment. We find that the value of resolving key scientific uncertainties would be non-trivial in the face of binding climate limits, but at the same time it can significantly decrease with induced innovation and knowledge spillovers that might otherwise be absent. The results also show that scientific uncertainties in climate change could justify immediate mitigation actions and accelerated investments in new energy technologies, reflecting risk-reducing considerations.
    Keywords: Uncertainty; Learning; Optimal technological portfolios; Endogenous technological change; Stochastic growth model; Probabilistic integrated assessment; Carbon-free technology; Expected value of information
    JEL: Q28 D81 O33
    Date: 2005–11–11
  33. By: Alasdair Scott; George Kapetanios; Adrian Pagan
    Abstract: A persistent question arising in the development of models for the analysis of macroeconomic policy has been the relative role of economic theory and evidence (data) in their construction. This paper looks at some strategies for transforming a Conceptual Model to become a Data-Adjusted Model, and how to adjust further to an Operational Model for policy analysis. Using a typical dynamic GE small open economy calibrated to UK data, we examine how some simple but formal econometric tests can be applied to test the match of the CM to the data. We also use the CM as a laboratory to assess model-building strategies. Our example suggests that, since one will never be sure that the choice of variables is appropriate, it is better to start with a CM and work towards making it match the data than attempting the converse
    Keywords: economic model
    JEL: C52
    Date: 2005–11–11
    Abstract: Given that data indicates several countries with same, or nearly same, degree of tax evasion but widely different levels of reserve requirements, this paper analyzes the relationship between the ``optimal" degree of tax evasion and mandatory cash reserve requirements required to be held by banks using a simple overlapping generations framework. Proceeding on the initial premises that the above observation may be a fallout of the possibilities of multiple levels of tax evasion given the reserve requirements and other policy variables, or that the optimal degree of tax evasion may be completely unaffected by the movements in reserve requirements, we find the latter to be true. The model also suggests the following: (i) An economy with a less corrupt structure will have a higher steady-state of value of reported income; (ii) Increases in the penalty rates of evading taxes would induce consumers to report greater fraction of their income, while increases in the income-tax rates would cause them to evade greater fraction of their income, and ; (iii) The model does not vindicate the popular belief in the literature that, countries with lower percentage of reported income tend to have higher reserve requirements
    Keywords: Reserve requirements; Tax evasion
    JEL: E52
    Date: 2005–11–11
  35. By: Fernando Alvarez; Robert E. Lucas
    Abstract: We study a variation of the Eaton-Kortum model, a competitive, constant-returns-to-scale multicountry Ricardian model of trade. We establish existence and uniqueness of an equilibrium with balanced trade where each country imposes an import tariff. We analyze the determinants of the cross-country distribution of trade volumes, such as size, tariffs and distance, and compare a calibrated version of the model with data for the largest 60 economies. We use the calibrated model to estimate the gains of a world-wide trade elimination of tariffs, using the theory to explain the magnitude of the gains as well as the differential effect arising from cross-country differences in pre-liberalization of tariffs levels and country size.
    JEL: F0 F1
    Date: 2005–11
  36. By: Tommaso Monacelli; Ester Faia
    Abstract: We study optimal monetary policy in two prototype economies with sticky prices and credit market frictions. In the first economy, credit frictions apply to the financing of the capital stock, generate acceleration in response to shocks and the "financial markup" (i.e., the premium on external funds) is countercyclical and negatively correlated with the asset price. In the second economy, credit frictions apply to the flow of investment, generate persistence, and the financial markup is procyclical and positively correlated with the asset price. We model monetary policy in terms of welfare-maximizing interest rate rules. The main finding of our analysis is that strict inflation stabilization is a robust optimal monetary policy prescription. The intuition is that, in both models, credit frictions work in the direction of dampening the cyclical behavior of inflation relative to its credit-frictionless level. Thus neither economy, despite yielding different inflation and investment dynamics, generates a trade-off between price and financial markup stabilization. A corollary of this result is that reacting to asset prices does not bear any independent welfare role in the conduct of monetary policy
    JEL: E52 F41
    Date: 2005–11–11

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