nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2005‒12‒09
fourteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Electoral Uncertainty, Fiscal Policy and Macroeconomic Fluctuations By Jim Malley; Apostolis Philippopoulos; Ulrich Woitek
  2. Introducing Time-to-Educate in a Job Search Model By Sascha O. Becker
  3. Precautionary Savings or Working Longer Hours? By Pijoan-Mas, Josep
  4. Jobs and Unemployment in Macroeconomic Theory: A Turbulence Laboratory By Ljungqvist, Lars; Sargent, Thomas J
  5. New-Keynesian or RBC Transmission? The Effects of Fiscal Shocks in Labour Markets By Pappa, Evi
  6. An Estimated, New Keynesian Policy Model for Australia By Martin Melecky; Daniel Buncic
  7. Risk Sharing and Efficiency Implications of Progressive Pension Arrangements By Hans Fehr; Christian Habermann
  8. Pension Reform in Brazil: Transitional Issues in a Model with Endogenous Labor Supply By Sergio G. Ferreira
  9. Mind your Ps and Qs! Improving ARMA forecasts with RBC priors By Kirdan Lees; Troy Matheson
  10. Social Security and Longevity By Torben Andersen
  11. Technological Advance and the Growth in Healthcare Spending By Richard M. H. Suen
  12. Cash-Flow Risk, Discount Risk, and the Value Premium By Tano Santos; Pietro Veronesi
  13. Optimal Monetary and Fiscal Policy in a Currency Union By Jordi Gali; Tommaso Monacelli

  1. By: Jim Malley; Apostolis Philippopoulos; Ulrich Woitek
    Abstract: In this paper we study the link between elections, fiscal policy and aggregate fluctuations. The set-up is a stylized dynamic stochastic general equilibrium model incorporating both technology and political re-election shocks. The later are incorporated via a two-party model with elections. The main theoretical prediction is that forward-looking incumbents, with uncertain prospects of re-election, find it optimal to follow relatively shortsighted fiscal policies, and that this hurts capital accumulation. Our econometric estimation, using U.S. data, finds a statistically significant link between electoral uncertainty and policy instruments and in turn macroeconomic outcomes.
    Keywords: political uncertainty, business cycles & growth, optimal policy, hybrid maximum likelihood estimation
    JEL: D90 E60 H10 H50
    Date: 2005
  2. By: Sascha O. Becker
    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
  3. By: Pijoan-Mas, Josep
    Abstract: This paper quantifies the macroeconomic implications of the lack of insurance against idiosyncratic labour market risk. I show that in a model economy calibrated to observed individual level data, households make ample use of work effort as a consumption smoothing mechanism. As a consequence, aggregate consumption is 0.6% lower, work effort is 18% higher and labour productivity is 12% lower than they would be in a complete markets setting. Not surprisingly, the welfare benefits of moving towards complete markets are very large. Accounting for the whole transition to the new complete markets steady state I find the welfare costs of market incompleteness above 16% of individual lifetime consumption.
    Keywords: incomplete markets; labour supply; precautionary savings
    JEL: C68 D31 E21 J22
    Date: 2005–10
  4. By: Ljungqvist, Lars; Sargent, Thomas J
    Abstract: We use three general equilibrium frameworks with jobs and unemployed workers to study the effects of government mandated unemployment insurance (UI) and employment protection (EP). To illuminate the forces in these models, we study how UI and EP affect outcomes when there is higher 'turbulence' in the sense of worse skill transition probabilities for workers who suffer involuntary layoffs. Matching and search-island models have labour market frictions and incomplete markets. The representative family model with employment lotteries has no labour market frictions and complete markets. The adverse welfare state dynamics coming from high UI indexed to past earnings that were isolated by Ljungqvist and Sargent (1998) are so strong that they determine outcomes in all three frameworks. Another force stressed by Ljungqvist and Sargent (2005), through which higher layoff taxes suppress frictional unemployment in less turbulent times, prevails in the models with labour market frictions, but not in the frictionless representative family model. In addition, the high aggregate labour supply elasticity that emerges from employment lotteries and complete insurance markets in the representative family model makes it impossible to include generous government-supplied unemployment insurance in that model without getting the unrealistic result that economic activity virtually shuts down.
    Keywords: discouraged worker; employment protection; job; matching; search; skills; turbulence; unemployment; unemployment insurance
    JEL: E24 J64
    Date: 2005–11
  5. By: Pappa, Evi
    Abstract: We study the mechanics of transmission of fiscal shocks to labour markets. We characterize a set of robust implications following government consumption, investment and employment shocks in a RBC and a New-Keynesian model and use part of them to identify shocks in the data. In line with the New-Keynesian story, shocks to government consumption and investment increase real wages and employment contemporaneously both in US aggregate and in US state data. The dynamics in response to employment shocks are mixed, but in many cases are inconsistent with the predictions of the RBC model.
    Keywords: labour markets; sign-restrictions; sticky and flexible prices; VARs
    JEL: C11 E12 E32 E62
    Date: 2005–10
  6. By: Martin Melecky (University of New South Wales, School of Economics); Daniel Buncic (University of New South Wales, School of Economics)
    Abstract: A two-block open economy model is estimated in this paper using Australian and U.S. data. Evaluation of the estimated model is carried out in relation to a simple closed economy alternative. Namely, we inspect the implied transmission mechanisms, and examine the relative out-of-sample forecasting performance of the closed and open economy models.
    Keywords: DSGE Model, Open Economy, Australia, U.S., Bayesian Estimation.
    JEL: F41 E40 E37 C11
    Date: 2005–11–29
  7. By: Hans Fehr; Christian Habermann
    Abstract: The present paper aims to quantify the welfare effects of progressive pension arrangements in Germany. Starting from a purely contribution-related benefit system, we introduce basic allowances for contributions and a flat benefit fraction. Since our overlapping-generations model takes into account variable labor supply, borrowing constraints as well as stochastic income risk, we can compare the labor supply, the liquidity, and the insurance effects of the policy reform. Our simulations indicate that for a realistic parameter combination an increase in pension progressivity would yield an aggregate efficiency gain of more than 2 percent of resources. However, such a reform would not be implemented because it would not find political support of the currently living generations.
    Keywords: pension reform, idiosyncratic labor income uncertainty
    JEL: H55 J26
    Date: 2005
  8. By: Sergio G. Ferreira (IBMEC Business School - Rio de Janeiro)
    Abstract: Brazilian PAYG system has been under financial stress and needs to be reformed. I use a computational general equilibrium model, with 55 overlapping generations to simulate macroeconomic and welfare impacts of alternative social security reforms. Transition turns out to have quite different redistributional effects for the generations involved depending on which tax is used to finance it. Under a variety of possible transitional schemes, there is no tax path that is strictly preferred by every generation.
    Keywords: Social Security, Welfare, General Equilibrium, Macroeconomics, Overlapping Generation
    JEL: E62 D58 D91
    Date: 2005–11–25
  9. By: Kirdan Lees; Troy Matheson (Reserve Bank of New Zealand)
    Abstract: We utilise prior information from a simple RBC model to improve ARMA forecasts of post-war US GDP. We develop three alternative ARMA forecasting processes that use varying degrees of information from the Campbell (1994) flexible labour model. Directly calibrating the model produces poor forecasting performance whereas a model that uses a Bayesian framework to take the model to the data, yields forecasting performance comparable to a purely statistical ARMA process. A final model that uses theory only to restrict the order of the ARMA process (the ps and qs), but that estimates the ARMA parameters using maximum likelihood, yields improved forecasting performance.
    JEL: C11 C22 E37
    Date: 2005–10
  10. By: Torben Andersen
    Abstract: Many countries face the problem of how to reform social security systems to cope with increasing life expectancy. This raises questions concerning both distribution and risk sharing across generations. These issues are addressed within an OLG model with stochastic life expectancy across generations and endogenous retirement decisions. The social optimum is shown to imply that retirement age should be proportional to longevity. Moreover, increasing longevity calls for pre-funding even if the utility of all generations is weighted equal to the objective discount rate. The social optimum cannot be decentralized due to a conflict between incentives and risk sharing. The implications of stylized social security systems for risk sharing and retirement incentives are analyzed.
    JEL: H55 J11 J14 J18
    Date: 2005
  11. By: Richard M. H. Suen (University of Rochester)
    Abstract: The second half of the twentieth century recorded a rapid growth in healthcare spending and a significant increase in life expectancy. This paper hypothesizes that technological progress in medical treatment, combined with rising incomes, are the driving forces behind these two trends. Using a stochastic, multi-period overlapping-generations model as the analytical vehicle, this paper shows that the rapid growth in medical spending is not driven by factors associated with market structures or insurance opportunities, but instead by factors underlying the production and accumulation of health. According to this model, improvements in medical treatment and rising incomes can explain all of the increase in medical spending and about 37% of the increase in life expectancy during the second half of the twentieth century.
    Keywords: Technological progress, life expectancy, medical spending, health
    JEL: E13 I12 O11 O33
    Date: 2005–11
  12. By: Tano Santos; Pietro Veronesi
    Abstract: A habit persistence, general equilibrium model with multiple assets matches both the time series properties of the market portfolio and the cross-sectional predictability of returns on price sorted portfolios, the value premium. Consistent with empirical evidence, the model shows that (a) value stocks are those with higher cash-flow risk; (b) the size of the value premium is larger in “bad times,” due to time variation in risk preferences; (c) the unconditional CAPM fails, because of general equilibrium restrictions on the market portfolio. The dynamic nature of the value premium rationalizes why the conditional CAPM and a Fama and French (1993) HML factor outperform the unconditional CAPM.
    JEL: G12
    Date: 2005–12
  13. By: Jordi Gali; Tommaso Monacelli
    Abstract: We lay out a tractable model for fiscal and monetary policy analysis in a currency union, and analyze its implications for the optimal design of such policies. Monetary policy is conducted by a common central bank, which sets the interest rate for the union as a whole. Fiscal policy is implemented at the country level, through the choice of government spending level. The model incorporates country-specific shocks and nominal rigidities. Under our assumptions, the optimal monetary policy requires that inflation be stabilized at the union level. On the other hand, the relinquishment of an independent monetary policy, coupled with nominal price rigidities, generates a stabilization role for fiscal policy, one beyond the efficient provision of public goods. Interestingly, the stabilizing role for fiscal policy is shown to be desirable not only from the viewpoint of each individual country, but also from that of the union as a whole. In addition, our paper offers some insights on two aspects of policy design in currency unions: (i) the conditions for equilibrium determinacy and (ii) the effects of exogenous government spending variations.
    JEL: E52 F41 E62
    Date: 2005–12
  14. By: Mário Centeno; Márcio Corrêa
    Abstract: According to data from the OCDE, almost one third of the total quantity of on-the-job training is worker-provided. The aim of this paper is to study, in a labor market characterized by frictions, the effects of technological progress on the optimal worker-provided on-the-job training. The paper shows that the greater the technological progress rate less is the probability of the worker investing in specific human capital, if the technology is of creative destruction type, and the greater is the probability of the worker investing specific human capital, if the technology is characterized by renovation; whilst the effect over the general human capital investment doesn't exist in both models. The paper also shows that the impact of human capital investments on labor market outcomes depend on the type of investment - either firm or the market oriented. If the investment is totally aimed at the market, we have as a result an increase in the rate of unemployment, whilst if the investment is totally directed at the firm, we have the opposite effect.
    JEL: E24 J24 J63 J64
    Date: 2005

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