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on Dynamic General Equilibrium |
| By: | Marco Del Negro; Frank Schorfheide |
| Abstract: | The paper proposes a novel method for conducting policy analysis with potentially misspecified dynamic stochastic general equilibrium (DSGE) models and applies it to a New Keynesian DSGE model along the lines of Christiano, Eichenbaum, and Evans (JPE 2005) and Smets and Wouters (JEEA 2003). We first quantify the degree of model misspecification and then illustrate its implications for the performance of different interest rate feedback rules. We find that many of the prescriptions derived from the DSGE model are robust to model misspecification. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedawp:2005-26&r=dge |
| By: | Guillaume Rocheteau; Peter Rupert; Karl Shell; Randall Wright |
| Abstract: | We study general equilibrium with nonconvexities. In these economies there exist sunspot equilibria without the usual assumptions needed in convex economies, and they have good welfare properties. Moreover, in these equilibria, agents act as if they have quasi-linear utility. Hence wealth effects vanish. We use this to construct a new model of monetary exchange. As in Lagos-Wright, trade occurs in both centralized and decentralized markets, but while that model requires quasilinearity, we have general preferences. Given our specification looks much like the textbook Arrow-Debreu model, we think this constitutes progress on the classic problem of integrating money and general equilibrium theory. We also use the model to discuss another classic issue: the relation between inflation and unemployment. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedcwp:0513&r=dge |
| By: | Nicola Pavoni; Giovanni L. Violante |
| Abstract: | A Welfare-to-Work (WTW) program is a mix of government expenditures on “passive” (unemployment insurance, social assistance) and “active” (job search monitoring, training, wage taxes/subsidies) labor market policies targeted to the unemployed. This paper provides a dynamic principal-agent framework suitable for analyzing the optimal sequence and duration of the different WTW policies, and the dynamic pattern of payments along the unemployment spell and of taxes/subsidies upon re-employment. First, we show that the optimal program endogenously generates an absorbing policy of last resort (that we call “social assistance”) characterized by a constant lifetime payment and no active participation by the agent. Second, human capital depreciation is a necessary condition for policy transitions to be part of an optimal WTW program. Whenever training is not optimally provided, we show that the typical sequence of policies is quite simple: the program starts with standard unemployment insurance, then switches into monitored search and, finally, into social assistance. Only the presence of an optimal training activity may generate richer transition patterns. Third, the optimal benefits are generally decreasing or constant during unemployment, but they must increase after a successful spell of training. In a calibration exercise based on the U.S. labor market and on the evidence from several evaluation studies, we use our model to analyze quantitatively the features of the optimal WTW program for the U.S. economy. With respect to the existing U.S. system, the optimal WTW scheme delivers sizeable welfare gains, by providing more insurance to skilled workers and more incentives to unskilled workers. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmem:143&r=dge |
| By: | Salvador Ball; Amedeo Spadaro |
| Abstract: | The aim of this paper is to explore the characteristics of the optimal nonlinear labor income tax in dynamic economies with information asymmetries and human capital accumulation. We develop a dynamic optimal income tax model in which agent's productivity evolves over time according to two different factors: an exogenous component and a learning by doing process endogenous to the fiscal policy. The latter is determined by the government, maximizing in the initial period a social welfare function capturing some level of aversion to inequality. We characterize analytically the first order condition driving the optimal tax schedule in a model in which agents choose the consumption and labor supply patterns that maximize their lifetime utility function. We show that the inclusion of the endogenous evolution of productivities into the tax problem changes the results with respect to the static framework à la Mirrlees (1971). We find that the optimal tax strategy balances social marginal costs of increasing marginal tax rates with social marginal benefits of doing so. |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:pse:psecon:2006-01&r=dge |
| By: | Ricardo de O. Cavalcanti; Ed Nosal |
| Abstract: | In this paper, we present a simple random-matching model in which different seasons translate into different propensities to consume and produce. We find that the cyclical creation and destruction of money is beneficial for welfare under a wide variety of circumstances. Our model of seasons can be interpreted as providing support for the creation of the Federal Reserve System, with its mandate of supplying an elastic currency for the nation. |
| Keywords: | Monetary policy ; Money supply |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedcwp:0511&r=dge |
| By: | Robert Shimer |
| Abstract: | This paper develops a dynamic model of mismatch. Workers and jobs are randomly assigned to labor markets. Each labor market clears at each instant but some labor markets have more workers than jobs, hence unemployment, and some have more jobs than workers, hence vacancies. As workers and jobs move between labor markets, some unemployed workers find vacant jobs and some employed workers lose or leave their job and become unemployed. The model is quantitatively consistent with the comovement of unemployment, job vacancies, and the rate at which unemployed workers find jobs over the business cycle. It can also address a variety of labor market phenomena, including duration dependence in the job finding probability and employer-to-employer transitions, and it helps explain the cyclical volatility of vacancies and unemployment. |
| JEL: | E24 J63 J64 |
| Date: | 2005–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:11888&r=dge |
| By: | Suparna Chakraborty (Baruch College, CUNY) |
| Abstract: | After decades of slow growth since Independence from the British Raj, Indian economy registered its own small miracle, when growth rate of GDP per capita surpassed the long term growth rate of many advanced economies. What caused this miracle? In this paper, we search for an answer in the neoclassical growth model. We use productivity as measured by Solow residual as our exogenous shock. Our idea is to quantitatively measure to what extent ‡fluctuations in productivity can account for observed ‡uctuations in macro economic aggregates in India. We find that exogenous fl‡uctuations in productivity can well account for fl‡uctuations in output during the boom periods of 1982 to 1988 and 1993 to 2002. However, fluctuations in productivity alone results in a much worse drop in ouput during 1988 to 1993 than observed in the economy. |
| Keywords: | technology, growth accounting, neoclassical growth, calibration, transition dynamics, India |
| JEL: | E |
| Date: | 2005–12–19 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpma:0512013&r=dge |
| By: | Fernando Alvarez; Marcelo Veracierto |
| Abstract: | Fixed term employment contracts have been introduced in number of European countries as a way to provide flexibility to economies with high employment protection levels. We introduce these contracts into the equilibrium search model in Alvarez and Veracierto (1999), a version of the Lucas and Prescott island model, adapted to have undirected search and variable labor force participation. We model a contract of length J as a tax on separations of workers with tenure higher than J. We show a version of the welfare theorems, and characterize the efficient allocations. This requires solving a control problem, whose solution is characterized by two dimensional inaction sets. For J = 1 these contracts are equivalent to the case of firing taxes, and for large J they are equivalent to the laissez- faire case. In a calibrated version of the model, we evaluate to what extent contract lengths similar to those observed in Europe, close the gap between these two extremes. |
| Keywords: | Labor contract ; Employment (Economic theory) |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedhwp:wp-05-14&r=dge |
| By: | Gauti B. Eggertsson |
| Abstract: | This paper argues that the U.S. economy's recovery from the Great Depression was driven by a shift in expectations brought about by the policy actions of President Franklin Delano Roosevelt. On the monetary policy side, Roosevelt abolished the gold standard and-even more important-announced the policy objective of inflating the price level to pre-depression levels. On the fiscal policy side, Roosevelt expanded real and deficit spending. Together, these actions made his policy objective credible; they violated prevailing policy dogmas and introduced a policy regime change such as that described in work by Sargent and by Temin and Wigmore. The economic consequences of Roosevelt's policies are evaluated in a dynamic stochastic general equilibrium model with sticky prices and rational expectations. |
| Keywords: | Depressions ; Gold standard ; Price levels ; Rational expectations (Economic theory) ; Economic policy |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:234&r=dge |
| By: | Alan Ahearne; Finn Kydland; Mark A. Wynne |
| Abstract: | We argue that Ireland experienced a great depression in the 1980s comparable in severity to the better known and more studied depression episodes of the interwar period. Using the business cycle accounting framework of Chari, Kehoe and McGrattan (2005), we examine the factors that lead to the depression and the subsequent recovery in the 1990s. We calculate efficiency, labor, investment and government wedges, and evaluate the contribution of each to the downturn and subsequent recovery. We find that the efficiency wedge on its own can account for a significant portion of the downturn, but predicts a stronger recovery in output. The labor wedge also helps account for what happened during the depression episode. We also find that the investment wedge played no role in the depression. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:feddwp:05-10&r=dge |
| By: | Thomas A Lubik (Reserve Bank of New Zealand) |
| Abstract: | This paper studies the transmission of business cycles and the sources of economic fluctuations in Australia and New Zealand by estimating a Bayesian DSGE model. The theoretical model is that of two open economies that are tightly integrated by trade in goods and assets. They can be thought of as economically large relative to each other, but small with respect to the rest of the world. The two economies are hit by a variety of country-specific and world-wide shocks. The main findings are that the pre-eminent driving forces of Antipodean business cycles are worldwide technology shocks and foreign, i.e. rest-of-the-world, expenditure shocks. Domestic technology shocks and monetary policy shocks appear to play only a minor role. Transmission of policy shocks is asymmetric, and neither central bank is found to respond to exchange rate movements. The model can explain 15 percent of the observed exchange rate volatility. |
| JEL: | C11 C51 C52 E58 |
| Date: | 2005–12 |
| URL: | http://d.repec.org/n?u=RePEc:nzb:nzbdps:2005/06&r=dge |
| By: | Yuzhe Zhang |
| Abstract: | In this paper I develop continuous-time methods for solving dynamic principal-agent problems in which the agent’s privately observed productivity shocks are persistent over time. I characterize the optimal contract as the solution to a system of ordinary differential equations, and show that, under this contract, the agent’s utility converges to its lower bound—immiseration occurs. I also show that, unlike in environments with i.i.d. shocks, the principal would like to renegotiate with the agent when the agent’s productivity is low—it is not renegotiation-proof. I apply the theoretical methods I have developed and numerically solve this (Mirrleesian) dynamic taxation model. I find that it is optimal to allow a wedge between the marginal rate of transformation and individuals’ marginal rate of substitution between consumption and leisure. This wedge is significantly higher than what is found in the i.i.d. case. Thus, using the i.i.d. assumption is not a good approximation quantitatively when there is persistence in productivity shocks. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmwp:640&r=dge |
| By: | Juan Carols Hatchondo |
| Abstract: | This paper studies the equilibrium properties of asset prices in a Lucas-tree model when agents display a concave coefficient of absolute risk tolerance. The latter introduces a role for wealth inequality, even under the presence of complete markets. The paper finds evidence suggesting that the role of wealth inequality on asset prices may be non-negligible. For the baseline calibration, the equity premium in the unequal economy is half a percentage point larger than the equity premium displayed by an egalitarian economy. The difference increases to one percentage point once we allow for the fact that agents tend to hold highly concentrated portfolios. |
| Keywords: | Wealth ; Assets (Accounting) - Prices |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedrwp:05-12&r=dge |
| By: | Travis D. Nesmith |
| Abstract: | This paper analyzes the necessary and sufficient conditions for solving money-in-the-utility-function models when contemporaneous asset returns are uncertain. A unique solution to such models is shown to exist under certain measurability conditions. Stochastic Euler equations, whose existence is normally assumed in these models, are then formally derived. The regularity conditions are weak, and economically innocuous. The results apply to the broad range of discrete-time monetary and financial models that are special cases of the model used in this paper. The method is also applicable to other dynamic models that incorporate contemporaneous uncertainty. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2005-52&r=dge |
| By: | Yuzhe Zhang |
| Abstract: | This paper studies the stability of a stochastic optimal growth economy introduced by Brock and Mirman [J. Econ. Theory 4 (1972)] by utilizing stochastic monotonicity in a dynamic system. The construction of two boundary distributions leads to a new method of studying systems with non-compact state space. The paper shows the existence of a unique invariant distribution. It also shows the equivalence between the stability and the uniqueness of the invariant distribution in this dynamic system. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmwp:639&r=dge |
| By: | Huberto M. Ennis |
| Abstract: | I study the effects of inflation on the purchasing behavior of buyers in an economy where money is essential for certain transactions (as in Lagos and Wright, 2005). A long-standing intuition in this subject is that when inflation increases, agents try to spend their money holdings more speedily. The standard framework fails to capture this kind of effect (Lagos and Rocheteau, 2005). I propose a simple modification of the model in which trading of goods and rebalancing of money holdings happen less frequently. In such a framework, I show that higher inflation induces buyers to search for transactions more intensively and buy goods of worse quality. The modification proposed also sheds new light on the connection between the search-theoretic and the inventory-theoretic models of money. |
| Keywords: | Inflation (Finance) ; Money |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedrwp:05-10&r=dge |
| By: | Guillaume Vandenbroucke |
| Abstract: | During the first half of the 20th century the workweek in the United States declined, and the distribution of hours across wage deciles narrowed. At the same time, the distribution of wages narrowed too. The hypothesis proposed is (i) Households have access to an increasing number of leisure activities which enhance the value of non-market time; (ii) The rise of education accounts for the narrowing of the wage and hours distributions. Such mechanisms, embedded into a neoclassical growth model, quantitatively account for the observations. The rise in wages is the main contributor to the decline in hours. The decline in the price of leisure goods is second in importance, yet its contribution is large. |
| Keywords: | Hours worked, leisure, home production, technological progress |
| JEL: | E24 J22 O11 O33 |
| Date: | 2005–12 |
| URL: | http://d.repec.org/n?u=RePEc:scp:wpaper:05-40&r=dge |
| By: | Giancarlo Corsetti; Luca Dedola; Sylvain Leduc |
| Abstract: | This paper develops a quantitative, dynamic, open-economy model which endogenously generates high exchange rate volatility, whereas a low degree of pass-through stems from both nominal rigidities (in the form of local currency pricing) and price discrimination. We model real exchange rate volatility in response to real shocks by reconsidering and extending two approaches suggested by the quantitative literature (one by Backus Kehoe and Kydland [1995], the other by Chari, Kehoe and McGrattan [2003]), within a common framework with incomplete markets and segmented domestic economies. Our model accounts for a variable degree of ERPT over different horizons. In the short run, we find that a very small amount of nominal rigidities--consistent with the evidence in Bils and Klenow [2004--lowers the elasticity of import prices at border and consumer level to 27% and 13%, respectively. Still, exchange rate depreciation worsens the terms of trade -- in accord with the evidence stressed by Obstfeld and Rogoff [2000]. In the long run, exchange-rate pass-through coefficients are also below one, as a result of price discrimination. The latter is an implication of distribution services, which makes the goods demand elasticity market specific. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:845&r=dge |
| By: | Alvaro Forteza (Departmento de Economía, Facultad de Ciencias Sociales, Universidad de la República) |
| Abstract: | We present in this paper an estimation of the distributive effects of the reform of the Uruguayan pensions system initiated in 1995. The estimation is based on simulations done with an overlapping generations model adapted and calibrated to the Uruguayan reality. We compute the expected changes in the generational accounts of several groups of workers, considering different generations, gender and income level. The simulations are done in a general equilibrium framework, and hence we can simultaneous and consistently assess the micro and macro impact of the reform. |
| Date: | 2004–05 |
| URL: | http://d.repec.org/n?u=RePEc:ude:wpaper:0104&r=dge |
| By: | Lubos Pastor; Pietro Veronesi |
| Abstract: | During technological revolutions, stock prices of innovative firms tend to exhibit high volatility and bubble-like patterns, which are often attributed to investor irrationality. We develop a general equilibrium model that rationalizes the observed price patterns. The high volatility results from high uncertainty about the average productivity of a new technology. Investors learn about this productivity before deciding whether to adopt the technology on a large scale. For technologies that are ultimately adopted, the nature of uncertainty changes from idiosyncratic to systematic as the adoption becomes more likely; as a result, stock prices fall after an initial run-up. This “bubble” in stock prices is observable ex post but unpredictable ex ante, and it is most pronounced for technologies characterized by high uncertainty and fast adoption. We examine stock prices in the early days of American railroads, and find evidence consistent with a large-scale adoption of the railroad technology by the late 1850s. |
| JEL: | G1 |
| Date: | 2005–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:11876&r=dge |
| By: | Robert F. Martin |
| Abstract: | This paper explores the baby boom's impact on U.S. house prices and interest rates in the post-war 20th century and beyond. Using a simple Lucas asset pricing model, I quantitatively account for the increase in real house prices, the path of real interest rates, and the timing of low-frequency fluctuations in real house prices. The model predicts that the primary force underlying the evolution of real house prices is the systematic and predictable changes in the working age population driven by the baby boom. The model is calibrated to U.S. data and tested on international data. One surprising success of the model is its ability to predict the boom and bust in Japanese real estate markets around 1974 and 1990. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:847&r=dge |
| By: | Richard Dutu; Ed Nosal; Guillaume Rocheteau |
| Abstract: | This paper develops a model of currency circulation under asymmetric information. Agents are heterogeneous and trade in bilateral matches. Coins are intrinsically valuable and are available in two weights, light and heavy. We characterize the equilibrium under complete information and under imperfect information about the quality of coins. We deter- mine a set of conditions under which the two currencies circulate and are traded according to di¤erent terms of trade. We study how output, welfare, and the velocity of currency are a¤ected by the recognizability of coins. We show that society.s welfare increases as coins become more easily recognizable. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedcwp:0512&r=dge |
| By: | Fabià Gumbau-Brisa |
| Abstract: | This paper looks at the implications of heterogeneous beliefs for inflation dynamics. Following a monetary policy shock, inflation peaks after output, is inertial, and can be characterized by a Hybrid Phillips Curve. It presents a novel channel through which systematic monetary policy can affect the degree of inflation persistence. It does so by altering the effective extent of strategic complementarities in pricing, and hence the role of higher-order expectations in the equilibrium. In particular, stronger inflation targeting reduces the impact of uncertainty on the economy and therefore the degree of inertia. It is possible to calibrate at around 25 percent the fraction of relevant information processed every period by the private sector. The imperfect common knowledge framework does not require any exogenous shocks to create heterogeneity. Despite the fact that prices can be adjusted at no cost in every period, there are nominal rigidities, and monetary policy has real effects. |
| Keywords: | Inflation (Finance) |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedbwp:05-16&r=dge |