nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2006‒08‒05
seventeen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Cycles and Indeterminacy in Overlapping Generations Economies with Stone-Geary Preferences By Erkki Koskela; Mikko Puhakka
  2. Measurement with minimal theory By Ellen R. McGrattan
  3. Search in asset markets By Ricardo Lagos; Guillaume Rocheteau
  4. Putting the New Keynesian Model to a Test By Roland Straub; Gert Peersman
  5. Identifying the role of labor markets for monetary policy in an estimated DSGE model By Christoffel, Kai Philipp; Küster, Keith; Linzert, Tobias
  6. Monetary policy analysis with potentially misspecified models By Marco Del Negro; Frank Schorfheide
  7. The relative price and relative productivity channels for aggregate fluctuations By Eric T. Swanson
  8. Financial intermediaries, markets and growth By Fecht, Falko; Huang, Kevin; Martin, Antoine
  9. Job matching and propagation By Shigeru Fugita; Garey Ramey
  10. Ageing and Growth in the Small Open Economy By Ben J. Heijdra; Ward E. Romp
  11. The Dynamics of Wealth and Income Distribution in a Neoclassical Growth Model By Stephen J. Turnovsky; Cecilia García-Peñalosa
  12. Banks, markets, and efficiency By Fecht, Falko; Martin, Antoine
  13. An estimated DSGE model for the German economy within the euro area By Pytlarczyk, Ernest
  14. Macroeconomic Effects and Policy Challenges of Population Aging By Hamid Faruqee; Natalia T. Tamirisa
  15. Expenditure Composition and Distortionary Tax for Equitable Economic Growth By Hyun Park
  16. Asset pricing implications of Pareto optimality with private information By Kocherlakota, Narayana R.; Pistaferri, Luigi
  17. Multi-Dimensional Transitional Dynamics: A Simple Numberical Procedure By Timo Trimborn; Karl-Josef Koch; Thomas Steger

  1. By: Erkki Koskela; Mikko Puhakka
    Abstract: We investigate dynamics in an overlapping generations economy with Stone-Geary preferences. We show that a steady state exists, and furthermore and importantly, that there can be a multitude of two cycles even though intertemporal elasticity of substitution in consumption exceeds unity.
    Keywords: Stone-Geary preferences, overlapping generations economy, cycles and indeterminacy
    JEL: E21 E32
    Date: 2006
  2. By: Ellen R. McGrattan
    Abstract: A central debate in applied macroeconomics is whether statistical tools that use minimal identifying assumptions are useful for isolating promising models within a broad class. In this paper, I compare three statistical models—a vector autoregressive moving average (VARMA) model, an unrestricted state space model, and a restricted state space model—that are all consistent with the same prototype business cycle model. The business cycle model is a prototype in the sense that many models, with various frictions and shocks, are observationally equivalent to it. The statistical models I consider differ in the amount of a priori theory that is imposed, with VARMAs imposing minimal assumptions and restricted state space models imposing the maximal. The objective is to determine if it is possible to successfully uncover statistics of interest for business cycle theorists with sample sizes used in practice and only minimal identifying assumptions imposed. I find that the identifying assumptions of VARMAs and unrestricted state space models are too minimal: The range of estimates are so large as to be uninformative for most statistics that business cycle researchers need to distinguish alternative theories.
    Date: 2006
  3. By: Ricardo Lagos; Guillaume Rocheteau
    Abstract: We investigate how trading frictions in asset markets affect portfolio choices, asset prices and efficiency. We generalize the search-theoretic model of financial intermediation of Duffie, Gârleanu and Pedersen (2005) to allow for more general preferences and idiosyncratic shock structure, unrestricted portfolio choices, aggregate uncertainty and entry of dealers. With a fixed measure of dealers, we show that a steady-state equilibrium exists and is unique, and provide a condition on preferences under which a reduction in trading frictions leads to an increase in the price of the asset. We also analyze the effects of trading frictions on bid-ask spreads, trade volume and the volatility of asset prices, and find that the asset allocation is constrained-inefficient unless investors have all the bargaining power in bilateral negotiations with dealers. We show that the dealers’ entry decision introduces a feedback that can give rise to multiple equilibria, and that free-entry equilibria are generically inefficient.
    Date: 2006
  4. By: Roland Straub; Gert Peersman
    Abstract: In recent years, New Keynesian dynamic stochastic general equilibrium (NK DSGE) models have become increasingly popular in the academic literature and in policy analysis. However, the success of these models in reproducing the dynamic behavior of an economy following structural shocks is still disputed. This paper attempts to shed light on this issue. We use a VAR with sign restrictions that are robust to model and parameter uncertainty to estimate the effects of monetary policy, preference, government spending, investment, price markup, technology, and labor supply shocks on macroeconomic variables in the United States and the euro area. In contrast to the NK DSGE models, the empirical results indicate that technology shocks have a positive effect on hours worked, and investment and preference shocks have a positive impact on consumption and investment, respectively. While the former is in line with the predictions of Real Business Cycle models, the latter indicates the relevance of accelerator effects, as described by earlier Keynesian models. We also show that NK DSGE models might overemphasize the contribution of cost-push shocks to business cycle fluctuations while, at the same time, underestimating the importance of other shocks such as changes to technology and investment adjustment costs.
    Date: 2006–06–12
  5. By: Christoffel, Kai Philipp; Küster, Keith; Linzert, Tobias
    Abstract: We focus on a quantitative assessment of rigid labor markets in an environment of stable monetary policy. We ask how wages and labor market shocks feed into the inflation process and derive monetary policy implications. Towards that aim, we structurally model matching frictions and rigid wages in line with an optimizing rationale in a New Keynesian closed economy DSGE model. We estimate the model using Bayesian techniques for German data from the late 1970s to present. Given the pre-euro heterogeneity in wage bargaining we take this as the first-best approximation at hand for modelling monetary policy in the presence of labor market frictions in the current European regime. In our framework, we find that labor market structure is of prime importance for the evolution of the business cycle, and for monetary policy in particular. Yet shocks originating in the labor market itself may contain only limited information for the conduct of stabilization policy.
    Keywords: Labor market, wage rigidity, bargaining, Bayesian estimation
    JEL: C11 E32 E52 J64
    Date: 2006
  6. 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 (JPE2005) and Smets and Wouters (JEEA2003). 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.
    Keywords: Monetary policy
    Date: 2005
  7. By: Eric T. Swanson
    Abstract: This paper demonstrates that sectoral heterogeneity itself--without any additional bells or whistles--has first-order implications for the transmission of aggregate shocks to aggregate variables in an otherwise standard DSGE model. The effects of sectoral heterogeneity on this transmission are decomposed into two channels: a "relative price" channel and a "relative productivity" channel. The relative price channel results from changes in the relative prices of aggregates, such as investment vis-a-vis consumption goods, which occurs in a sectoral model in response to even standard aggregate shocks. The relative productivity channel arises from changes in the distribution of inputs across sectors. We show that, for standard sectoral models, this latter channel is second-order, but becomes first-order if we consider a nontraded input such as capital utilization or introduce a wedge that thwarts the steady-state equalization of marginal products of a traded input across sectors. For reasonable parameterizations, the relative productivity channel causes aggregate productivity to vary procyclically in response to non-technological shocks such as changes in government purchases.
    Keywords: Prices ; Productivity ; Econometric models
    Date: 2006
  8. By: Fecht, Falko; Huang, Kevin; Martin, Antoine
    Abstract: We build a model in which financial intermediaries provide insurance to households against a liquidity shock. Households can also invest directly on a financial market if they pay a cost. In equilibrium, the ability of intermediaries to share risk is constrained by the market. This can be beneficial because intermediaries invest less in the productive technology when they provide more risk-sharing. Our model predicts that bank-oriented economies should grow slower than more market-oriented economies, which is consistent with some recent empirical evidence. We show that the mix of intermediaries and market that maximizes welfare under a given level of financial development depends on economic fundamentals. We also show the optimal mix of two structurally very similar economies can be very different.
    Keywords: Financial Intermediaries, Risk Sharing, Finance and Growth, Comparing Financial Systems
    JEL: E44 G10 G20
    Date: 2005
  9. By: Shigeru Fugita; Garey Ramey
    Abstract: In the U.S. labor market, the vacancy-unemployment ratio and employment react sluggishly to productivity shocks. The authors show that the job matching model in its standard form cannot reproduce these patterns due to excessively rapid vacancy responses. Extending the model to incorporate sunk costs for vacancy creation yields highly realistic dynamics. Creation costs induce entrant firms to smooth the adjustment of new openings following a shock, leading the stock of vacancies to react sluggishly.
    Keywords: Job creation ; Employment ; Unemployment
    Date: 2006
  10. By: Ben J. Heijdra; Ward E. Romp
    Abstract: We construct an overlapping generations model for the small open economy which incorporates a realistic description of the mortality process. Agents engage in educational activities at the start of life and thus create human capital to be used later on in life for production purposes. Depending on the strength of the intergenerational externality in the human capital production function, the model gives rise to exogenous or endogenous growth. The effects of demographic shocks and fiscal stimuli on the growth path are derived, both at impact, during transition, and in the long run.
    Keywords: demography, education, human capital, economic growth, fertility rate, ageing, overlapping generations, small open economy
    JEL: D91 E10 F41 J11 O40
    Date: 2006
  11. By: Stephen J. Turnovsky (University of Washington, Seattle); Cecilia García-Peñalosa (Greqam-Idep)
    Abstract: We examine the evolution of the distributions of wealth and income in a Ramsey model in which agents differ in their initial capital endowment and where the labor supply is endogenous. The assumption that the utility function is homogeneous in consumption and leisure implies that the macroeconomic equilibrium is independent of the distribution of wealth and allows us to fully characterize income and wealth dynamics. We find non-degenerate longrun distributions of wealth and income. The model shows that (i) the initial level of aggregate capital is an essential determinant of whether inequality increases or decreases during the transition to the steady state; (ii) temporary shocks to the stock of capital have long-run effects on the distribution of wealth even if they do not affect the stationary aggregate variables; (iii) income inequality need not move together with wealth inequality if factor shares change during the transition. JEL Classification Numbers: D31
    Keywords: wealth distribution; income distribution; endogenous labor supply; transitional dynamics.
    Date: 2006–06
  12. By: Fecht, Falko; Martin, Antoine
    Abstract: Following Diamond (1997) and Fecht (2004) we use a model in which financial market access of households restrains the efficiency of the liquidity insurance that banks' deposit contracts provide to households that are subject to idiosyncratic liquidity shocks. But in contrast to these approaches we assume spacial monopolistic competition among banks. Since monopoly rents are assumed to bring about inefficiencies, improved financial market access that limits monopoly rents also entails a positive effect. But this beneficial effect is only relevant if competition among banks does not sufficiently restrain monopoly rents already. Thus our results suggest that in the bank-dominated financial system of Germany, in which banks intensely compete for households' deposits, improved financial market access might reduce welfare because it only reduces risk sharing. In contrast, in the banking system of the U.S., with less competition for households' deposits, a high level of households' financial market participation might be beneficial.
    Keywords: Financial Intermediaries, Risk Sharing, Banking Competition, Comparing Financial Systems
    JEL: E44 G10 G21
    Date: 2005
  13. By: Pytlarczyk, Ernest
    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. We advance the empirical literature by estimating an open-economy model with unfiltered data, which is a much more challenging task than a similar exercise done in the closedeconomy framework. In the estimation we utilize disaggregated information, employing single country data, along with the aggregated EMU data 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 tworegion 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) assessments of the relative importance of various shocks and frictions for explaining the model dynamics and (iii) an evaluation of the model’s empirical properties.
    JEL: E4 E5 F4
    Date: 2005
  14. By: Hamid Faruqee; Natalia T. Tamirisa
    Abstract: This paper simulates the macroeconomic effects of population aging in a dynamic overlapping generations model of a small open economy. The model is calibrated to data for the Czech Republic, where population aging is proceeding at a pace comparable to that in other advanced countries in Europe. Simulations show that population aging is likely to slow economic growth and improvements in living standards. Although reforms to raise labor force participation and productivity growth can mitigate these adverse effects, they are unlikely to eliminate the need for fiscal reforms. The budget will come under pressure from rising age-related expenditures, and consolidation will be needed to preserve debt sustainability.
    Date: 2006–04–20
  15. By: Hyun Park
    Abstract: This paper continues the study of optimal fiscal policy in a growing economy by exploring a case in which the government simultaneously provides three main categories of expenditures with distortionary tax finance: public production services, public consumption services, and state-contingent redistributive transfers. The paper shows that in a general equilibrium model with given exogenous fiscal policy, a nonlinear relation exists between the suboptimal longrun growth rate in a competitive economy and distortionary tax rates. When fiscal policy is endogenously chosen at a social optimum, the relation between the rate of growth and tax rates is always negative. These two conclusions suggest that the interaction between fiscal policy and growth may be complicated enough that it cannot be captured in a simple linear model using an aggregate measure of fiscal policy. The sources of nonlinearity include expectation and coordination of fiscal policy, impluse response of government policies, and the presence of positive externality due to government spending.
    Date: 2006–07–12
  16. By: Kocherlakota, Narayana R.; Pistaferri, Luigi
    Abstract: In this paper, we consider a dynamic economy in which the agents in the economy are privately informed about their skills, which evolve stochastically over time in an arbitrary fashion. We consider an asset pricing equilibrium in which equilibrium quantities are constrained Pareto optimal. Under the assumption that agents have constant relative risk aversion, we derive a novel asset pricing kernel for financial asset returns. The kernel equals the reciprocal of the gross growth of the ãth moment of the consumption distribution, where ã is the coefficient of relative risk aversion. We use data from the consumer expenditure survey (CEX) and show that the new stochastic discount factor performs better than existing stochastic discount factors at rationalizing the equity premium. However, its ability to simultaneously explain the equity premium and the expected return to the Treasury bill is about the same as existing discount factors.
    Date: 2005
  17. By: Timo Trimborn; Karl-Josef Koch; Thomas Steger
    Abstract: We propose the relaxation algorithm as a simple and powerful method for simulating the transition process in growth models. This method has a number of important advantages: (1 It can easily deal with a wide range of dynamic systems including stiff differential equations and systems giving rise to a continuum of stationary equilibria. (2) The application of the procedure is fairly user friendly. The only input required consists of the dynamic system. (3) The variant of the relaxation algorithm we propose exploits in a natural manner the infinite time horizon, which usually underlies optimal control problems in economics. As an illustrative application, we simulate the transition process of the Jones (1995) and the Lucas (1988) model.
    Keywords: transitional dynamics, continuous time growth models, saddle-point problems, multi-dimensional stable manifolds
    JEL: C61 C63 O40
    Date: 2006

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