nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2006‒09‒23
fifteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Pension Sytems and the Allocation of Macroeconomic Risk By Lans Bovenberg; Harald Uhlig
  2. On the Cyclicality of Labor Market Mismatch and Aggregate Employment Flows By Kenneth Beauchemin; Murat Tasci
  3. What do “residuals” from first-order conditions reveal about DGE models? By Alok Johri and Marc-André Letendre
  4. Dynamic models with non clearing markets By Jean-Pascal Bénassy
  5. Growth, Cycles and Welfare: A Schumpeterian Perspective By Patrick Francois; Huw Lloyd-Ellis
  6. A Bayesian DSGE Model with Infinite-Horizon Learning: Do "Mechanical" Sources of Persistence Become Superfluous? By Fabio Milani
  7. Directed Search without Wage Commitment and the Role of Labor Market Institutions By Adrian Masters
  8. Contacts, Social Capital and Market Institutions - A Theory of Development By Paul Frijters; Dirk Bezemer; Uwe Dulleck
  9. Employment Protection Reform in Search Economies By Olivier L'Haridon; Franck Malherbet
  10. Money or Joy By Alstadsæter, Annette; Kolm, Anne-Sofie; Larsen, Birthe
  11. Inflation, Variability, and the Evolution of Human Capital in a Model with Transactions Costs By Dimitrios Varvarigos
  12. Does Employment Protection Create Its Own Political Support? By Björn Brügemann
  13. The Solow Model in the Empirics of Growth and Trade By Erich Gundlach
  14. A Note on the (In)stability of Diamond’s By Blomgren-Hansen, Niels
  15. A Three-period Samuelson-Diamond Growth By Blomgren-Hansen, Niels

  1. By: Lans Bovenberg; Harald Uhlig
    Abstract: This paper explores the optimal risk sharing arrangement between generations in an overlapping generations model with endogenous growth. We allow for nonseparable preferences, paying particular attention to the risk aversion of the old as well as overall ``life-cycle´´ risk aversion. We provide a fairly tractable model, which can serve as a starting point to explore these issues in models with a larger number of periods of life, and show how it can be solved. We provide a general risk sharing condition, and discuss its implications. We explore the properties of the model quantitatively. Among the key findings are the following. First and for reasonable parameters, the old typically bear a larger burden of the risk in productivity surprises, if old-age risk-aversion is smaller than life risk aversion, and vice versa. Thus, it is not necessarily the case that the young ensure smooth consumption of the old. Second, consumption of the young and the old always move in the same direction, even for population growth shocks. This result is in contrast to the result of a fully-funded decentralized system without risk-sharing between generations. Third, persistent increases in longevity will lead to lower total consumption of the old (and thus certainly lower per-period consumption of the old) as well as the young as well as higher work effort of the young. The additional resources are instead used to increase growth and future output, resulting in higher consumption of future generations.
    Keywords: Social optimum, pension systems, risk sharing, overlapping generations
    JEL: E21 E61 E62 O40 H21 H55
    Date: 2006–09
  2. By: Kenneth Beauchemin; Murat Tasci
    Abstract: This paper combines a discrete-time dynamic general equilibrium articulation of the standard model of labor market search with observed U.S. time series measures on employment, vacancies, and aggregate output to uncover the cyclical properties of three unobserved forcing variables that comprise the exogenous state of the aggregate labor market: labor productivity, the rate of job separation, and the allocational efficiency of the labor market. We posit the latter variable to be inversely related to the degree of mismatch in the pool of searching workers and vacancies, given numbers of each, and identify its movements as scalar shifts in the standard matching function. Given that the model exactly reconciles observed net employment changes, our procedure also implies measured time series of the flows into and out of employment. We find that labor productivity, the job separation rate and allocational efficiency are all procyclical with the latter two highly variable. These cyclical patterns lead to procyclical implied gross employment flows, thereby concentrating labor force reallocation during booms. We discuss the implications for conventional views of business cycle fluctuations and for the standard search theories of labor market behavior.
    Date: 2005
  3. By: Alok Johri and Marc-André Letendre
    Abstract: The first-order condition (FOC) associated with labour in many dynamic general equilibrium models involves only current period variables. Residuals constructed from this FOC are inconsistent with aggregate US data in that they are very large and highly persistent. The persistence suggests that models which introduce dynamic terms in the labour FOC may be more consistent with the data. Three such models (one with learning by doing, one with habit formation, and one with labour adjustment costs) confirm that they can reduce the persistence in the residuals making the models more consistent with the joint dynamics of consumption, output and hours.
    Keywords: dynamic general equilibrium models, real business cycles, first-order conditions.
    JEL: E32 C52
    Date: 2006–09
  4. By: Jean-Pascal Bénassy
    Abstract: This article studies a new class of models which synthesize the two traditions of general equilibrium with nonclearing markets and imperfect competition on the one hand, and dynamic stochastic general equilibrium (DSGE) models on the other hand. This line of models has become a central paradigm of modern macroeconomics for at least three reasons: (a) it displays solid microeconomic foundations, (b) it is a highly synthetic theory, which combines in a unified framework general equilibrium, nonclearing markets, imperfect competition, growth theory and rational expectations, (c) it is also an empirical success, leading to substantial progress towards matching real world statistics.
    Date: 2006
  5. By: Patrick Francois (University of British Columbia); Huw Lloyd-Ellis (Queen's University)
    Abstract: We use a Schumpeterian model in which both the economy's growth rate and its volatility are endogenously determined to assess some welfare and policy implications associated with business cycle fluctuations. Because it features a higher average growth rate than its acyclical counterpart, steady-state welfare is higher along the cyclical equilibrium growth path of the model. We assess the impact of alternative stabilization policies designed to smooth cyclical fluctuations. Although, it is possible to significantly reduce the variance of output growth via simple policy measures, the welfare benefits are at best negligible and at worst completely offset by the resulting reduction long-term productivity growth.
    Keywords: Endogenous cycles, Endogenous growth, Welfare, Stabilization policy
    JEL: E0 E1 O3 O4
    Date: 2006–09
  6. By: Fabio Milani (Department of Economics, University of California-Irvine)
    Abstract: This paper estimates a monetary DSGE model with learning introduced from the primitive assumptions. The model nests infinite-horizon learning and features, such as habit formation in consumption and inflation indexation, that are essential for the model fit under rational expectations. I estimate the DSGE model by Bayesian methods, obtaining estimates of the main learning parameter, the constant gain, jointly with the deep parameters of the economy. The results show that relaxing the assumption of rational expectations in favor of learning may render mechanical sources of persistence superfluous. In particular, learning appears a crucial determinant of inflation inertia.
    Keywords: Infinite-horizon learning; DSGE model; Bayesian estimation; Non-rational expectations; Inflation persistence; Habit formation
    JEL: C11 D84 E30 E50 E52
    Date: 2005–12
  7. By: Adrian Masters
    Abstract: An urn-ball matching model of directed search is analyzed in which the usual assumption of commitment to posted wages is dropped. One-on-one matches lead to a Nash bargained wage but when multiple applicants arrive competition drives the workers down to their continuation value. A minimum wage can act as a commitment device when (as in the USA) willful underpayment carries a stiffer penalty than "inadvertetn underpayment. The theory sheds new light on why firms appear to voluntarily bind themselves into paying higher wages than they would otherwise pay. Robustness to various sources of heterogeneity is considered
    Date: 2005
  8. By: Paul Frijters; Dirk Bezemer; Uwe Dulleck (School of Economics and Finance, Queensland University of Technology)
    Abstract: We propose an endogenous growth model, that incorporates both an individual and a communal aspect of Social Capital. In our model, output increases with the stock of business contacts (Relational Capital as one aspect of Social Capital). The modelling of contact creation is based on matching theory. The cost of creating contacts decreases with more Community level Social Capital and Market Institutions.
    Keywords: Social Capital, Endogenous Growth, Relational Capital, Development, Economic Systems
    Date: 2005
  9. By: Olivier L'Haridon (GRID, CNRS, ENSAM); Franck Malherbet (THEMA, CNRS, Université de Cergy-Pontoise, fRDB and IZA Bonn)
    Abstract: The design of the employment protection legislation (EPL) is of a particular acuity in the European debate on the contours of the EPL reform. In this article we used an equilibrium unemployment model to investigate the virtue of an EPL reform whose modality is a lessening in the red tape and legal costs associated with layoffs and the introduction of an U.S. like experience rating system modelled as a combination of a layoff tax and a payroll subsidy. The reform considered shows that it is possible to improve both the consistency and the efficiency of employment protection policies while leaving the workers' protection untouched on the labor market. These results are consistent with the conventional wisdom that experience rating is desirable, not only as a part of unemployment compensation finance as most studies acknowledge but also as part and parcel of a virtuous EPL system.
    Keywords: matching models, employment protection, experience rating
    JEL: J41 J48 J60
    Date: 2006–09
  10. By: Alstadsæter, Annette (Department of Economics, Copenhagen Business School); Kolm, Anne-Sofie (Department of Economics, Copenhagen Business School); Larsen, Birthe (Department of Economics, Copenhagen Business School)
    Abstract: This paper examines the effect of taxes on the individuals' choices of educational direction, and thus on the economy.s skill composition. A proportional labour tax induces too many workers with high innate ability to choose an educational type associated with high consumption value and low effort. This increases the skill mismatch and aggregate unemployment in the economy. The government can correct for this distortion by use of differentiated tuition fees or tax rates.
    Keywords: Unemployment; matching; education; optimal taxation; tuition fees
    JEL: H21 H24 J64 J68
    Date: 2005–11–28
  11. By: Dimitrios Varvarigos (Dept of Economics, Loughborough University)
    Abstract: In a monetary growth model, I show that average inflation inhibits growth while inflation volatility enhances it. The effect of nominal volatility on human capital accumulation depends on the response of money demand and the corresponding extent of transactions costs rather than from a direct, precautionary motive.
    Keywords: money; growth; volatility.
    JEL: E32 E60 O42
    Date: 2006–07
  12. By: Björn Brügemann (Yale University and IZA Bonn)
    Abstract: This paper investigates the ability of employment protection to generate its own political support. A version of the Mortensen-Pissarides model is used for this purpose. Under the standard assumption of Nash bargaining, workers value employment protection because it strengthens their hand in bargaining. Workers in high productivity matches benefit most from higher wages as they expect to stay employed for longer. By reducing turnover employment protection shifts the distribution of match-specific productivity toward lower values. Thus stringent protection in the past actually reduces support for employment protection today. Introducing involuntary separations is a way of reversing this result. Now workers value employment protection because it delays involuntary dismissals. Workers in low productivity matches gain most since they face the highest risk of dismissal. The downward shift in the productivity distribution is now a shift towards ardent supporters of employment protection. In a calibrated example this mechanism sustains both low and high employment protection as stationary political outcomes. A survey of German employees provides support for employment protection being more strongly favored by workers likely to be dismissed.
    Keywords: employment protection, wage determination, search and matching, political economy
    JEL: E24 J41 J65
    Date: 2006–09
  13. By: Erich Gundlach
    Abstract: Translated to a cross-country context, the Solow model (Solow, 1956) predicts that international differences in steady state output per person are due to international differences in technology for a constant capital output ratio. However, most of the cross-country growth literature that refers to the Solow model has employed a specification where steady state differences in output per person are due to international differences in the capital output ratio for a constant level of technology. My empirical results show that the former specification can summarize the data quite well by using a measure of institutional technology and treating the capital output ratio as part of the regression constant. This reinterpretation of the cross-country Solow model provides an interesting implication for empirical studies of international trade. Harrod-neutral technology differences as presumed by the Solow model can explain why countries have different factor intensities and may end up in different cones of specialization.
    Keywords: Solow Model, Lerner diagram
    JEL: O40 F11
    Date: 2006–09
  14. By: Blomgren-Hansen, Niels (Department of Economics, Copenhagen Business School)
    Abstract: Diamond’s two-period OLG growth model is based on the assumption that the stock of capital in any period is equal to the wealth accumulated in the previous period by the generation of pensioners. This stock equlibrium condition may appear an innocuous paraphrase of the ordinary macro-economic flow equilibrium condition, S = I. This is not the case. In this note I demonstrate that Diamond’s solution is unstable in a monetary market economy where households and firms make independent decisions as to how much to save and how much to invest. An increase in the rate of interest above the Diamond long-run equilibrium level will cause saving to fall by more than investment and, hence, result in excess demand for loanable funds and an upward pressure on the rate of interest. However, substituting the ordinary S = I flow equilibrium condition for Diamonds stock equilibrium condition reveals that the model has another solution - the rate of interest equals the rate of growth - and that this solution is stable in a capital-based economy (contrary to the pure consumption loan model of interest suggested by Samuelson(1958)). The model has interesting implications. Diamond’s model predict that an increase in rate of time preference causing the young generation to save less will reduce the capital stock and raise the rate of interest. However,the S = I based two period OLG model reveals that the old generation’s consumption falls by more than the the young generation’s consumption increases. Consequently, excess supply of loanable funds will drive down the rate of interest. If the rate of interest is equal to the rate of growth an increase in the time preference has no effect on the supply of loanable funds and, consequently, neither on the rate of interest or the stock of capital. Whether people prefer to consume as young or old should not be a matter of public concern (although the transition from one state to another may be).
    Keywords: None
    JEL: H00
    Date: 2005–09–13
  15. By: Blomgren-Hansen, Niels (Department of Economics, Copenhagen Business School)
    Abstract: Samuelson (1958) analyses a three-period model, whereas Diamod (1965) considers a two-period model. This difference poses the question whether the insights derived by analysing the simple two-period model carry over in the more complicated three-period case. They do. The Samuelson model (no productive capital) has only one positive solution (r = n); however, this root is unstable. The Diamond model (no nonproductive abode of purchasing power) has also only one positive solution; the root is stable but inefficient. In a model with both productive capital and a non-productive abode of purchasing power, the inefficient Diamond solution becomes unstable and the socially optimal solution becomes stable.
    Keywords: None
    JEL: H00
    Date: 2005–11–13

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