nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2006‒10‒28
twenty papers chosen by
Christian Zimmermann
University of Connecticut

  1. Cyclical Wages in a Search-and-Bargaining Model with Large Firms By Rotemberg, Julio
  2. The Consumption-Tightness Puzzle By Ravn, Morten O.
  3. Competition, Innovation and Growth with Limited Commitment By Marimon, Ramon; Quadrini, Vincenzo
  4. On the Consequences of Demographic Change for Rates of Return to Capital, and the Distribution of Wealth and Welfare By Krüger, Dirk; Ludwig, Alexander
  5. Flat Tax Reforms in the US: A Boon for the Income Poor By Díaz-Giménez, Javier; Pijoan-Mas, Josep
  6. On the equilibrium in a discrete-time Lucas Model with endogenous leisure. By Marius Valentin Boldea
  7. Financial Innovations and Macroeconomic Volatility By Jermann, Urban; Quadrini, Vincenzo
  8. Hiring Freeze and Bankruptcy in Unemployment Dynamics By Garibaldi, Pietro
  9. Labour Contracts, Equal Treatment and Wage-Unemployment Dynamics By Andy Snell; Jonathan Thomas
  10. The Marginal Worker and The Aggregate Elasticity of Labor Supply By François Gourio; Pierre-Alexandre Noual
  11. Tax Rate Variability and Public Spending as Sources of Inderterminacy By Lloyd-Braga, Teresa; Modesto, Leonor; Seegmuller, Thomas
  12. The Timing of Monetary Policy Shocks By Olivei, Giovanni; Tenreyro, Silvana
  13. The Stabilizing Role of Government Size By Rafael Domenech; Javier Andres; Antonio Fatas
  14. Firms’ Heterogeneous Sensitivities to the Business Cycle, and the Cross-Section of Expected Returns By François Gourio;
  15. Money Creation in a Random Matching Model By Alexei Deviatov
  16. Dynamic General Equilibrium and T-Period Fund Separation By Gerber, Anke; Hens, Thorsten; Woehrmann, Peter
  17. How Far Are We From the Slippery Slope? The Laffer Curve Revisited By Trabandt, Mathias; Uhlig, Harald
  18. Investments into Education - Doing as the Parents Did By Kirchsteiger, Georg; Sebald, Alexander
  19. The Effect of Introducing a Non-redundant Derivative on the Volatility of Stock-Market Returns By Singh Bhamra, Harjoat; Uppal, Raman
  20. Exchange-rate volatility, exchange-rate disconnect, and the failure of volatility conservation By Alexei Deviatov; Igor Dodonov

  1. By: Rotemberg, Julio
    Abstract: This paper presents a complete general equilibrium model with flexible wages where the degree to which wages and productivity change when cyclical employment changes is roughly consistent with postwar U.S. data. Firms with market power are assumed to bargain simultaneously with many employees, each of whom finds himself matched with a firm only after a process of search. When employment increases as a result of reductions in market power, the marginal product of labor falls. This fall tempers the bargaining power of workers and thus dampens the increase in their real wages. The procyclical movement of wages is dampened further if the posting of vacancies is subject to increasing returns.
    Keywords: cyclical wages; matching models
    JEL: E24 E37 J64
    Date: 2006–08
  2. By: Ravn, Morten O.
    Abstract: This paper introduces a labour force participation choice into a standard labour market matching model embedded in a dynamic stochastic general equilibrium set-up. The participation choice is modelled as a trade-off between forgoing the expected benefits of being search active and engaging in costly labour market search. In contrast to models with constant labour force participation, the model that we analyse induces a symmetry in firms' and workers' search decision since both sides of the labour market vary search effort at the extensive margins. We show that this set-up is (a) of considerable analytical convenience, and (b) that the introduction of a participation choice leads to a strong tendency for procyclical unemployment, very low volatility of labour market tightness, and for a positively sloped Beveridge curve. These implications are summarized by a linear relationship between the vu-ratio and the marginal utility of consumption that we refer to as the consumption-tightness puzzle given its counterfacutal implications. Moreover, we show that this relationship survives a number of extentions of the standard model and that it derives from the allowance for an endogeneous labour market participation choice.
    Keywords: homework; intensive search margin; labour market participation; labour market tightness; matching models; unemployment
    JEL: E24 E32 J20 J41 J64
    Date: 2006–05
  3. By: Marimon, Ramon; Quadrini, Vincenzo
    Abstract: We study how barriers to competition - such as, restrictions to business start-up and strict enforcement of covenants or IPR - affect the investment in knowledge capital when contracts are not enforceable. These barriers lower the competition for human capital and reduce the incentive to accumulate knowledge. We show in a dynamic general equilibrium model that this mechanism has the potential to account for significant cross-country income inequality.
    Keywords: contract enforcement; economic growth; human capital
    JEL: L14 O4
    Date: 2006–09
  4. By: Krüger, Dirk; Ludwig, Alexander
    Abstract: This paper employs a multi-country large scale Overlapping Generations model with uninsurable labour productivity and mortality risk to quantify the impact of the demographic transition towards an older population in industrialized countries on world-wide rates of return, international capital flows and the distribution of wealth and welfare in the OECD. We find that for the US as an open economy, rates of return are predicted to decline by 86 basis points between 2005 and 2080 and wages increase by about 4.1%. If the US were a closed economy, rates of return would decline and wages increase by less. This is due to the fact that other regions in the OECD will age even more rapidly; therefore the US is 'importing' the more severe demographic transition from the rest of the OECD in the form of larger factor price changes. In terms of welfare, our model suggests that young agents with little assets and currently low labour productivity gain, up to 1% in consumption, from higher wages associated with population aging. Older, asset-rich households tend to lose, because of the predicted decline in real returns to capital.
    Keywords: distribution of welfare; international capital flows; population aging
    JEL: C68 D33 E17 E25
    Date: 2006–09
  5. By: Díaz-Giménez, Javier; Pijoan-Mas, Josep
    Abstract: In this article we quantify the aggregate, distributional and welfare consequences of two revenue neutral flat-tax reforms using a model economy that replicates the U.S. distributions of earnings, income and wealth in very much detail. We find that the less progressive reform brings about a 2.4% increase in steady state output and a more unequal distribution of after-tax income. In contrast, the more progressive reform brings about a -2.6% reduction in steady state output and a distribution of after-tax income that is more egalitarian. We also find that in the less progressive flat-tax economy aggregate welfare falls by -0.17% of consumption, and in the more progressive flat-tax economy it increases by 0.45% of consumption. In both flat-tax reforms the income poor pay less income taxes and obtain sizeable welfare gains.
    Keywords: earnings distribution; efficiency; flat-tax reforms; income distribution; inequality; wealth distribution
    JEL: D31 E62 H23
    Date: 2006–09
  6. By: Marius Valentin Boldea (Panthéon-Sorbonne Economie)
    Abstract: In this paper I study a discrete-time version of the Lucas model with the endogenous leisure but without physical capital. Under standard conditions I prove that the optimal human capital sequence is increasing. If the instantaneous utility function and the production function are Cobb-Douglas, I prove that the human capital sequence grow at a constant rate. I finish by studying the existence and the unicity of the equilibrium in the sense of Lucas or Romer.
    Keywords: Lucas Model, human capital, externalities, optimal growth, equilibrium.
    Date: 2006–07
  7. By: Jermann, Urban; Quadrini, Vincenzo
    Abstract: The volatility of US business cycle has declined during the last two decades. During the same period the financial structure of firms has become more volatile. In this paper we develop a model in which financial factors play a key role in generating economic fluctuations. Innovations in financial markets allow for greater financial flexibility and generate a lower volatility of output together with a higher volatile in the financial structure of firms.
    Keywords: business cycle; debt-equity finance; financing constraints
    JEL: E3 G1 G3
    Date: 2006–06
  8. By: Garibaldi, Pietro
    Abstract: This paper proposes a matching model that distinguishes between job creation by existing firms and job creation by firm entrants. The paper argues that vacancy posting and job destruction on the extensive margin, i.e. from firms that enter and exit the labour market, represents a viable mechanism for understanding the cyclical properties of vacancies and unemployment. The model features both hiring freeze and bankruptcies, where the former represents a sudden shut down of vacancy posting at the firm level with labour downsizing governed by natural turnover. A bankrupt firm, conversely, shut down its vacancies and lay offs its stock of workers. Recent research in macroeconomics has shown that a calibration of the Mortensen and Pissarides matching model account for 10 percent of the cyclical variability of the vacancy unemployment ratio displayed by U.S. data. A calibration of the model that explicitly considers hiring freeze and bankruptcy can account for 20 to 35 percent of the variability displayed by the data.
    Keywords: matching models; unemployment dynamics
    JEL: J30
    Date: 2006–09
  9. By: Andy Snell; Jonathan Thomas
    Abstract: This paper analyses a model in which .rms cannot pay discriminate based on year of entry to a .rm, and develops an equilibrium model of wage dynamics and unemployment. The model is developed under the assumption of worker mobility, so that workers can costlessly quit jobs at any time. Firms on the other hand are committed to contracts. Thus the model is related to Beaudry and DiNardo (1991). We solve for the dynamics of wages and unemployment, and show that real wages do not necessarily clear the labor market. Using sectoral productivity data from the post-war US economy, we assess the ability of the model to match actual unemployment and wage series. We also show that equal treatment follows in our model from the assumption of at-will employment contracting.
    Keywords: Labor contracts, business cycle, unemployment, equal treatment, cohort effects
    JEL: E32 J41
  10. By: François Gourio (Department of Economics, Boston University); Pierre-Alexandre Noual (University of Chicago.)
    Abstract: This paper attempts to reconcile the high apparent aggregate elasticity of labor supply with small micro estimates. We elaborate on Rogerson’s seminal work (1988) and show that his results rely neither on complete markets nor on lotteries, but rather on the indivisibility of labor supply and the marginal homogeneity of the workforce. We derive two robust implications of a setup with indivisible labor but without lotteries, using either a complete markets model or an incomplete markets model. Implication (1) is that agents with reservation wages far above or below the market wage are less responsive (in labor supply) to the business cycle than agents whose reservation wage is around the market wage. Implication (2) is that the aggregate elasticity is given by the marginal homogeneity of the workforce. We test implication (1) using the PSID and find support for it. We build an incomplete market model and calibrate it to cross-sectional moments of hours worked. We show that it can reproduce the feature (1). This allows us to use the model to evaluate the importance of feature (2), i.e. to estimate the aggregate elasticity of labor supply implied by the marginal homogeneity.
    Keywords: indivisible labor, reservation wage distribution, labor supply, business cycles.
    Date: 2006–03
  11. By: Lloyd-Braga, Teresa; Modesto, Leonor; Seegmuller, Thomas
    Abstract: We consider a constant returns to scale, one sector economy with segmented asset markets, encompassing both the Woodford (1986) and overlapping generations models. We analyze the role of public spending, financed by (labour or capital) income and consumption taxation, on the emergence of indeterminacy. We find that what is relevant for indeterminacy is the variability of the distortion introduced by government intervention. We further discuss the results in terms of the level of the tax rate, its variability with respect to the tax base and the degree of externalities in preferences due to the existence of a public good. We show that the degree of public spending externalities affects the combinations between the tax rate and its variability under which indeterminacy occurs. Moreover, in contrast to previous results, we find that consumption taxes can lead to local indeterminacy when asset markets are segmented.
    Keywords: indeterminacy; public spending; segmented asset markets; taxation
    JEL: E32 E63 H23
    Date: 2006–08
  12. By: Olivei, Giovanni; Tenreyro, Silvana
    Abstract: A vast empirical literature has documented delayed and persistent effects of monetary policy shocks on output. We show that this finding results from the aggregation of output impulse responses that differ sharply depending on the timing of the shock: When the monetary policy shock takes place in the first two quarters of the year, the response of output is quick, sizable, and dies out at a relatively fast pace. In contrast, output responds very little when the shock takes place in the third or fourth quarter. We propose a potential explanation for the differential responses based on uneven staggering of wage contracts across quarters. Using a stylized dynamic general equilibrium model, we show that a very modest amount of uneven staggering can generate differences in output responses similar to those found in the data.
    Keywords: business cycles; impulse-response function; monetary policy; nominal rigidity
    JEL: E1 E31 E32 E52 E58
    Date: 2006–06
  13. By: Rafael Domenech (Institute of International Economics, University of Valencia); Javier Andres (Institute of International Economics, University of Valencia); Antonio Fatas (INSEAD)
    Abstract: This paper presents an analysis of how alternative models of the business cycle can replicate the stylized fact that large governments are associated with less volatile economies. Our analysis shows that adding nominal rigidities and costs of capital adjustment to an otherwise standard RBC model can generate a negative correlation between government size and the volatility of output. However, in the model, we find that the stabilizing effect is only due to a composition effect and it is not present when we look at the volatility of private output. Given that empirically we also observe a negative correlation between government size and the volatility of consumption, we modify the model by introducing rule-of-thumb consumers. In this modified version of our initial model we observe that consumption volatility is also reduced when government size increases in similar way to the observed pattern in OECD economies over the last 45 years.
    Keywords: Government size, output volatility, automatic stabilizers.
    JEL: E32 E52 E63
    Date: 2006–10
  14. By: François Gourio (Department of Economics, Boston University);
    Abstract: In this paper, I propose and test a simple technology-based theory of firms’ sensitivities to aggregate shocks. I show that when the elasticity of substitution between capital and labor is below unity, low profitability firms are more sensitive to aggregate shocks, i.e. to the business cycle. Since the wage is smoother than productivity, revenues are more procyclical than costs, making profits, the residual procyclical. Firms with low profitability are more procyclical since the residual is smaller and the amplification greater. I study the asset pricing implications of this technology and find that it can explain the riskiness of small and “value” firms (Fama and French 1996). These firms are less profitable and are thus more procyclical. I find empirically that the cross-section of expected returns is well explained by differences in sensitivities of firms’ earnings to GDP growth, or by differences in profitability. The model yields rich empirical implications by linking a firm’s real behavior (the elasticity of output, employment and profits to an aggregate shock) to its financial characteristics (the firm’s betas and its average return). I next embed my partial equilibrium model in a full DSGE model to conduct a GE analysis. Empirically I show that firms with low margins are indeed more sensitive to the business cycle in their employment, sales or profits.
    Keywords: Cross-Section of Returns, Book-to-Market, Value Premium, Productivity Heterogeneity.
    JEL: E44 G12
    Date: 2006–02
  15. By: Alexei Deviatov (New Economic School)
    Abstract: I study money creation in versions of the Trejos-Wright (1995) and Shi (1995) models with indivisible money and individual holdings bounded at two units. I work with the same class of policies as in Deviatov and Wallace (2001), who study money creation in that model. However, I consider an alternative notion of implementability–the ex ante pairwise core. I compute a set of numerical examples to determine whether money creation is beneficial. I find beneficial e?ects of money creation if individuals are su?ciently risk averse (obtain su?ciently high utility gains from trade) and impatient.
    Keywords: inflation; Friedman rule; optimal monetary policy
    JEL: E31
    Date: 2006–09
  16. By: Gerber, Anke (Institute for Empirical Research in Economics, University of Zurich); Hens, Thorsten (Institute for Empirical Research in Economics, University of Zurich); Woehrmann, Peter (Institute for Empirical Research in Economics, University of Zurich)
    Abstract: We consider a dynamic general equilibrium model with incomplete markets in which we derive conditions for separating the savings decision from the asset allocation decision. It is shown that with logarithmic utility functions this separation holds for any heterogeneity of discount factors while the generalization to constant relative risk aversion only holds for homogeneous discount factors. Our results have simple asset pricing implications for the time series and also the cross section of asset prices. It is found that on data from the DJIA a risk aversion weaker than in the logarithmic case fits best.
    Keywords: Dynamic general equilibrium model; asset pricing
    JEL: D50
    Date: 2005–12–22
  17. By: Trabandt, Mathias; Uhlig, Harald
    Abstract: The goal of this paper is to examine the shape of the Laffer curve quantitatively in a simple neoclassical growth model calibrated to the US as well as to the EU-15 economy. We show that the US and the EU-15 area are located on the left side of their labor and capital tax Laffer curves, but the EU-15 economy being much closer to the slippery slopes than the US. Our results indicate that since 1975 the EU-15 area has moved considerably closer to the peaks of their Laffer curves. We find that the slope of the Laffer curve in the EU-15 economy is much flatter than in the US which documents a much higher degree of distortions in the EU-15 area. A dynamic scoring analysis shows that more than one half of a labor tax cut and more than four fifth of a capital tax cut are self-financing in the EU-15 economy.
    Keywords: Laffer curve; US and EU-15 economy
    JEL: E0 E60 H0
    Date: 2006–05
  18. By: Kirchsteiger, Georg; Sebald, Alexander
    Abstract: Empirical evidence suggests that parents with higher levels of education generally also attach a higher importance to the education of their children. This implies an intergenerational chain transmitting the attitude towards the formation of human capital from one generation to the next. We incorporate this intergenerational chain into an OLG-model with endogenous human capital formation. In absence of any state intervention such an economy might be characterized by multiple steady states. A temporary public investment into human capital formation is then needed for a transition from a steady state with low human capital levels to one with a higher human capital level. Furthermore, it can be shown that even the best steady state is suboptimal when the human capital is privately provided. This inefficiency can be overcome by a permanent public subsidy for education.
    Keywords: education subsidy; human capital formation; indirect reciprocity
    JEL: H23 H52 I2
    Date: 2006–05
  19. By: Singh Bhamra, Harjoat; Uppal, Raman
    Abstract: We study the effect of introducing a new security, such as a non-redundant derivative, on the volatility of stock-market returns. Our analysis uses a standard, continuous time, dynamic, general-equilibrium, full-information, frictionless, Lucas endowment economy where there are two classes of agents who have time-additive power utility functions and differ only in their risk aversion. We solve for equilibrium in two versions of this economy. In the first version, risk-sharing opportunities are limited because investors can trade in only the market portfolio, which is a claim on the aggregate endowment. In the second version, agents can trade in both the market portfolio and a new zero-net-supply derivative. We show analytically that for a sufficiently small precautionary-savings effect, the introduction of a non-redundant derivative on the market increases the volatility of stock-market returns.
    Keywords: general equilibrium; options; risk-sharing; volatility
    JEL: G12 G13
    Date: 2006–06
  20. By: Alexei Deviatov (New Economic School); Igor Dodonov (New Economic School)
    Abstract: Empirical analysis of exchange rates has produced puzzles that conventional models of exchange rates cannot explain. Here we deal with four puzzles regarding both real and nominal exchange rates, which are robust and inconsistent with standard theory. These puzzles are that both real and nominal exchange rates: i) are disconnected from fundamentals, ii) are much more volatile than fundamentals, iii) show little di?erence in behavior, and iv) fail to satisfy conservation of volatility. We develop a two-country, two-currency version of the random matching model to study exchange rates. We show that search and legal restrictions can produce exchange-rate dynamics consistent with these four puzzles.
    Keywords: exchange-rate puzzles, exchange-rate volatility, bargaining, search
    JEL: F31 C78
    Date: 2006–06

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