nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2007‒01‒28
seventeen papers chosen by
Christian Zimmermann
University of Connecticut

  1. THE WEALTH DISTRIBUTION WITH DURABLE GOODS By Antonia Díaz; Maria Jose Luengo-Prado
  2. A Neoclassical Analysis of the Postwar Japanese Economy By Keisuke Otsu
  3. Anticipated Growth and Business Cycles in Matching Models By Den Haan, Wouter; Kaltenbrunner, Georg
  4. Population ageing in a small open economy – some policy experiments with a tractable general equilibrium model By Kilponen , Juha; Kinnunen , Helvi; Ripatti , Antti
  5. Solving Heterogeneous-Agent Models with Parameterized Cross-Sectional Distributions By Algan, Yann; Allais, Olivier; Den Haan, Wouter
  6. Strategic Wage Bargaining, Labor Market Volatility, and Persistence By Matthias S. Hertweck
  7. Explaining Asset Prices with External Habits and Wage Rigidities in a DSGE Model. By Harald Uhlig
  8. Optimal external debt and default By Guimarães, Bernardo
  9. Idiosyncratic Shocks and the Role of Nonconvexities in Plant and Aggregate Investment Dynamics By Aubhik Khan; Julia Thomas
  10. Oil Dependence and Economic Instability By Luís Francisco Aguiar-Conraria; Yi Wen
  11. S-Curve Redux: On the International Transmission of Technology Shocks. By Zeno Enders; Gernot J. Mueller
  12. Optimal Monetary and Fiscal Policy in an Economy with Non-Ricardian Agents By Michal Horvath
  13. Investment Frictions and the Relative Price of Investment Goods in an Open Economy Model By Parantap Basu; Christoph Thoenissen
  14. The Productivity Paradox and the New Economy: The Spanish Case By Jesús Rodríguez López; Diego Martínez López; José Luis Torres Chacón
  15. Employment Protection, Firm Selection, and Growth By Markus Poschke
  16. Business Cycle Analysis and VARMA models By Christian Kascha; Karel Mertens
  17. The hypostatisation of the concept of equilibrium in neoclassical economics By Andy Denis

  1. By: Antonia Díaz; Maria Jose Luengo-Prado
    Abstract: This paper studies the effect that illiquid assets and collateral credit frictions have on the level of wealth inequality in a standard model of ex-ante heterogenous agents with idiosyncratic uncertainty. We calibrate our model so that its steady state statistics match selected aggregate statistics of the U.S. economy and data on the earnings distribution. We find that adding illiquid assets and collateral credit frictions decreases wealth inequality decreases slightly relative to an economy with liquid assets and no credit frictions. The effect is small because these frictions mostly affect poor households that account for a small fraction of aggregate wealth. Nevertheless, our richer model allows us to study other dimensions of wealth inequality. In particular, our model replicates the fact that financial assets are more concentrated than total wealth, while residential assets are less concentrated. Furthermore, we document that, in the U.S., the earnings and housing distributions are remarkably similar. Our model can account for this fact so long as the earnings process is fairly persistent
    Date: 2006–12
  2. By: Keisuke Otsu (Institute for Monetary and Economic Studies, Bank of Japan (E-mail:
    Abstract: Two key features of the postwar Japanese economy are the delay of catch up during the 50s followed by rapid economic growth during the 60s and early 70s and the consistent decline in labor supply during the rapid growth period. A standard neoclassical growth model can quantitatively account for the Japanese postwar growth patterns of capital, output, consumption and investment taking the destruction of capital stock during the war and postwar TFP growth as given. The decline in labor can be explained by strong income effects caused by subsistence consumption during the rapidly growing period.
    Keywords: Japanese Postwar Growth, Neoclassical Growth Model, TFP
    JEL: E13 O40
    Date: 2007–01
  3. By: Den Haan, Wouter; Kaltenbrunner, Georg
    Abstract: Positive news about future productivity growth causes a contraction in most neoclassical business cycle models, which is counterfactual. We show that a business cycle model that incorporates the standard matching framework can generate an expansion. Although the wealth effect of an increase in expected productivity induces workers to reduce their labour supply, the matching friction has the opposite effect leaving labour supply roughly unaffected. Employment increases because the matching friction also induces firms to post more vacancies. This translates into additional resources, which makes it possible for both consumption and investment to increase in response to positive news about future productivity growth before the actual increase in productivity materializes.
    Keywords: labour force participation; Pigou cycles; productivity growth
    JEL: E24 E32 J41
    Date: 2007–01
  4. By: Kilponen , Juha (Bank of Finland Research); Kinnunen , Helvi (Bank of Finland); Ripatti , Antti (Bank of Finland)
    Abstract: This paper extends Gertler’s (1999) tractable overlapping generations model with life-cycle features by allowing for distortionary taxation, demographic transition and stochastic variation in demographic structure. The model is then used to study demographic change in the small open economy of Finland. Simulations highlight the key role played by labour market responses to ageing. When the responses of labour supply, wages, and hence private consumption, to higher taxation are consistently accounted for, population ageing has clearly much larger effects on public finance, when compared to mechanical sustainability calculations. Stochastic simulations suggest that lengthening of working time has only a modest alleviating effect on the fiscal burden of ageing. This is due to the fact that stochastic variation in the length of working time has only a relatively small effect on the model’s dependency ratio. Variation in life expectancy is clearly much more important.
    Keywords: ageing; general equilibrium; public finance; demographic uncertainty
    JEL: E13 H55 J11 J26
    Date: 2006–12–23
  5. By: Algan, Yann; Allais, Olivier; Den Haan, Wouter
    Abstract: A new algorithm is developed to solve models with heterogeneous agents and aggregate uncertainty that avoids some disadvantages of the prevailing algorithm that strongly relies on simulation techniques and is easier to implement than existing algorithms. A key aspect of the algorithm is a new procedure that parameterizes the cross-sectional distribution, which makes it possible to avoid Monte Carlo integration. The paper also develops a new simulation procedure that not only avoids cross-sectional sampling variation but is also more than ten times faster than the standard procedure of simulating an economy with a large but finite number of agents. This procedure can help to improve the efficiency of the most popular algorithm in which simulation procedures play a key role.
    Keywords: incomplete markets; numerical solution; projection method; simulation
    JEL: C63 D52
    Date: 2007–01
  6. By: Matthias S. Hertweck
    Abstract: This paper modifies the standard Mortensen-Pissarides job matching model in order to explain the cyclical behavior of vacancies and unemployment. The modifications include strategic wage bargaining (Hall and Milgrom, 2006) and convex labor adjustment costs. The results reveal that our model replicates the cyclical behavior of both variables remarkably well. First, we show that strategic wage bargaining increases the volatility of vacancies and unemployment enormously. Second, the introduction of convex labor adjustment costs makes both variables much more persistent. Third, our analysis indicates that both modifications are complementary in generating volatile and persistent labor market variables.
    Keywords: Business Cycles, Matching, Strategic Bargaining
    JEL: E24 E32 J41
    Date: 2006
  7. By: Harald Uhlig
    Abstract: In this paper, I investigate the scope of a model with exogenous habit formation - or `catching up with the Joneses`, see Abel (1990) - to generate the observed equity premium as well as other key macroeconomic facts. Along the way, I derive restrictions for four out of eight parameters for a rather general preference specification of habit formation by imposing consistency with long-run growth, the leisure share, the aggregate Frisch elasticity of labor supply, the observed risk-free rate, and the observed Sharpe ratio. I show that a DSGE model with (exogenous and lagged) habits in both leisure and consumption, but not necessarily with additional persistence, is well capable of matching the observed asset market facts as well as macro facts, provided one allows for moderate real wage stickiness and provided one allows for sufficient curvature on preferences, as dictated by the asset market observations. Without wage stickiness, delivery on both the asset pricing implications as well as the macroeconomic implications seems to be much harder.
    Keywords: asset pricing, wage rigidity, habit formation, Frisch elasticity, Sharpe ratio, log-linear approximation
    JEL: E24 E30 G12
    Date: 2007–01
  8. By: Guimarães, Bernardo
    Abstract: This paper analyses whether sovereign default episodes can be seen as contingencies of optimal international lending contracts. The model considers a small open economy with capital accumulation and without commitment to repay debt. Taking first order approximations of Bellman equations, I derive analytical expressions for the equilibrium level of debt and the optimal debt contract. In this environment, debt relief generated by reasonable fluctuations in productivity is an order of magnitude below that generated by shocks to world interest rates. Debt relief prescribed by the model following the interest rate hikes of 1980-81 accounts for a substantial part of the debt forgiveness obtained by the main Latin American countries through the Brady agreements.
    Keywords: default; optimal contract; sovereign debt; world interest rates
    JEL: F3 F4 G1
    Date: 2007–01
  9. By: Aubhik Khan; Julia Thomas
    Abstract: We study a model of lumpy investment wherein establishments face persistent shocks to common and plant-specific productivity, and nonconvex adjustment costs lead them to pursue generalized (S,s) investment rules. We allow persistent heterogeneity in both capital and total factor productivity alongside low-level investments exempt from adjustment costs to develop the first model consistent with available evidence on establishment-level investment rates. Examining the implications of lumpy investment for aggregate dynamics in this setting, we find that they remain substantial when factor supply considerations are ignored, but are quantitatively irrelevant in general equilibrium. The substantial implications of general equilibrium extend beyond the dynamics of aggregate series. While the presence of idiosyncratic shocks makes the time-averaged distribution of plant-level investment rates largely invariant to market-clearing movements in real wages and interest rates, we show that the dynamics of plants' investments differ sharply in their presence. Thus, model-based estimations of capital adjustment costs involving panel data may be quite sensitive to the assumption about equilibrium. Our analysis also offers new insights about how nonconvex adjustment costs influence investment at the plant. When establishments face idiosyncratic productivity shocks consistent with existing estimates, we find that nonconvex costs do not cause lumpy investments, but act to eliminate them.
    JEL: E22 E32
    Date: 2007–01
  10. By: Luís Francisco Aguiar-Conraria (Universidade do Minho - NIPE); Yi Wen (Federal Reserve Bank of St. Louis)
    Abstract: We show that dependence on foreign energy can increase economic instability by raising the likelihood of equilibrium indeterminacy, hence making fluctuations driven by self-fulfilling expectations easier to occur. This is demonstrated in a standard neoclassical growth model. Calibration exercises, based on the estimated share of imported energy in production for several countries, show that the degree of reliance on foreign energy for many countries can easily make an otherwise determinate and stable economy indeterminate and unstable.
    Keywords: Indeterminacy, Energy Imports, Externality, Returns to Scale, Sunspots, Self-Fulfilling Expectations.
    JEL: E13 E20 E30
    Date: 2007
  11. By: Zeno Enders; Gernot J. Mueller
    Abstract: Using vector autoregressions on U.S. time series, we find that technology shocks induce an ‘S’- shaped cross-correlation function for the trade balance and the terms of trade (S-curve). In calibrating a prototypical international business cycle model to match the S-curve under complete and incomplete financial markets, we find two distinct sets of parameter values. While both model specifications deliver the S-curve, the underlying transmission mechanism of technology shocks is fundamentally different. Most importantly, only in the incomplete markets economy the terms of trade appreciate and thus amplify the relative wealth effects of technology shocks - as suggested by time series evidence.
    Keywords: S-curve, Technology shocks, Terms of trade, Trade balance, Incomplete markets
    JEL: F41 E32 F32
    Date: 2006
  12. By: Michal Horvath
    Abstract: The optimal policy mix maximizes a quadratic welfare objective which follows from the agents. utility function and depends only on inflation and output gap volatility. We analyze the optimal response of the economy to a rise in government spending. We find that the optimal economy moves along an analogue of a conventional inflation-output variance frontier, as the population share of non-Ricardian agents rises. Output should optimally vary more, as this is to the benefit of the liquidity-constrained agents via net real wages, while optimal inflation volatility falls as there is less of a need to use inflation to maintain fiscal solvency. There is little evidence that increased government spending would crowd in private consumption. The tax rate varies to contain pressures on prices by shifting the natural rate of output towards its preference-driven target level. We identify the size of the target deviation in output and the interest rate elasticity of demand as the key determinants of the optimal interest rate policy.
    Keywords: Optimal Monetary and Fiscal Policy, Macroeconomic Stabilization, Non-Ricardian Agents.
    JEL: E61 E63
    Date: 2007–01
  13. By: Parantap Basu; Christoph Thoenissen
    Abstract: Is the relative price of investment goods a good proxy for investment frictions? We analyze investment frictions in an open economy, flexible price, two-sector two-country model and show that when the relative price of investment goods is endogenously determined in such a model, the relative price of investment can actually rise in response to a reduction in investment frictions. Only when the model is driven by TFP shocks do we observe a data congruent negative correlation between investment and the relative price of investment goods.
    Date: 2007–01
  14. By: Jesús Rodríguez López (Department of Economics, Universidad Pablo de Olavide); Diego Martínez López (Centro de Estudios Andaluces y Department of Economics, Universidad Pablo de Olavide); José Luis Torres Chacón (Departamento de Teoría e Historia Económica, Universidad de Málaga)
    Abstract: This paper studies the impact of the information and communication technologies (ICT) on economic growth in Spain using a dynamic general equilibrium approach. Contrary to previous works, we use a production function with six different capital inputs, three of them corresponding to ICT assets. Calibration of the model suggests that the contribution of ICT to Spanish productivity growth is very relevant, whereas the contribution of non-ICT capital has been even negative. Additionally, over the sample period 1995-2002, we find a negative TFP and productivity growth. These results together aim at the hypothesis that the Spanish economy could be placed within the productivity paradox.
    Keywords: New economy, information and communication technologies, technological change, productivity paradox.
    JEL: E22 O30 O40
    Date: 2007–01
  15. By: Markus Poschke
    Abstract: This paper analyzes the effect of firing costs on aggregate productivity growth. For this purpose, a model of endogenous growth through selection and imitation is developed. It is consistent with recent evidence on firm dynamics and the contribution of firm entry and exit to aggregate productivity growth. In this model, growth arises endogenously via market selection among heterogeneous incumbent firms. It is sustained as entrants imitate the best incumbents. In this framework, besides inducing misallocation of labor and reducing entry, firing costs also discourage exit of low-productivity firms. This makes selection less severe and reduces growth. However, exempting exiting firms from firing costs speeds up the exit of inefficient firms and thereby growth, with little change in job turnover. These effects are stronger in sectors where firms face larger idiosyncratic shocks, as in services, fitting evidence that here, EU-US growth rate differences are largest. Introducing firing costs of one year’s wages in a benchmark economy calibrated to the US business (services) sector then leads to 0.1 (0.3) points lower growth. A brief empirical analysis of the impact of firing costs on the size of exiting firms supports the model’s conclusions.
    Keywords: endogenous growth theory, firm dynamics, labor market regulation, firing costs, entry and exit, firm selection
    JEL: E24 J63 J65 L11 L16 O40
    Date: 2006
  16. By: Christian Kascha; Karel Mertens
    Abstract: An important question in empirical macroeconomics is whether structural vector autoregressions (SVARs) can reliably discriminate between competing DSGE models. Several recent papers have suggested that one reason SVARs may fail to do so is because they are finite-order approximations to infinite-order processes. In this context, we investigate the performance of models that do not suffer from this type of misspecification. We estimate VARMA and state space models using simulated data from a standard economic model and compare true with estimated impulse responses. For our examples, we find that one cannot gain much by using algorithms based on a VARMA representation. However, algorithms that are based on the state space representation do outperform VARs. Unfortunately, these alternative estimates remain heavily biased and very imprecise. The findings of this paper suggest that the reason SVARs perform weakly in these types of simulation studies is not because they are simple finite-order approximations. Given the properties of the generated data, their failure seems almost entirely due to the use of small samples.
    Keywords: Structural VARs, VARMA, State Space Models, Identification, Business Cycles
    JEL: E32 C15 C52
    Date: 2006
  17. By: Andy Denis (Department of Economics, City University, London)
    Abstract: This paper explores the meanings of ‘equilibrium’ in economics, distinguishing salient appropriate and inappropriate modes of deployment of the concept. I examine a specific instance of the deployment of the concept of equilibrium by a neoclassical writer – Robert Lucas – and conclude that the concept has been hypostatised, substituting an aspect for the whole. The temporary is made permanent, and process subordinated to stasis, with apologetic results. Under far-from-equilibrium conditions, equilibrium is not even an approximate description of the condition of the system, but an abstraction – something which might obtain should a process under consideration run to its conclusion. The order of the system is, not an equilibrium, but an ephemeral balance of forces, destined to be disturbed by the passage of time. I suggest that the hypostatisation of equilibrium exemplifies the contrast between formal and dialectical modes of thought, and that the heterodoxy can make its most telling contribution by applying a dialectical notion of equilibrium.
    Date: 2006–01

This nep-dge issue is ©2007 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.
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