nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2007‒03‒24
twelve papers chosen by
Christian Zimmermann
University of Connecticut

  1. A "Simple" Currency Union Model with Labor Market Frictions, Real Wage Rigidities and Equilibrium Unemployment By Mirko Abbritti
  2. Identifying the Role of Labor Markets for Monetary Policy in an Estimated DSGE Model By Kai Christoffel; Keith Kuester; Tobias Linzert
  3. Should Old-Age Benefits Be Earnings-Tested? By Niku Määttänen; Panu Poutvaara
  4. Public Budget Composition, Fiscal (De)Centralization and Welfare By Calin Arcalean; Gerhard Glomm; Ioana Schiopu; Jens Suedekum
  5. Dynamic Inefficiency in an Overlapping Generations Economy with Production By Guido Cazzavillan; Patrick Pintus
  6. Security Income Taxes in a Dynamic Semi-Closed Economy By Marc Rapp
  7. Unemployment Fluctuation with Staggered Nash Wage Bargaining By Mark Gertler; Antonella Trigari
  8. Nontraded Goods, Market Segmentation, and Exchange Rates By Michael Dotsey; Margarida Duarte
  9. Mortgage Markets, Collateral Constraints, and Monetary Policy: Do Institutional Factors Matter? By Alessandro Calza; Tommaso Monacelli; Livio Stracca
  10. Household Heterogeneity and Real Exchange Rates By Kocherlakota, Narayana; Pistaferri, Luigi
  11. The Redistributive Design of Social Security Systems By J. Ignacio Conde-Ruiz; Paola Profeta
  12. The Mistake of 1937: A General Equilibrium Analysis By Gauti B. Eggertsson; Benjamin Pugsley

  1. By: Mirko Abbritti (IUHEI, The Graduate Institute of International Studies, Geneva)
    Abstract: This paper derives a DSGE currency union model with labor market frictions, real wage rigidities and price staggering. The model combines many realistic features, but it is still tractable: like standard open-economy models, it can be closed in six equations. We derive and discuss the constrained efficient allocation and the decentralised equilibrium, under both flexible and sticky prices. We use the model to analyse how different labor market institutions or degrees of real wage rigidities influence the functioning of the currency union and the size and persistence of inflation and output differentials. We show that the presence of non trivial real imperfections affects substantially the transmission mechanism of shocks in general and, in particular, of monetary policy. Interestingly, we find that the implications of real wage rigidities and labor market frictions for business cycle fluctuations are likely to operate in opposite directions: a high degree of real wage rigidities tends to amplify the response of the real economy to shocks; when labor market are more sclerotic, instead, unemployment volatility tends to decrease while inflation volatility increases.
    Keywords: Currency Union, labor market frictions, real wage rigidities, unemployment, sticky prices, inflation and output differentials
    JEL: E32 E52 F41
    Date: 2007–01
  2. By: Kai Christoffel (European Central Bank); Keith Kuester (European Central Bank); Tobias Linzert (European Central Bank)
    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: E32 E52 J64 C11
    Date: 2007–02–14
  3. By: Niku Määttänen (ETLA, Helsinki); Panu Poutvaara (University of Helsinki and IZA)
    Abstract: We study the welfare effects of earnings testing flat-rate old-age benefits in a quantitative overlapping generations model with idiosyncratic labor income risk. In our model economy, even a moderate earnings testing reduces individuals’ expected lifetime utility, whenever other taxes are taken into account. Moreover, it also lowers the realized lifetime utilities of those at the bottom of the lifetime utility distribution.
    Keywords: social security, retirement, means-testing
    JEL: H55 J26 C68
    Date: 2007–02
  4. By: Calin Arcalean (Indiana University Bloomington); Gerhard Glomm (Indiana University Bloomington); Ioana Schiopu (Indiana University Bloomington); Jens Suedekum (University of Konstanz and IZA)
    Abstract: We present a dynamic two-region model with overlapping generations. There are two types of public expenditure, education and infrastructure funding, and governments decide optimally on budget size (tax rate) and its allocation across the two outlays. Productivity of government infrastructure spending can differ across regions. This assumption follows well established empirical evidence, and highlights regional heterogeneity in a previously unexplored dimension. We study the implications of three different fiscal regimes for capital accumulation and aggregate national welfare. Full centralization of revenue and expenditure decisions is the optimal fiscal arrangement for the country when infrastructure spending productivity is similar across regions. When regional differences exist but are not too large, the partial centralization regime is optimal where the federal government sets a common tax rate, but allows the regional governments to decide on the budget composition. Only when the differences are sufficiently large does full decentralization become the optimal regime. National steady state output is instead highest when the economy is decentralized. This result is consistent with the "Oates conjecture" that fiscal decentralization increases capital accumulation. However, in terms of welfare this result can be reversed.
    Keywords: fiscal federalism, decentralization, capital accumulation, infrastructure
    JEL: H72 H74 E62
    Date: 2007–02
  5. By: Guido Cazzavillan (Department of Economics, University Of Venice Ca’ Foscari); Patrick Pintus (Universitè de la Mèditerranée and GREQAM-IDEP, France)
    Abstract: Reichlin (JET, 1986) has shown in an OLG model with productive capital that whenever the steady state is locally indeterminate and undergoes a Hopf bifurcation, it is Pareto-optimal. While these results were established under the assumption of Leontief technology, the author has partially extended them to show that the Hopf bifurcation is robust with respect to the introduction of capital-labor substitution. In this note, we prove that the Pareto-optimality of the steady state does not extend to technologies with capital-labor substitution. When the steady state is a sink or undergoes a Hopf bifurcation, it is characterized by over-accumulation with respect to the Golden Rule - the interest rate is negative - hence not Pareto-optimal. Most importantly, it follows that stabilization policies targeting the steady state leave room for welfare losses associated with productive inefficiency, apart from the very special case of Leontief technology.
    Keywords: Endogenous fluctuations, local bifurcations, dynamic inefficiency
    JEL: C62 D61 E32
    Date: 2006
  6. By: Marc Rapp (Leipzig Graduate School of Management (HHL))
    Abstract: This paper analyzes security income taxes in a dynamic two-period model of an economy that is part of a cluster of economies with perfectly integrated bond markets but locally segmented equity markets. For an economic income tax, it is shown that if tax proceeds are immediately redistributed within the cohort of market participants, taxation is non-distortionary in the sense that neither optimal production decisions of firms, nor the optimal aggregate consumption path or security prices are affected by taxation. If, however, tax proceeds are transferred to 'outsiders', i.e. non-market-participants, a shift in the tax rate in general affects the optimal aggregate consumption path and equilibrium security prices reflect the prevailing tax rate. While the equilibrium analysis is concerned with a rather stylized tax code, it is argued that the analysis may be interpreted as a partial equilibrium analysis of capital gains taxes within more general tax systems.
    Keywords: capital income tax, asset prices, home-bias,
    JEL: G12 G18 H24
  7. By: Mark Gertler (New York University); Antonella Trigari (Bocconi University)
    Abstract: A number of authors have recently emphasized that the conventional model of unemployment dynamics due to Mortensen and Pissarides has difficulty accounting for the relatively volatile behavior of labor market activity over the business cycle. We address this issue by modifying the MP framework to allow for staggered multiperiod wage contracting. What emerges is a tractable relation for wage dynamics that is a natural generalization of the period-by-period Nash bargaining outcome in the conventional formulation. An interesting side-product is the emergence of spillover effects of average wages on the bargaining process. We then show that a reasonable calibration of the model can account well for the cyclical behavior of wages and labor market activity observed in the data. The spillover effects turn out to be important in this respect.
    Keywords: Unemployment, Labor Market, Nash Bargaining, Wage Rigidity
    JEL: E32 E50 J64
    Date: 2007–02–15
  8. By: Michael Dotsey; Margarida Duarte
    Abstract: Empirical evidence suggests that movements in international relative prices are large and persistent. Nontraded goods, both in the form of final consumption goods and as an input into the production of final tradable goods, are an important aspect behind international relative price movements. In this paper we show that nontraded goods play an important role in the context of an otherwise standard open-economy macro model. Our quantitative study with nontraded goods generates implications along several dimensions that are more closely in line with the data relative to the model that abstracts from nontraded goods. In addition, contrary to a large literature, standard alternative assumptions about the currency in which firms price their goods are virtually inconsequential for the properties of aggregate variables in our model, other than the terms of trade.
    Keywords: exchange rates; nontraded goods; distribution services; incomplete asset markets.
    JEL: F3 F41
    Date: 2007–03–15
  9. By: Alessandro Calza (European Central Bank); Tommaso Monacelli (Bocconi University); Livio Stracca (European Central Bank)
    Abstract: We study the role of institutional characteristics of mortgage markets in affecting the strength and timing of the effects of monetary policy shocks on house prices and consumption in a sample of OECD countries. We document three facts: (1) there is significant divergence in the structure of mortgage markets across the main industrialised countries; (2) at the business cycle frequency, the correlation between consumption and house prices increases with the degree of flexibility/development of mortgage markets; (3) the transmission of monetary policy shocks on consumption and house prices is stronger in countries with more flexible/developed mortgage markets. We then build a two-sector dynamic general equilibrium model with price stickiness and collateral constraints, where the ability of borrowing is endogenously linked to the nominal value of a durable asset (housing). We study how the response of consumption to monetary policy shocks is affected by alternative values of three key institutional parameters: (i) down-payment rate; (ii) mortgage repayment rate; (iii) interest rate mortgage structure (variable vs. fixed interest rate). In line with our empirical evidence, the sensitivity of consumption to monetary policy shocks increases with lower values of (i) and (ii), and is larger under a variable-rate mortgage structure.
    Keywords: House Prices, Mortgage Markets, Collateral Constraints, Monetary Policy
    JEL: E21 E44 E52
    Date: 2007–02–16
  10. By: Kocherlakota, Narayana; Pistaferri, Luigi
    Abstract: We assume that individuals can fully insure themselves against cross-country shocks, but not against individual-specific shocks. We consider two particular models of limited risk-sharing: domestically incomplete markets (DI) and private information-Pareto optimal (PIPO) risk-sharing. For each model, we derive a restriction relating the cross-sectional distributions of consumption and real exchange rates. We evaluate these restrictions using household-level consumption data from the US and the UK. We show that the PIPO restriction fits the data well when households have a coefficient of relative risk aversion of around 5. The restrictions implied by the complete risk-sharing model and the DI model fare poorly.
    Keywords: market incompleteness; Pareto optimality; precautionary savings; real exchange rate
    JEL: D63 E21 F31
    Date: 2007–03
  11. By: J. Ignacio Conde-Ruiz; Paola Profeta
    Abstract: Countries with low intragenerational redistribution in social security systems (Bismarckian) are associated with larger public pension expenditures, a smaller fraction of private pension and lower income inequality than countries with more redistributive social security (Beveridgean). This paper introduces a bidimensional voting model to account for these features. Agents different in age, income and in their ability to invest in the capital market vote on the degree of redistribution of the social security system and on the size of the transfer. In an economy with three income groups, a small Beveridgean system is supported by low-income agents, who gain from its redistributive feature, and high-income individuals, who seek to minimize their tax contribution and to invest in a private scheme. Middle-income individuals instead favor a large Bismarckian system.
  12. By: Gauti B. Eggertsson (Federal Reserve Bank of New York); Benjamin Pugsley (University of Chicago)
    Abstract: This paper studies a dynamic general equilibrium model with sticky prices and rational expectations in an environment of low interest rates and deflationary pressures. We show that small changes in the public’s beliefs about the future inflation target of the government can lead to large swings in both inflation and output. This effect is much larger at low interest rates than under regular circumstances. This highlights the importance of effective communication policy at zero interest rates. We argue that confusing communications by the US Federal Reserve, the President of the United States, and key administration officials about future price objectives were responsible for the sharp recession in the US in 1937-38, one of the sharpest recessions in US economic history. Poor communication policy is the mistake of 1937. Before committing the mistake of 1937 the US policy makers faced economic conditions that are similar in some respect to those confronted by Japanese policy makers in the first half of 2006.
    Keywords: Sticky Prices, Central Bank Communication, Stochastic General Equilibrium Model
    JEL: E61 E52 E32
    Date: 2007–02–12

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