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on Dynamic General Equilibrium |
| By: | Frank Smets (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Rafael Wouters (National Bank of Belgium, Boulevard de Berlaimont 14, B-1000 Brussels, Belgium.) |
| Abstract: | Using a Bayesian likelihood approach, we estimate a dynamic stochastic general equilibrium model for the US economy using seven macro-economic time series. The model incorporates many types of real and nominal frictions and seven types of structural shocks. We show that this model is able to compete with Bayesian Vector Autoregression models in out-of-sample prediction. We investigate the relative empirical importance of the various frictions. Finally, using the estimated model we address a number of key issues in business cycle analysis: What are the sources of business cycle fluctuations? Can the model explain the cross-correlation between output and inflation? What are the effects of productivity on hours worked? What are the sources of the “Great Moderation”? JEL Classification: E4-E5. |
| Keywords: | Keywords: DSGE models; monetary policy |
| Date: | 2007–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20070722&r=dge |
| By: | Enchuan Shao; Pedro Silos |
| Abstract: | This paper is concerned with the business cycle dynamics in search-and-matching models of the labor market when agents are ex post heterogeneous. We focus on wealth heterogeneity that comes as a result of imperfect opportunities to insure against idiosyncratic risk. We show that this heterogeneity implies wage rigidity relative to a complete insurance economy. The fraction of wealth-poor agents prevents real wages from falling too much in recessions since small decreases in income imply large losses in utility. Analogously, wages rise less in expansions compared with the standard model because small increases are enough for poor workers to accept job offers. This mechanism reduces the volatility of wages and increases the volatility of vacancies and unemployment. This channel can be relevant if the lack of insurance is large enough so that the fraction of agents close to the borrowing constraint is significant. However, discipline in the parameterization implies an earnings variance and persistence in the unemployment state that result in a large degree of self-insurance. |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedawp:2007-05&r=dge |
| By: | Nir Jaimovich; Henry E. Siu |
| Abstract: | We investigate the consequences of demographic change for business cycle analysis. We find that changes in the age composition of the labor force account for a significant fraction of the variation in business cycle volatility observed in the U.S. and other G7 economies. During the postwar period, these countries experienced dramatic demographic change, although details regarding extent and timing differ from place to place. Using panel-data methods, we exploit this variation to show that the age composition of the workforce has a large and statistically significant effect on cyclical volatility. We conclude by relating these findings to the recent decline in U.S. business cycle volatility. Using both simple accounting exercises and a quantitative general equilibrium model, we find that demographic change accounts for a significant part of this moderation. |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmsr:387&r=dge |
| By: | KOBAYASHI Keiichiro; NAKAJIMA Tomoyuki; INABA Masaru |
| Abstract: | The boom-bust cycles such as the episode of the "Internet bubble" in the late 1990s may be described as the business cycle driven by changes in expectations or news about the future. The comovements in consumption, labor, and investment, in response to news about productivity changes in the future can be called the news-driven cycles. We show that with the assumption that firms are subject to the collateral constraint in financing input costs, a fairly standard Real Business Cycle model can generate the news-driven cycles. The collateral constraint models have several virtues: (1) The model structure is simple; (2) introduction of the intermediate input enables our models to reproduce procyclical movements in the total factor productivity; (3) our models can generate procyclical movements in price of capital (Tobin's q); and (4) the second model in our paper, which is a modified version of the Carlstrom-Fuerst model, can generate countercyclical movements in bankruptcies, while the original Carlstrom-Fuerst model cannot. |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:eti:dpaper:07013&r=dge |
| By: | Devereux, Michael B; Sutherland, Alan |
| Abstract: | This paper presents a general approximation method for characterizing time-varying equilibrium portfolios in a two-country dynamic general equilibrium model. The method can be easily adapted to most dynamic general equilibrium models, it applies to environments in which markets are complete or incomplete, and it can be used for models of any dimension. Moreover, the approximation provides simple, easily interpretable closed form solutions for the dynamics of equilibrium portfolios. |
| Keywords: | country portfolios; solution methods |
| JEL: | E52 E58 F41 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6208&r=dge |
| By: | Milton H. Marquis; Bharat Trehan |
| Abstract: | We construct a vintage capital model in which worker skills lie along a continuum and workers can be paired with different vintages (as technology evolves) under a matching rule of "best worker with the best machine." Labor reallocation in response to technology shocks has two key implications for the wage premium. First, it limits both the magnitude and duration of change in the wage premium following a (permanent) embodied technology shock, so empirically plausible shocks do not lead to the kind of increases in the wage premium observed in the U.S. during the 1980s and early 1990s (though an increase in labor force heterogeneity does). Second, positive disembodied technology shocks tend to push up the wage premium as well, and while this effect is small, it does mean that a higher premium does not provide unambiguous information about the underlying shock. Labor reallocation also means that if embodied technology comes to play a larger role in long-run growth, investment and savings tend to fall in steady state, with little effect on output and employment, enabling the household to increase consumption without sacrificing leisure. The short run effects are more conventional: permanent shocks to disembodied technology induce a strong wealth effect that reduces savings and induces a consumption boom while permanent shocks to embodied technology induce dominant substitution effects and an expansion characterized by an investment boom. |
| Keywords: | Productivity |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:2007-06&r=dge |
| By: | Matteo Iacoviello (Boston College); Stefano Neri (Banca D'Italia) |
| Abstract: | The ability of a two-sector model to quantify the contribution of the housing market to business fluctuations is investigated using U.S. data and Bayesian methods. The estimated model, which contains nominal and real rigidities and collateral constraints, displays the following features: First, a large fraction of the upward trend in real housing prices over the last 40 years can be accounted for by slow technological progress in the housing sector; second, residential investment and housing prices are very sensitive to monetary policy and housing demand shocks; third, the wealth effects from housing on consumption are positive and significant. The structural nature of the model allows identifying and quantifying the sources of áuctuations in house prices and residential investment and measuring the contribution of housing booms and busts to business cycles. |
| Keywords: | Housing, Collateral Constraints, Bayesian Estimation, Two-sector Models |
| JEL: | E32 E44 E47 R21 R31 |
| Date: | 2007–03–25 |
| URL: | http://d.repec.org/n?u=RePEc:boc:bocoec:659&r=dge |
| By: | Cédric Tille; Eric van Wincoop |
| Abstract: | The sharp increase in both gross and net international capital flows over the past two decades has prompted renewed interest in their determinants. Most existing theories of international capital flows are based on one-asset models, which have implications only for net capital flows, not for gross flows. Moreover, because there is no portfolio choice, these models allow no role for capital flows as a result of assets? changing expected returns and risk characteristics. In this paper, we develop a method for solving dynamic stochastic general equilibrium open-economy models with portfolio choice. After showing why standard first- and second-order solution methods no longer work in the presence of portfolio choice, we extend these methods, giving special treatment to the optimality conditions for portfolio choice. We apply our solution method to a particular two-country, two-good, two-asset model and show that it leads to a much richer understanding of both gross and net capital flows. The approach identifies the time-varying portfolio shares that result from assets? time-varying expected returns and risk characteristics as a potential key source of international capital flows. |
| Keywords: | Capital movements ; International finance ; Portfolio management |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:280&r=dge |
| By: | Riccardo DiCecio; Edward Nelson |
| Abstract: | We estimate the dynamic stochastic general equilibrium model of Christiano, Eichenbaum, and Evans (2005) on United Kingdom data. Our estimates suggest that price stickiness is a more important source of nominal rigidity in the U.K. than wage stickiness. Our estimates of parameters governing investment behavior are only well behaved when post-1979 observations are included, which reflects government policies until the late 1970s that obstructed the influence of market forces on investment. |
| Keywords: | Equilibrium (Economics) - Mathematical models ; Economic policy - Great Britain |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2007-006&r=dge |
| By: | Matteo Iacoviello (Boston College); Fabio Schiantarelli (Boston College); Scott Schuh (Federal Reserve Bank of Boston) |
| Abstract: | We build and estimate a two-sector (goods and services) dynamic general equilibrium model with two types of inventories: finished goods (output) inventories yield utility services while materials (input) inventories facilitate the production of goods. The model, which contains neutral and inventory-specific technology shocks and preference shocks, is estimated by Bayesian methods. The estimated model replicates the volatility and cyclicality of inventory investment and inventory-target ratios. When estimated over subperiods, the results suggest that changes in the volatility of inventory shocks, or in structural parameters associated with inventories, play a minor role in the reduction of the volatility of output. |
| Keywords: | Inventories, business cycles, output volatility, Bayesian estimation |
| JEL: | E22 E32 E37 |
| Date: | 2007–03–23 |
| URL: | http://d.repec.org/n?u=RePEc:boc:bocoec:658&r=dge |
| By: | Orazio Attanasio; Nicola Pavoni |
| Abstract: | We derive testable implications of model in which first best allocations are not achieved because of a moral hazard problem with hidden saving. We show that in this environment agents typically achieve more insurance than that obtained under autarchy via saving, and that consumption allocation gives rise to 'excess smoothness of consumption', as found and defined by Campbell and Deaton (1987). We argue that the evidence on excess smoothness is consistent with a violation of the simple intertemporal budget constraint considered in a Bewley economy (with a single asset) and use techniques proposed by Hansen et al. (1991) to test the intertemporal budget constraint. We also construct closed form examples where the excess smoothness parameter has a structural interpretation in terms of the severity of the moral hazard problem. Evidence from the UK on the dynamic properties of consumption and income in micro data is consistent with the implications of the model. |
| JEL: | D82 E21 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:12994&r=dge |
| By: | Martin Bodenstein |
| Abstract: | The real exchange rate is very volatile relative to major macroeconomic aggregates and its correlation with the ratio of domestic over foreign consumption is negative (Backus-Smith puzzle). These two observations constitute a puzzle to standard international macroeconomic theory. This paper develops a two country model with complete asset markets and limited enforcement for international financial contracts that provides a possible explanation of these two puzzles. The model performs poorly with respect to asset pricing. However, with limited enforcement for both domestic and international financial contracts, the model's asset pricing implications are brought into line with the empirical evidence, albeit at the expense of raising real exchange rate volatility. |
| Keywords: | Foreign exchange rates |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:884&r=dge |
| By: | Ljungqvist, Lars; Sargent, Thomas J |
| Abstract: | Adding generous government supplied benefits to Prescott's (2002) model with employment lotteries and private consumption insurance causes employment to implode and prevents the model from matching outcomes observed in Europe. To understand the role of a 'not-so-well-known aggregation theory' that Prescott uses to rationalize the high labour supply elasticity that underlies his finding that higher taxes on labour have depressed Europe relative to the US, this paper compares aggregate outcomes for economies with two arrangements for coping with indivisible labour: (1) employment lotteries plus complete consumption insurance, and (2) individual consumption smoothing via borrowing and lending at a risk-free interest rate. The two arrangements support equivalent outcomes when human capital is not present; when it is present, allocations differ because households' reliance on personal savings in the incomplete markets model constrains the 'career choices' that are implicit in their human capital acquisition plans relative to those that can be supported by lotteries and consumption insurance in the complete markets model. Nevertheless, the responses of aggregate outcomes to changes in tax rates are quantitatively similar across the two market structures. Thus, under both aggregation theories, the high disutility that Prescott assigns to labour is an impediment to explaining European non-employment and benefits levels. Moreover, while the identities of the non-employed under Prescott's tax hypothesis differ between the two aggregation theories, they all seem counterfactual. |
| Keywords: | aggregation theories; employment lotteries; human capital; indivisible labour; labour supply elasticity; labour taxation; social and private insurance |
| JEL: | E24 E62 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6196&r=dge |
| By: | Gianluca Benigno; Christoph Theonissen |
| Abstract: | This paper addresses the consumption-real exchange rate anomaly. International real businesscycle models based on complete financial markets predict a unitary correlation between thereal exchange rate and the ratio of home to foreign consumption when subjected to supplyside shocks. In the data, this correlation is usually small and often negative. This paper showsthat this anomaly can be successfully addressed by models that have an incomplete financialmarket structure and a non-traded as well as traded goods production sector. |
| Keywords: | Consumption-real exchange rate anomaly, incomplete financial markets,nontraded goods |
| JEL: | F31 F41 |
| Date: | 2006–12 |
| URL: | http://d.repec.org/n?u=RePEc:cep:cepdps:dp0771&r=dge |
| By: | Doraszelski, Ulrich; Satterthwaite, Mark |
| Abstract: | We provide a general model of dynamic competition in an oligopolistic industry with investment, entry, and exit. To ensure that there exists a computationally tractable Markov perfect equilibrium, we introduce firm heterogeneity in the form of randomly drawn, privately known scrap values and setup costs into the model. Our game of incomplete information always has an equilibrium in cutoff entry/exit strategies. In contrast, the existence of an equilibrium in the Ericson & Pakes (1995) model of industry dynamics requires admissibility of mixed entry/exit strategies, contrary to the assertion in their paper, that existing algorithms cannot cope with. In addition, we provide a condition on the model's primitives that ensures that the equilibrium is in pure investment strategies. Building on this basic existence result, we first show that a symmetric equilibrium exists under appropriate assumptions on the model's primitives. Second, we show that, as the distribution of the random scrap values/setup costs becomes degenerate, equilibria in cutoff entry/exit strategies converge to equilibria in mixed entry/exit strategies of the game of complete information. Finally, we provide the first example of multiple symmetric equilibria in this literature. |
| Keywords: | dynamic oligopoly; industry dynamics; Markov perfect equilibrium |
| JEL: | C73 L13 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6212&r=dge |
| By: | Juan Pablo Rincon-Zapatero; Manuel S. Santos |
| Abstract: | This paper studies first-order differentiability properties of the value function in concave dynamic programs. Motivated by economic considerations, we dispense with commonly imposed interiority assumptions. We suppose that the correspondence of feasible choices varies with the vector of state variables, and we allow the optimal solution to belong to the boundary of this correspondence. Under minimal assumptions we show that the value function is continuously differentiable. We then discuss this result in the context of several economic models. |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:cte:werepe:we071405&r=dge |
| By: | Robert M. Hunt |
| Abstract: | This paper generalizes and extends the labor market search and matching model of Berliant, Reed, and Wang (2006). In this model, the density of cities is determined endogenously, but the matching process becomes more efficient as density increases. As a result, workers become more selective in their matches, and this raises average productivity (the intensive margin). Despite being more selective, the search process is more rapid so that workers spend more time in productive matches (the extensive margin). The effect of an exogenous increase in land area on productivity depends on the sensitivity of the matching function and congestion costs to changes in density. |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:07-7&r=dge |
| By: | Michael D. Bordo; Christopher Erceg; Andrew Levin; Ryan Michaels |
| Abstract: | This paper analyzes the role of transparency and credibility in accounting for the widely divergent macroeconomic effects of three episodes of deliberate monetary contraction: the post-Civil War deflation, the post-WWI deflation, and the Volcker disinflation. Using a dynamic general equilibrium model in which private agents use optimal filtering to infer the central bank's nominal anchor, we demonstrate that the salient features of these three historical episodes can be explained by differences in the design and transparency of monetary policy, even without any time variation in economic structure or model parameters. For a policy regime with relatively high credibility, our analysis highlights the benefits of a gradualist approach (as in the 1870s) rather than a sudden change in policy (as in 1920-21). In contrast, for a policy institution with relatively low credibility (such as the Federal Reserve in late 1980), an aggressive policy stance can play an important signalling role by making the policy shift more evident to private agents. |
| JEL: | E32 E42 E52 E58 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:12982&r=dge |