nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2007‒04‒09
23 papers chosen by
Christian Zimmermann
University of Connecticut

  1. Endogenous Cycles and Liquidity Risk By Jos van Bommel
  2. Growth and Bubbles with Consumption Externalities By Kazuo Mino
  3. Two-Fund Separation in Dynamic General Equilibrium By Karl Schmedders
  4. Money and Monetary Policy in DSGE Models By Arnab Bhattacharjee; Christoph Thoenissen
  5. The Future of Social Security By Martin Gonzalez-Eiras; Dirk Niepelt
  6. A Simple Business-Cycle Model with Schumpeterian Features By Luis F. Costa; Huw D. Dixon
  7. Imperfect Demand Expectations and Endogenous Business Cycles By Orlando Gomes
  8. Wealth as a Signal in the Search Model of Money By Tsunao Okumura
  9. Credit Constraints, Idiosyncratic Risks, and the Wealth Distribution in a Heterogeneous Agent Model By Chrsitiane Clemens; Maik Heinemann
  10. Optimal State-Contingent Unemployment Insurance By Sanchez, Juan M.
  11. Policy Analysis in a Matching Model with Intensive and Extensive Margins By Lei Fang; Richard Rogerson
  12. On the role of debt constraints in monetary equilibrium By Mario R. Páscoa; Myrian Petrassi; Juan Pablo Torres-Martinez
  13. The Persistence of Differences in Productivity, Wages, Skill Mixes and Profits Between Firms By Katsuya Takii
  14. Monetary Policy Amplification Effects through a Bank Capital Channel By Alvaro Aguiar; Inês Drumond
  15. The External Finance Premium and the Macroeconomy: US post-WWII Evidence By De Graeve Ferre
  16. A New Cost Channel of Monetary Policy By M. Alper Cenesiz
  17. Internal Increasing Returns to Scale and Economic Growth By John A. List; Haiwen Zhou
  18. Credit Cycles in a OLG Economy with Money and Bequest By Agliari Anna; Assenza Tiziana; Delli Gatti Domenico; Santoro Emiliano
  19. Unemployment Insurance in an Economy with a Hidden Labor Market By Alvarez-Parra, Fernando A.; Sanchez, Juan M.
  20. Equilibrium with default-dependent credit constraints By Emma Moreno Garcia; Juan Pablo Torres-Martinez
  21. On Finance as a Theory of TFP, Cross-Industry Productivity Differences, and Economic Rents. By Andres Erosa; Ana Hidalgo
  22. Policy Distortions and Aggregate Productivity with Heterogeneous Plants By Diego Restuccia; Richard Rogerson
  23. Bond Portfolios and Two-Fund Separation in the Lucas Asset-Pricing Model By Kenneth L. Judd; Felix Kubler; Karl Schmedders

  1. By: Jos van Bommel (University of Oxford)
    Abstract: Using an overlapping generations model with liquidity risk, we show that equilibrium aggregate investment and asset prices are cyclical. In an economy with neither a beginning nor an ending date, a stationary equilibrium can be obtained. In a startable equilibrium however, economic activity is highly cyclical. The first generations and consecutive odd ones invest most of their wealth in new long lived technologies, while even generations flock to seasoned claims that are sold by liquidity challenged older cohorts. We find that this liquidity driven cyclicality is driven by the optimal length of the investment horizon, not by agent live span
    Keywords: Business Cycles, Overlapping Generations, Liquidity
    JEL: E32 D91 E43
    Date: 2007–02–02
  2. By: Kazuo Mino (Graduate School of Economics, Osaka University)
    Abstract: This paper explores the role of consumption externalities in an overlapping generations economy with capital accumulation. If consumers in each generation are concerned with other agentsf consumption behaviors, there exist intergenerational as well as intragenerational consumption externalities. It is the presence of intergenreational consumption externalities that may produce fundamental effects both on equilibrium dynamics and on steady-state characterization of the economy. This paper demonstrates this fact in the context of a simple model of endogenously growing, overlapping-generations economy with or without asset bubbles.
    Keywords: Consumption Externalities, Overlapping Generations, Long-run Growth, Asset Bubbles.
    JEL: E32 J24 O40
    Date: 2007–02
  3. By: Karl Schmedders
    Abstract: The purpose of this paper is to examine the two-fund separation paradigm in the context of an infinite-horizon general equilibrium model with dynamically complete markets and heterogeneous consumers with time and state separable utility functions. With the exception of the dynamic structure, we maintain the assumptions of the classical static models that exhibit two-fund separation with a riskless security. In addition to a se- curity with state-independent payoffs agents can trade a collection of assets with dividends following a time-homogeneous Markov process. We make no further assumptions about the distribution of asset dividends, returns, or prices. Agents have equi-cautious HARA utility functions. If the riskless security in the economy is a consol then agents' portfolios exhibit two-fund separation. But if agents can trade only a one-period bond, this result no longer holds. Examples show this effect to be quantitatively signifcant. The underly- ing intuition is that general equilibrium restrictions lead to interest rate °uctuations that destroy the optimality of two-fund separation in economies with a one-period bond and result in different equilibrium portfolios.
  4. By: Arnab Bhattacharjee (University of St Andrews); Christoph Thoenissen (University of St Andrews)
    Abstract: We compare three methods of motivating money in New Keynesian DSGE Models: Money-in-the-utility function, shopping time and cash-in-advance constraint, as well as two ways of modelling monetary policy, interest rate feedback rule and money growth rules. We use impulse response analysis, and a set of econometric distance measures based on comparing model and data variance-covariance matrices to compare the different models. We find all models closed by an estimated interest rate feedback rule imply counter-cyclical policy and inflation rates, which is at odds with the data. This problem is robust to the introduction of demand side shocks, but is not a feature of models closed by an estimated money growth rule. Drawing on our econometric analysis, we argue that the cash-in-advance model, closed by a money growth rule, comes closest to the data
    Keywords: Intertemporal Macroeconomics, monetary policy, role of money, model selection, model selection
    JEL: C13 E32 E52
    Date: 2007–02–02
  5. By: Martin Gonzalez-Eiras (Universidad de San Andres); Dirk Niepelt (Study Center Gerzensee, IIES, Stockholm University and CEPR)
    Abstract: We analyze the effect of the projected demographic transition on the political support for social security, and equilibrium outcomes. Embedding a probabilistic-voting setup of electoral competition in the Diamond (1965) OLG model, we find that intergenerational transfers arise in the absence of altruism, commitment, or trigger strategies. Closed-form solutions predict population ageing to lead to higher social security tax rates, a rising share of pensions in GDP, but eventually lower social security benefits per retiree. The response of equilibrium tax rates to demographic shocks reduces old-age consumption risk. Calibrated to match features of the U.S. economy, the model suggests that, in response to the projected demographic transition, social security tax rates will gradually increase to 16 percent; other policies that distort labor supply will become less important; and in contrast with frequently voiced fears, labor supply therefore will rise.
    Date: 2007–02
  6. By: Luis F. Costa (ISEG/Technical University of Lisbon and UECE); Huw D. Dixon (University of York)
    Abstract: We develop a dynamic general equilibrium model of imperfect competition where a sunk cost of creating a new product regulates the type of entry that dominates in the economy: new products or more competition in existing industries. Considering the process of product innovation is irreversible, introduces hysteresis in the business cycle. Expansionary shocks may lead the economy to a new ‘prosperity plateau,’ but contractionary shocks only affect the market power of mature industries
    Keywords: Entry, Hysteresis, Mark-up
    JEL: E62 L13 L16
    Date: 2007–02–02
  7. By: Orlando Gomes (Escola Superior de Comunicação Social)
    Abstract: Optimal growth models aim at explaining long run trends of growth under the strong assumption of full efficiency in the allocation of resources. As a result, the steady state time paths of the main economic aggregates reflect constant, exogenous or endogenous, growth. To introduce business cycles in this optimality structure one has to consider some source of inefficiency. By assuming that firms adopt a simple non optimal rule to predict future demand, we let investment decisions to depart from the ones that would guarantee the total efficiency outcome. The new investment hypothesis is considered under three growth setups (the simple one equation Solow model of capital accumulation, the Ramsey model with consumption utility maximization, and a two sector endogenous growth setup); for each one of the models, we find that endogenous business cycles of various orders (regular and irregular) are observable
    Keywords: Endogenous business cycles, Nonlinear dynamics, Growth models, Bifurcation analysis.
    JEL: C61 E32 O41
    Date: 2007–02–02
  8. By: Tsunao Okumura
    Abstract: This paper investigates the possibility that wealth (holdings of money) serves as a signal of ability to produce high quality products for agents who cannot directly observe the quality of the products. A producer’s wealth may advertise past success in selling products to agents who knew the producer’s ability and thus signal its ability. This analysis shows that such signaling effects may arise in equilibrium and may lead to more unequal distributions of wealth and lower welfare than would otherwise arise.
    Keywords: Random matching, Money holdings, Signaling, Distribution of wealth, Welfare, Divisible money, Product quality.
    JEL: E40 D82 D83 D31
  9. By: Chrsitiane Clemens (Otto-von-Guericke University Magdeburg); Maik Heinemann (University of Lueneburg)
    Abstract: This paper examines the effects of credit market imperfections and idiosyncratic risks on occupational choice, capital accumulation, as well as on the income and wealth distribution in a two sectore heterogeneous agent general equilibrium model. Workers and firm owners are subject to idiosyncratic shocks. Entrepreneurship is the riskier occupation. Compared to an economy with perfect capital markets, we find for the case of serially correlated shocks that more individuals choose the entrepreneurial profession in the presence of credit consraints, and that the fluctuation between occupationa increase too. Workers and entrepreneurs with high individual productivity tend to remain in their present occupantion, whereas low productivity individuals are more likely to switch between professions. Interestingly, these results reverse if we assume iid shocks, thus indicating that the nature of the underlying shocks plays an important role for the general equilibrium effects. In general, the likelihood of entrepreneurship increases with individual wealth.
    Keywords: DSGE model, wealth distribution, occupational choice, credit constraints
    JEL: C68 D3 D8 D9 G0 J24
    Date: 2007–03
  10. By: Sanchez, Juan M.
    Abstract: Since the probability of finding a job is affected not only by individual effort but also by the aggregate state of the economy, designing unemployment insurance payments conditional on the business cycle could be valuable. This paper answers a fundamental question related to this issue: How should the payments vary with the aggregate state of the economy?
    Keywords: Unemployment Insurance; Aggregate Fluctuations; Recursive Contracts and Moral Hazard.
    JEL: J68 D82 D61 J65 D74
    Date: 2006–04
  11. By: Lei Fang; Richard Rogerson
    Abstract: The large differences in hours of work across industrialized countries reflect large differences in both employment to population ratios and hours per worker. We imbed the canonical model of labor supply into a standard matching model to produce a model in which both the intensive and extensive margins are operative. We then assess the implications of several policies for changes along the two margins. Firing taxes and entry barriers both lead to changes in hours and employment in opposite directions, while tax and transfer policies lead to decreases in both employment and hours per worker.
    JEL: E2 J2
    Date: 2007–04
  12. By: Mario R. Páscoa; Myrian Petrassi (Department of Economics, PUC-Rio); Juan Pablo Torres-Martinez (Department of Economics, PUC-Rio)
    Abstract: We show that in economies without liquidity frictions, but with incomplete financial markets, when agents are infinitely lived and uniformly impatient, money can still be essential (that is, have a positive price in equilibrium) if and only if each agent has binding debt constraints at some node of her life span. That is, contrary to what might be expected, in the absence of a very productive financial market, frictions induced by debt constraints create some room for improving efficiency, by allowing money to have a role in transferring wealth across dates and states of nature.
    Keywords: Cashless economies, Binding debt constraints, Fundamental value of money.
    JEL: D50 D52
    Date: 2007–03
  13. By: Katsuya Takii (Osaka School of International Public Policy, Osaka University)
    Abstract: In this paper, we construct a dynamic assignment model that can provide a unified explanation of several observed features of persistent differences in productivity, wages, skill mixes and profits between firms. Large organization capital (high firm-specific knowledge) attracts skilled workers, who can create further organization capital in the future. This positive feedback brings about persistent differences in these variables. We also analyze how the real and perceived values of a firm's organization capital interactively influence persistence. We estimate parameters and simulate the model. Our results show that a positive assignment mechanism accounts for a large part of the observed persistence.
    Keywords: Organization Capital, Assignment, Persistence
    JEL: J24 L25
    Date: 2007–03
  14. By: Alvaro Aguiar (Faculdade de Economia, Universidade do Porto); Inês Drumond (Faculdade de Economia, Universidade do Porto)
    Abstract: This paper improves the analysis of the role of financial frictions in the transmission of monetary policy, by bringing together the borrowers' balance sheet channel with an additional channel working through bank capital, considering capital adequacy regulations and households' preferences for liquidity. Detailing a dynamic new Keynesian general equilibrium model, in which households require a (countercyclical) liquidity premium to hold bank capital, we find that the introduction of bank capital amplifies monetary shocks to the macroeconomy through a liquidity premium effect on the external finance premium. This effect, together with the financial accelerator, generates quantitatively large amplification effects
    Keywords: Bank capital channel; Bank capital requirements; Financial accelerator; Liquidity premium; Monetary transmission mechanism
    JEL: E44 E32 E52 G28
    Date: 2007–02–02
  15. By: De Graeve Ferre (Ghent University)
    Abstract: This paper embeds the financial accelerator into a medium-scale DSGE model and estimates it using Bayesian methods. Incorporation of financial frictions enhances the model's description of the main macroeconomic aggregates. The financial accelerator accounts for approximately ten percent of monetary policy transmission. The model-consistent premium for external finance compares well to observable proxies of the premium, such as the high-yield spread. Fluctuations in the external finance premium are primarily driven by investment supply and monetary policy shocks. In terms of recession prediction, false signals of the premium can be given an economic interpretation
    Keywords: financial accelerator, external finance premium, DSGE model, Bayesian estimation
    JEL: E4 E5 G32
    Date: 2007–02–02
  16. By: M. Alper Cenesiz (Saarland University, University of Kiel)
    Abstract: In this paper, I developed a new cost channel of monetary policy transmission in a small scale, dynamic, general equilibrium model. The new cost channel of monetary policy transmission implies that the frequency of price adjustment increases in the nominal interest rate. I found that allowing for the new cost channel can account both for the muted and delayed inflation response and for the persistence of the output response to monetary policy shocks. Without any additional assumption, my model can also generate the delayed output response, though for a slightly more competitive goods market calibration
    Keywords: Price stickiness, Monetary policy, Price adjustment, Persistence
    JEL: E31 E32 E52
    Date: 2007–02–02
  17. By: John A. List; Haiwen Zhou
    Abstract: This study develops a model of endogenous growth based on increasing returns due to firms' technology choices. Particular attention is paid to the implications of these choices, combined with the substitution of capital for labor, on economic growth in a general equilibrium model in which the R&D sector produces machines to be used for the sector producing final goods. We show that incorporating oligopolistic competition in the sector producing finals goods into a general equilibrium model with endogenous technology choice is tractable, and we explore the equilibrium path analytically. The model illustrates a novel manner in which sustained per capita growth of consumption can be achieved -- through continuous adoption of new technologies featuring the substitution between capital and labor. Further insights of the model are that during the growth process, the size of firms producing final goods increases over time, the real interest rate is constant, and the real wage rate increases over time.
    JEL: E10 E22 O41
    Date: 2007–03
  18. By: Agliari Anna (Catholic University of Piacenza); Assenza Tiziana (Catholic University of Piacenza); Delli Gatti Domenico (Catholic University of Piacenza); Santoro Emiliano (University of Cambridge and University of Trento)
    Abstract: In this paper we develop an extended version of the original Kiyotaki and Moore's model ("Credit Cycles" Journal of Political Economy, vol. 105, no 2, April 1997)(hereafter KM) using an overlapping generation structure instead of the assumption of infinitely lived agents adopted by the authors. In each period the population consists of two classes of heterogeneous interacting agents, in particular: a financially constrained young agent (young farmer), a financially constrained old agent (old farmer), an unconstrained young agent (young gatherer), an unconstrained old agent (old gatherer). By assumption each young agent is endowed with one unit of labour. Heterogeneity is introduced in the model by assuming that each class of agents use different technologies to pro- duce the same non durable good. If we study the effect of a technological shock it is possible to demonstrate that its effects are persistent over time in fact the mechanism that it induces is the reallocation the durable asset ("land")among agents. As in KM we develop a dynamic model in which the durable asset is not only an input for production processes but also collateralizable wealth to secure lenders from the risk of borrowers'default. In a context of intergenerational altruism, old agents leave a bequest to their offspring. Money is a means of payment and a reserve of value because it enables to access consumption in old age. For simplicity we assume that preferences are defined over consumption and bequest of the agent when old. Money plays two different and contrasting roles with respect to landholding. On the one hand, given the bequest, the higher the amount of money the young wants to hold, the lower landholding. On the other hand the higher the money of the old, the higher the resources available to him and the higher bequest and landholding. We study the complex dynamics of the allocation of land to farmers and gatherers - which determines aggregate output - and of the price of the durable asset. If a policy move does not change the ratio of money of the farmer and of the gatherer, i.e. if the central bank changes the rates of growth of the two monetary aggregates by the same amount, monetary policy is superneutral, i.e. the allocation of land to the farmer and to the gatherer does not change, real variables are unaffected and the only e¤ect of the policy move is an increase in the rate of inflation, which is pinned down to the (uniform) rate of change of money, and of the nominal interest rate. If, on the other hand, the move is differentiated, i.e. the central bank changes the rates of growth of the two monetary aggregates by different amounts so that the rates of growth are heterogeneous, money is not superneutral, i.e. the allocation of land changes and real variables are permanently affected, even if the rates of growth of the two aggregates go back to the original value afterwards
    Keywords: Credit Cycles, monetary policy
    JEL: E3 E4
    Date: 2007–02–02
  19. By: Alvarez-Parra, Fernando A.; Sanchez, Juan M.
    Abstract: This paper considers the problem of optimal unemployment insurance in a moral hazard framework. Unlike existing literature, unemployed workers can secretly participate in a hidden labor market; as a consequence, an endogenous lower bound for promised utility preventing "immiserization" arises. Moreover, the presence of a hidden labor market makes possible an extra deviation and therefore hardens the provision of incentives. Under linear cost of effort, we show that the optimal contract prescribes no participation in the hidden labor market and a decreasing sequence of unemployment payments until the lower bound for promised utility is reached. At that moment, participation jumps and unemployment payments drop down to zero. For the case of non-linear effort cost we calibrate the model to Spain. As in the linear cost of effort, this exercise reproduces no participation and decreasing payments during the initial phase of unemployment. After around three years of unemployment, the contract prescribes a jump in participation and an abrupt decline in unemployment payments. To the best of our knowledge, this is the first paper justifying an abrupt drop in unemployment payments. In addition, the quantitative analysis suggests that in an environment in which agents differ in separation rate, the hidden labor market reinforces the benefits from a type-dependent unemployment system.
    Keywords: Unemployment Insurance; Hidden Labor Markets; Moral Hazard; Recursive Contracts
    JEL: J68 D82
    Date: 2006–12
  20. By: Emma Moreno Garcia; Juan Pablo Torres-Martinez (Department of Economics, PUC-Rio)
    Abstract: We state an infinite horizon sequential markets model with real assets in positive net supply and subject to credit risk. By introducing default-dependent borrowing constraints, we show the existence of equilibrium.
    Keywords: Equilibrium, Infinite horizon incomplete markets, Infinite-lived real assets.
    Date: 2007–03
  21. By: Andres Erosa; Ana Hidalgo
    Abstract: We develop a theory of capital-market imperfections to study how the ability to enforce contracts affects resource allocation across entrepreneurs of different productivities, and across industries with different needs for external financing. The theory implies that countries with a poor ability to enforce contracts are characterized by the use of inefficient technologies, low aggregate TFP, low development of financial markets, large differences in labor productivity across industries, and large employment shares in industries with low productivity. These implications of our theory are supported by the empirical evidence. The theory also suggests that entrepreneurs have a vested interest in maintaining a status quo with low enforcement since it allows them to extract rents from the factor services they hire.
    Keywords: Macroeconmics, Capital Market Imperfections, Total-factor Productivity, Relative Prices, Sectorial Allocation, Limited Enforcement
    JEL: E2 E5 O16
    Date: 2007–04–03
  22. By: Diego Restuccia; Richard Rogerson
    Abstract: We formulate a version of the growth model in which production is carried out by heterogeneous plants and calibrate it to US data. In the context of this model we argue that differences in the allocation of resources across heterogeneous plants may be an important factor in accounting for cross-country differences in output per capita. In particular, we show that policies which create heterogeneity in the prices faced by individual producers can lead to sizeable decreases in output and measured TFP in the range of 30 to 50 percent. We show that these effects can result from policies that do not rely on aggregate capital accumulation or aggregate relative price differences. More generally, the model can be used to generate differences in capital accumulation, relative prices, and measured TFP.
    Keywords: Plant heterogeneity, productivity, policy
    JEL: O1
    Date: 2007–03–29
  23. By: Kenneth L. Judd; Felix Kubler; Karl Schmedders
    Abstract: The two-fund separation theorem from static porfolio analysis generalizes to dynamic Lucas-style asset model only when a consol is presemt. If all bonds have finite maturity and do not span the consol, then equilibrium will devitate, often significantly, from two-fund separation even with the classical preference assumptions. Furthermore, equilibrium bond trading volume is unrealistically large, particularly for long-term bond, and would be very costly in the presence of transaction costs. We demonstrate that investors choosing two-fund portfolios with bond ladders that approximately replicate consols do almost as well as traders with equilibrium investment strategies. This result is enhanced by adding bonds to the collection of assets even if they are not necessary for spanning. In the light of these results, we argue that transaction cost considerations make portfolios using two-fund separation and bond laddering nearly optimal investment strategies.
    Keywords: Dynamically complete markets, general equilibrium, consol, bonds, interest rate fluctuation, reinvestment risk, bond laddering

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