New Economics Papers
on Dynamic General Equilibrium
Issue of 2007‒05‒19
fourteen papers chosen by

  1. Unemployment and employment protection in a unionized economy with search frictions By Stähler, Nikolai
  2. The stabilizing role of government size By Javier Andrés; Rafael Doménech; Antonio Fatás
  3. Monetary Policy Analysis with Potentially Misspecified Models By Marco Del Negro; Frank Schorfheide
  4. An Idealized View of Financial Intermediation By Sissoko, Carolyn
  5. Welfare Analysis of HIV/AIDS: Formulating and Computing a Continuous Time Overlapping Generations Policy Model By Shorish, Jamsheed
  6. Information Criteria for Impulse Response Function Matching Estimation of DSGE Models By Hall, Alastair; Inoue, Atsushi; Nason M, James; Rossi, Barbara
  7. Variable Retirement and the Effects of Social Insurance on Savings, Wealth, and Welfare By Bruce, Neil; Turnovsky, Stephen J.
  8. Employment Protection, Product Market Regulation and Firm Selection By Winfried Koeniger; Julien Prat
  9. Should Central Banks Adjust Their Target Horizons in Response to House-Price Bubbles? By Meenakshi Basant Roi; Rhys R. Mendes
  10. Taking a DSGE Model to the Data Meaningfully By Juselius, Katarina; Franchi, Massimo
  11. Rational and near-rational bubbles without drift By Kevin J. Lansing
  12. Welfare-maximizing monetary policy under parameter uncertainty By Rochelle M. Edge; Thomas Laubach; John C. Williams
  13. Optimal Severance Pay in a Matching Model By Giulio Fella
  14. Asset Pricing in a Production Economy with Chew-Dekel Preferences By Claudio Campanale; Rui Castro; Gian Luca Clementi

  1. By: Stähler, Nikolai
    Abstract: In theoretical literature, the effects of employment protection on unemployment are ambiguous. Higher employment protection decreases job creation as well as job destruction. However, in most models, wages are bargained individually between workers and firms. Using a conventional matching model in which a monopoly union sets wages, I show that employment protection can unambiguously increase unemployment. Interestingly, I find that tightening the restrictions on redundancies and dismissals may even increase the probability of dismissal.
    Keywords: employment protection, search and matching models, unemployment, unions
    JEL: J41 J64 J65 J68
    Date: 2007
  2. By: Javier Andrés (Universidad de Valencia); Rafael Doménech (Economic Bureau of the Prime Minister, Spain); Antonio Fatás (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: 2007–05
  3. By: Marco Del Negro; Frank Schorfheide
    Abstract: Policy analysis with potentially misspecified dynamic stochastic general equilibrium (DSGE) models faces two challenges: estimation of parameters that are relevant for policy trade-offs and treatment of estimated deviations from the cross-equation restrictions. This paper develops and explores policy analysis approaches that are either based on a generalized shock structure for the DSGE model or the explicit modelling of deviations from cross-equation restrictions. Using post-1982 U.S. data we first quantify the degree of misspecification in a state-of-the-art DSGE model and then document the performance of different interest-rate feedback rules. We find that many of the policy prescriptions derived from the benchmark DSGE model are robust to the various treatments of misspecifications considered in this paper, but that quantitatively the cost of deviating from such prescriptions varies substantially.
    JEL: C32 E52
    Date: 2007–05
  4. By: Sissoko, Carolyn
    Abstract: Using the monetary model developed in Sissoko (2007), where the general equilibrium assumption that every agent buys and sells simultaneously is relaxed, we observe that in this environment fiat money can implement a Pareto optimum only if taxes are type-specific. We then consider intermediated money by assuming that financial intermediaries whose liabilities circulate as money have an important identifying characteristic: they are widely viewed as default-free. The paper demonstrates that default-free intermediaries who issue credit lines to consumers can resolve the monetary problem and make it possible for the economy to reach a Pareto optimum. We argue that our idealized concept of financial intermediation is a starting point for studying the monetary use of credit.
    Keywords: Fiat Money, Cash-in-advance, Financial Intermediation
    JEL: E5 G2
    Date: 2007
  5. By: Shorish, Jamsheed (Department of Economics and Finance, Institute for Advanced Studies, Vienna, Austria and Department of Economics, University of Illinois at Urbana-Champaign)
    Abstract: We introduce a continuous time overlapping generations demographic model, in which a social planner seeks to generate an optimal policy for influencing the demographic change of the underlying population in a neoclassical growth model. The model has the notable feature that the underlying state space is a continuum, leading to a Hamilton-Jacobi-Bellman PDE system which is defined over a Hilbert space generated by the ages of the population cohorts. In this technical report the dynamic programming problem is presented and the numerical approximation using a finite difference approximation is derived. This analysis is part of a larger research program on welfare analysis and policy development for the HIV/AIDS global pandemic.
    Keywords: Optimal control, continuous time overlapping generations, Hamilton-Jacobi-Bellman PDE, finite difference approximation, HIV/AIDS, demographic modeling
    JEL: C61 C63 D61
    Date: 2007–05
  6. By: Hall, Alastair; Inoue, Atsushi; Nason M, James; Rossi, Barbara
    Abstract: We propose a new Information Criterion for Impulse Response Function Matching estimators of the structural parameters of macroeconomic models. The main advantage of our procedure is that it allows the researcher to select the impulse responses that are most informative about the deep parameters, therefore reducing the bias and improving the efficiency of the estimates of the model's parameters. We show that our method substantially changes key parameter estimates of representative Dynamic Stochastic General Equilibrium models, thus reconciling their empirical results with the existing literature. Our criterion is general enough to apply to impulse responses estimated by VARs, local projections, as well as simulation methods.
    Keywords: impulse responses, matching, information criteria, DSGE models, structural macroeconomic models, estimation
    JEL: C32 E47 C52 C53
    Date: 2007
  7. By: Bruce, Neil; Turnovsky, Stephen J.
    Abstract: We construct a Blanchard-style overlapping generations model consisting of long-lived individuals who have uninsurable idiosyncratic risk resulting from uncertain retirement periods and medical costs in retirement. Without social insurance, such individuals must save for these eventualities. We examine the impact of pay-as-you-go social insurance policies (public pensions and medicare coverage) on individual and aggregate consumption, saving, and wealth levels as well as wealth distribution. We also derive expressions for optimal (Pareto improving) social insurance policies.
    JEL: D91 E10 J20
    Date: 2007
  8. By: Winfried Koeniger; Julien Prat
    Abstract: Why are firm and job turnover rates so similar across OECD countries? We argue that this may be due to the joint regulation of product and labor markets. For our analysis, we build a stochastic equilibrium model with search frictions and heterogeneous multiple-worker firms. This allows us to distinguish firm entry and exit from hiring and firing in a model with equilibrium unemployment. We show that firing costs, sunk entry costs and bureaucratic flow costs have countervailing effects on firm and job turnover as different types of firms select to operate in the market.
    Keywords: Firing Cost, Product Market Regulation, Firm Selection, Firm Turnover, Job Turnover, Unemployment
    JEL: E24 J63 J64 J65
    Date: 2007–01
  9. By: Meenakshi Basant Roi; Rhys R. Mendes
    Abstract: The authors investigate the implications of house-price bubbles for the optimal inflation-target horizon using a dynamic general-equilibrium model with credit frictions, house-price bubbles, and small open-economy features. They find that, given the distribution of shocks and inflation persistence over the past 25 years, the optimal target horizon for Canada tends to be at the lower end of the six- to eight-quarter range that has characterized the Bank of Canada's policy since the inception of the inflation-targeting regime. The authors' results also suggest that it may be appropriate to take a longer view of the inflation-target horizon when the economy faces a houseprice bubble.
    Keywords: Central bank research; Economic models; Monetary policy framework; Credit and credit aggregates; Inflation targets; Transmission of monetary policy
    JEL: E5 E42 E44 E52 E58 E61
    Date: 2007
  10. By: Juselius, Katarina; Franchi, Massimo
    Abstract: All economists say that they want to take their model to the data. But with incomplete and highly imperfect data, doing so is difficult and requires carefully matching the assumptions of the model with the statistical properties of the data. The cointegrated VAR (CVAR) offers a way of doing so. In this paper we outline a method for translating the assumptions underlying a DSGE model into a set of testable assumptions on a cointegrated VAR model and illustrate the ideas with the RBC model in Ireland (2004). Accounting for unit roots (near unit roots) in the model is shown to provide a powerful robustification of the statistical and economic inference about persistent and less persistent movements in the data. We propose that all basic assumptions underlying the theory model should be formulated as a set of testable hypotheses on the long-run structure of a CVAR model, a so called ‘theory consistent hypothetical scenario’. The advantage of such a scenario is that if forces us to formulate all testable implications of the basic hypotheses underlying a theory model. We demonstrate that most assumptions underlying the DSGE model and, hence, the RBC model are rejected when properly tested. Leaving the RBC model aside, we then report a structured CVAR analysis that summarizes the main features of the data in terms of long-run relations and common stochastic trends. We argue that structuring the data in this way offers a number of ‘sophisticated’ stylized facts that a theory model has to replicate in order to claim empirical relevance.
    Keywords: DSGE, RBC, cointegrated VAR
    JEL: C32 C52 E32
    Date: 2007
  11. By: Kevin J. Lansing
    Abstract: This paper derives a general class of intrinsic rational bubble solutions in a standard Lucas-type asset pricing model. I show that the rational bubble component of the price-dividend ratio can evolve as a geometric random walk without drift. The volatility of bubble innovations depends exclusively on fundamentals. Starting from an arbitrarily small positive value, the rational bubble expands and contracts over time in an irregular, wholly endogenous fashion, always returning to the vicinity of the fundamental solution. I also examine a near-rational solution in which the representative agent does not construct separate forecasts for the fundamental and bubble components of the asset price. Rather, the agent constructs only a single forecast for the total asset price that is based on a geometric random walk without drift. The agent's forecast rule is parameterized to match the moments of observable data. In equilibrium, the actual law of motion for the price-dividend ratio is stationary, highly persistent, and nonlinear. The agent's forecast errors exhibit near-zero autocorrelation at all lags, making it difficult for the agent to detect a misspecification of the forecast rule. Unlike a rational bubble, the near-rational solution allows the asset price to occasionally dip below its fundamental value. Under mild risk aversion, the near-rational solution generates pronounced low-frequency swings in the price-dividend ratio, positive skewness, excess kurtosis, and time-varying volatility--all of which are present in long-run U.S. stock market data. An independent contribution of the paper is to demonstrate an approximate analytical solution for the fundamental asset price that employs a nonlinear change of variables.
    Keywords: Stock - Prices ; Forecasting
    Date: 2007
  12. By: Rochelle M. Edge; Thomas Laubach; John C. Williams
    Abstract: This paper examines welfare-maximizing monetary policy in an estimated micro-founded general equilibrium model of the U.S. economy where the policymaker faces uncertainty about model parameters. Uncertainty about parameters describing preferences and technology implies not only uncertainty about the dynamics of the economy. It also implies uncertainty about the model's utility-based welfare criterion and about the eonomy's natural rate measures of interest and output. We analyze the characteristics and performance of alternative monetary policy rules given the estimated uncertainty regarding parameter estimates. We find that the natural rates of interest and output are imprecisely estimated. We then show that, relative to the case of known parameters, optimal policy under parameter uncertainty responds less to natural-rate terms and more to other variables, such as price and wage inflation and measures of tightness or slack that do not depend on natural rates.
    Keywords: Monetary policy
    Date: 2007
  13. By: Giulio Fella
    Abstract: This paper uses an equilibrium matching framework to study jointly the optimal private provision of severance pay and the allocational and welfare consequences of government intervention in excess of private arrangements. Firms insure riskaverse workers by means of simple explicit employment contracts. Contracts can be renegotiated ex post by mutual consent. It is shown that the lower bound on the privately optimal severance payment equals the fall in lifetime wealth associated with job loss. Simulations show that, despite contract incompleteness, legislated dismissal costs largely in excess of such private optimum are effectively undone by renegotiation and have only a small allocational effect. Welfare falls. Yet, for deviations from laissez faire in line with those observed for most OECD countries, the welfare loss is small.
    Keywords: Severance Pay, Contracts, Renegotiation
    JEL: J23 J64 J65
    Date: 2007–03
  14. By: Claudio Campanale; Rui Castro; Gian Luca Clementi
    Date: 2007

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