nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2007‒05‒26
fourteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. To React or Not? Fiscal Policy, Volatility and Welfare in the EU-3 By Jim Malley; Apostolis Philippopoulos; Ulrich Woitek
  2. Financing Development: The Role of Information Costs By Jeremy Greenwood; Juan M. Sanchez; Cheng Wang
  3. Implications of More Precise Information for Technological Development and Welfare By Bernhard Eckwert; Burkhard Drees
  4. Are Shocks to the Terms of Trade Shocks to Productivity? By Timothy J. Kehoe; Kim J. Ruhl
  5. Rational Pessimism, Rational Exuberance, and Asset Pricing Models By Ravi Bansal; A. Ronald Gallant; George Tauchen
  6. When the Joneses’ Consumption Hurts: Optimal Income Taxation and Public Good Provision in an OLG Model By Aronsson, Thomas
  7. Wage Gaps and Development: Lessons from U.S. History By Peter Rangazas; Alex Mourmouras
  8. Robust Optimal Control for a Consumption-investment Problem By Alexander Schied
  9. Time preference and cyclical endogenous growth By Gomes, Orlando
  10. The Role of Immigration in Sustaining the Social Security System: A Political Economy Approach By Razin, Assaf; Sand, Edith
  12. Dynamic Legislative Policy Making By John Duggan; Tasos Kalandrakis
  13. Dollarization and financial integration By Cristina Arellano; Jonathan Heathcote
  14. Altruism, Fertility, and the Value of Children: Health Policy Evaluation and Intergenerational Welfare By Javier A. Birchenall; Rodrigo R. Soares

  1. By: Jim Malley; Apostolis Philippopoulos; Ulrich Woitek
    Abstract: This paper develops a dynamic stochastic general equilibrium model to examine the quantitative macroeconomic implications of countercyclical fiscal policy for France, Germany and the UK. The model incorporates real wage rigidity which is the particular market failure justifying policy intervention. We subject the model to productivity shocks and use either government consumption or investment to react to the output gap or the public debt-to-output ratio. If the object of fiscal policy is purely to stabilize output or debt volatility, then our results suggest substantial reductions can be obtained, especially with respect to output. In stark contrast, however, a formal general equilibrium welfare assessment of the volatility implications of these alternative instrument/target combinations reveals the welfare gains from active policy, measured as a share of consumption, to be very modest.
  2. By: Jeremy Greenwood; Juan M. Sanchez; Cheng Wang
    Abstract: How does technological progress in financial intermediation affect the economy? To address this question a costly-state verification framework is embedded into a standard growth model. In particular, financial intermediaries can invest resources to monitor the returns earned by firms. The inability to monitor perfectly leads to firms earning rents. Undeserving firms are financed, while deserving ones are under funded. A more efficient monitoring technology squeezes the rents earned by firms. With technological advance in the financial sector, the economy moves continuously from a credit-rationing equilibrium to a perfectly efficient competitive equilibrium. A numerical example suggests that finance is important for growth.
    JEL: E44 O11 O16 O43
    Date: 2007–05
  3. By: Bernhard Eckwert; Burkhard Drees
    Abstract: This paper analyzes the dynamic interactions between the precision of information, technological development, and welfare within an overlapping generations model. More precise information about idiosyncratic production shocks has ambiguous effects on technological progress and welfare, which depend critically on the risk sharing capacity of the economy's financial system. For example, we show that with efficient risk sharing more precise information adversely affects the equilibrium risk allocation and creates a negative uncertainty-related welfare effect, at the same time as it accelerates technological progress and increases R&D investment.
    Keywords: Economic growth , Development , Financial systems , Risk management , Economic models ,
    Date: 2007–04–20
  4. By: Timothy J. Kehoe; Kim J. Ruhl
    Abstract: International trade is frequently thought of as a production technology in which the inputs are exports and the outputs are imports. Exports are transformed into imports at the rate of the price of exports relative to the price of imports: the reciprocal of the terms of trade. Cast this way, a change in the terms of trade acts as a productivity shock. Or does it? In this paper, we show that this line of reasoning cannot work in standard models. Starting with a simple model and then generalizing, we show that changes in the terms of trade have no first-order effect on productivity when output is measured as chain-weighted real gross domestic product. The terms of trade do affect real income and consumption in a country, and we show how measures of real income change with the terms of trade at business cycle frequencies and during financial crises.
    JEL: E23 F41 F43
    Date: 2007–05
  5. By: Ravi Bansal; A. Ronald Gallant; George Tauchen
    Abstract: The paper estimates and examines the empirical plausibiltiy of asset pricing models that attempt to explain features of financial markets such as the size of the equity premium and the volatility of the stock market. In one model, the long run risks model of Bansal and Yaron (2004), low frequency movements and time varying uncertainty in aggregate consumption growth are the key channels for understanding asset prices. In another, as typified by Campbell and Cochrane (1999), habit formation, which generates time-varying risk-aversion and consequently time-variation in risk-premia, is the key channel. These models are fitted to data using simulation estimators. Both models are found to fit the data equally well at conventional significance levels, and they can track quite closely a new measure of realized annual volatility. Further scrutiny using a rich array of diagnostics suggests that the long run risk model is preferred.
    JEL: G0 G00 G1 G10 G12
    Date: 2007–05
  6. By: Aronsson, Thomas (Department of Economics, Umeå University)
    Abstract: This paper considers a two-type, self-selection, overlapping generations model with nonlinear labor income and capital income taxation and public good provision, when people care about their relative consumption compared to others. In each case, the standard optimality expressions are modified by terms that reflect the extent to which people care about relative consumption. The modified tax formulas imply substantially higher marginal labor income tax rates than in the conventional case, under plausible assumptions and available empirical estimates regarding comparison consumption concerns. The extent to which the public good provision rule should be modified is shown to depend critically on the preference elicitation format. The effects of positionality on the marginal capital income tax rates are ambiguous.
    Keywords: Optimal taxation; redistribution; public goods; relative consumption; status; positional goods
    JEL: D62 H21 H23 H41
    Date: 2007–05–16
  7. By: Peter Rangazas; Alex Mourmouras
    Abstract: During the course of development, wages and labor productivity are much higher in the nonfarm sectors of the economy than in agriculture. In this paper, we examine the sources and consequences of wage and productivity gaps in the U.S. from 1800 to 2000. We build a quantitative general equilibrium model that closely matches the two-century long paths of farm and non-farm labor productivity growth, schooling, and fertility in the U.S. The family farm emerges as an important institution that contributes to differences in wages and labor productivity. Income from farm ownership compensates farm workers for the relatively low labor productivity and wages earned in agriculture. Farm ownership, along with the higher cost of raising children off the farm, generated a two-fold gap in labor productivity across the farm and nonfarm sectors in the 19th century US. Consequently, the reallocation of labor from farming to industry raised the average annual growth rate of output per worker by about half a percentage point over the 19th century. The paper also draws some lessons from the quantitative analysis of U.S. economic history for currently developing countries.
    Date: 2007–05–03
  8. By: Alexander Schied
    Abstract: We give an explicit PDE characterization for the solution of the problem of maximizing the utility of both terminal wealth and intertemporal consumption under model uncertainty. The underlying market model consists of a risky asset, whose volatility and long-term trend are driven by an external stochastic factor process. The robust utility functional is defined in terms of a HARA utility function with risk aversion parameter 0 < a < 1 and a dynamically consistent coherent risk measure, which allows for model uncertainty in the distributions of both the asset price dynamics and the factor process. Our method combines recent results by Wittmüss (2007) on the duality theory of robust optimization of consumption with a stochastic control approach to the dual problem of determining a 'worst-case martingale measure'.
    Keywords: Optimal Consumption, Robust Control, Model Uncertainty, Incomplete Markets, Stochastic Volatility, Coherent Risk Measures, Convex Duality
    JEL: G11 D81
    Date: 2007–05
  9. By: Gomes, Orlando
    Abstract: The paper develops an AK endogenous growth model with an endogenously determined rate of intertemporal preference. Following some of the related literature, we assume that the degree of impatience that is revealed by the representative agent, regarding future consumption, depends on income. To be precise, the proposed framework establishes a link between the output gap and the discount rate attached to the sequence of future utility functions. We analyze both local and global dynamics. From a local analysis point of view, a variety of stability results is possible to obtain, depending on parameter values. The study of global dynamics allows to find endogenous business cycles under some reasonable circumstances. On a second stage, the model is extended to include the role of leisure.
    Keywords: Time preference; Endogenous growth; Endogenous fluctuations; Quasiperiodic orbits.
    JEL: O41 C61 E32
    Date: 2007–05
  10. By: Razin, Assaf; Sand, Edith
    Abstract: In the political debate people express the idea that immigrants are good because they can help pay for the old. The paper explores this idea in a dynamic political-economy setup. We characterize sub-game perfect Markov equilibria where immigration policy and pay-as-you-go (PAYG) social security system are jointly determined through a majority voting process. The main feature of the model is that immigrants are desirable for the sustainability of the social security system, because the political system is able to manipulate the ratio of old to young and thereby the coalition which supports future high social security benefits. We demonstrate that the older is the native born population the more likely is that the immigration policy is liberalized; which in turn has a positive effect on the sustainability of the social security system.
    Keywords: demographic stretegic voting; overlapping generations; social security sustainability
    JEL: E1 H3 P1
    Date: 2007–05
  11. By: Ewald, Christian-Oliver; Xiao, Yajun
    Abstract: We consider a continuous time market model, in which agents influence asset prices. The agents are assumed to be rational and maximizing expected utility from terminal wealth. They share the same utility function but are allowed to possess different levels of information. Technically our model represents a stochastic differential game with anticipative strategy sets. We derive necessary and sufficient criteria for the existence of Nash-equilibria and characterize them for various levels of information asymmetry. Furthermore we study in how far the asymmetry in the level of information influences Nash-equilibria and general welfare. We show that under certain conditions in a competitive environment an increased level of information may in fact lower the level of general welfare. This effect can not be observed in representative agent based models, where information always increases welfare. Finally we extend our model in a way, that we add prior stages, in which agents are allowed to buy and sell information from each other, before engaging in trading with the market assets. We determine equilibrium prices for particular pieces of information in this setup.
    Keywords: information; financial markets; stochastic differential games
    JEL: G14 G11 C73
    Date: 2007
  12. By: John Duggan; Tasos Kalandrakis (W. Allen Wallis Institute of Political Economy, 107 Harkness Hall, University of Rochester, Rochester, NY 14627-0158)
    Abstract: We prove existence of stationary Markov perfect equilibria in an infinite-horizon model of legislative policy making in which the policy outcome in one period determines the status quo in the next. We allow for a multidimensional policy space and arbitrary smooth stage utilities. We prove that all such equilibria are essentially in pure strategies and that proposal strategies are differentiable almost everywhere. We establish upper hemicontinuity of the equilibrium correspondence, and we derive conditions under which each equilibrium of our model determines a unique invariant distribution characterizing long run policy outcomes. We illustrate the equilibria of the model in a numerical example of policy making in a single dimension, and we discuss extensions of our approach to accommodate much of the institutional structure observed in real-world politics.
    Date: 2007–05
  13. By: Cristina Arellano; Jonathan Heathcote
    Abstract: How does a country’s choice of exchange rate regime impact its ability to borrow from abroad? We build a small open economy model in which the government can potentially respond to shocks via domestic monetary policy and by international borrowing. We assume that debt repayment must be incentive compatible when the default punishment is equivalent to permanent exclusion from debt markets. We compare a floating regime to full dollarization. We find that dollarization is potentially beneficial, even though it means the loss of the monetary instrument, precisely because this loss can strengthen incentives to maintain access to debt markets. Given stronger repayment incentives, more borrowing can be supported, and thus dollarization can increase international financial integration. This prediction of theory is consistent with the experiences of El Salvador and Ecuador, which recently dollarized, as well as with that of highly-indebted countries like Italy which adopted the Euro as part of Economic and Monetary Union. In each case, spreads on foreign currency government debt declined substantially around the time of regime change.
    Date: 2007
  14. By: Javier A. Birchenall (University of California, Santa Barbara); Rodrigo R. Soares (University of Maryland, Catholic University of Rio de Janeiro, NBER and IZA)
    Abstract: This paper accounts for the value of children and future generations in the evaluation of health policies. This is achieved through the incorporation of altruism and fertility in a "value of life" type of framework. We are able to express adults’ willingness to pay for changes in child mortality and also to incorporate the welfare of future generations in the evaluation of current policies. Our model clarifies a series of puzzles from the literature on the "value of life" and on intergenerational welfare comparisons. We show that, by incorporating altruism and fertility into the analysis, the estimated welfare gain from recent reductions in mortality in the U.S. easily doubles.
    Keywords: value of life, mortality, fertility, altruism, intergenerational welfare, willingness to pay
    JEL: J17 J13 I10
    Date: 2007–05

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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