nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2007‒08‒08
25 papers chosen by
Christian Zimmermann
University of Connecticut

  1. On-the-job search and the cyclical dynamics of the labor market By Michael U. Krause; Thomas A. Lubik
  2. Monetary regime change and business cycles By Vasco Cúrdia; Daria Finocchiaro
  3. Interpreting Life-Cycle Inequality Patterns asan Efficient Allocation: Mission Impossible? By Mark Huggett; Alejandro Badel
  4. Liquidity in asset markets with search frictions By Ricardo Lagos; Guillaume Rocheteau
  5. Sources of Lifetime Inequality By Mark Huggett; Gustavo Ventura; Amir Yaron
  6. Worker Absenteeism in Search Equilibrium By Per Engström; Bertil Holmlund
  7. Why Are Married Men Working So Much? The Macroeconomics of Bargaining Between Spouses By John Knowles
  8. Inflation, Investment Composition and Total Factor Productivity By Stefan Niemann; Michael Evers; Marc Schiffbauer
  9. Dynamics and monetary policy in a fair wage model of the business cycle By David de la Croix; Gregory de Walque; Rafael Wouters
  10. Human Capital, Mortality and Fertility: A Unified Theory of the Economic and Demographic Transition By Matteo Cervellati; Uwe Sunde
  11. Resurrecting Equilibria Through Cycles By Barnett, Richard; Bhattacharya, Joydeep; Bunzel, Helle
  12. "Tit-For-Tat Equilibria in Discounted Repeated Games with Private Monitoring" By Masanao Aoki; Hiroshi Yoshikawa
  13. GAMMA, a Simulation Model for Ageing, Pensions and Public Finances By Nick Draper; Alex Armstrong
  14. A Monetary Union Model with Cash-in-Advance Constraints By Cengiz, Gulfer; Cicek, Deniz; Kuzubas, Tolga Umut; Olcay, Nadide Banu; Saglam, Ismail
  15. Asymmetric expectation effects of regime shifts and the Great Moderation By Zheng Liu; Daniel F. Waggoner; Tao Zha
  16. Efficiency, Depth and Growth: Quantitative Implications of Finance and Growth Theory By Alex William Trew
  17. Money and bonds: an equivalence theorem By Narayana R. Kocherlakota
  18. "Habit Formation and the Present-Value Model of the Current Account: Yet Another Suspect" By Takashi Kano
  19. Oil shocks and external adjustment By Martin Bodenstein; Christopher J. Erceg; Luca Guerrieri
  20. Measuring the Impact of Technological Progress on the Household By Karen A. Kopecky
  21. Two-Country New Keynesian DSGE Model: A Small Open Economy as a Limit Case By Marcos Antonio C. da Silveira
  22. Credit constraints and housing markets in New Zealand By Andrew Coleman
  23. Extracting business cycle fluctuations: what do time series filters really do? By Arturo Estrella
  24. Optimal Growth and Uncertainty: Learning By Christos Koulovatianos; Leonard J. Mirman; Marc Santugini
  25. Shocks, structures or monetary policies? The euro area and US after 2001 By Lawrence Christiano; Roberto Motto; Massimo Rostagno

  1. By: Michael U. Krause (Economic Research Center, Deutsche Bundesbank, Wilhelm-Epstein-Str. 14, D-60431 Frankfurt, Germany.); Thomas A. Lubik (Federal Reserve Bank of Richmond, 701 East Byrd Street, Richmond, VA 23261, USA.)
    Abstract: We show how on-the-job search and the propagation of shocks to the economy are intricately linked. Rising search by employed workers in a boom amplifies the incentives of firms to post vacancies. In turn, more vacancies increases job search. By keeping job creation costs low for firms, on-the-job search greatly amplifies shocks. In our baseline calibration, this allows the model to generate fluctuations of unemployment, vacancies, and labor productivity whose magnitudes are close to the data, and leads output to be highly autocorrelated. JEL Classification: E24, E32, J64.
    Keywords: Search and matching, job-to-job mobility, worker flows Beveridge curve, business cycle, propagation.
    Date: 2007–07
  2. By: Vasco Cúrdia; Daria Finocchiaro
    Abstract: This paper analyzes how changes in monetary policy regimes influence the business cycle in a small open economy. We estimate a dynamic stochastic general equilibrium (DSGE) model on Swedish data, explicitly taking into account the 1993 monetary regime change, from exchange rate targeting to inflation targeting. The results confirm that monetary policy reacted primarily to exchange rate movements in the target zone and to inflation in the inflation-targeting regime. Devaluation expectations were the principal source of volatility in the target zone period. In the inflation-targeting period, labor supply and preference shocks have become relatively more important.
    Keywords: Business cycles ; Monetary policy ; Foreign exchange rates ; Inflation (Finance) ; Equilibrium (Economics) ; Stochastic analysis ; Econometric models
    Date: 2007
  3. By: Mark Huggett; Alejandro Badel (Department of Economics, Georgetown University)
    Abstract: Data on consumption, earnings, wages and hours dispersion over the life cycle has been viewed as being at odds with an efficient allocation. We challenge this view. We show that a model with preference and wage shocks and full insurance produces the type of inequality patterns across age groups found in U.S. data. The efficient allocation model requires an increasing preference shifter dispersion profile to account for an increasing consumption dispersion profile. We examine U.S. data and find support for the view that the dispersion in preference shifters increases with age. Classification-JEL Codes: E21, D91, D52
    Keywords: Life Cycle Inequality, Efficient Allocation, Preference Shocks
    Date: 2007–07–03
  4. By: Ricardo Lagos; Guillaume Rocheteau
    Abstract: We study how trading frictions in asset markets affect the distribution of asset holdings, asset prices, efficiency, and standard measures of liquidity. To this end, we analyze the equilibrium and optimal allocations of a search-theoretic model of financial intermediation similar to Duffie, Gârleanu and Pedersen (2005). In contrast with the existing literature, the model we develop imposes no restrictions on asset holdings, so traders can accommodate frictions by varying their trading needs through changes in their asset positions. We find that this is a critical aspect of investor behavior in illiquid markets. A reduction in trading frictions leads to an increase in the dispersion of asset holdings and trade volume. Transaction costs and intermediaries’ incentives to make markets are nonmonotonic in trade frictions. With the entry of dealers, these nonmonotonicities give rise to an externality in liquidity provision that can lead to multiple equilibria. Tight spreads are correlated with large volume and short trading delays across equilibria. From a normative standpoint we show that the asset allocation across investors and the number of dealers are socially inefficient.
    Keywords: Asset pricing ; Over-the-counter markets
    Date: 2007
  5. By: Mark Huggett; Gustavo Ventura; Amir Yaron (Department of Economics, Georgetown University)
    Abstract: Is lifetime inequality mainly due to differences across people established early in life or to differences in luck experienced over the working lifetime? We answer this question within a model that features idiosyncratic shocks to human capital, estimated directly from data, as well as heterogeneity in ability to learn, initial human capital, and initial wealth { features which are chosen to match observed properties of earnings dynamics by cohorts. We find that as of age 20, differences in initial conditions account for more of the variation in lifetime utility, lifetime earnings and lifetime wealth than do differences in shocks received over the lifetime. Among initial conditions, variation in initial human capital is substantially more important than variation in learning ability or initial wealth for determining how an agent fares in life. An increase in an agent's human capital affects expected lifetime utility by raising an agent's expected earnings pro¯le, whereas an increase in learning ability affects expected utility by producing a steeper expected earnings profile. Classification-JEL Codes: E21, D3, D91.
    Keywords: Lifetime Inequality, Human Capital, Idiosyncratic Risk
    Date: 2007–07–04
  6. By: Per Engström (Uppsala University); Bertil Holmlund (Uppsala University and IZA)
    Abstract: The paper presents a general equilibrium model of search unemployment that incorporates absence from work as a distinct labor force state. Absenteeism is driven by random shocks to the value of leisure that are private information to the workers. Firms maximize profits while recognizing that the compensation package may affect the queue of job applicants and the absence rate. The analysis provides results concerning the effects of social insurance benefits and other determinants of workers’ and firms’ behavior. The normative anlysis identifies externalities associated with firm-provided sick pay and examines the welfare implications of alternative policies.
    Keywords: absenteeism, search, unemployment, social insurance
    JEL: J21 J64 J65
    Date: 2007–07
  7. By: John Knowles (University of Pennsylvania and IZA)
    Abstract: The rise in per-capita labor over the last 30 years is difficult to explain in a standard macroeconomic model because rising wages of women should have lead to a large rise in husband’s leisure. This paper argues that home production and bargaining are both essential for understanding these trends, and develops an equilibrium model of marriage and bargaining. Calibration to US data suggests that the bargaining position of husbands has deteriorated with the closing of the gender gap in wages, that the decline of home-equipment prices plays a role in the rise in per-capita hours, and that the labor trends are consistent with stationarity along a balanced-growth path.
    Keywords: general aggregative models: neoclassical, time allocation and labor supply, economics of gender, marriage, marital dissolution
    JEL: E13 J12 J16 J20 J22
    Date: 2007–07
  8. By: Stefan Niemann; Michael Evers; Marc Schiffbauer
    Abstract: This paper employs a dynamic stochastic general equilibrium model with a financial market friction to rationalize the empirically observed negative relationship between inflation and total factor productivity (TFP). Specifically, an empirical analysis of US macroeconomic time series establishes that there is a negative causal effect of inflation on aggregate productivity. Rather than taking the productivity process as exogenous, the model is therefore set up to feature an endogenous component of TFP. This is achieved by allowing physical investment to be channelled into two distinct technologies: a safe, but return-dominated technology and a superior technology which is subject to idiosyncratic liquidity risk. An agency problem prevents complete insurance against liquidity risk, and the scope for insurance is endogenously determined via the relevant liquidity premium. Since the liquidity premium is positively related to the rate of inflation, the model demonstrates how nominal fluctuations have an influence not only on the overall amount, but also on the qualitative composition of aggregate investment and hence on TFP. The quantitative relevance of the underlying transmission mechanism which links nominal fluctuations to TFP via corporate liquidity holdings and the composition of aggregate investment is corroborated by means of the quantitative analysis of the calibrated model economy as well as a detailed analysis of industry-level and firm-level panel data. Notably, the empirical findings are consistent with both the properties of the agency problem postulated in the theoretical model and its implications for corporate liquidity holdings and physical investment portfolios.
    Date: 2007–07–13
  9. By: David de la Croix (Department of Economics, Université catholique de Louvain, 1, Place de l’Université, B-1348 Louvain-la-Neuve, Belgium.); Gregory de Walque (Department of Economics, University of Namur and National Bank of Belgium (NBB), Boulevard de Berlaimont 14, B-1000, Brussels, Belgium.); Rafael Wouters (Department of Economics, Université catholique de Louvain and National Bank of Belgium (NBB), Boulevard de Berlaimont 14, B-1000, Brussels, Belgium.)
    Abstract: We first build a fair wage model in which effort varies over the business cycle. This mechanism decreases the need for other sources of sluggishness to explain the observed high inflation persistence. Second, we confront empirically our fair wage model with a New Keynesian model based on the standard assumption of monopolistic competition in the labor market. We show that, in terms of overall fit, the fair wage model outperforms the New Keynesian one. The extension of the fair wage model with lagged wage is judged insignificant by the data, but the extension based on a rent sharing argument including firm’s productivity gains in the fair wage is not. Looking at the implications for monetary policy, we conclude that the additional trade-off problem created by the inefficient real wage behavior significantly affect nominal interest rates and inflation outcomes. JEL Classification: E4, E5.
    Keywords: Efficiency wage, effort, inflation persistence, monetary policy.
    Date: 2007–07
  10. By: Matteo Cervellati (University of Bologna, IAE Barcelona and IZA); Uwe Sunde (IZA, University of Bonn and CEPR)
    Abstract: This paper provides a unified theory of the economic and demographic transition. Individuals make optimal decisions about fertility, education of their children and the type and intensity of the investments in their own education. These decisions are affected by different dimensions of mortality and technological progress which change endogenously during the process of development. The model generates an endogenous transition from a regime characterized by limited human capital formation, little longevity, high child mortality, large fertility and a sluggish income and productivity growth to a modern growth regime in which lower net fertility is associated with the acquisition of human capital and improved living standards. Unlike previous models, the framework emphasizes the education composition of the population in terms of the equilibrium share of educated individuals, and differential fertility related to education. The framework explores the roles of different dimensions of mortality, wages and schooling in triggering the transition. The dynamics of the model are consistent with empirical observations and stylized facts that have been difficult to reconcile so far. For illustration we simulate the model and discuss the novel predictions using historical and cross-country data.
    Keywords: long-term development, demographic transition, endogenous life expectancy, child mortality, heterogeneous human capital, technological change, industrial revolution
    JEL: E10 J10 O10 O40 O41
    Date: 2007–07
  11. By: Barnett, Richard; Bhattacharya, Joydeep; Bunzel, Helle
    Abstract: In an overlapping generations model, momentary equilibria are defined as points that lie on the intergenerational offer curve, i.e., they satisfy agents' optimality conditions and market clearing at any date. However, some dynamic sequences commencing from such points may not be considered valid equilibria because they asymptotically violate some economic restriction of the model. The literature has always ruled out such paths. This paper studies a pure-exchange monetary overlapping generations economy in which real balances cycle forever between momentary equilibrium points. The novelty is to show that segments of the offer curve that have been previously ignored, can in fact be used to produce asymptotically valid cyclical paths. Indeed, a cycle can bestow dynamic validity on momentary equilibrium points that had erstwhile been classified as dynamically invalid.
    Keywords: overlapping generations models, monetary equilibria, cycles, minimum consumption requirements
    JEL: E4 D5 E3
    Date: 2007–07–26
  12. By: Masanao Aoki (Department of Economics, University of California, Los Angeles); Hiroshi Yoshikawa (Faculty of Economics, University of Tokyo)
    Abstract: Using a simple stochastic growth model, this paper demonstrates that the coefficient of variation of aggregate output or GDP does not necessarily go to zero even if the number of sectors or economic agents goes to infinity. This phenomenon known as non-self-averaging implies that even if the number of economic agents is large, dispersion can remain significant, and, therefore, that we can not legitimately focus on the means of aggregate variables. It, in turn, means that the standard microeconomic foundations based on the representative agent has little value for they are expected to provide us with dynamics of the means of aggregate variables. The paper also shows that non-self-averaging emerges in some representative urn models. It suggests that non-self-averaging is not pathological but quite generic. Thus, contrary to the main stream view, micro-founded macroeconomics such as a dynamic general equilibrium model does not provide solid micro foundations.
    Date: 2007–04
  13. By: Nick Draper; Alex Armstrong
    Abstract: To answer policy questions that have intergenerational implications, a computable simulation model should obey four conditions: it should incorporate long-term demographic developments, it should include a detailed modelling of the public sector, it should decompose the population into several generations and it should account for the behaviour of the various economic agents. This document describes and illustrates a model that meets all these conditions. It is an applied general equilibrium model that is based on generational accounting principles named GAMMA (Generational Accounting Model with Maximizing Agents).
    Keywords: Computable general equilibrium model; Ageing; Pensions and Public Finances
    JEL: E62 H55
    Date: 2007–06
  14. By: Cengiz, Gulfer; Cicek, Deniz; Kuzubas, Tolga Umut; Olcay, Nadide Banu; Saglam, Ismail
    Abstract: We characterize the monetary competitive equilibrium in a two-country monetary union model involving cash-in-advance constraints both in the factor markets and in the good markets. Simulations show that common money inflation in the union have asymmetric effects on the welfare of workers in the two countries which are technologically differentiated. We also find that the distribution of the money stock within the union may affect labor flow across the countries.
    Keywords: Monetary union; cash-in-advance; monetary policy
    JEL: F22 E24
    Date: 2007–07
  15. By: Zheng Liu; Daniel F. Waggoner; Tao Zha
    Abstract: We assess the quantitative importance of the expectation effects of regime shifts in monetary policy in a DSGE model that allows the monetary policy rule to switch between a “bad” regime and a “good” regime. When agents take into account such regime shifts in forming expectations, the expectation effect is asymmetric across regimes. In the good regime, the expectation effect is small despite agents’ disbelief that the regime will last forever. In the bad regime, however, the expectation effect on equilibrium dynamics of inflation and output is quantitatively important, even if agents put a small probability that monetary policy will switch to the good regime. Although the expectation effect dampens aggregate fluctuations in the bad regime, a switch from the bad regime to the good regime can still substantially reduce the volatility of both inflation and output, provided that we allow some “reduced-form” parameters in the private sector to change with monetary policy regime. Much of the volatility reduction is attributed to a structural break in the persistence of equilibrium dynamics of macroeconomic variables.
    Date: 2007
  16. By: Alex William Trew
    Abstract: We develop a parsimonious finance and endogenous growth model with microeconomic frictions in entrepreneurship and a role for credit constraints. We demonstrate that though an efficiency-growth relation will always exist, the efficiency-depth-growth relation may not. This has implications for the connection between the theory and empirics of finance and growth. We go on to ask whether the model can account for some historical trends in growth, financial depth and financial efficiency for the UK over the period 1850--1913. The best model of finance and growth is one that departs from the standard depth-growth link.
    Keywords: finance and growth, endogenous growth, economic history.
    JEL: O11 O16 O40 N13 N23
    Date: 2007–07
  17. By: Narayana R. Kocherlakota
    Abstract: This paper considers four models in which immortal agents face idiosyncratic shocks and trade only a single risk-free asset over time. The four models specify this single asset to be private bonds, public bonds, public money, or private money respectively. I prove that, given an equilibrium in one of these economies, it is possible to pick the exogenous elements in the other three economies so that there is an outcome-equivalent equilibrium in each of them. (The term “exogenous variables” refers to the limits on private issue of money or bonds, or the supplies of publicly issued bonds or money.)
    Date: 2007
  18. By: Takashi Kano (Faculty of Economics, University of Tokyo)
    Abstract: A recent paper claims that habit formation in consumption plays an important role in current ac- count fluctuations in selected developed countries, extending the present-value model of the current account (PVM) with consumption habits. In this paper, however, I show that the habit-forming PVM is observationally equivalent to the PVM augmented with persistent transitory consumption, which is induced by world real interest rate shocks. Based on a small open-economy real busi- ness cycle (SOE-RBC) model endowed with consumption habits as well as world real interest rate shocks, this paper seeks effects of habit formation on current account fluctuations in a typical small open economy, Canada, by a Bayesian calibration approach. Results reveal no clear evidence that habit formation plays a crucial role in current account fluctuations.
    Date: 2007–08
  19. By: Martin Bodenstein; Christopher J. Erceg; Luca Guerrieri
    Abstract: This paper investigates how oil price shocks affect the trade balance and terms of trade in a two country DSGE model. We show that the response of the external sector depends critically on the structure of financial market risk-sharing. Under incomplete markets, higher oil prices reduce the relative wealth of an oil-importing country, and induce its nonoil terms of trade to deteriorate, and its nonoil trade balance to improve. The magnitude of the nonoil terms of trade response hinges on structural parameters that affect the divergence in wealth effects across oil importers and exporters, including the elasticity of substitution between oil and other inputs in production, and the discount factor. By contrast, cross-country wealth differences effectively disappear under complete markets, with the implication that oil shocks have essentially no effect on the nonoil terms of trade or the nonoil trade balance.
    Date: 2007
  20. By: Karen A. Kopecky (The University of Western Ontario)
    Abstract: In each of the following chapters, macro models are developed to explore the impact of technological progress on the household. Chapter 1 focuses on the impact of technological progress in transportation on suburbanization. In this chapter, a model of a city is developed in which agents choose both whether or not to own a car, and where to live. Focusing on the period 1910 to 1970, the model is calibrated to match the fall in automobile prices, the rise in real incomes, and the rise in the cost of commuting by public transportation relative to commuting by car. Under the baseline calibration the model predicts both a rise in car-ownership and decentralization. In Chapter 2, a model with leisure production and endogenous retirement is used to explain the declining labor-force participation rates of elderly males. Using the Health and Retirement Study, the model is calibrated to cross-sectional data on the labor-force participation rates of elderly US males by age and their average drop in market consumption in the year 2000. Running the calibrated model for the period 1850 to 2000, a prediction of the evolution of the cross-section is obtained and compared with data. The model is able to predict both the increase in retirement since 1850 and the observed drop in market consumption at the moment of retirement. The increase in retirement is driven by rising real wages and a falling price of leisure goods over time. Finally, in Chapter 3, the welfare gain from technological progress in personal computer production is measured by constructing a simple model of computer demand. The innovation of the model is in the agent's utility function. Preferences are defined such that the marginal utility of zero computer consumption is finite. Thus the model can predict the zero demand for computers observed in the data and generate a finite welfare gain from their introduction into the market. The model is calibrated using data on computer expenditures. The model suggests that the welfare gain from technological progress in personal computers is approximately 4 percent of total consumption expenditure.
    Keywords: technological progress, suburbanization, population density gradient, retirement leisure goods, computers, welfare gain
    Date: 2007–07
  21. By: Marcos Antonio C. da Silveira
    Abstract: We build a two-country version of the model in Gali & Monacelli (2005), which extends for a small open economy the new Keynesain DSGE model used as tool for monetary policy analysis in closed economies. A distinctive feature of the model is that the terms of trade enters directly into the new Keynesian Phillips curve as a new pushing-cost variable feeding the inflation. Furthermore, home bias in households’ preferences allows for real exchange rate fluctuation, giving rise to alternative channels of monetary transmission. Unlike most part of the literature, the small domestic open economy is derived as a limit case of the two-coutry model, rather than assuming exogenous processes for the foreign variables. This procedure preserves the role played by foreign nominal frictions in the way as international monetary policy shocks are conveyed into the small domestic economy.
    Date: 2006–02
  22. By: Andrew Coleman (Reserve Bank of New Zealand)
    Abstract: The paper develops an overlapping generations model incorporating a realistic depiction of the credit constraints facing home buyers to explain why home ownerships rates have declined in New Zealand since 1990 despite a significant relaxation of credit constraints. The model focuses attention on the role of property investors in the property market, and suggests changes in credit constraints mainly affect the tenure decisions of individual households, but not the aggregate level of house prices. The model suggests the decline in real interest rates is likely to be the cause of the rise in house prices and the decline in home ownership rates since 1990.
    JEL: E40
    Date: 2007–07
  23. By: Arturo Estrella
    Abstract: Various methods are available to extract the "business cycle component" of a given time series variable. These methods may be derived as solutions to frequency extraction or signal extraction problems and differ in both their handling of trends and noise and their assumptions about the ideal time-series properties of a business cycle component. The filters are frequently illustrated by application to white noise, but applications to other processes may have very different and possibly unintended effects. This paper examines several frequently used filters as they apply to a range of dynamic process specifications and derives some guidelines for the use of such techniques.
    Keywords: Business cycles ; Time-series analysis
    Date: 2007
  24. By: Christos Koulovatianos; Leonard J. Mirman; Marc Santugini (IEA, HEC Montréal)
    Abstract: We introduce learning in the Brock and Mirman (1972) optimal growth model. Here, the agent makes consumption and investment decisions, while at the same time learning about an unspecified parameter of the distribution of the production shock governing the evolution of output. We then focus on learning in a class of optimal stochastic growth models studied by Mirman and Zilcha (1975) in order to study the effect of learning on optimal consumption. Learning has a profound effect on optimal consumption through increasing the uncertainty of future payoffs. We also analyze the effect of changes in the mean and riskiness of the distribution of the production shock and beliefs on optimal consumption.
    Date: 2007–06
  25. By: Lawrence Christiano (Northwestern University and National Bureau of Economic Research. Mailing address: Department of Economics, Northwestern University, 2001 Sheridan Road, Evanston, Illinois 60208, USA.); Roberto Motto (European Central Bank, Kaiserstrasse 29, D-60311, Frankfurt am Main, Germany.); Massimo Rostagno (European Central Bank, Kaiserstrasse 29, D-60311, Frankfurt am Main, Germany.)
    Abstract: The US Federal Reserve cut interest rates more vigorously in the recent recession than the European Central Bank did. By comparison with the Fed, the ECB followed a more measured course of action. We use an estimated dynamic general equilibrium model with financial frictions to show that comparisons based on such simple metrics as the variance of policy rates are misleading. We find that - because there is greater inertia in the ECB’s policy rule - the ECB’s policy actions actually had a greater stabilizing effect than did those of the Fed. As a consequence, a potentially severe recession turned out to be only a slowdown, and inflation never departed from levels consistent with the ECB’s quantitative definition of price stability. Other factors that account for the different economic outcomes in the Euro Area and US include differences in shocks and differences in the degree of wage and price flexibility. JEL Classification: C51, E52, E58.
    Keywords: Policy activism, DSGEmodel, policy inertia, shocks.
    Date: 2007–07

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