nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2007‒08‒27
eighteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. A Dynamic Analysis of Educational Attainment, Occupational Choices, and Job Search By Sullivan, Paul
  2. Population and Endogenous Growth By Creina Day
  3. Assessing the impact of a change in the composition of public spending - a DSGE approach. By Roland Straub; Ivan Tchakarov
  4. A Small Open Economy Model with Currency Mismactches and a Financial Accelerator Mechanism By Santiago L.E. Acosta Ormaechea
  5. Endogenously Segmented Asset Market in an Inventory Theoretic Model of Money Demand By Jonathan Chiu
  6. Software Production, Human Capital and Endogenous Growth: Theoretical Analysis and Empirical Evidence from India By Supriyo De
  7. Innovation, firm dynamics, and international trade By Andrew Atkeson; Ariel Burstein
  8. Overconfidence and Consumption over the Life Cycle By Frank Caliendo; Kevin X.D. Huang
  9. Terms of Trade Shocks and Endogenous Search Unemployment: A Two-sector Model with Non-Traded goods By Yu Sheng; Xingpeng Xu
  10. Trend Inflation, Wage and Price Rigidities, and Welfare By Robert Amano; Kevin Moran; Stephen Murchison; Andrew Rennison
  11. History : Sunk Cost, or Widespread Externality? By Hammond, Peter J.
  12. Private Intergenerational Transfers and Their Ability to Alleviate the Fiscal Burden of Ageing By Hayat Khan
  13. Public Capital Spillovers and Growth: A Foray Downunder By Timothy Kam; Yi-Chia Wang
  14. Optimal monetary policy in an estimated DSGE for the euro area. By Matthieu Darracq Pariès; Stéphane Adjemian; Stéphane Moyen
  15. Markov Perfect Political Equilibria with Public Policy: The Role of Education Cost By Ryo Arawatari; Tetsuo Ono
  16. Temptation and Self-Control: Some Evidence and Applications By Kevin X.D. Huang; Zheng Liu; John Q. Zhu
  17. Endogenous Political Instability By Ryo Arawatari; Kazuo Mino
  18. Estimating Discount Functions with Consumption Choices over the Lifecycle By David Laibson; Andrea Repetto; Jeremy Tobacman

  1. By: Sullivan, Paul
    Abstract: This paper examines career choices using a dynamic structural model that nests a job search model within a human capital model of occupational and educational choices. Individuals in the model decide when to attend school and when to move between firms and occupations over the course of their career. Workers search for suitable wage and non-pecuniary match values at firms across occupations given their heterogeneous skill endowments and preferences for employment in each occupation. Over the course of their careers workers endogenously accumulate firm and occupation specific human capital that affects wages differently across occupations. The parameters of the model are estimated with simulated maximum likelihood using data from the 1979 cohort of the National Longitudinal Survey of Youth. The structural parameter estimates reveal that both self-selection in occupational choices and mobility between firms account for a much larger share of total earnings and utility than the combined effects of firm and occupation specific human capital. Eliminating the gains from matching between workers and occupations would reduce total wages by 31%, eliminating the gains from job search would reduce wages by 19%, and eliminating the effects of firm and occupation specific human capital on wages would reduce wages by only 2.8%.
    Keywords: occupational choice; job search; human capital; dynamic programming models
    JEL: J62 I21 J24
    Date: 2007–06
  2. By: Creina Day
    Abstract: Using a general three sector growth model, this paper derives general conditions for positive growth in the economy along a balanced growth path under the alternative assumptions of a static population and a growing population. The framework is general enough to replicate endogenous and semi-endogenous R&D based growth models. This paper challenges the conventional wisdom that (non-) linearity is synonymous with (semi-) endogenous growth. CES technology is introduced to human capital accumulation to obtain positive balanced growth with or without population growth.
    JEL: O30 O41
    Date: 2006–10
  3. By: Roland Straub (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Ivan Tchakarov (International Monetary Fund (IMF) Asia and Pacific Department, 700 19th Street NW, Washington, DC 20431, USA.)
    Abstract: Despite intense calls for safeguarding public investment in Europe, public investment expenditure, when measured in relation to GDP, has steadily fallen in the last three decades, evoking fears that economic activity may be correspondingly negatively affected. At the same time, however, public consumption in the EU-12 countries has trended up. In this paper, we provide a macroeconomic assessment of the observed change in the composition of public spending in the euro area in a medium-scale two-country dynamic stochastic general equilibrium (DSGE) model. First, we analyze the channels through which, both temporary and permanent public investment shocks generate larger fiscal multipliers than exogenous increases in public consumption. Furthermore, we quantify the negative impact of a change in fiscal stance, characterized by a permanent rise in public consumption and a permanent fall in public investment, keeping thereby the overall level of public spending constant. The key message of the paper is that calls for reversing the observed trend in the composition of public spending are well justified. JEL Classification: F41, F42.
    Keywords: Public investment, Public consumption, Euro area, DSGE models.
    Date: 2007–08
  4. By: Santiago L.E. Acosta Ormaechea
    Abstract: We develop a two-sectors small open economy model with imperfect competition, one-period nominal price rigidities and a financial accelerator mechanism. The latter assumes an asymmetric information problem between lenders and capital good producers (entrepreneurs). Studying the zero-inflation steady state, it is shown that the model with the financial accelerator mechanism nests a fairly standard RBC model; case in which entrepreneurs “disappear" as a differentiated sector from households. It is also explained that credit market imperfections essentially reduce the aggregate supply of capital relative to the RBC case. Turning to the dynamics, we study the effects of an unanticipated and permanent increase in the level of the money supply. In this context the exchange rate jumps immediately to its new steady state level without showing any overshooting process as in Dornbusch (1976). Analysing the case without credit market imperfections but with pre-set prices, it is demonstrated that money is not neutral in the long-run, that capital adds persistence to the initial shock, and that some traditional results of the Mundell-Fleming model still hold.
    Keywords: Credit Market Imperfections, Financial Accelerator, Currency Mismatches, Currency Depreciation.
    JEL: F3 F4
    Date: 2007–06
  5. By: Jonathan Chiu
    Abstract: This paper studies the effects of monetary policy in an inventory theoretic model of money demand. In this model, agents keep inventories of money, despite the fact that money is dominated in rate of return by interest bearing assets, because they must pay a fixed cost to transfer funds between the asset market and the goods market. Unlike the exogenous segmentation models in the literature, the timings of money transfers are endogenous. By allowing agents to choose the timings of money transfers, the model endogenizes the degree of market segmentation as well as the magnitude of liquidity effects, price sluggishness and variability of velocity. First, I show that the endogenous segmentation model can generate the positive long run relationship between money growth and velocity in the data which the exogenous segmentation model fails to capture. Second, I show that the short run effects of money shocks in an exogenous segmentation model (such as the linear inflation response to money shock, the liquidity effect and the sluggish price adjustment) are not robust. In an endogenous segmentation model, the equilibrium response to money shocks is non-linear and non-monotonic. Moreover, for large money shocks, there is no liquidity effect and no sluggish price adjustment.
    Keywords: Transmission of monetary policy; Monetary policy framework
    JEL: E31 E41 E50
    Date: 2007
  6. By: Supriyo De
    Abstract: Propelled by the rise of a vibrant software industry the Indian economy has demonstrated rapid growth since the 1990s. A novel three-sector endogenous growth model that encapsulates the salient features of an information technology oriented economy is developed. The dynamic optimization problem leads to a balanced growth path equilibrium characterized by output, physical capital, software assets, human capital and consumption growing at a uniform rate. Major implications of the model are reflected in empirical evidence from the growth trajectories of Indian states. The human capital production apparatus has a significant impact on economic growth. This has critical policy implications.
    Keywords: endogenous growth, India, information technology, human capital, software
    Date: 2007–06
  7. By: Andrew Atkeson; Ariel Burstein
    Abstract: We present a general equilibrium model of the decisions of firms to innovate and to engage in international trade. We use the model to analyze the impact of a reduction in international trade costs on firms' process and product innovative activity. We first show analytically that if all firms export with equal intensity, then a reduction in international trade costs has no impact at all, in steady-state, on firms' investments in process innovation. We then show that if only a subset of firms export, a decline in marginal trade costs raises process innovation in exporting firms relative to that of non-exporting firms. This reallocation of process innovation reinforces existing patterns of comparative advantage, and leads to an amplified response of trade volumes and output over time. In a quantitative version of the model, we show that the increase in process innovation is largely offset by a decline in product innovation. We find that, even if process innovation is very elastic and leads to a large dynamic response of trade, output, consumption, and the firm size distribution, the dynamic welfare gains are very similar to those in a model with inelastic process innovation.
    JEL: F1 L11 L16 O3
    Date: 2007–08
  8. By: Frank Caliendo (Department of Economics, Colorado State University); Kevin X.D. Huang (Department of Economics, Vanderbilt University)
    Abstract: Overconfidence is a widely documented phenomenon. In this paper, we study the implications of consumer overconfidence in a life-cycle consumption/saving model. Our main analytical result is a necessary and sufficient condition under which any degree of overconfidence concerning the mean return on savings can produce a hump in the work-life consumption profile. This condition is almost always met in the data. We show by simulations that overconfidence concerning the variance of the return can have little effect on the long-run average behavior of consumption over the life cycle, and that our basic conclusion is fairly robust with various realistic modifications to the baseline model. We interpret the general applicability of our analytical framework and discuss our numerical results in the light of aggregate consumption data.
    Keywords: Overconfidence, consumption, life cycle, time inconsistency, hump shape, elasticity of intertemporal substitution <br><br>
    JEL: D91 E21
    Date: 2007–08
  9. By: Yu Sheng; Xingpeng Xu
    Abstract: We develop a simple and tractable two-sector search model featuring a non-traded sector and endogenous search unemployment to examine the impact of terms of trade shocks on unemployment. We show that changes in terms of trade will not only lead to employment reallocation across sectors, as in the traditional trade models, but more importantly, impact upon search unemployment within each sector. Specifically, we show that an improvement (deterioration) of terms of trade reduces (increases) unemployment rates in both traded and non-traded sectors.
    Keywords: two-sector search model, trade and unemployment, non-traded good
    JEL: F16 F23 J64
    Date: 2007–06
  10. By: Robert Amano; Kevin Moran; Stephen Murchison; Andrew Rennison
    Abstract: This paper studies the steady-state costs of inflation in a general-equilibrium model with real per capita output growth and staggered nominal price and wage contracts. Our analysis shows that trend inflation has important effects on the economy when combined with nominal contracts and real output growth. Steady-state output and welfare losses are quantitatively important even for low values of trend inflation. Further, we show that nominal wage contracting is quantitatively more important than nominal price contracting in generating these losses. This important result does not arise from price dispersion per se but from an effect of nominal output growth on the optimal markup of monopolistically competitive labour suppliers. We also demonstrate that accounting for productivity growth is important for calculating the welfare costs of inflation. Indeed, the presence of two percent productivity growth increases the welfare costs of inflation in our benchmark specification by a factor of four relative to the no-growth case.
    Keywords: Inflation, costs and benefits, wage and price rigidities
    JEL: E0 E5
    Date: 2007
  11. By: Hammond, Peter J. (Department of Economics, University of Warwick)
    Abstract: In an intertemporal Arrow-Debreu economy with a continuum of agents, suppose that the auctioneer sets prices while the government institutes optimal lump-sum transfers period by period. An earlier paper showed how subgame imperfections arise because agents understand how their current decisions such as those determining investment will influence future lump-sum transfers. This observation undermines the second efficiency theorem of welfare economics and makes “history” a widespread externality. A two-period model is used to investigate the constrained efficiency properties of different kinds of equilibrium. Possibilities for remedial policy are also discussed.
    Date: 2007
  12. By: Hayat Khan
    Abstract: The ratio of retirees to workers in developed countries is expected to increase sharply in the next few decades. In the presence of unfunded income support policies, this increase in old age dependency is expected to increase the future fiscal burden which is seen as a threat to living standards. This paper quantifies the ability of private intergenerational transfers to alleviate the future fiscal burden of ageing. This is done through developing an extended dynamic overlapping generations simulation model with realistic demographics. Calculation based on steady state simulations suggests that a bequest to GDP ratio of 1% offsets about 33.3 % of the fiscal burden over the lifecycle when measured as a % of simple labour income and 8.9% of the fiscal burden when measured as % of the full income. The model is calibrated for Australia under small open economy assumption such that the optimal solution mimic important cross sectional and time series fundamentals of the Australian Economy. Intergenerational accounting suggests that the empirically plausible intergenerational transfers are strong enough to offset most of the tax burden (81 to 91%) when measured as % of simple labour income and up to 1/4 of the burden when fiscal burden is measured as % of full income. In the endogenous labour supply case, 81 to 91 percent of the fiscal burden of ageing will be alleviated by inheritances in the base case. Due to the calibration strategy adopted, the paper analytically demonstrates that results of the simulations are robust to the introduction of lifetime uncertainty in the model where people discount the future by a rate of time preference and by a survival probability irrespective of whether there are perfect annuity markets or no annuity markets at all.
    Keywords: Ageing, Overlapping Generations (OLG) model, bequests, fiscal
    Date: 2007–06
  13. By: Timothy Kam; Yi-Chia Wang
    Abstract: We extend the deterministic growth model of Glomm and Ravikumar (1994) to a stochastic endogenous growth model which nests both exogenous and endogenous growth factors. By introducing simple shocks to production technology, private capital and public capital investment, we can derive testable time series properties of the analytical model. The hypothesis of strict endogenous growth due to public capital spillovers cannot be statistically rejected for our Australian data set. We find further short-run evidence of public capital contributing to permanent increases in the levels of per capita income and private capital.
    JEL: O41 C32
    Date: 2006–09
  14. By: Matthieu Darracq Pariès (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Stéphane Adjemian (CEPREMAP & GAINS, Université du Maine, Avenue Olivier Messiaen, 72085 Le Mans Cedex 9, France.); Stéphane Moyen (Centre d‘Études des Politiques Économiques (EPEE), Université d‘Évry Val d‘Essonne, 4, bld Francois Mitterand, 91025 Évry Cedex, France.)
    Abstract: The objective of this paper is to examine the main features of optimal monetary policy within a micro-founded macroeconometric framework. First, using Bayesian techniques, we estimate a medium scale closed economy DSGE for the euro area. Then, we study the properties of the Ramsey allocation through impulse response, variance decomposition and counterfactual analysis. In particular, we show that, controlling for the zero lower bound constraint, does not seem to limit the stabilization properties of optimal monetary policy. We also present simple monetary policy rules which can "approximate" and implement the Ramsey allocation reasonably well. Such optimal simple operational rules seem to react specifically to nominal wage inflation. Overall, the Ramsey policy together with its simple rule approximations seem to deliver consistent policy messages and may constitute some useful normative benchmarks within medium to large scale estimated DSGE framework. However, this normative analysis based on estimated models reinforces the need to improve the economic micro-foundation and the econometric identification of the structural disturbances. JEL Classification: E4, E5.
    Keywords: DSGE models, Monetary policy, Bayesian estimation, Welfare calculations.
    Date: 2007–08
  15. By: Ryo Arawatari (Graduate School of Economics, Osaka University); Tetsuo Ono (Graduate School of Economics, Osaka University)
    Abstract: This paper focuses on how education costs affect the political determination of public policy via individual decision-making. The paper extends the model in Hassler, Storesletten, and Zilibotti (2007, Journal of Economic Theory; henceforth HSZ) by generalizing the cost function of education and considers several cases, along with HSZ as a special case. In cases where education cost is high, the characterization of political equilibrium is similar to HSZ. In cases where education cost is low, the characterization is entirely different from HSZ: namely, a political equilibrium exists where (i) the rich are always politically decisive and (ii) the equilibrium outcome is unique.
    Keywords: Markov perfect equilibrium; Dynamic political economy; Public policy; Education cost
    JEL: D72 D78 E62
    Date: 2007–08
  16. By: Kevin X.D. Huang (Department of Economics, Vanderbilt University); Zheng Liu (Department of Economics, Emory University); John Q. Zhu (Department of Economics, Emory University)
    Abstract: This paper studies the empirical relevance of temptation and self-control using household-level data from the Consumer Expenditure Survey. We construct an infinite-horizon consumption-savings model that allows, but does not require, temptation and self-control in preferences. To distinguish temptation preferences from others, we exploit individual-level heterogeneities in our data set, and we rely on an implication of the theory that a more tempted individual should be more likely to hold commitment assets. In the presence of temptation, the cross-sectional distribution of the wealth-consumption ratio, in addition to that of consumption growth, becomes a determinant of the asset-pricing kernel, and the importance of this additional pricing factor depends on the strength of temptation. The empirical estimates that we obtain provide statistical evidence supporting the presence of temptation. Based on our estimates, we explore some quantitative implications of this class of preferences for capital accumulation in a neoclassical growth model and the welfare cost of the business cycle.
    Keywords: Temptation, self-control, limited participation, growth, welfare <br><br>
    JEL: D91 E21 G12
    Date: 2007–08
  17. By: Ryo Arawatari (Graduate School of Economics, Osaka University); Kazuo Mino (Graduate School of Economics, Osaka University)
    Abstract: In this paper, we construct a simple dynamic two-party electoral competition model in which the degree of political instability is endogenously determined: which has never been studied so far. We consider the campaign contributions as stock variable which is gradually accumulated by both partyfs direct investment and induced the Markov-perfect Nash equilibrium. We then examine the stability of the symmetric steady state and find that it may be either totally stable or unstable depending on the parameter values involved in the model. We also found that under certain conditions, at least near the symmetric steady state, there exists indeterminancy of equilibrium path: there exist both stable and unstable paths, that is, under given levels of political assets, both high instability political system and low instability political system can emerge depending on expectations of political parties.
    Keywords: Political assets; Dynamic political economy; Differential game; Markovperfect Nash equilibrium; Two-party model
    JEL: C73 D72 D78
    Date: 2007–08
  18. By: David Laibson; Andrea Repetto; Jeremy Tobacman
    Abstract: Intertemporal preferences are difficult to measure. We estimate time preferences using a structural buffer stock consumption model and the Method of Simulated Moments. The model includes stochastic labor income, liquidity constraints, child and adult dependents, liquid and illiquid assets, revolving credit, retirement, and discount functions that allow short-run and long-run discount rates to differ. Data on retirement wealth accumulation, credit card borrowing, and consumption-income comovement identify the model. Our benchmark estimates imply a 40% short-term annualized discount rate and a 4.3% long-term annualized discount rate. Almost all specifications reject the restriction to a constant discount rate. Our quantitative results are sensitive to assumptions about the return on illiquid assets and the coefficient of relative risk aversion. When we jointly estimate the coefficient of relative risk aversion and the discount function, the short-term discount rate is 15% and the long-term discount rate is 3.8%.
    JEL: D91 E21
    Date: 2007–08

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