nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2007‒10‒27
eighteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. The Role of Expectations in Sudden Stops By Karel Mertens
  2. Financing Development: The Role of Information Costs By Greenwood, Jeremy; Sanchez, Juan M; Wang, Cheng
  3. Productivity and U.S. Macroeconomic Performance: Interpreting the Past and Predicting the Future with a Two-Sector Real Business Cycle Model By Peter N. Ireland; Scott Schuh
  4. Growth, Volatility And Stabilisation Policy In A DSGE Model With Nominal Rigidities And Learning-By-Doing By Pham The Anh
  5. Openness, technology capital, and development By Ellen R. McGrattan; Edward C. Prescott
  6. Explaining the size distribution of cities: X-treme economies By Berliant, Marcus; Watanabe, Hiroki
  7. An endogenous growth model with quality ladders and consumers’ heterogeneity By Marasco, Antonio
  8. Disinflation Shocks in the Eurozone: a DSGE Perspective By FÈVE, Patrick; MATHERON, Julien; SAHUC, Jean-Guillaume
  9. Asset Based Unemployment Insurance By Pontus Rendahl
  10. Money and capital By S. Boragan Aruoba; Christopher J. Waller; Randall Wright
  11. Twin Deficits, Openness and the Business Cycle By Giancarlo Corsetti; Gernot J. Mueller
  12. Unemployment and Within-Group Wage Inequality: Can Information Explain the Trade-Off? By Renato Faccini
  13. How much structure in empirical models? By Fabio Canova
  14. Shocks, Structures or Monetary Policies? The Euro Area and US After 2001 By Lawrence Christiano; Roberto Motto; Massimo Rostagno
  15. Asymmetric expectation effects of regime shifts and the Great Moderation By Zheng Liu; Daniel F. Waggoner; Tao Zha
  16. The Role of the Structural Transformation in Aggregate Productivity By Margarida Duarte; Diego Restuccia
  17. Incomplete markets and households’ exposure to interest rate and inflation risk: implications for the monetary policy maker By Andrea Pescatori
  18. Monetary Policy Coordination Revisited in a Two-Bloc DSGE Model By Paul Levine; Joseph Pearlman; Richard Pierse

  1. By: Karel Mertens
    Abstract: This paper presents a flexible-price small open economy model with a “peso problem” in productivity states. Agents rationally adjust their beliefs about future productivity growth after the arrival of news. A downward revision of expectations triggers a Sudden Stop, together with large declines in GDP, employment, consumption and investment. There need not be any actual change in productivity growth to generate large fluctuations. Quantitatively, the model goes a long way in matching the 1998 Korean Crisis and subsequent swift recovery.
    Keywords: sudden stops, small open economy, expectations, peso problem
    JEL: E2 E3 F3 F4
    Date: 2007
  2. By: Greenwood, Jeremy; Sanchez, Juan M; Wang, Cheng
    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.
    Date: 2007–10–18
  3. By: Peter N. Ireland; Scott Schuh
    Abstract: A two-sector real business cycle model, estimated with postwar U.S. data, identifies shocks to the levels and growth rates of total factor productivity in distinct consumption- and investment-goods-producing technologies. This model attributes most of the productivity slowdown of the 1970s to the consumption-goods sector; it suggests that a slowdown in the investment-goods sector occurred later and was much less persistent. Against this broader backdrop, the model interprets the more recent episode of robust investment and investment-specific technological change during the 1990s largely as a catch-up in levels that is unlikely to persist or be repeated anytime soon.
    JEL: E32 O41 O47
    Date: 2007–10
  4. By: Pham The Anh (Department of Economics, National Economics University, Vietnam)
    Abstract: The paper aims to analyse the question of how cyclical fluctuations might affect long run growth. The analysis is based on a dynamic stochastic general equilibrium model for an imperfectly competitive economy with fully optimising agents. The model is characterized with nominal rigidities, an endogenous technology, and multiple shocks. It predicts either a negative or positive relationship between short run volatility and long run growth depending on the source of shocks and the reaction of the central bank. The model also shows that, even when the negative relationship exits the policy that is designed to stabilise short run volatility may either increase or decrease growth depending on the source of shocks.
    Keywords: Imperfect Competition; Nominal Rigidities; Growth; Volatility; Stabilisation Policy
    JEL: E31 E37 E52 O42
    Date: 2007–06
  5. By: Ellen R. McGrattan; Edward C. Prescott
    Abstract: In this paper, we extend the growth model to include firm-specific technology capital and use it to assess the gains from opening to foreign direct investment. A firm’s technology capital is its unique know-how from investing in research and development, brands, and organization capital. What distinguishes technology capital from other forms of capital is the fact that a firm can use it simultaneously in multiple domestic and foreign locations. Foreign technology capital is exploited by permitting foreign direct investment by multinationals. In both steady-state and transitional analyses, the extended growth model predicts large gains to being open.
    Date: 2007
  6. By: Berliant, Marcus; Watanabe, Hiroki
    Abstract: The methodology used by theories to explain the size distribution of cities is contrived in that it takes an empirical fact and works backward to first obtain a reduced form of a model, then pushes this reduced form back to assumptions on primitives. The induced assumptions on consumer behavior, particularly about their ability to insure against the city-level productivity shocks in the model, are untenable. With either self insurance or insurance markets, and either an arbitrarily small cost of moving or the assumption that consumers do not perfectly observe the shocks to firms' technologies, the agents will never move. Equilibrium implies a uniform distribution of agents. Even without these frictions, our analysis yields another equilibrium with insurance that gives exactly the same utility level to consumers as the equilibrium studied in the literature, but where consumers never move. Thus, insurance is a substitute for movement. Even aggregate shocks are insufficent to generate consumer movement, since consumers can borrow and save. We propose an alternative class of models, involving extreme risk against which consumers will not insure. Instead, they will move.
    Keywords: Zipf's Law; Gibrat's Law; Size Distribution of Cities; Extreme Value Theory
    JEL: R12
    Date: 2007–10–24
  7. By: Marasco, Antonio
    Abstract: This paper develops an endogenous growth model with quality ladders where consumers heterogeneity is assumed and is modelled through non homothetic preferences. We show that in such a model, unlike mainstream quality ladders models, the steady state equilibrium is characterised by a duopoly were the state of the art technology and the one immediately below it are both able to survive and thrive, under given conditions for the income distribution. In the words of Schumpeter, this model delivers only partial creative destruction. Furthermore, we show that under duopoly, an increase in the degree of income inequality, raises the intensity of research activities and the growth rate of the economy.
    Keywords: Industrial Organization; Income Distribution; Technological Change; Innovation; Growth
    JEL: O40 O30 D40
    Date: 2002–09
  8. By: FÈVE, Patrick; MATHERON, Julien; SAHUC, Jean-Guillaume
    JEL: E31 E32 E52
    Date: 2007–10
  9. By: Pontus Rendahl
    Abstract: This paper studies a model of optimal redistribution policies in which agents face unemployment risk and in which savings may provide partial self-insurance. Moral hazard arises as job search effort is unobservable. The optimal redistribution policies provide new insights into how an unemployment insurance scheme should be designed: First, the unemployment insurance policy is recursive in an agent's wealth level, and thus independent of the duration of the unemployment spell. Second, the level of benefit payments is negatively related to the agent's asset position. The reason behind the latter result is twofold; in addition to the first-order insurance effect of wealth, an increase in non-labor income (wealth) amplifies the opportunity cost of employment and thus reduces the agent's incentive to search for a job. During unemployment the agent decumulates assets and the sequence of benefit payments is observationally increasing - a result that stands in sharp contrast with previous studies.
    Keywords: Unemployment insurance; Moral hazard; Self-insurance; Decentralized taxes
    JEL: D82 H21 J64 J65
    Date: 2007
  10. By: S. Boragan Aruoba; Christopher J. Waller; Randall Wright
    Abstract: We revisit classic questions concerning the effects of money on investment in a new framework: a two-sector model where some trade occurs in centralized and some in decentralized markets, as in recent monetary theory, but extended to include capital. This allows us to incorporate novel elements from the microfoundations literature on trading with frictions, including stochastic exchange opportunities, alternative pricing mechanisms, etc. We calibrate models with bargaining and with price taking in the decentralized market.
    Keywords: Money ; Capital ; Monetary policy
    Date: 2007
  11. By: Giancarlo Corsetti; Gernot J. Mueller
    Abstract: In this paper, we study the co-movement of the government budget balance and the trade balance at business cycle frequencies. In a sample of 10 OECD countries we find that the correlation of the two time series is negative, but less so in more open economies. Moreover, for the US the crosscorrelation function is S-shaped. We analyze these regularities taking the perspective of international business cycle theory. First, we show that a standard model delivers predictions broadly in line with the evidence. Second, we show that conditional on spending shocks the model predicts a perfect correlation of the budget balance and the trade balance. Yet, the effect of spending shocks on the trade balance is contained if an economy is not very open to trade.
    Keywords: Fiscal Policy, Twin deficits, Openness, Business Cycle
    JEL: F41 F42 E32
    Date: 2007
  12. By: Renato Faccini
    Abstract: In Italy, following WWII, specific hiring procedures were developed that prevented firms from screening workers. More in particular, these institutions characterized the Italian labor market with respect to the US labor market, and were gradually removed during the 1990s. A simple matching model in which the usual Nash bargaining criterion is replaced by a game of incomplete information, shows that such hiring procedures endogenously generate wage compression within groups of observationally equivalent workers, as well as higher unemployment rates. Both the estimated behavior of within-group wage inequality in Italy, computed from the micro-data of the SHIW panel of the Bank of Italy, and the behavior of the unemployment rate in the late 1990s, are consistent with the predictions of the model.
    Keywords: job-search, labor market institutions, within-group wage inequality, bargaining with incomplete information, screening
    JEL: C78 J31 J64
    Date: 2007
  13. By: Fabio Canova
    Abstract: This chapter highlights the problems that structural methods and SVAR approaches have when estimating DSGE models and examining their ability to capture important features of the data. We show that structural methods are subject to severe identification problems due, in large part, to the nature of DSGE models. The problems can be patched up in a number of ways but solved only if DSGEs are completely reparametrized or respecified. The potential misspecification of the structural relationships give Bayesian methods an hedge over classical ones in structural estimation. SVAR approaches may face invertibility problems but simple diagnostics can help to detect and remedy these problems. A pragmatic empirical approach ought to use the flexibility of SVARs against potential misspecification of the structural relationships but must firmly tie SVARs to the class of DSGE models which could have have generated the data.
    Keywords: DSGE models, SVAR models, Identification, Invertibility, Misspecification, Small Samples.
    JEL: C10 C52 E32 E50
    Date: 2007–10
  14. By: Lawrence Christiano; Roberto Motto; Massimo Rostagno
    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: C51 E47 E52 E58 F0 F00
    Date: 2007–10
  15. By: Zheng Liu; Daniel F. Waggoner; Tao Zha
    Abstract: The possibility of regime shifts in monetary policy can have important effects on rational agents' expectation formation and equilibrium dynamics. In a dynamic stochastic general equilibrium model where the monetary policy rule switches between a dovish regime that accommodates inflation and a hawkish regime that stabilizes inflation, the expectation effect is asymmetric across regimes. Such an asymmetric effect makes it difficult but still possible to generate substantial reductions in the volatilities of inflation and output as the monetary policy switches from the dovish regime to the hawkish one.
    Date: 2007
  16. By: Margarida Duarte; Diego Restuccia
    Abstract: We investigate the role of sectoral differences in labor productivity and the process of structural transformation (the secular reallocation of labor across sectors) in accounting for the time path of aggregate productivity across countries. Using a simple model of the structural transformation that is calibrated to the growth experience of the United States, we measure sectoral labor productivity differences across countries. These differences are large and systematic: labor productivity differences between rich and poor countries are large in agriculture and services and smaller in manufacturing. When fed into the model, these sectoral labor productivity differences and the structural transformation they produce account for more than 50 percent of the fast catch-up in aggregate productivity observed in less developed economies and all of the stagnation and decline observed in more developed economies in recent decades.
    Keywords: labor productivity, structural transformation, sectoral productivity, employment, hours, cross-country data
    JEL: O1 O4
    Date: 2007–10–22
  17. By: Andrea Pescatori
    Abstract: The present paper studies optimal monetary policy when the representative agent assumption is abandoned and financial wealth heterogeneity across households is introduced. Incomplete markets make households incapable of perfectly insuring against interest rate and inflation risk, creating a trade-off between price level and debt-servicing stabilization. We derive a welfare-based loss function for the policymaker, which includes an additional target related to the cross-sectional distribution of household debt. The extent of the deviation from price stability depends on the initial level of debt dispersion. Using U.S. microdata to calibrate the model, we find an optimal inflation volatility equal to almost 20 percent of the actual volatility of the last 15 years. Finally, the paper studies the design of optimal simple implementable rules. Superinertial rules, which imply a hump-shaped interest rate response to shocks, significantly outperform standard rules.
    Keywords: Monetary policy ; Interest rates ; Inflation (Finance) ; Consumer credit
    Date: 2007
  18. By: Paul Levine (University of Surrey); Joseph Pearlman (London Metropolitan University); Richard Pierse (University of Surrey)
    Abstract: We reassess the gains from monetary policy coordination within the confines of the canonical NOEM in the light of three issues. First, the literature uses a number of cooperative and non-cooperative equilibrium concepts that do not always clearly distinguish commitment and discretionary outcomes, and in some cases adopts inappropriate concepts. Second, our analysis is welfare based. Moreover, as with much of this literature, we adopt a linear-quadratic approximation of the actual non-linear non-quadratic stochastic optimization problem facing the monetary policymakers. Our second objective then is to re-assess welfare gains using an accurate approximation for such a problem, a feature that for the most part is lacking in previous studies. Finally, we examine the issue where the monetary authority is restricted to rules that are operational in two senses: first, the zero lower bound constraint is imposed on the optimal rule and second, we study simple Taylor-type commitment rules that unlike fully optimal rules are easily monitored by the public.
    Keywords: monetary rules, open economy, coordination games, commitment, discretion, zero bound constraint
    JEL: E52 E37 E58
    Date: 2007–10

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