nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2007‒11‒10
eighteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Country Portfolio Dynamics By Michael B Devereux; Alan Sutherland
  2. Can a Representative Agent Model Represent a Heterogeneous Agent Economy? By Sungbae An; Yongsung Chang; Sun-Bin Kim
  3. Information, heterogeneity and market incompleteness in the stochastic growth model By Liam Graham; Stephen Wright
  4. Documentation of the Research and Statistics Division’s estimated DSGE model of the U.S. economy: 2006 version By Rochelle M. Edge; Michael T. Kiley; Jean-Philippe Laforte
  5. The international diversification puzzle is not as bad as you think By Jonathan Heathcote; Fabrizio Perri
  6. A Multiplier Approach to Understanding the Macro Implications of Household Finance By YiLi Chien; Harold Cole; Hanno Lustig
  7. Trade and the (Dis)Incentive to Reform Labor Markets: The Case of Reform in the European Union By George Alessandria; Alain Delacroix
  8. Comparative Advantage in Cyclical Unemployment By Mark Bils; Yongsung Chang; Sun-Bin Kim
  9. Crime and the labor market: a search model with optimal contracts By Bryan Engelhardt; Guillaume Rocheteau; Peter Rupert
  10. An Endogenous Taylor Condition in an Endogenous Growth Monetary Policy Model By Le, Vo Phuong Mai; Gillman, Max; Minford, Patrick
  11. Optimal Monetary Policy and Technological Shocks in the Post-War US Business Cycle By FÈVE, Patrick; MATHERON, Julien; SAHUC, Jean-Guillaume
  12. Welfare-maximizing monetary policy under parameter uncertainty By Rochelle M. Edge; Thomas Laubach; John C. Williams
  13. Homogeneity, Saddle Path Stability, and Logarithmic Preferences in Economic Models By Dirk Bethmann
  15. Public Infrastructure, Strategic Interactions and Endogeneous Growth By Charles Figuières; Fabien Prieur; Mabel Tidball
  16. What Are In‡ation Expectations Rational? By David Andolfatto; Scott Hendry; Kevin Moran
  17. Inflation, Financial Development and Human Capital-Based Endogenous Growth: an Explanation of Ten Empirical Findings By Max Gillman; Michal Kejak
  18. The heterogeneous state of modern macroeconomics: a reply to Solow By V. V. Chari; Patrick J. Kehoe

  1. By: Michael B Devereux; Alan Sutherland
    Abstract: This paper presents a general approximation method for characterizing timevarying equilibrium portfolios in a two-country dynamic general equilibrium model. The method can be easily adapted to most dynamic general equilibrium models, it applies to environments in which markets are complete or incomplete, and it can be used for models of any dimension. Moreover, the approximation provides simple, easily interpretable closed form solutions for the dynamics of equilibrium portfolios.
    Keywords: Country portfolios, solution methods.
    JEL: E52 E58 F41
    Date: 2007–11
  2. By: Sungbae An (Singapore Management University); Yongsung Chang (University of Rochester and Seoul National University); Sun-Bin Kim (Department of Economics, Korea University)
    Abstract: Accounting for observed uctuations in aggregate employment, consumption, and real wage using optimality conditions of a representative household often requires preferences that are incompatible with economic priors (e.g., Mankiw, Rotemberg, and Summers, 1985). This discrepancy between the equilibrium model and the aggregate data is often viewed as evidence of the failure of labor-market clearing. We argue that such a conclusion is premature. We construct a model economy where all prices are exible and all markets clear at all times but household decisions are not readily aggregated because of incomplete capital markets and the indivisible nature of labor supply. We demonstrate that if we were to explain the model-generated aggregate time series using decisions of a "fictitious" stand-in household, such a household is likely to have a non-concave or unstable utility. Our analysis suggests that the representative agent model often fails to represent an equilibrium outcome of a heterogeneous agent economy.
    Keywords: Representative agent model, Aggregation, Heterogeneity, Incomplete Markets, Indivisible Labor, GMM Estimation
    JEL: E24 E32 J21 J22
    Date: 2007
  3. By: Liam Graham; Stephen Wright
    Abstract: We provide a microfounded account of imperfect information in the stochastic growth model which dramatically changes the properties of the model. We describe heterogenous households that acquire information about aggregates through their participation in markets. If markets are incomplete, household information will be imperfect. We solve the model taking account of the infinite regress of expectations that this lack of information implies. We derive analytical and numerical results to show that imperfect information can significantly change the properties of the model: under virtually all calibrations the impact response of consumption to a positive aggregate technology shock is negative.
    Keywords: imperfect information; higher order expectations; Kalman filter; dynamic general equilibrium
    JEL: D52 D84 E32
    Date: 2007–11
  4. By: Rochelle M. Edge; Michael T. Kiley; Jean-Philippe Laforte
    Abstract: This paper provides documentation for the large-scale estimated DSGE model of the U.S. economy used in Edge, Kiley, and Laforte (2007). The model represents part of an ongoing research project (the Federal Reserve Board's Estimated, Dynamic, Optimization-based--FRB/EDO--model project) in the Macroeconomic and Quantitative Studies section of the Federal Reserve Board aimed at developing a DSGE model that can be used to address practical policy questions and the model documented here is the version that was current at the end of 2006. The paper discusses the model's specification, estimated parameters, and key properties.
    Date: 2007
  5. By: Jonathan Heathcote; Fabrizio Perri
    Abstract: In simple one-good international macro models, the presence of non-diversifiable labor income risk means that country portfolios should be heavily biased toward foreign assets. The fact that the opposite pattern of diversification is observed empirically constitutes the international diversification puzzle. We embed a portfolio choice decision in a frictionless two-country, two-good version of the stochastic growth model. In this environment, which is a workhorse for international business cycle research, we derive a closed-form expression for equilibrium country portfolios. These are biased towards domestic assets, as in the data. Home bias arises because endogenous international relative price fluctuations make domestic stocks a good hedge against non-diversifiable labor income risk. We then use our theory to link openness to trade to the level of diversification, and find that it offers a quantitatively compelling account for the patterns of international diversification observed across developed economies in recent years.
    Date: 2007
  6. By: YiLi Chien; Harold Cole; Hanno Lustig
    Abstract: Our paper examines the impact of heterogeneous investment opportunities on the distribution of asset shares and wealth in an equilibrium model. We develop a new method for computing equilibria in this class of economies. This method relies on an optimal consumption sharing rule and an aggregation result for state prices that allows us to solve for equilibrium prices and allocations without having to search for market-clearing prices in each asset market. In a calibrated version of our model, we show that the heterogeneity in trading opportunities allows for a closer match of the wealth and asset share distribution as well as the moments of asset prices. We distinguish between "passive" traders who hold fixed portfolios of equity and bonds, and "active" traders who adjust their portfolios to changes in the investment opportunity set. In the presence of non-participants, the fraction of total wealth held by active traders is critical for asset prices, because only these traders respond to variation in state prices and hence help to clear the market, not the fraction of wealth held by all agents that participate in asset markets.
    JEL: G12
    Date: 2007–10
  7. By: George Alessandria; Alain Delacroix
    Abstract: In a closed economy general equilibrium model, Hopenhayn and Rogerson (1993) find large welfare gains to removing firing restrictions. We explore the extent to which international trade alters this result. When economies trade, labor market policies in one country spill over to other countries through their effect on the terms of trade. A key finding in the open economy is that the share of the welfare gains from domestic labor market reform exported substantially exceeds the share of goods exported. In our baseline case, 105 percent of the welfare gains are exported even though the domestic economy only exports 30 percent of its goods. Thus, with international trade a country receives little to no benefit, and possibly even loses, from unilaterally reforming its labor market. A coordinated elimination of firing taxes yields considerable benefits. We find the welfare gains to the U.K. from labor market reform by its continental trading partners of 0.21 percent of steady state consumption. This insight provides some explanation for recent efforts toward labor market reform in the European Union.
    Keywords: Firing Costs, International Trade, Labor Market Reform
    JEL: D78 E24 E61 F16 F42 J65
    Date: 2007
  8. By: Mark Bils (University of Rochester and NBER); Yongsung Chang (University of Rochester and Seoul National University); Sun-Bin Kim (Department of Economics, Korea University)
    Abstract: We introduce worker differences in labor supply, reecting differences in skills and assets, into a model of separations, matching, and unemployment over the business cycle. Separating from employment when unemployment duration is long is particularly costly for workers with high labor supply. This provides a rich set of testable predictions across workers: those with higher labor supply, say due to lower assets, should display more procyclical wages and less countercyclical separations. Consequently, the model predicts that the pool of unemployed will sort toward workers with lower labor supply in a downturn. Because these workers generate lower rents to employers, this discourages vacancy creation and exacerbates the cyclicality of unemployment and unemployment durations. We examine wage cyclicality and employment separations over the past twenty years for workers in the Survey of Income and Program Participation (SIPP).Wages are much more procyclical for workers who work more. This pattern is mirrored in separations; separations from employment are much less cyclical for those who work more. We do see for recessions a strong compositional shift among those unemployed toward workers who typically work less.
    Date: 2007
  9. By: Bryan Engelhardt; Guillaume Rocheteau; Peter Rupert
    Abstract: This paper extends the Pissarides (2000) model of the labor market to include crime and punishment `a la Becker (1968). All workers, irrespective of their labor force status can commit crimes and the employment contract is determined optimally. The model is used to study, analytically and quantitatively, the effects of various labor market and crime policies. For instance, a more generous unemployment insurance system reduces the crime rate of the unemployed but its effect on the crime rate of the employed depends on job duration and jail sentences. When the model is calibrated to U.S. data, the overall effect on crime is positive but quantitatively small. Wage subsidies reduce unemployment and crime rates of employed and unemployed workers, and improve society’s welfare. Hiring subsidies reduce unemployment but they can raise the crime rate of employed workers. Crime policies (police technology and jail sentences) affect crime rates signifi cantly but have only negligible effects on the labor market.
    Keywords: Crime ; Unemployment ; Labor market
    Date: 2007
  10. By: Le, Vo Phuong Mai (Cardiff Business School); Gillman, Max (Cardiff Business School); Minford, Patrick (Cardiff Business School)
    Abstract: The paper derives a Taylor condition as part of the agent's equilibrium behavior in an endogenous growth monetary economy. It shows the assumptions necessary to make it almost identical to the original Taylor rule, and that it can interchangably take a money supply growth rate form. From the money supply form, simple policy experiments are conducted. A full central bank policy model is derived that includes the Taylor condition along with equations comparable to the standard aggregate-demand/aggregate-supply model.
    Keywords: Taylor Rule ;endogenous growth; money supply; policy model
    JEL: E51 E52 O0
    Date: 2007–11
  11. By: FÈVE, Patrick; MATHERON, Julien; SAHUC, Jean-Guillaume
    JEL: E31 E32 E52
    Date: 2007–10
  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 economy'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.
    Date: 2007
  13. By: Dirk Bethmann (Department of Economics, Korea University)
    Abstract: In a stylized Robinson Crusoe economy, we demonstrate the usefulness of homogeneity in initial conditions when solving and analyzing macroeconomic models. In a first step, we define state-like and control-like variables. In a second step, we introduce the value-function-like function. While the former step reduces the number of variables that have to be considered when solving the model, the latter step reduces the dimensionality of the Bellman equation associated with the optimization problem. The model’s solution is shown to be saddle-path stable, such that the phase diagram associated with the Bellman equation has two solution branches and the structure of our model allows us to state both the stable and the unstable branch explicitly. We also explain the usefulness of logarithmic preferences when studying the continuoustime Hamilton-Jacobi-Bellman equation. In this case the utility maximization problem can be transformed into an initial value problem for an ordinary differential equation.
    Keywords: Closed-form solution, saddle path, homogeneity in initial conditions, continuous time
    JEL: C61 C65 C63
    Date: 2007
  14. By: Isaac Ehrlich (State University of New York at Buffalo and NBER); Jinyoung Kim (Department of Economics, Korea University)
    Abstract: Using an endogenous-growth, overlapping-generations framework where human capital is the engine of growth, we derive propositions concerning the evolution of income and fertility distributions and their interdependencies over three phases of economic development. In our model, heterogeneous families determine fertility and children’s human capital, and generations are linked through intra-family and inter-family interactions. Through simulations and regression analyses we test key implications concerning the dynamic behavior of inequalities in fertility, educational attainments, and three income inequality measures -- family-income inequality, income-group inequality, and the Gini coefficient. In this context, we also reexamine the “Kuznets hypothesis?concerning the relation between income growth and inequality.
    Keywords: income inequality, human capital, fertility, schooling, family, endogenous growth
    JEL: D1 D3 J1 J2
    Date: 2007
  15. By: Charles Figuières; Fabien Prieur; Mabel Tidball
    Abstract: This paper develops a two-country general equilibrium model with endogenous growth where governements behave strategically in the provision of productive infrastructure. The public capitals enter both national and foreign production as an external input, and they are financed by a flat tax on income. In the private sector, firms and households take the public policy as given when making their decisions. It is shown that both a Markov Perfect Equillibrium (MPE) and a Centralized Solution (CS) exist, even when the parameters allow for endogenous growth, therefore explosive paths for the state variables. And the dynamic analysis reveals three important features. Firstly, under constant returns, the two countries' growth rates differ during the transition but are identical on the balanced growth path. Secondly, due to the infrastructure externality, assuming away constant returns to scale a country with decreasing returns can experience sustained growth provided that the other grows at a positive constant rate. Thirdly, Nash growth rates are compared with the centralized rates. We show that cooperation in infrastructure provision does not necessarily lead to higher growth for each country. We also show that, in some configurations of households' preferences and initial conditions, cooperation would call for a recession in the initial stages of development, whereas strategic investments would not. Lastly, depending also on the configuration of preferences, we show that cooperation can increase or decrease the gap between countries' growth rates.
    Date: 2007–05
  16. By: David Andolfatto (Simon Fraser University, Canada and The Rimini Centre for Economics Analysis, Italy.); Scott Hendry (Bank of Canada, Canada); Kevin Moran (UniversitŽ Laval, Canada)
    Abstract: Several recent papers report evidence of an apparent statistical bias in in‡ation expectations and interpret these …ndings as overturning the rational expectations hypothesis. In this paper, we investigate the validity of such an interpretation. We present a computational dynamic general equilibrium model capable of generating aggregate behavior similar to the data along several dimensions. By construction, model agents form “rational” expectations. We run a standard regression on equilibrium realizations of in‡ation and in‡ation expectations over sample periods corresponding to those tests performed on actual data and …nd evidence of an apparent bias in in‡ation expectations. Our experiments suggest that this incorrect inference is largely the product of a small sample problem, exacerbated by short-run learning dynamics in response to infrequent shifts in monetary policy regimes.
    Keywords: Regime changes; Learning dynamics; Monte Carlo exp eriments; Sample size.
    JEL: E47 E52 E58
    Date: 2007–07
  17. By: Max Gillman; Michal Kejak
    Abstract: The paper presents a general equilibrium that can explain ten related sets of empirical results, providing a unified approach to understand usually disparate effects typically treated separately. These are grouped into two sets, one on financial development, investment and inflation, and one on inflations effect on other economy-wide variables such as growth, real interest rates, employment, and money demand. The unified approach also contributes a systematic explanation of certain nonlinearities that are found across these results, as based on the production function for financial intermediary services and the resultant money demand function.
    Keywords: Inflation, financial development, growth, exchange credit production
    JEL: C23 E44 O16 O42
    Date: 2007–11
  18. By: V. V. Chari; Patrick J. Kehoe
    Abstract: Robert Solow has criticized our 2006 Journal of Economic Perspectives essay describing “Modern Macroeconomics in Practice.” Solow eloquently voices the commonly heard complaint that too much macroeconomic work today starts with a model with a single type of agent. We argue that modern macroeconomics may not end too far from where Solow prefers. He is also critical of how modern macroeconomists use data to construct models. Specifically, he seems to think that calibration is the only way that our models encounter data. To the contrary, we argue that modern macroeconomics uses a wide variety of empirical methods and that this big-tent approach has served macroeconomics well. Solow also questions our claim that modern macroeconomics is firmly grounded in economic theory. We disagree and explain why.
    Date: 2007

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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