nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2007‒11‒17
eighteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Business Cycle Fluctuations and the Life Cycle: How Important is On-The-Job Skill Accumulation? By Gary D. Hansen; Selo Imrohoroglu
  2. Modeling Great Depressions: The Depression in Finland in the 1990s By Juan Carlos Conesa; Timothy J. Kehoe; Kim J. Ruhl
  3. Taxes, Benefits, and Careers: Complete Versus Incomplete Markets By Ljungqvist, Lars; Sargent, Thomas J
  4. Rent-seeking competition from state coffers in a calibrated DSGE model of the euro area By Konstantinos Angelopoulos; Apostolis Philippopoulos; Vanghelis Vassilatos
  5. Countercyclical Taxes in a Monopolistically Competitive Environment By Ioana Moldovan
  6. Accounting for the Changing Role of Family Income in Determining College Entry By Christoph Winter
  7. RBCs and DSGEs:The Computational Approach to Business Cycle Theory and Evidence By Özer Karagedikli; Troy Matheson; Christie Smith; Shaun P. Vahey
  8. Intangible Capital, Barriers to Technology Adoption and Cross-Country Income Differences By Hashmi, Aamir Rafique
  9. On Efficient Child Making By Philippe Michel; Bertrand Wigniolle
  10. Welfare Implications of Exchange Rate Changes By Marques, Luis B
  11. Markov-Perfect Optimal Fiscal Policy: The Case of Unbalanced Budgets By Salvador Ortigueira; Joana Pereira
  12. The Extension of Social Security Coverage in Developing Countries By Chung Tran; Juergen Jung
  13. Agriculture and Aggregate Productivity: A Quantitative Cross-Country Analysis By Diego Restuccia; Dennis Tao Yang; Xiaodong Zhu
  14. Endogenous Political Instability By Ryo Arawatari; Kazuo Mino
  15. Executive Compensation: The View from General Equilibrium By Danthine, Jean-Pierre; Donaldson, John B
  16. Rationalizing Seven Consumption-Saving Puzzles in a Unified Framework By Kevin X.D. Huang; Frank Caliendo
  17. How should the government allocate its tax revenues between productivity-enhancing and utility-enhancing public goods? By George Economides; Hyun Park; Apostolis Philippopoulos
  18. Labor Adjustment: Disentangling Firing and Mobility Costs By Luigi Guiso; Luigi Pistaferri; Fabiano Schivardi

  1. By: Gary D. Hansen; Selo Imrohoroglu
    Abstract: We study the effects of on-the-job skill accumulation on average hours worked by age and the volatility of hours over the life cycle in a calibrated general equilibrium model. Two forms of skill accumulation are considered: learning by doing and on-the-job training. In our economy with learning by doing, individuals supply more labor early in the life cycle and less as they approach retirement than they do in an economy without this feature. The impact of this feature on the volatility of hours over the life cycle depends on the value of the intertemporal elasticity of labor supply. When individuals accumulate skills by on-the-job training, there are only weak effects on both the steady-state labor supply and its volatility over the life cycle.
    JEL: E32 J22 J24
    Date: 2007–11
  2. By: Juan Carlos Conesa; Timothy J. Kehoe; Kim J. Ruhl
    Abstract: This paper is a primer on the great depressions methodology developed by Cole and Ohanian (1999, 2007) and Kehoe and Prescott (2002, 2007). We use growth accounting and simple dynamic general equilibrium models to study the depression that occurred in Finland in the early 1990s. We find that the sharp drop in real GDP over the period 1990-93 was driven by a combination of a drop in total factor productivity (TFP) during 1990-92 and of increases in taxes on labor and consumption and increases in government consumption during 1989-94, which drove down hours worked in Finland. We attempt to endogenize the drop in TFP in variants of the model with an investment sector and with terms-of-trade shocks but are unsuccessful.
    JEL: E13 E32 E50 F41 F59
    Date: 2007–11
  3. By: Ljungqvist, Lars; Sargent, Thomas J
    Abstract: An incomplete markets life-cycle model with indivisible labour makes career lengths and human capital accumulation respond to labour tax rates and government supplied non-employment benefits. We compare aggregate and individual outcomes in this individualistic incomplete markets model with those in a comparable collectivist representative family with employment lotteries and complete insurance markets. The incomplete and complete market structures assign leisure to different types of individuals who are distinguished by their human capital and age. These microeconomic differences distinguish the two models in terms of how macroeconomic aggregates respond to some types of government supplied non-employment benefits, but remarkably, not to labor tax changes.
    Keywords: benefits; career; complete markets; employment lotteries; human capital; incomplete markets; indivisible labour; labour supply elasticity; retirement; taxes
    JEL: E24 E62 J21 J26
    Date: 2007–11
  4. By: Konstantinos Angelopoulos; Apostolis Philippopoulos; Vanghelis Vassilatos
    Abstract: We incorporate an uncoordinated redistributive struggle for extra fiscal privileges into an otherwise standard dynamic stochastic general equilibrium model. The main aim is to get model-consistent quantitative evidence of the extent of rent seeking. Our work is motivated by the common belief that interest groups compete with each other for privileged transfers, subsidies and tax treatments at the expense of the general public interest. The model is calibrated to the euro area as a whole, and to individual euro member-countries, over the period 1980-2003. We find that an important proportion of tax revenue is appropriated by rent seekers and that the introduction of rent seeking moves the model in the right direction vis-à-vis the data
    Keywords: Fiscal policy, real business cycles, rent seeking.
    JEL: E62 E32 O17
    Date: 2007–09
  5. By: Ioana Moldovan
    Abstract: In a neoclassical growth model with monopolistic competition in the product market, distortionary taxes, and debt, countercyclical income tax rates can reduce the volatility of output, consumption, and investment. The variability of employment however is a non-monotonic function of the income elasticity of the tax rate. In terms of welfare, the reduced volatility raises welfare. However, when solving the model with a second order approximation, so that agents take direct account of the level of uncertainty when making decisions, then the reduced volatility results in agents accumulating less capital and lowers consumption in the long run. This second effect dominates in the welfare calculations so that countercyclical taxes end up reducing welfare. The fiscal financing role of income taxes tends to raise the volatility of aggregate variables and can lead to a destabilizing role of countercyclical taxes. But a more aggressive response to debt improves the stabilization and welfare properties of countercyclical taxes.
    Keywords: tax policy, countercyclical, stabilization, government debt, welfare
    Date: 2007–09
  6. By: Christoph Winter
    Abstract: Assessing the importance of borrowing constraints for college entry is key for education policy analysis in the U.S. economy. I present a computable dynamic general equilibrium model with overlapping generations and incomplete markets that allows me to measure the fraction of households constrained in their college entry decision. College education is financed by family transfers and public subsidies, where transfers are generated through altruism on part of the parents. Parents face a trade-off between making transfers to their children and own savings. Ceteris paribus, parents who expect lower future earnings transfer less and save more. Data from the 1986 Survey of Consumer Finances give support to this mechanism. I show that this trade-off leads to substantially higher estimates of the fraction of constrained households compared to the results in the empirical literature (18 instead of 8 percent). The model also predicts that an increment in parents' earnings uncertainty decreases their willingness to provide transfers. In combination with rising returns to education, which makes college going more attractive, this boosts the number of constrained youths and explains why family income has become more important for college access over the last decades in the U.S. economy.
    Keywords: College Enrolment, Borrowing Constraints,Parental Transfers, Household Savings, Dynamic General Equilibrium Models
    JEL: I20 I22 D58 D91
    Date: 2007
  7. By: Özer Karagedikli; Troy Matheson; Christie Smith; Shaun P. Vahey (Reserve Bank of New Zealand)
    Abstract: Real Business Cycle (RBC) and Dynamic Stochastic General Equilibrium (DSGE) methods have become essential components of the macroeconomist’s toolkit. This literature review stresses recently developed (often Bayesian) techniques for computation and inference, providing a supplement to the Romer (2006) textbook treatment which stresses theoretical issues. Many computational aspects are illustrated with reference to the simple divisible labour RBC model familiar to graduate students from King, Plosser and Rebelo (1988), Christiano and Eichenbaum (1992), Campbell (1994) and Romer (2006). Code and US data to replicate the computations are provided on the Internet, together with a number of appendices providing background details.
    JEL: C11 C22 E17 E32 E52
    Date: 2007–11
  8. By: Hashmi, Aamir Rafique
    Abstract: I add intangible capital to a variant of the neoclassical growth model and study the implications of this extension for cross-country income differences. I calibrate the parameters associated with intangible capital by using new estimates of investment in intangibles by Corrado et al. [2006]. I find that the addition of intangible capital significantly improves the model's ability to account for cross-country income differences. Specifically, when intangible capital is added to the model, the required TFP ratio to explain observed income differences falls from 4.05 to 2.97. I also study variants of the model with endogenous and exogenous barriers to accumulation of technology capital, which consists of intangible capital and a fraction of physical capital that embodies technology. The addition of endogenous barriers, for reasonable parameter values, has a very small positive effect on the ability of the model to account for income differences. The addition of exogenous barriers suggests that huge cross-country differences in such barriers are needed to generate the observed income differences.
    Keywords: Cross-country Income Differences; Intangible Capital; Technology Adoption
    JEL: O3 O4
    Date: 2007–11
  9. By: Philippe Michel (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille II - Université Paul Cézanne - Aix-Marseille III - Ecole des Hautes Etudes en Sciences Sociales); Bertrand Wigniolle (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I)
    Abstract: This paper is devoted to the study of the Pareto-efficiency of the competitive equilibrium for an overlapping generations economy with endogenous fertility. Pareto-efficiency needs a reformulation when fertility is endogenous. Then it is proved that a competitive equilibrium that converges in over-accumulation is non-Pareto-efficient. However, we provide an example in which a competitive equilibrium that converges in under-accumulation is non-Pareto-efficient. Finally, we give a general condition that ensures the Pareto-efficiency of the competitive equilibrium.
    Keywords: endogenous fertility, Pareto-efficiency
    Date: 2007–05
  10. By: Marques, Luis B
    Abstract: This paper measures the welfare implications of a depreciation of the US dollar against the euro using a dynamic equilibrium model. I calibrate a simple two country stochastic endowment economy with trade in goods and financial assets and exogenous variations in the exchange rate. The model displays both a trade channel effect and an asset channel effect after a change in the value of the exchange rate. The welfare loss coming from the trade channel translates into the relatively higher price that consumers have to pay for imports. The asset channel effect arises from three sources. One is the traditional valuation effect associated with US debt being denominated mostly in dollars. The other two novel effects are: (1) the dollar value of investors net worth, mostly denominated in local currency, increases more in Europe than in the US; (2) asset prices change, causing a portfolio rebalancing effect which results in a fall in the share of world assets owned by the US. I show that a dollar depreciation has potentially large negative welfare effects as measured by the net present value of future consumption. After a temporary 10% depreciation of the dollar, with a half-life of one year, I calculate a 0.25% decrease in lifetime aggregate consumption for the US consumer.
    Keywords: trade effect; valuation effect; wealth effect; exchange rate; dynamic equilibrium model; welfare.
    JEL: F41 F47 F31
    Date: 2007–03
  11. By: Salvador Ortigueira; Joana Pereira
    Abstract: We study optimal income taxation and public debt policy in a neoclassical economy populated by infinitely-lived households and a benevolent government. The government makes sequential decisions on the provision of a valued public good, on income taxation and the issue of public debt. We characterize and compute Markov-perfect optimal fiscal policy in this economy with two payoff-relevant state variables: physical capital and public debt. We find two stable, steady-state equilibria: one with no income taxation and positive government asset holdings, and another with positive taxation and public debt issuances. We prove that the two steady states are associated with different policy rules, which implies a multiplicity of (expectation-driven) Markov-perfect equilibria.
    Keywords: Optimal taxation; optimal public debt; Markov-perfect equilibrium; Time-consistent policy
    JEL: E61 E62 H21 H63
    Date: 2007
  12. By: Chung Tran (Indiana University Bloomington); Juergen Jung (Indiana University Bloomington)
    Abstract: We investigate the effects of extending the coverage of social security to uncovered elderly individuals in the informal sector in developing countries. We use a stochastic overlapping generations framework and incorporate important characteristics of developing countries including family transfers and a sizeable informal sector. Our calibrated model predicts that the introduction of a moderately sized social assistance program decreases steady state output by up to 3.25% and labor supply by up to 2.5%. In contrast to literature focusing on developed countries, the model predicts that extending the coverage of the social security system results in welfare gains for low income households. This result indicates that the insurance function and the redistribution function of the social assistance program dominate the distortionary effects in an environment without adequate risk sharing mechanisms and high inequality.
    Keywords: Social Security Reform, Altruism, Informal Sector, Private Transfers, Savings, Labor Supply and Welfare
    JEL: E6 E21 E26 H30 H53 H55 I38 O17
    Date: 2007–11
  13. By: Diego Restuccia; Dennis Tao Yang; Xiaodong Zhu
    Abstract: A decomposition of aggregate labor productivity based on internationally comparable data reveals that a high share of employment and low labor productivity in agriculture are mainly responsible for low aggregate productivity in poor countries. Using a two-sector general-equilibrium model, we show that differences in economy-wide productivity, barriers to modern intermediate inputs in agriculture, and barriers in the labor market generate large cross-country di?erences in the share of employment and labor productivity in agriculture. The model implies a factor difference of 10.8 in aggregate labor productivity between the richest and the poorest 5 percent of the countries in the world, leaving the unexplained factor at 3.2. Overall, this two-sector framework performs much better than a single-sector growth model in explaining observed differences in international productivity.
    Keywords: Productivity, International Comparisons, Agriculture, Intermediate Inputs, Barriers, Two-sector Model
    Date: 2007
  14. 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. 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 indeterminacy 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
  15. By: Danthine, Jean-Pierre; Donaldson, John B
    Abstract: We study the dynamic general equilibrium of an economy where risk averse shareholders delegate the management of the firm to risk averse managers. The optimal contract has two main components: an incentive component corresponding to a non-tradable equity position and a variable 'salary' component indexed to the aggregate wage bill and to aggregate dividends. Tying a manager's compensation to the performance of her own firm ensures that her interests are aligned with the goals of firm owners and that maximizing the discounted sum of future dividends will be her objective. Linking managers' compensation to overall economic performance is also required to make sure that managers use the appropriate stochastic discount factor to value those future dividends.
    Keywords: incentives; optimal contracting; stochastic discount factor
    JEL: E32 E44
    Date: 2007–11
  16. By: Kevin X.D. Huang (Department of Economics, Vanderbilt University); Frank Caliendo (Department of Economics, Utah State University)
    Abstract: Empirical evidence suggests that it may cost time, effort, and resources to properly implement a saving plan, though such cost may differ across individual consumers. We document seven facts on macroeconomic consumption and saving over the life cycle, and we enrich a simple life-cycle model by costly saving implementation to explain these facts. This friction is the sole and common mechanism in our model for rationalizing this series of facts, as the model abstracts from all existing mechanisms that are known to help explain some of them. The implementation costs in our model are small, yet they help resolve these macroeconomic consumption and saving puzzles in a simple and unified way.
    Keywords: Overconfidence, consumption, life cycle, time inconsistency, hump shape, elasticity of intertemporal substitution <br><br>
    JEL: C61 D91 E21
    Date: 2007–10
  17. By: George Economides; Hyun Park; Apostolis Philippopoulos
    Abstract: We present a fairly standard general equilibrium model of endogenous growth with productive and non-productive public goods and servives. The former enhance private productivity and the latter private utility. We solve for Ramsey second-best optimal policy (where policy is summarized by the paths of the income tax rate and the allocation of the collected tax revenues between productivity-enhancing and utilityenhancing public expenditures). We show that the properties and implications of second-best optimal policy (a) differ from the benchmark case of the social planner’s first-best allocation (b) depend crucially on whether public goods and services are subject to congestion.
    Keywords: Second-best optimal policy; Congested public goods; Growth
    JEL: H2 H4 D9
    Date: 2007–09
  18. By: Luigi Guiso; Luigi Pistaferri; Fabiano Schivardi
    Abstract: This paper studies the costs of adjusting employment, distinguishing between firms’ firing and workers’ mobility costs. We construct a simple dynamic general equilibrium model of labor demand and supply and show that only the joint response of employment and wages to firm level shocks can discriminate between the two types of costs. We use matched employer-employees data for Italy to estimate the model and find that both types of costs are present, that they are sizeable (in the range of 19,000 euros in total) and that firing costs account for almost 90 percent of total adjustment costs.
    Keywords: Adjustment costs, mobility costs, matched employer-employees data
    JEL: C33 D21 J63
    Date: 2007

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