nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2008‒01‒05
24 papers chosen by
Christian Zimmermann
University of Connecticut

  1. Should we take inside money seriously? By Livio Stracca
  2. Entry, exit and plant-level dynamics over the business cycle By Yoonsoo Lee; Toshihiko Mukoyama
  3. Input and output inventories in general equilibrium By Matteo Iacoviello; Fabio Schiantarelli; Scott Schuh
  4. On the Ramsey equilibrium with heterogeneous consumers and endogenous labor supply. By Stefano Bosi; Thomas Seegmuller
  5. Frictional Wage Dispersion in Search Models: A Quantitative Assessment By Andreas Hornstein; Per Krusell; Giovanni L. Violante
  6. GDP at risk in a DSGE model: an application to banking sector stress testing By Jokivuolle, Esa; Kilponen , Juha; Kuusi, Tero
  7. The Baby Boom and World War II: A Macroeconomic Analysis By Matthias Doepke; Moshe Hazan; Yishay Maoz
  8. Evaluating Asset Pricing Models with Limited Commitment using Household Consumption Data By Dirk Krueger; Hanno Lustig; Fabrizio Perri
  9. Equilibrium mortgage choice and housing tenure decisions with refinancing By Matthew S. Chambers; Carlos Garriga; Don Schlagenhauf
  10. Non-Self-Averaging in Macroeconomic Models: A Criticism of Modern Micro-founded Macroeconomics By Aoki, Masanao; Yoshikawa, Hiroshi
  11. Rare Disasters, Asset Prices, and Welfare Costs By Robert J. Barro
  12. Optimal simple and implementable monetary and fiscal rules By Stephanie Schmitt-Grohé; Martín Uribe
  13. Labor-Market Matching with Precautionary Savings and Aggregate Fluctuations By Per Krusell; Toshihiko Mukoyama; Ayseg ul Sahin
  14. A general equilibrium theory of college with education subsidies, in-school labor supply, and borrowing constraints By Carlos Garriga; Mark P. Keightley
  15. Taylor Rules Cause Fiscal Policy Ineffectiveness By Guido Ascari; Neil Rankin
  16. Optimal reserve management and sovereign debt By Laura Alfaro; Fabio Kanczuk
  17. Avoiding the inflation tax By Huberto M. Ennis
  18. The Fundamental Duality Theorem of Balanced Growth By Ian King; Don Ferguson
  19. Pricing-to-market, trade costs, and international relative prices By Andrew Atkeson; Ariel Burstein
  20. Indeterminacy under input-specific externalities and implications for fiscal policy. By Thomas Seegmuller
  21. Complements versus Substitutes and Trends in Fertility Choice in Dynastic Models By Larry E. Jones; Alice Schoonbroodt
  22. DSGE Modeling at the Fund: Applications and Further Developments By Philippe D Karam; Dennis P. J. Botman; Douglas Laxton; David Rose
  23. Nominal Debt as a Burden on Monetary Policy By Ramon Marimon; Javier Díaz-Giménez; Giorgia Giovannetti; Pedro Teles
  24. Uncertainty and the Specificity of Human Capital By Martin Gervais; Igor Livshits; Césaire Meh

  1. By: Livio Stracca (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper presents a dynamic general equilibrium model with sticky prices, in which "inside" money, made out of commercial banks’ liabilities, plays an active, structural role role. It is shown that, in such a model, an inside money shock has a well-defined meaning. A calibrated version of the model is shown to generate small, but non-negligible effects of inside money shocks on output and inflation. I also simulate the effect of a banking crisis in the model. Moreover, I find that it is optimal for monetary policy to react to such shocks, although reacting to inflation alone does not result in a significant welfare loss. JEL Classification: E43.
    Keywords: Endogenous money, inside money, monetary policy, dynamic general equilibrium models, deposit in advance constraint.
    Date: 2007–12
  2. By: Yoonsoo Lee; Toshihiko Mukoyama
    Abstract: This paper analyzes the implications of plant-level dynamics over the business cycle. We first document basic patterns of entry and exit of U.S. manufacturing plants, in terms of employment and productivity between 1972 and 1997. We show how entry and exit patterns vary during the business cycle, and that the cyclical pattern of entry is very different from the cyclical pattern of exit. Second, we build a general equilibrium model of plant entry, exit, and employment and compare its predictions to the data. In our model, plants enter and exit endogenously, and the size and productivity of entering and exiting plants are also determined endogenously. Finally, we explore the policy implications of the model. Imposing a firing tax that is constant over time can destabilize the economy by causing fluctuations in the entry rate. Entry subsidies are found to be effective in stabilizing the entry rate and output.
    Keywords: Business cycles ; Manufacturing industries
    Date: 2007
  3. By: Matteo Iacoviello; Fabio Schiantarelli; Scott Schuh
    Abstract: We build and estimate a two-sector (goods and services) dynamic stochastic general equilibrium model with two types of inventories: materials (input) inventories facilitate the production of finished goods, while finished goods (output) inventories yield utility services. The model is estimated using Bayesian methods. The estimated model replicates the volatility and cyclicality of inventory investment and inventory-to-target ratios. Although inventories are an important element of the model’s propagation mechanism, shocks to inventory efficiency or management are not an important source of business cycles. When the model is estimated over two subperiods (pre- and post-1984), changes in the volatility of inventory shocks, or in structural parameters associated with inventories play a minor role in reducing the volatility of output.
    Keywords: Stochastic analysis ; Inventories
    Date: 2007
  4. By: Stefano Bosi (EQUIPPE - Université de Lille 1 et EPEE); Thomas Seegmuller (Centre d'Economie de la Sorbonne)
    Abstract: In this paper, we address the question of deterministic cycles in a Ramsey model with heterogeneous infinite-lived agents and borrowing constraints, augmented to take into account the case of elastic labor supply. Under usual restrictions, not only we show that the steady state is unique, but also we clarify its stability properties through a local analysis. We find that, in many cases, the introduction of elastic labor supply promotes convergence by widening the range of parameters for saddle-path stability and endogenous cycles can eventually disappear. These results are robustly illustrated by means of canonical examples in which consumers have separable, KPR or homogeneous preferences.
    Keywords: Saddle-path stability, endogenous cycles, heterogeneous agents, endogenous labor supply, borrowing constraint.
    JEL: C62 D30 E32
    Date: 2007–01
  5. By: Andreas Hornstein; Per Krusell; Giovanni L. Violante
    Abstract: Standard search and matching models of equilibrium unemployment, once properly calibrated, can generate only a small amount of frictional wage dispersion, i.e., wage differentials among ex-ante similar workers induced purely by search frictions. We derive this result for a specific measure of wage dispersion -- the ratio between the average wage and the lowest (reservation) wage paid. We show that in a large class of search and matching models this statistic (the "mean-min ratio") can be obtained in closed form as a function of observable variables (i.e., the interest rate, the value of leisure, and statistics of labor market turnover). Various independent data sources suggest that actual residual wage dispersion (i.e., inequality among observationally similar workers) exceeds the model's prediction by a factor of 20. We discuss three extensions of the model (risk aversion, volatile wages during employment, and on-the-job search) and find that, in their simplest versions, they can improve its performance, but only modestly. We conclude that either frictions account for a tiny fraction of residual wage dispersion, or the standard model needs to be augmented to confront the data. In particular, the last generation of models with on-the-job search appears promising.
    JEL: E24 J24 J31 J6 J64
    Date: 2007–11
  6. By: Jokivuolle, Esa (Bank of Finland Research); Kilponen , Juha (Bank of Finland Research); Kuusi, Tero (Helsinki School of Economics)
    Abstract: We suggest a complementary tool for financial stability analysis based on stochastic simulation of a dynamic stochastic general equilibrium model (DSGE) of the macro economy. The paper relates to financial stability research in which financial aggregates crucial to financial stability are modelled as functions of macroeconomic variables. In these models, stress tests for eg banking sector loan losses can be generated by considering adverse scenarios of macro variables. A DSGE model provides a systematic way of generating coherent macro scenarios which can be given a rigorous economic interpretation. The approach is illustrated using a DSGE model of the Finnish economy and a simple model of Finnish banking sector loan losses.
    Keywords: DSGE models; financial stability; loan losses; stress testing
    JEL: E13 E37 G21 G28
    Date: 2007–12–19
  7. By: Matthias Doepke; Moshe Hazan; Yishay Maoz
    Abstract: We argue that one major cause of the U.S. postwar baby boom was the increased demand for female labor during World War II. We develop a quantitative dynamic general equilibrium model with endogenous fertility and female labor-force participation decisions. We use the model to assess the long-term implications of a one-time demand shock for female labor, such as the one experienced by American women during wartime mobilization. For the war generation, the shock leads to a persistent increase in female labor supply due to the accumulation of work experience. In contrast, younger women who turn adult after the war face increased labor-market competition, which impels them to exit the labor market and start having children earlier. In our calibrated model, this general-equilibrium effect generates a substantial baby boom followed by a baby bust, as well as patterns for age-specific labor-force participation and fertility rates that are consistent with U.S data.
    JEL: D58 E24 J13 J20
    Date: 2007–12
  8. By: Dirk Krueger; Hanno Lustig; Fabrizio Perri
    Abstract: We evaluate the asset pricing implications of a class of models in which risk sharing is imperfect because of limited enforcement of intertemporal contracts. Lustig (2004) has shown that in such a model the asset pricing kernel can be written as a simple function of the aggregate consumption growth rate and the growth rate of consumption of the set of households that do not face binding enforcement constraints. These unconstrained households have lower consumption growth rates than all other households in the economy. We use household data on consumption growth from the U.S. Consumer Expenditure Survey to identify unconstrained households, to estimate the pricing kernel implied by these models and evaluate their performance in pricing aggregate risk. We find that for high values of the relative risk aversion coefficient, the limited enforcement pricing kernel generates a market price of risk that is substantially closer to the data than the one obtained using the standard complete markets asset pricing kernel.
    JEL: D52 D53 E44 G12
    Date: 2007–11
  9. By: Matthew S. Chambers; Carlos Garriga; Don Schlagenhauf
    Abstract: The last decade has brought about substantial mortgage innovation and increased refinancing. The objective of this paper is to understand the determinants and implications of mortgage choice in the context of a general equilibrium model with incomplete markets. The equilibrium characterization allows us to study the impact of mortgage financing decisions in the productive economy. We show the influence of different contract characteristics such as the down payment requirement, repayment structure, and the amortization schedule for mortgage choice. We find that loan products that allow for low or no down payment or an increasing repayment schedule increase the participation of young and lower-income households. We find evidence that the volume of housing transactions increases when the payment profile is increasing and households have little housing equity. In contrast, we show that loans that allow for a rapid accumulation of home equity can still have positive participation effects without increasing the volatility of the housing market. The model predicts that the expansion of mortgage contracts and refinancing improves risk sharing opportunities for homeowners, but the magnitude varies with each contract.
    Date: 2007
  10. By: Aoki, Masanao; Yoshikawa, Hiroshi
    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 accurate 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.
    Keywords: Micro foundations, Macroeconomics, Non-self averaging phenomena, Power laws
    Date: 2007
  11. By: Robert J. Barro
    Abstract: A representative-consumer model with Epstein-Zin-Weil preferences and i.i.d. shocks, including rare disasters, accords with key asset-pricing observations. If the coefficient of relative risk aversion equals 3-4, the model accords with observed equity premia and risk-free real interest rates. If the intertemporal elasticity of substitution is greater than one, an increase in uncertainty lowers the price-dividend ratio for equity, whereas a rise in the expected growth rate raises this ratio. In a model with endogenous saving, more uncertainty lowers the saving ratio (because substitution effects dominate). The match with major features of asset pricing suggests that the model is a reasonable candidate for assessing the welfare cost of aggregate consumption uncertainty. In the baseline simulation, the welfare cost of disaster risk is large -- society would be willing to lower real GDP by as much as 20% each year to eliminate the small chance of major economic collapses. The welfare cost from usual economic fluctuations is much smaller, though still important, corresponding to lowering GDP by around 1.5% each year.
    JEL: E2 G12 O4
    Date: 2007–12
  12. By: Stephanie Schmitt-Grohé; Martín Uribe
    Abstract: This paper computes welfare-maximizing monetary and fiscal policy rules in a real business cycle model augmented with sticky prices, a demand for money, taxation, and stochastic government consumption. We consider simple feedback rules whereby the nominal interest rate is set as a function of output and inflation and taxes are set as a function of total government liabilities. We implement a second-order accurate solution to the model. We have several main findings. First, the size of the inflation coefficient in the interest rate rule plays a minor role for welfare. It matters only insofar as it affects the determinacy of equilibrium. Second, optimal monetary policy features a muted response to output. More importantly, interest rate rules that feature a positive response to output can lead to significant welfare losses. Third, the welfare gains from interest rate smoothing are negligible. Fourth, optimal fiscal policy is passive. Finally, the optimal monetary and fiscal rule combination attains virtually the same level of welfare as the Ramsey optimal policy.
    Date: 2007
  13. By: Per Krusell; Toshihiko Mukoyama; Ayseg ul Sahin
    Date: 2007–12–18
  14. By: Carlos Garriga; Mark P. Keightley
    Abstract: This paper analyzes the effectiveness of three different types of education policies: tuition subsidies (broad based, merit based, and flat tuition), grant subsidies (broad based and merit based), and loan limit restrictions. We develop a quantitative theory of college within the context of general equilibrium overlapping generations economy. College is modeled as a multi-period risky investment with endogenous enrollment, time-to-degree, and dropout behavior. Tuition costs can be financed using federal grants, student loans, and working while at college. We show that our model accounts for the main statistics regarding education (enrollment rate, dropout rate, and time to degree) while matching the observed aggregate wage premiums. Our model predicts that broad based tuition subsidies and grants increase college enrollment. However, due to the correlation between ability and financial resources most of these new students are from the lower end of the ability distribution and eventually dropout or take longer than average to complete college. Merit based education policies counteract this adverse selection problem but at the cost of a muted enrollment response. Our last policy experiment highlights an important interaction between the labor-supply margin and borrowing. A significant decrease in enrollment is found to occur only when borrowing constraints are severely tightened and the option to work while in school is removed. This result suggests that previous models that have ignored the student's labor supply when analyzing borrowing constraints may be insufficient.
    Keywords: Education - Economic aspects ; College costs
    Date: 2007
  15. By: Guido Ascari; Neil Rankin
    Abstract: With the aim of constructing a dynamic general equilibrium model where fiscal policy can operate as a demand management tool, we develop a framework which combines staggered prices and overlapping generations based on uncertain lifetimes. Price stickiness plus lack of Ricardian Equivalence could be expected to make tax cuts, financed by increasing government debt, effective in raising short-run output. Surprisingly, in our baseline model this fails to occur. We trace the cause to the assumption that monetary policy is governed by a Taylor Rule. If monetary policy is instead governed by a money supply rule, fiscal policy effectiveness is restored.
    Keywords: staggered prices, overlapping generations, fiscal policy effectiveness, Taylor Rules.
    JEL: E62 E63
    Date: 2007–11
  16. By: Laura Alfaro; Fabio Kanczuk
    Abstract: Most models currently used to determine optimal foreign reserve holdings take the level of international debt as given. However, given the sovereign's willingness-to-pay incentive problems, reserve accumulation may reduce sustainable debt levels. In addition, assuming constant debt levels does not allow addressing one of the puzzles behind using reserves as a means to avoid the negative effects of crisis: why do not sovereign countries reduce their sovereign debt instead? To study the joint decision of holding sovereign debt and reserves, we construct a stochastic dynamic equilibrium model calibrated to a sample of emerging markets. We obtain that the optimal policy is not to hold reserves at all. This finding is robust to considering interest rate shocks, sudden stops, contingent reserves and reserve dependent output costs.
    Keywords: Debt ; Default (Finance)
    Date: 2007
  17. By: Huberto M. Ennis
    Abstract: This paper is extensively revised from WP 05-10. I study the effects of inflation on the purchasing behavior of buyers in an economy where money is essential for certain transactions (as in Lagos and Wright, 2005). A long-standing intuition in this subject is that when inflation increases, agents try to spend their money holdings speedily. The standard framework fails to capture this kind of effect (see Lagos and Rocheteau, 2005). I propose a simple modification of the model that improves it in this dimension. I assume that buyers can rebalance their money holdings only sporadically (i.e., not every period). With this minimal change in the environment, I show that higher inflation induces some buyers to spend their money faster by frontloading their consumption, searching more intensively for transactions, and buying low-quality goods. In this way, the model is able to reproduce distortions in the pattern of transactions that, traditionally, have played an important role in the evaluation of the cost ofinflation.
    Keywords: Inflation (Finance) ; Money
    Date: 2007
  18. By: Ian King; Don Ferguson
    Abstract: In this paper we demonstrate that a simple duality relation underlies balanced growth models with non-joint production. Included in this class of models is the standard neoclassical growth model and endogenous growth models that admit balanced growth paths. In all of these models, the optimal transformation frontier and the factor price frontier take precisely the same mathematical formulation. Studying these identical frontiers in the context of the different models provides new insights into the relative structures of these models, the role of savings, and the nature of dynamic efficiency in each.
    JEL: O40 O41
    Date: 2007
  19. By: Andrew Atkeson; Ariel Burstein
    Abstract: Data on international relative prices from industrialized countries show large and systematic deviations from relative purchasing power parity. We embed a model of imperfect competition and variable markups in some of the recently developed quantitative models of international trade to examine whether such models can reproduce the main features of the fluctuations in international relative prices. We find that when our model is parameterized to match salient features of the data on international trade and market structure in the U.S., it reproduces deviations from relative purchasing power parity similar to those observed in the data because firms choose to price-to-market. We then examine how pricing-to-market depends on the presence of international trade costs and various features of market structure.
    Keywords: Prices ; Pricing ; Macroeconomics - Econometric models
    Date: 2007
  20. By: Thomas Seegmuller (Centre d'Economie de la Sorbonne)
    Abstract: In this paper, we introduce input-specific externalities in a dynamic general equilibrium model with heterogeneous households and a finance constraint (Woodford (1986)). In contrast to existing papers, average labor and capital have not a positive impact on the total productivity of factors, but respectively on labor and capital efficiencies. Focusing on not too low degrees of capital-labor substitution, we show that indeterminacy requires not only a lower bound for the elasticity of capital-labor substitution, but also an upper bound, although the returns are increasing. As a direct implication, the well known wrong slopes condition (labor demand steeper than labor supply) is neither a necessary nor a sufficient condition for indeterminacy and larger increasing returns promote sadlle-path stability when inputs are high substitutes. Using this framework, we are also able to analyze the role of variable tax rates on capital and labor income on the dynamics. In contrast to existing results, we show that tax rates decreasing with their tax base do not promote instability due to self-fulfilling expectations when capital and labor are sufficiently high substitutes, but rather have a stabilizing effect.
    Keywords: Indeterminacy, externalities, capital-labor substitution, fiscal policy.
    JEL: C62 E32 H20
    Date: 2006–12
  21. By: Larry E. Jones; Alice Schoonbroodt
    Abstract: The Barro-Becker model is a simple intuitive model of fertility choice. In its original formulation, however, it has not been very successful at reproducing the changes in fertility choice in response to decreased mortality and increased income growth that demographers have emphasized in explaining the demographic transition. In this paper we show that this is due to an implicit assumption that number and utility of children are complements, which is a byproduct of the high intertemporal elasticity of substitution (IES) typically assumed in the fertility literature. We show that, not only is this assumption not necessary, but both the qualitative and quantitative properties of the model in terms of fertility choice change dramatically when substitutability and high curvature are assumed. To do so, we first derive analytical comparative statics and perform quantitative experiments. We find that if IES is less than one, model predictions of changes in fertility amount to about two-thirds of those observed in U.S. data since 1800. There are two major sources to these predicted changes, the increase in the growth rate of productivity which accounts for about 90 percent of the predicted fall in fertility before 1880, and changes in mortality which account for 90 percent of the predicted change from 1880 to 1950.
    JEL: E13 J11 J13 O11
    Date: 2007–12
  22. By: Philippe D Karam; Dennis P. J. Botman; Douglas Laxton; David Rose
    Abstract: Researchers in policymaking institutions have expended significant effort to develop a new generation of macro models with more rigorous microfoundations. This paper provides a summary of the applications of two of these models. The Global Economy Model is a quarterly model that features a large assortment of nominal and real rigidities, which are necessary to create plausible short-run dynamics. However, because this model is based on a representative-agent paradigm, its Ricardian features make it unsuitable to study many fiscal policy issues. The Global Fiscal Model, which is an annual model that uses an overlappinggenerations structure, has been designed to analyze the longer-term consequences of alternative fiscal policies.
    Keywords: Working Paper , Fiscal policy , Economic models , Monetary policy ,
    Date: 2007–08–17
  23. By: Ramon Marimon; Javier Díaz-Giménez; Giorgia Giovannetti; Pedro Teles
    Abstract: We characterize the optimal sequential choice of monetary policy in economies with either nominal or indexed debt. In a model where nominal debt is the only source of time inconsistency, the Markov-perfect equilibrium policy implies the progressive depletion of the outstanding stock of debt, until the time inconsistency disappears. There is a resulting welfare loss if debt is nominal rather than indexed. We also analyze the case where monetary policy is time inconsistent even when debt is indexed. In this case, with nominal debt, the sequential optimal policy converges to a time-consistent steady state with positive -- or negative -- debt, depending on the value of the intertemporal elasticity of substitution. Welfare can be higher if debt is nominal rather than indexed and the level of debt is not too high.
    JEL: E40 E50 E58 E60
    Date: 2007–12
  24. By: Martin Gervais; Igor Livshits; Césaire Meh
    Abstract: This paper studies the choice between general and specific human capital. A trade-off arises because general human capital, while less productive, can easily be reallocated across firms. Accordingly, the fraction of individuals with specific human capital depends on the amount of uncertainty in the economy. Our model implies that while economies with more specific human capital tend to be more productive, they also tend to be more vulnerable to turbulence. As such, our theory sheds some light on the experience of Japan, where human capital is notoriously specific: while Japan benefited from this predominately specific labor force in tranquil times, this specificity may also have been at the heart of its prolonged stagnation.
    Keywords: Economic Models
    JEL: J24 J41 J62 D92
    Date: 2007

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