nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2008‒01‒12
twenty papers chosen by
Christian Zimmermann
University of Connecticut

  1. The Baby Boom and World War II: A Macroeconomic Analysis By Matthias Doepke; Moshe Hazan; Yishay D. Maoz
  2. Quantitative implications of indexed bonds in small open economies By Ceyhun Bora Durdu
  3. Diagnosing labor market search models: a multiple-shock approach By Kenneth Beauchemin; Murat Tasci
  4. Stability and Dynamics in an Overlapping Generations Economy with Flexible Wage Negotiations By Erkki Koskela; Mikko Puhakka
  5. An Endogenous Growth Model with Embodied Technical Change without Scale Effects By Bianco, Dominique
  6. Firms and flexibility By Bart Hobijn; Aysegül Sahin
  7. The general equilibrium effects of fiscal policy: estimates for the euro area By Lorenzo Forni; Libero Monteforte; Luca Sessa
  8. Precautionary demand for foreign assets in sudden stop economies: an assessment of the new mercantilism By Ceyhun Bora Durdu; Enrique G. Mendoza; Marco E. Terrones
  9. Optimal Savings Distortions with Recursive Preferences By Emmanuel Farhi; Iván Werning
  10. Heterogeneous Life-Cycle Profiles, Income Risk and Consumption Inequality By Giorgio E. Primiceri; Thijs van Rens
  11. Welfare effects of illegal immigration By Theodore Palivos
  12. Household Need for Liquidity and the Credit Card Debt Puzzle By Telyukova, Irina A.
  13. The elasticity of substitution as an engine of growth By Theodore Palivos; Giannis Karagiannis
  14. Stock-Based Compensation and CEO (Dis)Incentives By Efraim Benmelech; Eugene Kandel; Pietro Veronesi
  15. Optimal Banking Sector Recapitalization By Oviedo, P. Marcelo
  16. International Job Search: Mexicans In and Out of the US By Sílvio Rendon; Alfredo Cuecuecha
  17. Trade, Production Sharing, and the International Transmission of Business Cycles By Ariel Burstein; Christopher Kurz; Linda Tesar
  18. The Effect of the Federal Student Loan Program On College Enrollment and Default Rates By Ionescu, Anamaria Felicia
  19. With exhaustible resources, can a developing country escape from the poverty trap ?. By Cuong Le Van; Katheline Schubert; Tu Anh Nguyen
  20. A Multivariate Band-Pass Filter By Valle e Azevedo, João

  1. By: Matthias Doepke (University of California, Los Angeles, CEPR, NBER and IZA); Moshe Hazan (Hebrew University and CEPR); Yishay D. Maoz (University of Haifa)
    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 laborforce participation and fertility rates that are consistent with U.S. data.
    Keywords: fertility, baby boom, World War II, female labor-force participation
    JEL: D58 E24 J13 J20
    Date: 2007–12
  2. By: Ceyhun Bora Durdu
    Abstract: This paper analyzes the macroeconomic implications of real-indexed bonds, indexed to the terms of trade or GDP, using a general equilibrium model of a small open economy with financial frictions. Although indexed bonds provide a hedge to income fluctuations and can thereby mitigate the effects of financial frictions, they introduce interest rate fluctuations. Because of this tradeoff, there exists a nonmonotonic relation between the "degree of indexation" (i.e., the percentage of the shock reflected in the return) and the benefits that these bonds introduce. When the nonindexed bond market is shut down and only indexed bonds are available, indexation strengthens the precautionary savings motive, increases consumption volatility and deepens the impact of Sudden Stops for degrees of indexation higher than a certain threshold. When the nonindexed bond market is retained, nonmonotonic relationship between the degree of indexation and the benefits of indexed bonds still remain. Degrees of indexation higher than a certain threshold lead to more volatile consumption than lower degrees of indexation. The threshold degree of indexation depends on the volatility and persistence of income shocks as well as on the relative openness of the economy.
    Date: 2007
  3. By: Kenneth Beauchemin; Murat Tasci
    Abstract: This paper constructs a multiple-shock version of the Mortensen-Pissarides labor market search model to investigate the basic model’s well-known tendency to under predict the volatility of key labor market variables. Data on U.S. job finding and job separation probabilities are used to help estimate the parameters of a three-dimensional shock process comprising labor productivity, job separation, and matching or ‘allocative’ efficiency. The authors show that the Mortensen-Pissarides labor market search model requires significantly procyclical and volatile job separations to simultaneously account for high procyclical variations in jobfinding probabilities as well as relatively small net employment changes. Hence, the model is more fundamentally flawed than its inability to amplify shocks would suggest. This leads the authors to conclude that the model lacks mechanisms to generate procyclical matching efficiency and labor force reallocation. As for the latter, the authors conjecture that nontrivial labor force participation and job-to-job transitions are promising avenues of research.
    Keywords: Labor market ; Business cycles
    Date: 2007
  4. By: Erkki Koskela (University of Helsinki and IZA); Mikko Puhakka (University of Oulu)
    Abstract: We analyze the stability and dynamics of an overlapping generations model with imperfectly competitive labour markets. By focusing on the right-to-manage wage bargaining we assume that wage is negotiated after the capital stock decision. With Cobb-Douglas utility and production functions the steady state is unique and the steady state capital stock depends positively both on the trade union’s bargaining power and on the wage elasticity of labour demand. That elasticity depends either on lower decreasing returns to scale and/or more intensive product market competition. Finally, we show that the steady state equilibrium is a saddle.
    Keywords: overlapping generations economy, capital accumulation, flexible wage negotiation, stability and dynamics
    JEL: J51 C62
    Date: 2007–12
  5. By: Bianco, Dominique
    Abstract: In this paper, we extend the Romer90 model by introducing an embodied technological change and by removing the scale effects. We show that this model can still generate steady state growth in which the embodied technical change has an positive and permanent effect on growth in the long-run.
    Keywords: Endogenous growth; Information technology; Embodied technical change; Scale effects
    JEL: O41 O31
    Date: 2007–11–10
  6. By: Bart Hobijn; Aysegül Sahin
    Abstract: We study the effects of labor market rigidities and frictions on firm-size distributions and dynamics. We introduce a model of endogenous entrepreneurship, labor market frictions, and firm-size dynamics with many types of rigidities, such as hiring and firing costs, search frictions with vacancy costs, unemployment benefits, firm entry costs, and a tax wedge between wages and labor costs. We use the model to analyze how each rigidity explains firm-size differentials between the United States and France. We find that when we include all rigidities and frictions except hiring costs and search frictions, the model accounts for much of the firm-size differentials between the United States and France. The addition of search frictions with vacancy costs generates implausibly large differentials in firm-size distributions.>
    Keywords: Labor market ; Corporations - Finance ; Business enterprises - Finance ; Employment ; Unemployment
    Date: 2007
  7. By: Lorenzo Forni (Bank of Italy); Libero Monteforte (Bank of Italy); Luca Sessa (Bank of Italy)
    Abstract: This paper describes a dynamic stochastic general equilibrium model featuring a fraction of non-Ricardian agents in order to estimate the effects of fiscal policy in the euro area by means of Bayesian techniques. The model accounts for distortionary taxation on labor and capital income and on consumption, while expenditures are broken down into purchases of goods and services, compensation of public employees, and transfers to households. A newly computed quarterly dataset of fiscal variables is used. Our results point to a prevalence of mild Keynesian effects of fiscal policy. In particular, although innovations in fiscal policy variables tend to be rather persistent, government purchases of goods and services and compensation of public employees have small and short-lived expansionary effects on private consumption, while innovations in transfers to households show a slightly more sizeable and lasting effect. On the revenue side, decreases in labor income and consumption tax rates have a sizable effect on consumption and output, while a reduction in capital tax favors investment and output in the medium run. Finally, with the exception of transfers to households and labor income tax rates, most fiscal policy variables contribute little to the cyclical variability of the main macro variables.
    Keywords: fiscal policy, distortionary taxation, DSGE modeling, Bayesian estimation
    JEL: E32 E62
    Date: 2007–11
  8. By: Ceyhun Bora Durdu; Enrique G. Mendoza; Marco E. Terrones
    Abstract: Financial globalization had a rocky start in emerging economies hit by Sudden Stops. Foreign reserves have grown very rapidly since then, as if those countries were practicing a New Mercantilism that views foreign reserves as a war-chest for defense against Sudden Stops. This paper conducts a quantitative assessment of this argument using a stochastic intertemporal equilibrium framework in which precautionary foreign asset demand is driven by output variability, financial globalization, and Sudden Stop risk. In this framework, credit constraints produce endogenous Sudden Stops. We find that financial globalization and Sudden Stop risk can explain the surge in reserves but output variability cannot. These results hold using the intertemporal preferences of the Bewley-Aiyagari-Hugget precautionary savings model or the Uzawa-Epstein setup with endogenous impatience.
    Date: 2007
  9. By: Emmanuel Farhi; Iván Werning
    Abstract: This paper derives an intertemporal optimality condition for economies with private information, focusing on a class of recursive preferences. By comparing it to the situation where agents can freely save in a risk-free asset market, we derive the optimal savings distortions necessary for constrained optimality. Our recursive preferences are homogeneous and satisfy a balanced growth condition, while allowing us to separate the role of risk aversion and intertemporal elasticity of substitution. We perform some quantitative exercises that disentangle the respective roles played by these two parameters play in opt8imal distortions and the implied welfare gains.
    JEL: H0
    Date: 2008–01
  10. By: Giorgio E. Primiceri (Northwestern University, NBER and CEPR); Thijs van Rens (CREI, Universitat Pompeu Fabra, CEPR and IZA)
    Abstract: Was the increase in income inequality in the US due to permanent shocks or merely to an increase in the variance of transitory shocks? The implications for consumption and welfare depend crucially on the answer to this question. We use CEX repeated cross-section data on consumption and income to decompose idiosyncratic changes in income into predictable lifecycle changes, transitory and permanent shocks and estimate the contribution of each to total inequality. Our model fits the joint evolution of consumption and income inequality well and delivers two main results. First, we find that permanent changes in income explain all of the increase in inequality in the 1980s and 90s. Second, we reconcile this finding with the fact that consumption inequality did not increase much over this period. Our results support the view that many permanent changes in income are predictable for consumers, even if they look unpredictable to the econometrician, consistent with models of heterogeneous income profiles.
    Keywords: consumption, inequality, risk, incomplete markets, heterogeneity
    JEL: D12 D31 D52 D91 E21
    Date: 2007–12
  11. By: Theodore Palivos (Department of Economics, University of Macedonia)
    Abstract: This paper analyzes the welfare effect of illegal immigration on the host country within a dynamic general equilibrium framework and shows that it is positive for two reasons. First, immigrants are paid less than their marginal product and second, following an increase in immigration, domestic households find it optimal to increase their holdings of capital. It is also shown that dynamic inefficiency may arise, despite the fact that the model is of the Ramsey type. Nevertheless, the introduction of a minimum wage, which leads to job competition between domestic unskilled workers and immigrants reverses all of the above results.
    Keywords: Economic Growth, Illegal Immigration
    JEL: F2 O4
    Date: 2007–12
  12. By: Telyukova, Irina A.
    Abstract: In the 2001 U.S. Survey of Consumer Finances (SCF), 27% of households report simultaneously revolving significant credit card debt and holding sizeable amounts of liquid assets. These consumers report paying, on average, a 14% interest rate on their debt, while earning only 1 or 2% on their liquid deposit accounts. This phenomenon is known in the literature as the “credit card debt puzzle.” In this paper, I pose and quantitatively evaluate the following explanation for this puzzle: households that accumulate credit card debt may not pay it off using their money in the bank, because they expect to use that money for goods for which credit cards cannot be used. Using both aggregate and survey data (SCF and CEX), I document that liquid assets are a substantial part of households’ portfolios and that consumption in goods requiring liquid payments may have a sizeable unpredictable component. This would warrant holding precautionary balances in liquid accounts. I develop a dynamic heterogeneous-agent model of household portfolio choice, where households are subject to uninsurable income and preference uncertainty, and consumer credit and liquidity coexist as means of consumption and saving/borrowing. The calibration of the model parameters is based on the simulated method of moments. The calibrated model accounts for 73% of the households in the data who hold consumer debt and liquidity simultaneously, and for at least 55 cents of every dollar held by a median household in the puzzle group. I argue that these results are a lower bound, and that the liquidity-need hypothesis is thus successful in rendering most of the puzzle a rational phenomenon.
    JEL: D12 E21 E41 D14
    Date: 2007–12–26
  13. By: Theodore Palivos (Department of Economics, University of Macedonia); Giannis Karagiannis (Department of Economics, University of Macedonia)
    Abstract: This paper characterizes the elasticity of factor substitution in one-sector convex growth models with a general production function. It shows that an elasticity of substitution that is asymptotically greater than one is a sufficient (but not a necessary) condition for the existence of a lower bound on the marginal product of capital, which in turn can lead to unbounded endogenous growth. Hence, an elasticity of substitution that becomes eventually greater than one can counteract the role of diminishing returns to capital. This renders factor substitution a powerful engine of growth.
    Keywords: Elasticity of Substitution, Endogenous Growth, Convex Models
    JEL: O11 O40
    Date: 2007–12
  14. By: Efraim Benmelech; Eugene Kandel; Pietro Veronesi
    Abstract: Stock-based compensation is the standard solution to agency problems between shareholders and managers. In a dynamic rational expectations equilibrium model with asymmetric information we show that although stock-based compensation causes managers to work harder, it also induces them to hide any worsening of the firm's investment opportunities by following largely sub-optimal investment policies. This problem is especially severe for growth firms, whose stock prices then become over-valued while managers hide the bad news to shareholders. We find that a firm-specific compensation package based on both stock and earnings performance instead induces a combination of high effort, truth revelation and optimal investments. The model produces numerous predictions that are consistent with the empirical evidence.
    JEL: D2 G34 J3
    Date: 2008–01
  15. By: Oviedo, P. Marcelo
    Abstract: Government-financed bank restructuring programs, occasionally costing up to 50% of GDP, are commonly used to resolve banking crises. We analyze the Ramsey-optimal paths of bank recapitalization programs that weigh recapitalization benefits and costs under different financing options. In our model bank credit is essential, due to a working capital constraint on firms, and banks are financial intermediaries that borrow from households and lend to firms. A banking crisis produces a disruption of credit and a fall in output equivalent to those in developing countries affected by banking crises. Full recapitalization of the banking system immediately after the crisis is optimal only if international credit is available. One-shot recapitalization is not optimal with domestically-financed programs, even if the government has access to non-distortionary taxes. The welfare cost of a crisis is substantial: the equivalent permanent decline in the no-crisis steady state consumption ranges between 0.51% and 0.65%, depending on the source of financing the recapitalization program.
    Keywords: bank recapitalization; banking crises; financial intermediation; banking capital
    JEL: F3 G0 H0 H2
    Date: 2008–01–04
  16. By: Sílvio Rendon (Stony Brook University and IZA); Alfredo Cuecuecha (ITAM)
    Abstract: It is argued that migration from Mexico to the US and its corresponding return migration are determined by international wage differentials and preferences for origin. We use a model of job search, savings and migration to show that job turnover is a crucial determinant of the migration process. We estimate this model by Simulated Method of Moments (SMM) and find that migration practically disappears if Mexico has American arrival rates while employed. Doubling migration costs reduces migration rates in half, while subsidizing return migration in $300 reduces migration rates of older migrants but increases migration rates of younger migrants.
    Keywords: international migration, job search, job turnover, savings, structural estimation
    JEL: F22 J64 E20
    Date: 2007–12
  17. By: Ariel Burstein; Christopher Kurz; Linda Tesar
    Abstract: Countries that are more engaged in production sharing exhibit higher bilateral manufacturing output correlations. We use data on trade flows between US multinationals and their affiliates as well as trade between the United States and Mexican maquiladoras to measure production-sharing trade and its link with the business cycle. We then develop a quantitative model of international business cycles that generates a positive link between the extent of vertically integrated production-sharing trade and internationally synchronized business cycles. A key assumption in the model is a relatively low elasticity of substitution between home and foreign inputs in the production of the vertically integrated good.
    JEL: F4 F41
    Date: 2008–01
  18. By: Ionescu, Anamaria Felicia (Department of Economics, Colgate University)
    Abstract: I quantify the effects of alternative student loan policies on college enrollment, bor- rowing behavior, and default rates in a heterogeneous model of life-cycle earnings and human capital accumulation. I find that the combination of learning ability and initial human capital stock drives the decision to enroll in college while parental wealth has minimal effects on enrollment. Repayment flexibility increases enrollment significantly, whereas relaxation of eligibility requirements has little effect on enrollment or default rates. The former policy induces substantial welfare gains for bottom income quantiles, while the latter implies minimal welfare gains for bottom income quantiles.
    Keywords: Student loans; Human capital; Default
    JEL: D91 E44 J24 I28
    Date: 2007–12–31
  19. By: Cuong Le Van (Centre d'Economie de la Sorbonne - Paris School of Economics); Katheline Schubert (Centre d'Economie de la Sorbonne - Paris School of Economics); Tu Anh Nguyen (Centre d'Economie de la Sorbonne)
    Abstract: This paper studies the optimal growth of a developing non-renewable natural resource producer, which extracts the resource from its soil and produces a single consumption good with man-made capital. Moreover, it can sell the extracted resource abroad and use the revenues to buy an imported good, which is a perfect substitute of the domestic consumption good. The domestic technology is convex-concave, so that the economy may be locked into a poverty trap. We study the optimal extraction and depletion of the exhaustible resource and the optimal paths of accumulation of capital and of domestic consumption. We show that the extent to which the country will optimally escape from the poverty trap and the exhaustible resource will be a blessing depends on the characteristics of its technology and of the revenues from the resource function, on its impatience, on the level of its initial stock of capital and on the abundance of the natural resource. If the marginal productivity of capital at the origin is greater than the sum of the social discount rate and the depreciation rate, the country will accumulate capital along the entire growth path and will escape from the poverty trap, whatever its initial stocks of capital and resource, and provided that the marginal revenue obtained from the exportation of the resource is finite at the origin. On the contrary, if the marginal productivity of capital is lower than the depreciation rate whatever the level of capital and if moreover the initial stock of capital is small, then the country will never accumulate ; it will consume the revenues obtained from selling abroad the extracted resource, until there is no resource left and the economy collapses. We also show that any optimal path may be decentralized in a competitive equilibrium by using a tax/subsidy scheme for firms.
    Keywords: Optimal growth, exhaustible resource, convex-concave technology, poverty trap, competitive equilibrium with tax/subsidy.
    JEL: Q32 C61
    Date: 2007–07
  20. By: Valle e Azevedo, João
    Abstract: We develop a multivariate filter which is an optimal (in the mean squared error sense) approximation to the ideal filter that isolates a specified range of fluctuations in a time series, e.g., business cycle fluctuations in macroeconomic time series. This requires knowledge of the true second-order moments of the data. Otherwise these can be estimated and we show empirically that the method still leads to relevant improvements of the extracted signal, especially in the endpoints of the sample. Our filter is an extension of the univariate filter developed by Christiano and Fitzgerald (2003). Specifically, we allow an arbitrary number of covariates to be employed in the estimation of the signal. We illustrate the application of the filter by constructing a business cycle indicator for the U.S. economy. The filter can additionally be used in any similar signal extraction problem demanding accurate real-time estimates.
    JEL: E32 C14 C22
    Date: 2008–01–02

This nep-dge issue is ©2008 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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