New Economics Papers
on Dynamic General Equilibrium
Issue of 2008‒02‒09
27 papers chosen by

  1. The cyclical behavior of equilibrium unemployment and vacancies revisited By Marcus Hagedorn; Iourii Manovskii
  2. Accounting for Lifecycle Wealth Accumulation: The Role of Housing Institution By Sang-Wook Stanley Cho
  3. A Monetary Model with Strong Liquidity Effects By Marcus Hagedorn
  4. Search and Rest Unemployment By Fernando Alvarez; Robert Shimer
  5. The Baby Boom and World War II: A Macroeconomic Analysis By Matthias Doepke; Moshe Hazan; Yishay D. Maoz
  6. Optimal Ramsey Tax Cycles By Marcus Hagedorn
  7. Macroeconomic resilience in a DSGE model By Adam Elbourne; Debby Lanser; Bert Smid; Martin Vromans
  8. To React or Not? Fiscal Policy, Volatility and Welfare in the EU-3 By Jim Malley; Apostolis Philippopoulos; Ulrich Woitek
  9. Marginal Jobs, Heterogeneous Firms, & Unemployment Flows By Michael W. L. Elsby; Ryan Michaels
  10. Welfare analysis of HIV/AIDS: Formulating and computing a continuous time overlapping generations policy model By Jamsheed Shorish
  11. Robust Inflation-Targeting Rules and the Gains from International Policy Coordination By Paul Levine; Joseph Pearlman; Peter Welz
  12. Pro-cyclical Solow Residuals without Technology Shocks By Adnrew J. Clarke, Alok Johri
  13. The Cyclical Behavior of Equilibrium Unemployment and Vacancies Revisited By Marcus Hagedorn; Iourii Manovskii
  14. Household Wealth Accumulation and Portfolio Choices in Korea By Sang-Wook Stanley Cho
  15. Rotten parents and disciplined children: a politico-economic theory of public expenditure and debt By Zheng Song; Kjetil Storesletten; Fabrizio Zilibotti
  16. Matching frictions and the divide of schooling investment between general and specific skills By Decreuse, Bruno; Granier, Pierre
  17. Oil shocks and endogenous markups - results from an estimated euro area DSGE model By Marcelo Sánchez
  18. Asymmetric Labor Market Institutions in the EMU: positive and normative implications By Mirko Abbritti; Andreas Mueller
  19. The effects of macroeconomic institutions on economic performance in a general equilibrium model By Cuciniello Vincenzo
  20. International transmission and monetary policy cooperation By Günter Coenen; Giovanni Lombardo; Frank Smets; Roland Straub
  21. Technology Adoption, Turbulence and the Dynamics of Unemployment By Georg Duernecker
  22. An Adverse Selection Model of Optimal Unemployment Insurance By Marcus Hagedorn; Ashok Kaul; Tim Mennel
  23. Non-convex Aggregate Technology and Optimal Economic Growth By N. M. Hung; Cuong Le Van; P. Michel
  24. On the Optimal Timing of Capital Taxes By John Hassler; Per Krusell; Kjetil Storesletten; Fabrizio Zilibotti
  25. Solving, Estimating and Selecting Nonlinear Dynamic Models without the Curse of Dimensionality By Viktor Winschel; Markus Krätzig
  26. Can Good Events Lead to Bad Outcomes? Endogenous Banking Crises and Fiscal Policy Responses By Andrew Feltenstein; Céline Rochon
  27. Optimal monetary policy in economies with dual labor markets By Mattesini Fabrizio; Rossi Lorenza

  1. By: Marcus Hagedorn (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Iourii Manovskii (Department of Economics, University of Pennsylvania, 160 McNeil Building, 3718 Locust Walk, Philadelphia, PA, 19104-6297, USA.)
    Abstract: Recently, a number of authors have argued that the standard search model cannot generate the observed business-cycle-frequency fluctuations in unemployment and job vacancies, given shocks of a plausible magnitude. We use data on the cost of vacancy creation and cyclicality of wages to identify the two key parameters of the model - the value of non-market activity and the bargaining weights. Our calibration implies that the model is, in fact, consistent with the data. JEL Classification: E24, E32, J41, J63, J64.
    Keywords: Search, matching, business cycles, labor markets.
    Date: 2008–01
  2. By: Sang-Wook Stanley Cho (School of Economics, The University of New South Wales)
    Abstract: This paper constructs a quantitative general equilibrium lifecycle model with uninsurable labor income to account for the differences in the pattern of wealth accumulation across two countries, Korea and the United States. The model incorporates the differences in the housing market institution in the two countries, namely, the mortgage market and the rental market. As a focal point of the model, housing plays multiple roles for households: collateral as well as a source of service flows. The results from the calibrated model can quantitatively explain some empirical findings on the profile of wealth and homeownership in the aggregate as well as over the life cycle. The mortgage market can account for around 60 percent of the differences in the aggregate homeownership ratios in the two countries as well as 23 percent of the differences in the asset portfolio composition. However, the difference in the rental market does not play large role in accounting for the differences in wealth accumulation and homeownership patterns.
    Keywords: Lifecycle model; Consumption; Wealth; Housing Institution
    JEL: D91 E21 H31 R21
    Date: 2007–08
  3. By: Marcus Hagedorn
    Abstract: This paper studies the joint business cycle dynamics of in ation, money growth, nominal and real interest rates and the velocity of money. I extend and estimate a standard cash and credit monetary model by adding idiosyncratic preference shocks to cash consumption as well as a banking sector. The estimated model accounts very well for the business cycle data, a finding that standard monetary models have not been able to generate. I find that the quantitative performance of the model is explained through substantial liquidity effects.
    Keywords: Money, Banking, Monetary Transmission Mechanism, Liquidity, Business Cycles
    JEL: E31 E32 E41 E42 E51
    Date: 2007–12
  4. By: Fernando Alvarez; Robert Shimer
    Abstract: This paper extends Lucas and Prescott's (1974) search model to develop a notion of rest unemployment. The economy consists of a continuum of labor markets, each of which produces a heterogeneous good. There is a constant returns to scale production technology in each labor market, but labor productivity is continually hit by idiosyncratic shocks, inducing the costly reallocation of workers across labor markets. Under some conditions, some workers may be rest-unemployed, waiting for local labor market conditions to improve, rather than engaged in time consuming search. The model has distinct notions of unemployment (moving to a new labor market or waiting for labor market conditions to improve) and inactivity (enjoying leisure while disconnected from the labor market). We obtain closed-form expressions for key aggregate variables and use them to evaluate the model. Quantitatively, we find that in the U.S. economy many more people may be in rest unemployment than in search unemployment.
    JEL: E24 J2 J6
    Date: 2008–02
  5. By: Matthias Doepke; Moshe Hazan; Yishay D. 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.
    Keywords: Fertility, Baby Boom, World War II
    JEL: D58 E24 J13 J20
    Date: 2008–01
  6. By: Marcus Hagedorn
    Abstract: This paper asks whether tax cycles can represent the optimal policy in a model without any extrinsic uncertainty. I show, in an economy without capital and where labor is the only choice variable (a Lucas-Stokey economy), that a large class of preferences exists, where cycles are optimal, as well as a large class where they are not. The larger government expenditures are, the larger the class of preferences for which cycles are optimal becomes. Tax cycles are also more likely to be optimal if frictions (deviations of the model from Walrasian markets) are added. While this cannot be shown in general and will not be true for arbitrary frictions, I demonstrate this in two specific worlds. I consider an economy with search frictions in the labor market, and one with frictions in the goods and credit market. A reasonable parametrization of both economies shows that results change considerably. Even with constant relative risk aversion, cycles can be optimal, whereas this class of preferences rules out cycles in the Lucas-Stokey economy. Finally, I characterize the optimal policy. No more than two tax rates are needed to implement the Ramsey policy both in the Lucas-Stokey economy and in the model with frictions.
    Keywords: Optimal Taxation, Tax Cycles, First-order Approach.
    JEL: H21 E32 E62 E63
    Date: 2007–12
  7. By: Adam Elbourne; Debby Lanser; Bert Smid; Martin Vromans
    Abstract: We use the dynamic stochastic general equilibrium (DSGE) model of Altig et al. (2005) to analyse the resilience of an economy in the face of external shocks. The term resilience refers to the ability of an economy to propser in the face of shocks. The Altig et al. model was chosen because it combined both demand and supply shocks and because various market rigidities/imperfections, which have the potential to affect resilience, are modelled. We consider the level of expected discounted utility to be the relevant measure of resilience. The effect of market rigidities, eg. wage and price stickiness, on the expected level of utility is minimal. The effect on utility is especially small when compared to the effect of market competition, because the latter has a direct effect on the level of output. This conclusion holds for the family of constant relative risk aversion over consumption utility functions. A similar conclusion was drawn by Lucas (1987) regarding the costs of business cycles. We refer to the literature that followed Lucas for ideas for how a DSGE model might be adjusted to give a more meaningful analysis of resilience. We conclude that the Altig et al. DSGE model does not produce a relationship between rigidities and the level of output and, hence, does not capture the effect of inflexibility on utility that one observes colloquially.
    Keywords: Resilience; Nominal Rigidities; Capital Adjustment Costs; DSGE Models
    JEL: E17 E27 E37 C32
    Date: 2008–01
  8. By: Jim Malley; Apostolis Philippopoulos; Ulrich Woitek
    Abstract: This paper develops a dynamic stochastic general equilibrium model to examine the quantitative macroeconomic implications of counter- cyclical fiscal policy for France, Germany and the UK. The model incorporates real wage rigidity which is the particular market failure justifying policy intervention. We subject the model to productivity shocks and use either government consumption or investment to react to the output gap or the public debt-to-output ratio. If the object of fiscal policy is purely to stabilize output or debt volatility, then our results suggest substantial reductions can be obtained, especially with respect to output. In stark contrast, however, a formal general equilibrium welfare assessment of the volatility implications of these alternative instrument/target combinations reveals the welfare gains from active policy, measured as a share of consumption, to be very modest.
    Keywords: Fiscal Policy, Welfare, Europe
    JEL: E6 H5
    Date: 2007–02
  9. By: Michael W. L. Elsby; Ryan Michaels
    Abstract: Much recent research has sought to explain the cyclical amplitude of unemployment fluctuations in the US. This paper shows that amplification of the cyclical variation of unemployment can be obtained from adding two very simple features to an otherwise standard model of the aggregate labor market, namely downward sloped short run labor demand and endogenous job destruction. This generalized model is able to match more closely the cyclicality of both job finding and employment to unemployment flows observed in US data. Contrary to standard models, the model can generate amplification while maintaining realistic surplus to employment relationships. In addition, we uncover a novel source of amplification of cyclical shocks that is generated by the interaction of countercyclical unemployment inflows and job creation.
    JEL: E24 E32 J63 J64
    Date: 2008–02
  10. By: Jamsheed Shorish
    Date: 2007
  11. By: Paul Levine (University of Surrey); Joseph Pearlman (London Metropolitan University); Peter Welz (Sveriges Riksbank)
    Abstract: This paper empirically assesses the performance of interest-rate monetary rules for interdependent economies characterized by model uncertainty. We set out a two-bloc dynamic stochastic general equilibrium model with habit persistence (that generates output persistence), Calvo pricing and wage-setting with indexing of non-optimized prices and wages (generating inflation persistence), incomplete financial markets and the incomplete pass-through of exchange rate changes. We estimate a linearized form of the model by Bayesian maximum-likelihood methods using US and Euro-zone data. From the estimates of the posterior distributions we then examine monetary policy conducted both independently and cooperatively by the Fed and the ECB in the form of robust inflation-targeting interest-rate rules. Comparing the utility outcome in a closed-loop Nash equilibrium with the outcome from a coordinated design of policy rules, we find a new result: the gains from monetary policy coordination rise significantly when CPI inflation targeting interest-rate rules are designed to account for model uncertainty.
    Keywords: monetary policy coordination, robustness, inflation-targeting interest-rate rules.
    JEL: E52 E37 E58
    Date: 2008–01
  12. By: Adnrew J. Clarke, Alok Johri
    Abstract: Most Real Business Cycle models have a hard time jointly explaining the twin facts of strongly pro-cyclical Solow residuals and extremely low correlations between wages and hours. We present a model that delivers both these results without using exogenous variation in total factor productivity (technology shocks). The key innovation of the paper is to add learning-by-doing to firms technology. As a result firms optimally vary their prices to control the amount of learning which in turn influences future productivity. We show that exogenous variation in labour wedges (preference shocks) measured from aggregate data deliver around fifty percent of the standard deviation in the efficiency wedge (Solow residual) as well as realistic second moments for key aggregate variables which is in sharp contrast to the model without learning-by-doing.
    Keywords: Business cycles, Learning-by-Doing, Productivity
    JEL: E2 E3
    Date: 2008–02
  13. By: Marcus Hagedorn; Iourii Manovskii
    Abstract: Recently, a number of authors have argued that the standard search model cannot generate the observed business-cycle-frequency fluctuations in unemployment and job vacancies, given shocks of a plausible magnitude. We use data on the cost of vacancy creation and cyclicality of wages to identify the two key parameters of the model - the value of non-market activity and the bargaining weights. Our calibration implies that the model is, in fact, consistent with the data.
    Keywords: Search, Matching, Business Cycles, Labor Markets
    JEL: E24 E32 J41 J63 J64
    Date: 2007–12
  14. By: Sang-Wook Stanley Cho (School of Economics, The University of New South Wales)
    Abstract: This paper constructs a quantitative lifecycle model with uninsurable labor income and aggregate housing return risk to assess how Korean households make saving and portfolio allocation decisions. The model incorporates the special roles housing plays in the portfolio of households: collateral, a source of service flows, as well as a source of potential capital gains or losses. In the model, a household first makes the decision whether to rent or to buy a house and then chooses the housing value. The model adds to existing models of wealth accumulation some unique institutional features present in Korea, namely the rental system (`chonsae') and the lack of a mortgage system. When the model is calibrated to match the Korean economy, several key features of the data are better able to be reproduced. The paper also analyzes the role of institutional features by comparing several alternative housing market arrangements and the introduction of a pay-as-you-go social security system to assess their impact on wealth accumulation, portfolio choices, and the pattern of homeownership. I find that expanding the mortgage system significantly increases the homeownership ratio, while alternative rental arrangements have mixed effects on the homeownership ratio. All of the alternative market arrangements raise the fraction of household wealth invested into housing assets. I also find that the introduction of social security system will lower the overall savings in Korea by approximately 10% and lower the homeownership ratio by 6 percentage points.
    Keywords: Lifecycle model; Consumption; Wealth; Housing; Korea
    JEL: D91 E21 H31 R21
    Date: 2007–08
  15. By: Zheng Song; Kjetil Storesletten; Fabrizio Zilibotti
    Abstract: This paper proposes a dynamic politico-economic theory of debt, government finance and expenditure. Agents have preferences over a private and a government-provided public good, financed through labor taxation. Subsequent generations of voters choose taxation, government expenditure and debt accumulation through repeated elections. Debt introduces a conflict of interest between young and old voters: the young want more fiscal discipline. We characterize the Markov Perfect Equilibrium of the dynamic voting game. If taxes do not distort labor supply, the economy progressively depletes its resources through debt accumulation, leaving future generations “enslaved”. However, if tax distortions are sufficiently large, the economy converges to a stationary debt level which is bounded away from the endogenous debt limit. The current fiscal policy is disciplined by the concern of young voters for the ability of future government to provide public goods. The steady-state and dynamics of debt depend on the voters’ taste for public consumption. The stronger the preference for public consumption, the less debt is accumulates. We extend the analysis to redistributive policies and political shocks. The theory predicts government debt to be mean reverting and debt growth to be larger under right-wing than under left-wing governments. Data from the US and from a panel of 21 OECD countries confirm these theoretical predictions.
    Keywords: Fiscal discipline, Fiscal policy, Government debt, Intergenerational conflict, Left- and right-wing governments, Markov equilibrium, Political economy, Public finance, Repeated voting.
    JEL: D72 E62 H41 H62 H63
    Date: 2007–06
  16. By: Decreuse, Bruno; Granier, Pierre
    Abstract: This paper examines the impact of labor market frictions and institutions on the divide of schooling investment between general and specific skills. We offer a simple matching model of unemployment in which individuals determine the scope and intensity of their skills. In partial equilibrium, we show that the severity of market frictions distorts the schooling allocation towards more general skills. Then, we endogenize job creation and argue that changes in labor market institutions may well originate a non-monotonous relationship between unemployment and the divide of skills between specific and general human capital. We also investigate more carefully the impacts of unemployment compensation, minimum wage and firing costs. We suggest that unemployment compensation has an ambiguous impact on the skill divide, while minimum wage and firing costs are detrimental to general skill acquisition.
    Keywords: Matching frictions; education; general and specific skills; labour market institutions
    JEL: I21 J24
    Date: 2007–12
  17. By: Marcelo Sánchez (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper estimates a linearised DSGE model for the euro area. The model is New Keynesian and allows for a role for oil usage and endogenous price markups. We find that the price markup reacts positively to the ratio of expected discounted profits to current output, which is normally seen to give rise to a "countercyclical" markup. The importance of shocks to monetary policy and oil prices is estimated to have declined in the post-1990 period, in line with the higher predictability of policy and the fall in the persistence and - to a lesser extent - variability of oil disturbances. Counterfactual exercises show that oil efficiency gains would alleviate the inflationary and contractionary consequences of oil shocks, while higher wage flexibility would help ease the impact on real output at the expense of wider fluctuations in inflation. Finally, the rise in price markups induced by an oil disturbance is not found to considerably amplify the inflationary and contractionary effects of the shock. JEL Classification: C15, E31, E32, E37.
    Keywords: Estimated DSGE models, euro area, oil shocks, endogenous markup.
    Date: 2008–01
  18. By: Mirko Abbritti; Andreas Mueller
    Abstract: How do labor market institutions affect the volatility and persistence of inflation and unemployment in a monetary union? What are the implications for monetary policy? This paper sets up a DSGE currency union model with unemployment, hiring frictions and real wage rigidities. The model provides a rigorous but tractable framework for the analysis of the functioning of a currency union characterized by asymmetric labor market institutions. Positively, we find that inflation and unemployment differentials depend strongly on the underlying labor market structure: the hiring friction lowers the persistence and increases the volatility of the inflation differential whereas real wage rigidities imply more persistence and variability in output and unemployment differentials. Normatively, we find that macroeconomic stabilization is easier when labor market frictions are high and real wage rigidities are low. This has important implications for optimal monetary policy: The optimal inflation target should give a higher weight to regions with more sclerotic labor markets and more flexible real wages.
    Date: 2007–12
  19. By: Cuciniello Vincenzo
    Abstract: This paper analyzes the relation between inflation, output and government size by reexamining the time inconsistency of optimal monetary and fiscal policies in a general equilibrium model with staggered timing structure for the acquisition of nominal money a la Neiss (1999), and public expenditure financed by means of a distortive tax. It focuses on how macroeconomic institutions may affect output, inflation and taxation when monetary and fiscal policies strategically interact in presence of monopolistic distortions in labor markets. It is shown that, with pre determined wage setting, fiscal and monetary policy are subject to a time inconsistency problem, and the equilibrium rate of inflation is above the Friedman rule while the equilibrium tax rate is below the efficient level. In particular, the discretionary rate of inflation is nonmonotonically related to the natural output, positively related to government size, and negatively related to conservatism. Finally, a regime with commitment is always welfare improving over a regime with discretion.
    Date: 2008–02
  20. By: Günter Coenen (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Giovanni Lombardo (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Frank Smets (Corresponding author - European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Roland Straub (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We use a version of the New Area-Wide Model (NAWM) developed at the ECB in order to quantify the gains from monetary policy cooperation. The model is calibrated in order to match a set of empirical moments. We then derive the cooperative and (open-loop) Nash monetary policies, assuming that the central banks’ objectives is to maximize the welfare of the households. Our results show that given the current degree of openness of the US and euro area economies, the gains from monetary policy coordination are small, amounting to 0.03 percent of steady-state consumption. Nevertheless, the gains appear to be sensitive to the degree of openness and further economic integration between the two regions could generate sizable gains from cooperation. For example, increasing the trade shares to 32 percent of GDP in both regions, the gains from cooperation rise to about 1 percent of steady-state consumption. By decomposing the sources of the gains from cooperation with respect to the various shocks, we show that mark-up shocks are the most important source for gains from international monetary policy cooperation. JEL Classification: E32, F41, F42.
    Keywords: New Area Wide Model, international policy coordination, DSGE, two-country.
    Date: 2008–01
  21. By: Georg Duernecker
    Abstract: The divergence of unemployment rates between the U.S. and Europe coincided with a substantial acceleration in capital-embodied technical change in the late 70’s. Furthermore, evidence suggests that European economies have been lagging behind the U.S. in the adoption and usage of new technologies. This paper argues that the pace of technology adoption plays a fundamental role for how an economy’s labor market reacts to an acceleration in capital-embodied growth. The framework proposed offers an appealing and novel explanation for the divergence of unemployment rates across economies that are hit by the very same shock (i.e. the acceleration in embodied technical change) but differ in their technology adoption behavior. Moreover, we challenge the conventional wisdom that high European unemployment is the result of institutional rigidities by claiming that institutions are not the principal cause per se but they rather amplify certain forces that promote the emergence of high unemployment.
    Keywords: Unemployment, Labor Market Search and Matching, Turbulence, Skill Loss, Technology Adoption, Training
    JEL: J24 J64 O33
    Date: 2008
  22. By: Marcus Hagedorn; Ashok Kaul; Tim Mennel
    Abstract: We ask whether offering a menu of unemployment insurance contracts is welfare-improving in a heterogeneous population. We adopt a repeated moral hazard framework as in Shavell/Weiss (1979), supplemented by unobserved heterogeneity about agents’ job opportunities. Our main theoretical contribution is an analytical characterization of the sets of jointly feasible entitlements that renders an efficient computation of these sets feasible. Our main economic result is that optimal contracts for “bad” searchers tend to be upward-sloping due to an adverse selection effect. This is in contrast to the well-known optimal decreasing time profile of benefits in pure moral hazard environments that continue to be optimal for “good” searchers in our model.
    Keywords: Unemployment Insurance, Recursive Contracts, Adverse Selection, Repeated Moral Hazard
    JEL: J65 J64 D82 C61 E61
    Date: 2007–03
  23. By: N. M. Hung (Departement d'Economique, Université Laval, Cité Universitaire, St Foy , Qc, G1K 7P4, Canada); Cuong Le Van (Centre d'Economie de la Sorbonne, Universite Paris-1, France); P. Michel (Formerly with GREQAM and EUREQUA, University Paris 1)
    Abstract: This paper examines a model of optimal growth where the aggregation of two separate well behaved and concave production technologies exhibits a basic non-convexity. First, we consider the case of strictly concave utility function: when the discount rate is either low enough or high enough, there will be one steady state equilibrium toward which the convergence of the optimal paths is monotone and asymptotic. When the discount rate is in some intermediate range, we find sufficient conditions for having either one equilibrium or multiple equilibria steady state. Depending to whether the initial capital per capita is located with respect to a critical value, the optimal paths converge to one single appropriate equilibrium steady state. This state might be a poverty trap with low per capita capital, which acts as the extinction state encountered in earlier studies focused on S-shapes production functions. Second, we consider the case of linear utility and provide sufficient conditions to have either unique or two steady states when the discount rate is in some intermediate range . In the latter case, we give conditions under which the above critical value might not exist, and the economy attains one steady state in Â…nite time, then stays at the other steady state afterward.
    Date: 2008
  24. By: John Hassler; Per Krusell; Kjetil Storesletten; Fabrizio Zilibotti
    Abstract: For many kinds of capital, depreciation rates change systematically with the age of the capital. Consider an example that captures essential aspects of human capital, both regarding its accumulation and its depreciation: a worker obtains knowledge in period 0, then uses this knowledge in production in periods 1 and 2, and thereafter retires. Here, depreciation accelerates: it occurs at a 100% rate after period 2, and at a lower (perhaps zero) rate before that. The present paper analyzes the implications of non-constant depreciation rates for the optimal timing of taxes on capital income. The main finding is that under natural assumptions, the path of tax rates over time must be oscillatory. Oscillatory tax rates are optimal when depreciation rates accelerate with the age of the capital (as in the above example), and provided that the government can commit to the path of future tax rates but cannot apply different tax rates in a given year to different vintages of capital.
    Keywords: Asset depreciation, Human capital, Optimal taxation, Oscillations, State-contingent taxes, Tax dynamics.
    JEL: D90 E61 E62 H21 H30
    Date: 2007–12
  25. By: Viktor Winschel; Markus Krätzig
    Abstract: We present a comprehensive framework for Bayesian estimation of structural nonlinear dynamic economic models on sparse grids. TheSmolyak operator underlying the sparse grids approach frees global approximation from the curse of dimensionality and we apply it to a Chebyshev approximation of the model solution. The operator also eliminates the curse from Gaussian quadrature and we use it for the integrals arising from rational expectations and in three new nonlinear state space filters. The filters substantially decrease the computational burden compared to the sequential importance resampling particle filter. The posterior of the structural parameters is estimated by a new Metropolis-Hastings algorithm with mixing parallel sequences. The parallel extension improves the global maximization property of the algorithm, simplifies the choice of the innovation variances, allows for unbiased convergence diagnostics and for a simple implementation of the estimation on parallel computers. Finally, we provide all algorithms in the open source software JBendge4 for the solution and estimation of a general class of models.
    Keywords: Dynamic Stochastic General Equilibrium (DSGE) Models, Bayesian Time Series Econometrics, Curse of Dimensionality
    JEL: C11 C13 C15 C32 C52 C63 C68 C87
    Date: 2008–02
  26. By: Andrew Feltenstein; Céline Rochon
    Abstract: In this paper, we study the impact of labor market restructuring and foreign direct investment on the banking sector, using a dynamic general equilibrium model with a financial sector. Numerical simulations are performed using stylized Chinese data, and banks failures are generated through increases in the growth rate of the labor force, a revaluation of the exchange rate or an increase in debt issue to finance the government deficit, as compared to a benchmark scenario in which banks remain solvent. Thus bank failures can result from what might seem to be either beneficial economic trends, or correct monetary and fiscal policies. We introduce fiscal policies that modify relative factor prices by lowering the capital tax rate and increasing the tax rate on labor. Such policies can prevent banking failures by raising the return to capital. It is shown that such fiscal policies are, in the short run, welfare reducing.
    Keywords: Banking failures; fiscal policies
    JEL: D58 E44 F37 G21
    Date: 2008
  27. By: Mattesini Fabrizio; Rossi Lorenza
    Abstract: We analyze, in this paper, a DSGE New Keynesian model with indivisible labor where firms may belong to two different final goods producing sectors: one where wages and employment are determined in competitive labor markets and the other where wages and employment are the result of a contractual process between unions and ?rms. Bargaining between firms and monopoly unions implies real wage rigidity in the model and, in turn, an endogenous trade-o¤ between output stabilization and inflation stabilization. We show that the negative effect of a productivity shock on inflation and the positive effect of a cost-push shock is crucially determined by the proportion of firms that belong to the competitive sector. The larger is this number, the smaller are these effects. We derive a welfare based objective function as a second order Taylor approximation of the expected utility of the economy’s representative agent and we analyze optimal monetary policy. We show that the larger is the number of firms that belong to the competitive sector, the smaller should be the response of the nominal interest rate to exogenous productivity and cost-push shocks. If we consider, however, an instrument rule where the interest rate must react to inflationary expectations, the rule is not affected by the structure of the labor market. The results of the model are consistent with a well known empirical regularity in macroeconomics, i.e. that employment volatility is larger than real wage volatility.
    Date: 2008–02

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