nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2008‒03‒01
fourteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Real Business Cycles with Cournot Competition and Endogenous Entry By Colciago, Andrea; Etro, Federico
  2. Financial Frictions and Business Cycles in Middle-Income Countries By Jaime Guajardo
  3. The Macroeconomic Consequences of Financing Health Insurance By Stephen B. DeLoach; Jennifer M. Platania
  4. Crime and the Labor Market in a Search Model with Pairwise-Efficient Separations By Bryan Engelhardt; Guillaume Rocheteau; Peter Rupert
  5. Capital Flows and Economic Fluctuations: The Role of Commercials Banks in Transmitting Shocks By Yong Sarah Zhou
  6. The Return to Capital and the Business Cycle By Paul Gomme; B Ravikumar; Peter Rupert
  7. Household Need for Liquidity and the Credit Card Debt Puzzle By Irina Telyukova
  8. Informal Insurance and Income Inequality By Laczó, Sarolta
  9. Microeconomic Implications of Remittances in an Overlapping Generations Model with Altruism and Self-Interest By David A. Grigorian; Tigran A. Melkonyan
  10. Inflation and Unemployment in General Equilibrium By Guillaume Rocheteau; Peter Rupert; Randall Wright
  11. Lumpy Labor Adjustment as a Propagation Mechanism of Business Cycles By Fang Yao
  12. The Equity Premium: A Deeper Puzzle By Francisco Azeredo
  13. Assessing estimates of the exchange rate pass-through By Ida Wolden Bache
  14. Stock market volatility and learning. By Klaus Adam; Albert Marcet; Juan Pablo Nicolini

  1. By: Colciago, Andrea; Etro, Federico
    Abstract: We introduce Cournot competition and endogenous entry in an otherwise neoclassical macroeconomic framework. First, we develop a model with exogenous savings à la Solow describing the dynamic path of business creation. Then, we develop a model à la Ramsey describing the dynamic interaction of consumption and business creation. Our models are able to explain why markups vary countercylically and profits are procyclical. The analysis of permanent and temporary technology and preference shocks and of the second moments suggests that our model can outperform the Real Business Cycle framework in many dimensions.
    Keywords: Business Cycle; Cournot Competition; Endogenous Entry
    JEL: E32 L13
    Date: 2007–09–30
  2. By: Jaime Guajardo
    Abstract: A standard DSGE small open economy model can not generate the cyclical regularities of middle-income countries. It predicts excessive consumption smoothing, and procyclical, instead of countercyclical, real net exports. Previous studies have solved this problem by increasing the shocks’ persistence or by lowering the intertemporal elasticity of substitution. This paper tackles the problem by introducing market imperfections relevant for MICs into an otherwise standard model. More specifically, I build a model with limited access to the foreign capital market, identified as an external borrowing constraint, and asymmetric financing opportunities across nontradable and tradable sectors, identified as a sector-specific labor financing wedge. The key parameters associated to these frictions are deduced to replicate selected data for Chile between 1986 and 2004. I find that both frictions are necessary to replicate the cyclical regularities of middle-income countries as they help the model reproduce different features of the data: The external borrowing constraint makes investment and consumption of tradable goods more procyclical and volatile, and makes real net exports countercyclical, while the sector-specific labor financing wedge makes the model reproduce the cyclical moments of work hours and consumption of non tradable goods.
    Keywords: Consumption , Exports , Investment , Borrowing ,
    Date: 2008–01–30
  3. By: Stephen B. DeLoach (Department of Economics, Elon University); Jennifer M. Platania (Department of Economics, Elon University)
    Abstract: Employer-financed health insurance systems, like that used in the United States, distort firms' labor demand and adversely affect the economy. Since such costs vary with employment rather than hours worked, firms have an incentive to increase output by increasing worker hours rather than employment. Given that the returns to employment exceed the returns to hours worked, this results in lower levels of employment and output. In this paper we construct a heterogeneous agent general equilibrium model where individuals differ with respect to their productivity and employment opportunities. Calibrating the model to the U.S. economy, we generate steady state results for several alternative models for financing health insurance: one in which health insurance is financed primarily through employer contributions that vary with employment; a second where insurance is funded through a non-distortionary, lump-sum tax; and a third where insurance is funded by a payroll tax. We measure the effects of each of the alternatives on output, employment, hours worked and inequality.
    JEL: E62 O41 C68
    Date: 2008–02
  4. By: Bryan Engelhardt (University of Iowa); Guillaume Rocheteau (Federal Reserve Bank of Cleveland); Peter Rupert (University of California, Santa Barbara)
    Abstract: This paper extends the Pissarides (2000) model of the labor market to include crime and punishment à la Becker (1968). All workers, irrespective of their labor force status can commit crimes and the employment contract is determined optimally. The model is used to study, analytically and quantitatively, the effects of various labor market and crime policies. For instance, a more generous unemployment insurance system reduces the crime rate of the unemployed but its effect on the crime rate of the employed depends on job duration and jail sentences. When the model is calibrated to U.S. data, the overall effect on crime is positive but quantitatively small. Wage subsidies reduce unemployment and crime rates of employed and unemployed workers, and improve society's welfare. Hiring subsidies reduce unemployment but they can raise the crime rate of employed workers. Crime policies (police technology and jail sentences) affect crime rates significantly but have only negligible effects on the labor market.
    Keywords: crime, unemployment, search, matching,
    Date: 2007–08–01
  5. By: Yong Sarah Zhou
    Abstract: This paper uses a general equilibrium model to examine the central role played by commercial banks in intermediating and amplifying the capital flow shocks to the local economy in the 1997 Asia financial crisis. It finds that a sudden stop of capital inflows affects the equilibrium credit supply through two channels: first, the plunge of foreign financing decreases the loanable funds directly; and second the sudden stop drives up the cost of providing banking services, thereby additionally reducing the available bank credit to firms through a "deposit run". Empirical results from a VAR model broadly support the theoretical implications.
    Keywords: Capital flows , Bank credit , Employment , Financial crisis ,
    Date: 2008–01–29
  6. By: Paul Gomme (Concordia University); B Ravikumar (University of Iowa); Peter Rupert (University of California, Santa Barbara)
    Abstract: We measure the return to capital directly from the NIPA and BEA data and examine the return implications of the real business cycle model. We construct a quarterly time series of the after-tax return to business capital. Its volatility is considerably smaller than that of S&P 500 returns. The standard business cycle model captures almost 50% of the volatility in the return to capital (relative to the volatility of output). We consider several departures from the benchmark model; the most promising is one with stochastic taxes which captures nearly 80% of the relative volatility in the return to capital.
    Keywords: return to capital, volatility, real business cycles,
    Date: 2007–05–01
  7. By: Irina Telyukova (University of California, San Diego)
    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.
    Keywords: consumer debt, liquid assets,
    Date: 2008–01–03
  8. By: Laczó, Sarolta
    Abstract: This paper examines the effects of income inequality in a risk sharing model with limited commitment, that is, when insurance agreements have to be self-enforcing. In this context, numerical dynamic programming is used to examine three questions. First, I consider heterogeneity in mean income, and study the welfare effects when inequality together with aggregate income increases. Second, subsistence consumption is introduced to see how it affects consumption smoothing. Finally, income is endogenized by allowing households to choose between two production technologies, to look at the importance of consumption insurance for income smoothing.
    Keywords: risk sharing; limited commitment; inequality; technology choice; developing countries
    JEL: I30 D80 O12
    Date: 2008–02
  9. By: David A. Grigorian; Tigran A. Melkonyan
    Abstract: The paper explicitly models the dynamic strategic aspects of the interaction between the migrant and the remittance-receiving relative(s), with the migrant behaving as a Stackelberg leader. It is also different from other formalizations of remittance behavior in its treatment of the two parties' interaction to realize potential gains from exchange. We demonstrate that when the migrant and the relative(s) cooperate to maximize the joint utility of the household, this leads to higher level of remittances as well as investment and hours worked by the relative(s). We use data from Armenia to test our predictions regarding implications of remittances flows on behavior of receiving households. Consistent with our predictions, remittance-receiving households work fewer hours and spend less on the education of their children. While saving more, these households are not leveraging their savings to borrow from the banking system to expand their business activities. This evidence suggests that the benefits of remittances might be overstated and emphasizes the importance of measuring their impact in a general- rather than a partial-equilibrium context.
    Keywords: Workers remittances , Armenia , Labor supply ,
    Date: 2008–01–30
  10. By: Guillaume Rocheteau (none); Peter Rupert (University of California, Santa Barbara); Randall Wright (University of Pennsylvania)
    Abstract: When labor is indivisible, there exist efficient outcomes with some agents randomly unemployed (Rogerson 1988). We integrate this idea into the modern theory of monetary exchange, where some trade occurs in centralized markets and some in decentralized markets (as in Lagos and Wright 2006). This delivers a general equilibrium model of unemployment and money, with explicit microeconomic foundations. We show the implied relation between inflation and unemployment can be positive or negative, depending on simple preference conditions. Our Phillips Curve provides a long-run, exploitable, trade off for monetary policy; it turns out, however, that the optimal policy is the Freidman rule.
    Keywords: inflation, unemployment, Phillips Curve,
    Date: 2007–08–01
  11. By: Fang Yao
    Abstract: This paper aims to study the quantitative significance of lumpy labor adjustment as a propagation mechanism for business cycles. In the baseline model, I introduce lumpy job turnover in the spirit of Taylor (1980) and Calvo (1983) in a DSGE framework and find that it performs as same as the quadratic-adjustment-cost model at the aggregate level, but different at firm’s level. In particular, It can capture lumpy labor adjustment at plant’s level through the ’front-loading effect’. Then I implement the Weibull distribution in the same framework to incorporate the increasing hazards of the labor adjustment process, which is supported by the evidence from micro data. This extension represents a substantial improvement over benchmark models. It can replicate high volatility of employment, low volatile labor productivity and persistent dynamics in output. Based on these results, I conclude that intratemporal substitution between the two production factors and the aggregation mechanism play an important role in the propagation mechanism.
    Keywords: Business cycles, Lumpy labor adjustment, Weibull distribution, Increasing hazard function
    JEL: E32 E24 E22
    Date: 2008–02
  12. By: Francisco Azeredo (University of California - Santa Barbara)
    Abstract: Traditional pre-1930 consumption measures understate the extent of serial correlation in the U.S. annual real growth rate of per capita consumption of non-durables and services due to measurement limitations in the construction of their major components. Under alternative measures proposed in this study, the serial correlation of consumption growth is found to be 0.32, contrary to the original estimate of -0.14. This new evidence implies that the class of dynamic general equilibrium models studied by Mehra and Prescott [12] generates negative equity premium for reasonable risk-aversion levels, thus further exacerbating the equity premium puzzle.
    Keywords: persistence, consumption growth, equity premium puzzle, neoclassical growth model,
    Date: 2007–09–01
  13. By: Ida Wolden Bache (Norges Bank (Central Bank of Norway))
    Abstract: This paper uses Monte Carlo techniques to address the question: are structural VAR estimates of exchange rate pass-through a useful tool to evaluate macroeconomic models of open economies? The data generating process is a small open economy DSGE model with incomplete pass-through. The results suggest that (i) the pass-through estimates obtained from a first-differenced VAR exhibit a systematic downward bias; (ii) by contrast, estimates derived from a low order vector equilibrium correction model are fairly accurate; but (iii) standard cointegration tests have low power to detect the cointegration relations implied by the DSGE model.
    Keywords: Exchange rate pass-through, structural VAR, DSGE models, cointegration
    JEL: C32 C52 F41
    Date: 2008–01–11
  14. By: Klaus Adam (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Albert Marcet (Institut d’Anàlisi Economica CSIC, Universitat Autònoma de Barcelona, 08193 Bellaterra, Spain.); Juan Pablo Nicolini (Universidad Torcuato di Tella, Miñones 2177, Capital Federal, (C1428ATG) Argentina.)
    Abstract: Introducing bounded rationality into a standard consumption based asset pricing model with a representative agent and time separable preferences strongly improves empirical performance. Learning causes momentum and mean reversion of returns and thereby excess volatility, persistence of price-dividend ratios, long-horizon return predictability and a risk premium, as in the habit model of Campbell and Cochrane (1999), but for lower risk aversion. This is obtained, even though we restrict con- sideration to learning schemes that imply only small deviations from full rationality. The .ndings are robust to the particular learning rule used and the value chosen for the single free parameter introduced by learning, provided agents forecast future stock prices using past information on prices. JEL Classification: G12, D84.
    Keywords: Asset pricing, learning, near-rational price forecasts.
    Date: 2008–02

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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