New Economics Papers
on Dynamic General Equilibrium
Issue of 2008‒03‒15
twenty-two papers chosen by

  1. Real Business Cycles with Cournot Competition and Endogenous Entry By Andrea Colciago; Federico Etro
  2. Explaining the Evolution of Hours Worked and Employment across OECD Countries: An Equilibrium Search Approach By Langot, François; Quintero Rojas, Coralia
  3. Tax Structure, Growth and Welfare in the UK By Konstantinos Angelopoulos; Jim Malley; Apostolis Philippopoulos
  4. Borrowing Constraints, Entrepreneurial Risks, and the Wealth Distribution in a Heterogeneous Agent Model By Christiane Clemens; Maik Heinemann
  5. Skill Specific Unemployment with Imperfect Substitution of Skills By Runli Xie
  6. Emerging Markets in an Anxious Global Economy By Ana Fostel; John Geanakoplos
  7. Taxation, Aggregates and the Household By Guner, Nezih; Kaygusuz, Remzi; Ventura, Gustavo
  8. The Welfare Cost of Banking Regulation By TCHANA TCHANA , Fulbert
  9. Search, Wage Posting, and Urban Spatial Structure By Zenou, Yves
  10. Price Setting in a Decentralized Market and the Competitive Outcome By Stephan Lauermann
  11. Labor Supply and Growth Effects of Environmental Policy under Technological Risk By Christiane Clemens; Karen Pittel
  12. Debt and Deficit Fluctuations and the Structure of Bond Markets By Albert Marcet; Andrew Scott
  13. Optimal Taxation and Asymmetric Information in an Economy with Second-Hand Trade By Aronsson, Thomas; Sjögren, Tomas; Witterblad, Mikael
  14. "Can Robbery and Other Theft Help Explain the Textbook Currency-demand Puzzle? Two Dreadful Models of Money Demand with an Endogenous Probability of Crime" By Greg Hannsgen
  15. Financial Development and the Demand for Pay-As-You-Go Social Security By Pinotti, Paolo
  16. Why capital maintenance should be a key development tool ? By Raouf, BOUCEKKINE; Blanca, MARTINEZ; Cagri, SAGLAM
  17. Risk Sharing and Commuting Among US Federal States By Juessen, Falko
  18. Does product market competition improve the labour market performance ? By Gabriele, CARDULLO
  19. Globalization and Labor Market Outcomes: Wage Bargaining, Search Frictions, and Firm Heterogeneity By Felbermayr, Gabriel; Prat, Julien; Schmerer, Hans-Jörg
  20. The rationality of expectations formation and excess volatility By Julio Davila
  21. Intermediate Goods, Weak Links, and Superstars: A Theory of Economic Development By Charles I. Jones
  22. Technological Transfers, Limited Commitment and Growth By Alexandre Dmitriev

  1. By: Andrea Colciago; Federico Etro
    Abstract: We introduce Cournot competition and endogenous entry in an oth- erwise neoclassical macroeconomic framework. First, we develop a model with exogenous savings à la Solow describing the dynamic path of busi- ness 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 pro?ts 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.
    Date: 2007–09
  2. By: Langot, François (University of Le Mans); Quintero Rojas, Coralia (University of Le Mans)
    Abstract: Since 1960, the dynamics of the aggregate hours of market work exhibit dramatic differences across industrialized countries. Before 1980, these differences seem to come from the hours worked per employee (the intensive margin). However, since 1980 a notable feature of the data is that the divergence across countries responds to quantitatively important differences along the employment rate (the extensive margin). In this paper we develop an equilibrium matching model where both margins are endogenous. The model is rich enough to account for the behavior of the two margins of the aggregate hours when we include the observed heterogeneity across countries of both the taxes and the labor market institutions such as the unemployment benefits and the bargaining power. Because these findings come from an unified framework, they also give a strong support to the matching models.
    Keywords: hours worked, intensive and extensive margins, taxation, labor market institutions, matching model
    JEL: E2 J2 J6
    Date: 2008–02
  3. By: Konstantinos Angelopoulos; Jim Malley; Apostolis Philippopoulos
    Abstract: This paper studies the quantitative implications of changes in the composition of taxes for long-run growth and expected lifetime utility in the UK economy over 1970-2005. Our setup is a dynamic stochas- tic general equilibrium model incorporating a detailed .scal policy structure, and whose engine of endogenous growth is human capital accumulation. The government.s spending instruments include pub- lic consumption, investment and education spending. On the revenue side, labour, capital and consumption taxes are employed. Our results suggest that if the goal of tax policy is to promote long-run growth by altering relative tax rates, then it should reduce labour taxes while simultaneously increasing capital or consumption taxes to make up for the loss in labour tax revenue. In contrast, a welfare promoting policy would be to cut capital taxes, while concurrently increasing labour or consumption taxes to make up for the loss in capital tax revenue.
    Keywords: Fiscal policy, Economic growth, Welfare
    JEL: E62 O52
  4. By: Christiane Clemens (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg); Maik Heinemann (University of Lüneburg)
    Abstract: This paper deals with credit market imperfections and idiosyncratic risks in a two–sector heterogeneous agent dynamic general equilibrium model of occupational choice. We focus especially on the effects of tightening financial constraints on macroeconomic performance, entrepreneurial risk–taking, and social mobility. Contrary to many models in the literature, our comparative static results cover the entire range of borrowing constraints, from complete markets to a perfectly constrained economy. In our baseline model, we find substantial gains in output, welfare, and wealth equality associated with relaxing the constraints, but argue that it might also prove worthwhile to examine the marginal gains from credit market improvements. Interestingly, the amount of entrepreneurial activity and social mobility increases if borrowing constraints become more tight. These results can be attributed to the general equilibrium nature of our approach, where optimal firm sizes and the demand for credit are determined endogenously. The comparative static results on the entrepreneurship rate and social mobility respond sensitively to a change in income persistence.
    Keywords: DSGE model, wealth distribution, occupational choice, borrowing constraints
    JEL: C68 D3 D8 D9 G0 J24
    Date: 2008–03
  5. By: Runli Xie
    Abstract: A large body of literature explains the inferior position of unskilled workers by imposing a structural shift in the labor force skill composition. This paper takes a different approach by emphasizing the connection between cyclical variations in skilled and unskilled labor markets. Using a stylized business cycle model with search frictions in the respective sub-markets, I find that imperfect substitution between skilled and unskilled labor creates a channel for the variations in the sub-markets. Together with a general labor augment- ing technology shock, it can generate downward sloping Beveridge curves. Calibrating the model to US data yields higher volatilities in the unskilled labor markets and reproduces stylized business cycle facts.
    Keywords: business cycle, search frictions, skill specific unemployment, skill substitutability
    JEL: E24 E32 J63
    Date: 2008–03
  6. By: Ana Fostel (Dept. of Economics, George Washington University); John Geanakoplos (Cowles Foundation, Yale University)
    Abstract: We provide a theory of pricing for emerging asset classes, like emerging markets, that are not yet mature enough to be attractive to the general public. Our model provides an explanation for the volatile access of emerging economies to international financial markets and for several stylized facts we identify in the data during the 1990's. We present a general equilibrium model with incomplete markets and endogenous collateral and an extension encompassing adverse selection. We show that contagion, flight to liquidity and issuance rationing can occur in equilibrium during what we call global anxious times.
    Keywords: Margin, Leverage cycle, Liquidity preference, Collateral value, Informational volatility, Contagion, Portfolio effect, Flight to liquidity, Asymmetric information, Issuance rationing, Anxious economy, Emerging markets, High yield, Market closures
    JEL: D52 F34 F36 G15
    Date: 2008–03
  7. By: Guner, Nezih (Universidad Carlos III, Madrid); Kaygusuz, Remzi (Sabanci University); Ventura, Gustavo (University of Iowa)
    Abstract: We evaluate reforms to the U.S. tax system in a dynamic setup with heterogeneous married and single households, and with an operative extensive margin in labor supply. We restrict our model with observations on gender and skill premia, labor force participation of married females across skill groups, and the structure of marital sorting. We study four revenue-neutral tax reforms: a proportional consumption tax, a proportional income tax, a progressive consumption tax, and a reform in which married individuals file taxes separately. Our findings indicate that tax reforms are accompanied by large and differential effects on labor supply: while hours per-worker display small increases, total hours and female labor force participation increase substantially. Married females account for more than 50% of the changes in hours associated to reforms, and their importance increases sharply for values of the intertemporal labor supply elasticity on the low side of empirical estimates. Tax reforms in a standard version of the model result in output gains that are up to 15% lower than in our benchmark economy.
    Keywords: taxation, two-earner households, labor force participation
    JEL: E62 H31 J12 J22
    Date: 2008–01
  8. By: TCHANA TCHANA , Fulbert
    Abstract: The Basel Accords promote the adoption of capital adequacy requirements to increase the banking sector's stability. Unfortunately, this type of regulation can hamper economic growth by shifting banks' portfolios from more productive risky investment projects toward less productive but safer projects. This paper introduces banking regulation in an overlapping-generations model and studies how it affects economic growth, banking sector stability, and welfare. In this model, a banking crisis is the outcome of a productivity shock, and banking regulation is modeled as a constraint on the maximal share of banks' portfolios that can be allocated to risky assets. This model allows us to evaluate quantitatively the key trade-off, inherent in this type of regulation, between ensuring banking stability and fostering economic growth. The model implies an optimal level of regulation that prevents crises but at the same time is detrimental to growth. We find that the overall effect of optimal regulation on social welfare is positive when productivity shocks are sufficiently high and economic agents are sufficiently risk-averse.
    Keywords: Overlapping Generations; Competitive Equilibrium; Economic Growth; Banking Regulation
    JEL: G28 E44 D92
    Date: 2007–10–15
  9. By: Zenou, Yves (Stockholm University)
    Abstract: We develop an urban-search model in which firms post wages. When all workers are identical, the Diamond paradox holds, i.e. there is a unique wage in equilibrium even in the presence of search and spatial frictions. This wage is affected by spatial and labor costs. When workers differ according to the value imputed to leisure, we show that, under some conditions, two wages emerge in equilibrium. The commuting cost affects the land market but also the labor market through wages. Workers’ productivity also affects housing prices and this impact can be positive or negative depending on the location in the city. One important aspect of our model is that, even with positive search costs, wage dispersion prevails in equilibrium, a feature not possible in the non-spatial model.
    Keywords: diamond paradox, urban land-use, spatial compensation, search frictions, wage dispersion
    JEL: D83 J64 R14
    Date: 2008–02
  10. By: Stephan Lauermann (University of Bonn)
    Abstract: This paper studies a decentralized, dynamic matching and bargaining market: buyers and sellers are matched into pairs. Traders exit the market at a constant rate, inducing search costs (frictions). All price offers are made by sellers. Despite the fact that sellers have all the bargaining power we show that they set competitive prices in the limit when frictions become small. Previous literature has restricted the sellers' bargaining power. We dispense with this restriction and show that the convergence result does not depend on the distribution of bargaining power. Our model allows us to isolate basic market clearing forces that ensure the competitive outcome in the frictionless limit. For the particular case of homogeneous sellers we characterize the equilibrium price by the familiar Lerner formula. We use this formula to provide comparative static results of the decentralized trading outcome with respect to the level of the search frictions.
    Keywords: Dynamic Matching and Bargaining Games, Decentralized Markets, Non-cooperative Foundations of Competitive Equilibrium, Search Frictions, Rationing
    Date: 2008–01
  11. By: Christiane Clemens (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg); Karen Pittel (ETH Zürich)
    Abstract: This paper analyzes the effects of technological risk on long–run growth when labor supply is elastic and production gives rise to a pollution externality. For the social planner as well as for the market economy we show that the randomness of production as well as the endogeneity of labor supply matter with respect to the equilibrium solution. The direction in which changes in the model parameters as well as changes of policy instruments influence labor supply and growth depends crucially on the volatility of output.
    Keywords: stochastic growth, pollution, abatement, elastic labor supply
    JEL: Q5 O4 D8 D9
    Date: 2008–03
  12. By: Albert Marcet; Andrew Scott
    Abstract: We analyse the implications of optimal taxation for the stochastic behaviour of debt. We show that when a government pursues an optimal fiscal policy under complete markets, the value of debt has the same or less persistence than other variables in the economy and it declines in response to shocks that cause the deficit to increase. By contrast, under incomplete markets debt shows more persistence than other variables and it increases in response to shocks that cause a higher deficit. Data for US government debt reveals diametrically opposite results from those of complete markets and is much more supportive of bond market incompleteness.
    Keywords: Complete vs incomplete markets, Debt Management, Fiscal
    JEL: E62 H62 H63
    Date: 2007–09–23
  13. By: Aronsson, Thomas (Department of Economics, Umeå University); Sjögren, Tomas (Department of Economics, Umeå University); Witterblad, Mikael (Department of Economics, Umeå University)
    Abstract: This paper concerns optimal income and commodity taxation in a two-type overlapping generations model, where used durable goods are traded in a second-hand market. As second-hand transactions are difficult to observe, we assume that the government is unable to directly control second-hand transactions via commodity taxation. A basic question is how the government in this case may use the second-hand market as a channel for relaxation of the self-selection constraint. We show how the appearance of a second-hand market for used durable goods affects the optimal use of labor income and capital income taxation as well as the optimal use of commodity taxation on new durable goods.
    Keywords: Optimal taxation; Intertemporal Choice; Durable Goods
    JEL: D91 H21 H23
    Date: 2008–03–10
  14. By: Greg Hannsgen
    Abstract: This paper attempts to explain one version of an empirical puzzle noted by Mankiw (2003): a Baumol-Tobin inventory-theoretic money demand equation predicts that the average U.S. adult should have held approximately $551.05 in currency and coin in 1995, while data show an average of $100. The models in this paper help explain this discrepancy using two assumptions: (1) the probabilities of being robbed or pick-pocketed, or having a purse snatched, depend on the amount of cash held; and (2) there are costs of being robbed other than loss of cash, such as injury, medical bills, lost time at work, and trauma. Two models are presented: a dynamic, stochastic model with both instantaneous and decaying noncash costs of robbery, and a revised version of the inventory-theoretic model that includes one-period noncash costs. The former model yields an easily interpreted first-order condition for money demand involving various marginal costs and benefits of holding cash. The latter model gives quantitative solutions for money demand that come much closer to matching the 1995 data--$75.98 for one plausible set of parameters. This figure implies that consumers held approximately $96 billion less cash in May 1995 than they would have in a world without crime. The modified Baumol-Tobin model predicts a large increase in household money demand in 2005, mostly due to reduced crime rates.
    Date: 2008–03
  15. By: Pinotti, Paolo
    Abstract: Financial markets and pay-as-you-go social security are two alternative ways to provide for retirement. Voting over the size of social security programs could therefore be partly determined by financial development. In this paper I allow for this possibility in an OLG model where financial development may be hindered by frictions. The main implication of the model is that greater financial frictions lead to lower financial investment and higher social security transfers in the political-economy equilibrium. To explore this model implication empirically, I use countries’ legal origin as a proxy of frictions that may hold back financial development. The empirical analysis yields a strong and robust negative effect of financial development on the size of social security transfers.
    Keywords: social security; financial development; legal origins.
    JEL: H55 D91 G10
    Date: 2008
  16. By: Raouf, BOUCEKKINE (UNIVERSITE CATHOLIQUE DE LOUVAIN, Department of Economics); Blanca, MARTINEZ; Cagri, SAGLAM
    Abstract: We study optimal growth model à la Nelson and Phelps (1966) where labor resources can be allocated either to production, technology adoption or capital maintenance. We first characterize the balanced growth paths of a benchmark model without maintenance. Then we introduce the maintenance activity via the depreciation rate of capital. We characterize the optimal allocation of labor across the three activities. Through maintenance deepens the technological gap by diverting labor ressources from adoption, we find that it generally increases the long run output level. Moreover we find that long term output response to policy shocks is slightly higher in the presence of maintenance.
    Keywords: Adoption, Maintenance, Technological gap, Output gap
    JEL: E22 E32 O40
    Date: 2007–12–14
  17. By: Juessen, Falko (University of Dortmund)
    Abstract: Financial markets provide imperfect insurance of labor income risk. However, workers can partly insure against labor market risk by commuting to adjacent regions. Since commuters own wage claims to output produced in adjacent regions, the business cycle in the neighborhood becomes a relevant risk factor at the regional level. In our empirical analysis for US states, we show this effect to be important. State-specific consumption comoves with business cycle shocks that hit adjacent states, in particular if a state is integrated by commuter flows. This labor market perspective on regional risk sharing complements previous studies that investigated risk sharing through financial markets.
    Keywords: risk sharing, consumption smoothing, commuting, labor market risk
    JEL: E21 C33 R20
    Date: 2008–02
  18. By: Gabriele, CARDULLO (UNIVERSITE CATHOLIQUE DE LOUVAIN, Department of Economics)
    Abstract: In this paper, I construct a general equilibrium model in which the labour market exhibits search frictions, whereas Cournot competition is assumed in the goods market. The properties of the long run free-entry equiibrium show that a more competitive product market raises employment, but it has ambiguous effects both on the real wage and on the utility of the employees. Moreover, from a normative viewpoint, the level of employment and the degree of competition may be inefficiently high. Numerical results based on Belgian data are finally performed.
    Keywords: product market competition, search matching equilibrium, barriers to entry
    JEL: E24 J64 L16
    Date: 2008–02–20
  19. By: Felbermayr, Gabriel (University of Tuebingen); Prat, Julien (University of Vienna); Schmerer, Hans-Jörg (University of Tuebingen)
    Abstract: We introduce search unemployment à la Pissarides into Melitz’ (2003) model of trade with heterogeneous firms. We allow wages to be individually or collectively bargained and analytically solve for the equilibrium. We find that the selection effect of trade influences labor market outcomes. Trade liberalization lowers unemployment and raises real wages as long as it improves aggregate productivity net of transport costs. We show that this condition is likely to be met by a reduction in variable trade costs or the entry of new trading countries. On the other hand, the gains from a reduction in fixed market access costs are more elusive. Calibrating the model shows that the positive impact of trade openness on employment is significant when wages are bargained at the individual level but much smaller when wages are bargained at the collective level.
    Keywords: trade liberalization, unemployment, search model, firm heterogeneity
    JEL: F12 F15 F16
    Date: 2008–02
  20. By: Julio Davila (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, Ecole d'économie de Paris - Paris School of Economics - Université Panthéon-Sorbonne - Paris I)
    Abstract: I establish, in simple deterministic overlapping generations economies, that if each agent holds rationally formed expectations in the sense that any other expectations justifying his choices imply a smaller likelihood for the history he observes with limited memory, then there are rationally formed expectations equilibria exhibiting an excess volatility that no rational expectations equilibrium can match. Given that the limited records or finite memory case may arguably be the relevant one from a positive viewpoint, this result suggests that the possibility of excess volatility as an equilibrium phenomenon has been downplayed by the use of the rational expectations hypothesis.
    Keywords: Expectations, rationality, volatility.
    Date: 2008–02
  21. By: Charles I. Jones
    Abstract: Per capita income in the richest countries of the world exceeds that in the poorest countries by more than a factor of 50. What explains these enormous differences? This paper returns to several old ideas in development economics and proposes that linkages, complementarity, and superstar effects are at the heart of the explanation. First, linkages between firms through intermediate goods deliver a multiplier similar to the one associated with capital accumulation in a neoclassical growth model. Because the intermediate goods' share of revenue is about 1/2, this multiplier is substantial. Second, just as a chain is only as strong as its weakest link, problems at any point in a production chain can reduce output substantially if inputs enter production in a complementary fashion. Finally, the high elasticity of substitution associated with final consumption delivers a superstar effect: GDP depends disproportionately on the highest levels of productivity in the economy. This paper builds a model with links across sectors, complementary inputs, and highly substitutable consumption, and shows that it can easily generate 50-fold aggregate income differences.
    JEL: O11 O4
    Date: 2008–03
  22. By: Alexandre Dmitriev (School of Economics, The University of New South Wales)
    Abstract: Evidence shows that there are substantial rich-to-poor international capital flows although not as abundant as differences in rates of return would suggest. These flows are procylcical: abundant in good times and scarce in bad times. Conventional growth models face certain difficulties in accounting for this pattern. In this paper, we propose a dynamic model of capital flows to developing countries which is qualitatively consistent with these empirical regularities. The model is based on three main premises: i) international lending contracts are imperfectly enforceable; ii) access to the international financial markets results in technological transfers to a developing country from the rest of the world; iii) some of the productivity gains associated with the access to external financing are perishable. We solve for transitional dynamics of the model economy with endogenously incomplete markets and compare the results with the solutions obtained from the perfect risk-sharing and autarkic environments. Our findings suggest that technological transfers may play a role of an important enforcement mechanism. In our framework, existence of substantial rich-to-poor capital flows is not inconsistent with the presence of default risk.
    Keywords: Incentive compatibility; technological diffusion; international capital flows; default risk
    JEL: C63 F34 O33 O40
    Date: 2008–03

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