nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2008‒03‒25
twenty papers chosen by
Christian Zimmermann
University of Connecticut

  1. Aggregate Implications of Indivisible Labor, Incomplete Markets, and Labor Market Frictions By Per Krusell; Toshihiko Mukoyama; Richard Rogerson; Aysegul Sahin
  2. Housing market spillovers: Evidence from an estimated DSGE model By Matteo Iacoviello; Stefano Neri
  3. Pareto-Improving Optimal Capital and Labor Taxes By Albert Marcet; Katharina Greulich
  4. A Solution to the Default Risk-Business Cycle Disconnect By Enrique G. Mendoza; Vivian Z. Yue
  5. Default risk and income fluctuations in emerging economies By Arellano, Cristina
  6. Labor Market Fluctuations in the Small and in the Large By Richard Rogerson; Lodewijk P. Visschers; Randall Wright
  7. Can capacity constraints explain asymmetries By Knüppel, Malte
  8. Life-Cycle Equilibrium Unemployment By Chéron, Arnaud; Hairault, Jean-Olivier; Langot, François
  9. Bargaining Frictions, Labor Income Taxation and Economic Performance By Stéphane Auray; Samuel Danthine
  10. Optimal Monetary Policy under Uncertainty in DSGE Models: A Markov Jump-Linear-Quadratic Approach By Lars E.O. Svensson; Noah Williams
  11. Persistent Private Information By Noah Williams
  12. ICT-specific technological change and productivity growth in the US 1980-2004 By Diego Martínez; Jesús Rodríguez; José L. Torres
  13. ICT-specific technological change and productivity growth in the US 1980-2004 By Diego Martínez López; Jesús Rodríguez López; José Luis Torres Chacón
  14. A "double coincidence" search model of money By Amendola, Nicola
  15. On the importance of borrowing constraints for house price dynamics By Eerola, Essi; Määttänen, Niku
  16. Business Cycle Accounting For Chile By Ina Simonovska; Ludvig Soderling
  17. Entrepreneurial Innovation and Sustained Long-Run Growth without Weak or Strong Scale Effects By Grossmann, Volker
  18. Growth, Unemployment and Tax/Benefit system in European Countries By Quintero-Rojas, Coralia; Adjemian, Stéphane; Langot, François
  19. Information Acquisition and Under-Diversification By Stijn Van Nieuwerburgh; Laura Veldkamp
  20. Learning in a Credit Economy By Tiziana Assenzay; Michele Berardi

  1. By: Per Krusell; Toshihiko Mukoyama; Richard Rogerson; Aysegul Sahin
    Abstract: This paper analyzes a model that features frictions, an operative labor supply margin, and incomplete markets. We first provide analytic solutions to a benchmark model that includes indivisible labor and incomplete markets in the absence of trading frictions. We show that the steady state levels of aggregate hours and aggregate capital stock are identical to those obtained in the economy with employment lotteries, while individual employment and asset dynamics can be different. Second, we introduce labor market frictions to the benchmark model. We find that the effect of the frictions on the response of aggregate hours to a permanent tax change is highly non-linear. We also find that there is considerable scope for substitution between "voluntary" and "frictional" nonemployment in some situations.
    JEL: E2 J2
    Date: 2008–03
  2. By: Matteo Iacoviello (Boston College); Stefano Neri (Bank of Italy, Economics and International Relations)
    Abstract: The ability of a two-sector model to quantify the contribution of the housing market to business fluctuations is investigated using U.S. data and Bayesian methods. The estimated model, which contains nominal and real rigidities and collateral constraints, displays the following features: first, a large fraction of the upward trend in real housing prices over the last 40 years can be accounted for by slow technological progress in the housing sector; second, residential investment and housing prices are very sensitive to monetary policy and housing demand shocks; third, the wealth effects from housing on consumption are positive and significant, and have become more important over time. The structural nature of the model allows identifying and quantifying the sources of fluctuations in house prices and residential investment and measuring the contribution of housing booms and busts to business cycles.
    Keywords: House prices, Collateral Constraints, Bayesian methods, Two-sector Models
    JEL: E32 E44 E47 R21 R31
    Date: 2008–01
  3. By: Albert Marcet; Katharina Greulich
    Abstract: We show a standard model where the optimal tax reform is to cut labor taxes and leave capital taxes very high in the short and medium run. Only in the very long run would capital taxes be zero. Our model is a version of Chamley??s, with heterogeneous agents, without lump sum transfers, an upper bound on capital taxes, and a focus on Pareto improving plans. For our calibration labor taxes should be low for the first ten to twenty years, while capital taxes should be at their maximum. This policy ensures that all agents benefit from the tax reform and that capital grows quickly after when the reform begins. Therefore, the long run optimal tax mix is the opposite from the short and medium run tax mix. The initial labor tax cut is financed by deficits that lead to a positive long run level of government debt, reversing the standard prediction that government accumulates savings in models with optimal capital taxes. If labor supply is somewhat elastic benefits from tax reform are high and they can be shifted entirely to capitalists or workers by varying the length of the transition. With inelastic labor supply there is an increasing part of the equilibrium frontier, this means that the scope for benefitting the workers is limited and the total benefits from reforming taxes are much lower.
    Date: 2008–02–19
  4. By: Enrique G. Mendoza; Vivian Z. Yue
    Abstract: Models of business cycles in emerging economies explain the negative correlation between country spreads and output by modeling default risk as an exogenous interest rate on working capital. Models of strategic default explain the cyclical properties of sovereign spreads by assuming an exogenous output cost of default with special features, and they underestimate debt-output ratios by a wide margin. This paper proposes a solution to this default risk-business cycle disconnect based on a model of sovereign default with endogenous output dynamics. The model replicates observed V-shaped output dynamics around default episodes, countercyclical sovereign spreads, and high debt ratios, and it also matches the variability of consumption and the countercyclical fluctuations of net exports. Three features of the model are key for these results: (1) working capital loans pay for imported inputs; (2) imported inputs support more efficient factor allocations than when these inputs are produced internally; and (3) default on the foreign obligations of firms and the government occurs simultaneously.
    JEL: E32 E44 F32 F34
    Date: 2008–03
  5. By: Arellano, Cristina
    Abstract: Recent sovereign defaults in emerging countries are accompanied by interest rate spikes and deep recessions. This paper develops a small open economy model to study default risk and its interaction with output, consumption, and foreign debt. Default probabilities and interest rates depend on incentives for repayment. Default occurs in equilibrium because asset markets are incomplete. The model predicts that default incentives and interest rates are higher in recessions, as observed in the data. The reason is that in a recession, a risk averse borrower finds it more costly to repay non-contingent debt and is more likely to default. In a quantitative exercise the model matches various features of the business cycle in Argentina such as: high volatility of interest rates, higher volatility of consumption relative to output, a negative correlation of interest rates and output and a negative correlation of the trade balance and output. The model can also predict the recent default episode in Argentina.
    JEL: F34 F32 E44
    Date: 2008
  6. By: Richard Rogerson; Lodewijk P. Visschers; Randall Wright
    Abstract: Shimer's calibrated version of the Mortensen-Pissarides model generates unemployment fluctuates much smaller than the data. Hagedorn and Manovskii present an alternative calibration that yields fluctuations consistent with the data, but this has been challenged by Costain and Reiter, who say it generates unrealistically big differences in unemployment from the differences in policy we sees across countries. We argue this concern may be unwarranted, because one cannot assume elasticities relevant for small changes work for large changes. Models with fixed factors in market or household production can generate large effects from small changes and reasonable effects from large changes. This is reminiscent of attempts to improve the labor market in the Kydland-Prescott model, especially ones incorporating household production, like Benhabib, Rogerson and Wright.
    JEL: E2 E3 J2 J6
    Date: 2008–03
  7. By: Knüppel, Malte
    Abstract: In this paper, we investigate the ability of a modified RBC model to reproduce asymmetries observed for macroeconomic variables over the business cycle. In order to replicate the empirical skewness of major U.S. macroeconomic variables, we introduce a capacity constraint into an otherwise prototypical RBC model. This constraint emerges due to the assumption of kinked marginal costs of utilization, where the kink is located at a utilization rate of 100 percent. We find that a model with a suitably calibrated cost function reproduces the empirical coe􀀡cients of skewness remarkably well.
    Keywords: Capacity utilization, capacity constraints, asymmetry, RBC model
    JEL: E32
    Date: 2008
  8. By: Chéron, Arnaud (University of Le Mans); Hairault, Jean-Olivier (University of Paris 1); Langot, François (University of Le Mans)
    Abstract: This paper develops a life-cycle approach to equilibrium unemployment. Workers only differ respectively to their distance from deterministic retirement. A non age-directed search equilibrium is then typically featured by increasing (decreasing) firing (hiring) rates with age and a hump-shaped age profile for employment. Because of intergenerational inefficiencies, the Hosios condition no longer achieves efficiency. We then explore the optimal age-pattern of some policy tools to restore this efficiency. The optimal profile for employment subsidies should increase with age, whereas firing taxes and hirings subsidies would have to be hump-shaped. Lastly, we examine the robustness of our results. We show that age-directed recruitment policies cannot exist in equilibrium even if it would have been ex-ante possible, and that introducing endogenous search effort of unemployed workers reinforces our main results.
    Keywords: job search, matching, life cycle
    JEL: J22 J26 H55
    Date: 2008–03
  9. By: Stéphane Auray (Department of Economic, Université Charles-de-Gaulle lille 3); Samuel Danthine (Department of Economic Theory, Universidad de Málaga; Department of Economics, Université du Québec à Montréal)
    Abstract: A matching model with labor/leisure choice and bargaining frictions is used to explain (i ) differences in GDP per hour and GDP per capita, (ii) differences in employment, (iii ) differences in the proportion of part{time work across countries. The model predicts that the higher the level of rigidity in wages and hours the lower are GDP per capita, employment, part-time work and hours worked, but the higher is GDP per hour worked. In addition, it predicts that a country with a high level of rigidity in wages and hours and a high level of income taxation has higher GDP per hour and lower GDP per capita than a country with less rigidity and a lower level of taxation. This is due mostly to a lower level of employment. In contrast, a country with low levels of rigidity in hours and in wage setting but with a higher level of income taxation has a lower GDP per capita and a higher GDP per hour than the economy with low rigidity and low taxation. In this con¯guration,the level of employment is similar in both economies but the share of part-time work is larger.
    Keywords: models of search and matching, bargaining frictions, economic performance, labor market institutions, part-time jobs, labor market rigidities
    JEL: E24 J22 J30 J41 J50 J64
    Date: 2008–03
  10. By: Lars E.O. Svensson; Noah Williams
    Abstract: We study the design of optimal monetary policy under uncertainty in a dynamic stochastic general equilibrium models. We use a Markov jump-linear-quadratic (MJLQ) approach to study policy design, approximating the uncertainty by different discrete modes in a Markov chain, and by taking mode-dependent linear-quadratic approximations of the underlying model. This allows us to apply a powerful methodology with convenient solution algorithms that we have developed. We apply our methods to a benchmark New Keynesian model, analyzing how policy is affected by uncertainty, and how learning and active experimentation affect policy and losses.
    JEL: E42 E52 E58
    Date: 2008–03
  11. By: Noah Williams
    Abstract: This paper studies the design of optimal contracts in dynamic environments where agents have private information that is persistent. In particular, I focus on a continuous time version of a benchmark insurance problem where a risk averse agent would like to borrow from a risk neutral lender to stabilize his income stream. The income stream is private information to the borrower and is persistent. I find that the optimal contract conditions on the agent's reported endowment as well as two additional state variables: the agent's utility and marginal utility under the contract. I show how persistence alters the nature of the contract, and consider an exponential utility example which can be solved in closed form. Unlike the previous discrete time models with i.i.d. private information, the agent's consumption under the contract may grow over time. Furthermore, in my setting the efficiency losses due to private information increase with the persistence of the endowment, and the distortions vanish as I approximate an i.i.d. endowment.
    JEL: D82 D86 E21
    Date: 2008–03
  12. By: Diego Martínez (Universidad Pablo de Olavide); Jesús Rodríguez (Universidad Pablo de Olavide); José L. Torres (Universidad de Málaga)
    Abstract: This paper studies the impact of the information and communication technologies (ICT) on U.S. economic growth using a dynamic general equilibrium approach. We use a production function with six different capital inputs, three of them corresponding to ICT assets and other three to non-ICT assets. We find that the technological change mbedded in hardware equipment is the main leading non-neutral force of the U.S. roductivity growth and accounts for about one quarter of it during the period 1980-2004. As a whole, ICT-specific technological change accounts for about 35% of total labor productivity growth.
    Keywords: New economy, information and communications technologies, specific-technological change, neutral-technological change
    JEL: E22 O30 O40
    Date: 2008–03
  13. By: Diego Martínez López (Department of Economics, Universidad Pablo de Olavide); Jesús Rodríguez López (Department of Economics, Universidad Pablo de Olavide); José Luis Torres Chacón (Departamento de Teoría e Historia Económica, Universidad de Málaga)
    Abstract: This paper studies the impact of the information and communication technologies (ICT) on U.S. economic growth using a dynamic general equilibrium approach. We use a production function with six different capital inputs, three of them corresponding to ICT assets and other three to non-ICT assets. We find that the technological change embedded in hardware equipment is the main leading non-neutral force of the U.S. productivity growth and accounts for about one quarter of it during the period 1980-2004. As a whole, ICT-specific technological change accounts for about 35% of total labor productivity growth.
    Keywords: New economy, information and communication technologies, specific-technological change, neutral-technological change.
    JEL: E22 O30 O40
    Date: 2008–03
  14. By: Amendola, Nicola
    Abstract: According to Engineer and Shi (1998, 2001) and Berentsen and Rocheteau (2003), the double coincidence of wants problem seems to be not essential to rationalize the use of money in a search theoretic framework. This paper analyzes an endogenous price search model of money where there is universal double coincidence of wants. The existence of a monetary equilibrium depends, essentially, on the asymmetry in the role played by economic agents in the exchange and production processes. In particular, entrepreneurs are assumed to produce a fixed amount of a divisible consumption good by means of labour services provided by workers. Entrepreneurs can offer a co-operative (barter) contract or a monetary contract to workers. Under the co-operative contract real wages are determined in the labour exchange sector, while in the monetary regime real wages are determined in the commodity exchange sector. The monetary contract is proved to be an equilibrium strategy provided that: (i) the workers' labour disutility is sufficiently high and/or (ii) the entrepreneurs' bargaining power in the commodity market is sufficiently large relative to their bargaining power in the labour market. The rationale for money comes from the fact that entrepreneurs use it as an instrument to maximize their output share.
    Keywords: Money; Search; Double Coincidence; Bargaining
    JEL: C78 E40
    Date: 2008–03–19
  15. By: Eerola, Essi (University of Helsinki and HECER); Määttänen, Niku (The Research Institute of the Finnish Economy)
    Abstract: We study how a household borrowing constraint the the form of a down payment requirement affects house price dynamics in an OLG model with standard preferences. We find that in certain situations the borrowing constraint shapes house price dynamics substantially. The importance of the constraint depends very much on whether house price changes are driven by interest rate or aggregate income shocks. Moreover, because of the borrowing constraint, house price dynamics display substantial asymmetries between large positive and large negative income shocks. These results are related to the fact that the share of borrowing-constrained households is different following different shocks.
    Keywords: house prices; dynamics; borrowing constraints; down payment constraint
    JEL: E21 R21
    Date: 2008–03–17
  16. By: Ina Simonovska; Ludvig Soderling
    Abstract: We investigate sources of economic fluctuations in Chile during 1998-2007 within the framework of a standard neoclassical growth model with time-varying frictions (wedges). We analyze the relative importance of efficiency, labor, investment, and government/trade wedges for business cycles in Chile. The purpose of this exercise is twofold: (i) focus the policy discussion on the most important wedges in the economy; and (ii) identify which broad class of models would present fruitful avenues for further research. We find that different wedges have played different roles during our studied period, but that the efficiency and labor wedges have had the greatest impact. We also compare our results with existing studies on Argentina, Brazil, and Mexico.
    Date: 2008–03–19
  17. By: Grossmann, Volker (University of Fribourg)
    Abstract: R&D-based growth theory suggests that a larger population size raises either the long-run rate of economic growth (“strong scale effect”) or the level of per capita income (“weak scale effect”), with far-reaching policy implications. However, for modern times there is little empirical support for strong scale effects and evidence in favor of weak scale effects is mixed, at best. This paper develops a simple overlapping-generations framework with endogenous occupational choice of heterogeneous agents and entrepreneurial innovations in which any form of scale effect is absent. A higher population growth rate has a negligible, possibly negative effect on the long-run growth rate of per capita income. Long-run growth is sustained also in absence of population growth and generally is policy-dependent.
    Keywords: economic growth, endogenous technical change, entrepreneurial skills, population growth, scale effects
    JEL: O10 O30 O40
    Date: 2008–03
  18. By: Quintero-Rojas, Coralia; Adjemian, Stéphane; Langot, François
    Abstract: This paper analyzes how the frictions in the labor market simultaneously affect the economic growth and the long run unemployment. To this goal, we develop a Schumpeterian model of endogenous growth: agents have the choice of being employed or being doing R&D activities. Unemployment is caused by the wage-setting behavior of unions. We show that: (i) High labor costs or powerful trade unions lead to higher unemployment and lower economic growth. (ii) Efficient bargain allows to increase employment, at the price of a lower growth rate. These theoretical predictions are consistent with our empirical analysis based on 183 European Regions, between 1980-2003. Finally, in a welfare exercise, we show that the optimal growth rate can be reached by compensating the distortions on the goods-sector due to the growth process with the distortions induced by the labor market rigidities.
    Keywords: Endogenous growth; unemployment; labor market institutions; welfare.
    JEL: J51 E24 O33
    Date: 2008–03–14
  19. By: Stijn Van Nieuwerburgh; Laura Veldkamp
    Abstract: If an investor wants to form a portfolio of risky assets and can exert effort to collect information on the future value of these assets before he invests, which assets should he learn about? The best assets to acquire information about are ones the investor expects to hold. But the assets the investor holds depend on the information he observes. We build a framework to solve jointly for investment and information choices, with a variety of preferences and information cost functions. Although the optimal research strategies depend on preferences and costs, the main result is that the investor who can first collect information systematically deviates from holding a diversified portfolio. Information acquisition can rationalize investing in a diversified fund and a concentrated set of assets, an allocation often observed, but usually deemed anomalous.
    JEL: D82 D83 G11 G14
    Date: 2008–03
  20. By: Tiziana Assenzay; Michele Berardi
    Abstract: In this work we analyze a credit economy à la Kiyotaki and Moore (JPE, 1997) enriched with learning dynamics. Both borrowers and lenders need to make expectations about the future price of the collateral, and under heterogeneous learning this can have interesting consequences for the economy when the possibility of bankruptcy is taken into consideration.
    Date: 2008

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