nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2008‒04‒29
twenty-one papers chosen by
Christian Zimmermann
University of Connecticut

  1. Competitive search equilibrium in a DSGE model By David M. Arseneau; Sanjay K. Chugh
  2. The Role of Investment Wedges in the Carlstrom-Fuerst Economy and Business Cycle Accounting By Inaba, Masaru; Nutahara, Kengo
  3. Optimal Life-Cycle Investing with Flexible Labor Supply: A Welfare Analysis of Life-Cycle Funds By Francisco J. Gomes; Laurence J. Kotlikoff; Luis M. Viceira
  4. Country portfolios in open economy macro models By Michael B. Devereux; Alan Sutherland
  5. A solution to the default risk-business cycle disconnect By Enrique G. Mandoza; Vivian Z. Yue
  6. Reconciling Kuznets and Habbakuk in a Unified Growth Theory By Alex Mourmouras; Peter Rangazad
  7. Tariff and Equilibrium Indeterminacy--(I) By Zhang, Yan
  8. Happiness maintenance and asset prices By Antonio Falato
  9. Technology capital and the U.S. current account By Ellen R. McGrattan; Edward C. Prescott
  10. How much structure in empirical models? By Canova, Fabio
  11. Emerging market business cycles revisited: learning about the trend By Emine Boz; Christian Daude; Ceyhun Bora Durdu
  12. Bargaining Frictions, Labor Income Taxation and Economic Performance By Stéphane Auray; Samuel Danthine
  13. Globalization and monetary policy: an introduction By Enrique Martinez-Garcia
  14. Intermediated quantities and returns By Rajnish Mehra; Facundo Piguillem; Edward C. Prescott
  15. JBendge: An Object-Oriented System for Solving, Estimating and Selecting Nonlinear Dynamic Models By Viktor Winschel; Markus Krätzig
  16. Production Stages and the Transmission of Technological Progress By Louis Phaneuf; Nooman Rebei
  17. Competing Liquidities: Corporate Securities, Real Bonds and Bubbles By Emmanuel Farhi; Jean Tirole
  18. Monetary Policy Effects in Developing Countries with Minimum Wages By Kodama, Masahiro
  19. Coin sizes and payments in commodity money systems By Angela Redish; Warren E. Weber
  20. Adaptive microfoundations for emergent macroeconomics By Edoardo Gaffeo; Domenico Delli Gatti; Saul Desiderio; Mauro Gallegati
  21. Money and competing assets under private information By Guillaume Rocheteau

  1. By: David M. Arseneau; Sanjay K. Chugh
    Abstract: We show how to implement a competitive search equilibrium in a fully-specified DSGE environment. Competitive search, an equilibrium concept well-understood in labor market theory, offers an alternative to the commonly-used Nash bargaining in search-based macro models. Our simulation-based results show that business cycle fluctuations under competitive search equilibrium are virtually identical to those under Nash bargaining for a broad range of calibrations of Nash bargaining power. We also prove that business cycle fluctuations under competitive search equilibrium are exactly identical to those under Nash bargaining restricted to the popularly-used Hosios condition for search efficiency. This latter result extends the efficiency properties of competitive search equilibrium to a DSGE environment. Our results thus provide a foundation for researchers interested in studying business cycle fluctuations using search-based environments to claim that the sometimes-awkward assumption of bargaining per se does not obscure interpretation of results.
    Date: 2008
  2. By: Inaba, Masaru; Nutahara, Kengo
    Abstract: Many researches that apply business cycle accounting (hereafter, BCA) to actual data conclude that models with investment frictions or investment wedges are not promising for modeling business cycle dynamics. In this paper, we apply BCA to artificial data generated by a variant model of Carlstrom and Fuerst (1997, American Economic Review), which is one of representative models with investment frictions. We find that BCA leads us to conclude that models of investment wedges are not promising according to the criteria of BCA, although the true model contains investment frictions.
    Keywords: Business cycle accounting; investment wedge; investment friction; wedge decompsition
    JEL: C68 E32 E13
    Date: 2008–04–19
  3. By: Francisco J. Gomes; Laurence J. Kotlikoff; Luis M. Viceira
    Abstract: We investigate optimal consumption, asset accumulation and portfolio decisions in a realistically calibrated life-cycle model with flexible labor supply. Our framework allows for wage rate uncertainly, variable labor supply, social security benefits and portfolio choice over safe bonds and risky equities. Our analysis reinforces prior findings that equities are the preferred asset for young households, with the optimal share of equities generally declining prior to retirement. However, variable labor materially alters pre-retirement portfolio choice by significantly raising optimal equity holdings. Using this model, we also investigate the welfare costs of constraining portfolio allocations over the life cycle to mimic popular default investment choices in defined-contribution pension plans, such as stable value funds, balanced funds, and life-cycle (or target date) funds. We find that life-cycle funds designed to match the risk tolerance and investment horizon of investors have small welfare costs. All other choices, including life-cycle funds which do not match investors' risk tolerance, can have substantial welfare costs.
    JEL: D1 D91 E21 G11 G2 G23 H31 H55
    Date: 2008–04
  4. By: Michael B. Devereux; Alan Sutherland
    Abstract: This paper develops a simple approximation method for computing equilibrium portfolios in dynamic general equilibrium open economy macro models. The method is widely applicable, simple to implement, and gives analytical solutions for equilibrium portfolio positions in any combination or types of asset. It can be used in models with any number of assets, whether markets are complete or incomplete, and can be applied to stochastic dynamic general equilibrium models of any dimension, so long as the model is amenable to a solution using standard approximation methods. We first illustrate the approach using a simple two-asset endowment economy model, and then show how the results extend to the case of any number of assets and general economic structure.
    Keywords: Econometric models ; Equilibrium (Economics) - Mathematical models ; Macroeconomics - Econometric models ; Monetary policy
    Date: 2008
  5. By: Enrique G. Mandoza; 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.
    Date: 2008
  6. By: Alex Mourmouras; Peter Rangazad (Department of Economics, Indiana Unviersity-Purdue University Indianapolis)
    Abstract: Economic historians have debated the relative labor productivity of the United States agricultural sector during the 19th century. David (2005) offers a reconciliation of the opposing views by suggesting that while productivity per hour worked in agriculture was high, the number of hours worked per year was low. We model and extend a version of Davis’s reconciliation within a unified growth theory that connections the structural transformation away from traditional agriculture to several other features of United States development. Similar to David, our model predicts an almost two-fold annual workerproductivity advantage in the modern (industrial) sector of the economy, entirely due to greater hours worked per year. The dynamic general equilibrium model is consistent with the structural transformation having minor direct and indirect effects on aggregate labor productivity per hour, but substantial effects on aggregate labor productivity per worker. The model also provides a reasonable match to the trends in schooling, fertility, rates of return to physical capital, and labor productivity growth over the two centuries.
    Keywords: Wage Gaps, Human Capital, Fertility
    JEL: O11
    Date: 2007–12
  7. By: Zhang, Yan
    Abstract: Schmitt-Grohe and Uribe (1997, henceforth SGU) prove that in a standard neoclassical growth model the fiscal increasing returns induced by the endogenous factor income tax rate (assuming that the government expenditure is exogenous) has a close correspondence with the production increasing returns in Benhabib and Farmer (1994) model. Wen and Aguiar-Conraria (2005, 2006, henceforth WAC ) extend the Benhabib-Farmer model to open economy by introducing imported foreign production factors. We prove that in a modified WAC model without increasing returns, using the tariff revenue from the imported production factor to finance the exogenous government expenditure, we can also have indeterminacy. From this perspective, factor income tax and tariff share similar channels to generate indeterminacy.
    Keywords: Indeterminacy; Endogenous Tariff Rate; Small Open Economy; Exogenous Government Expenditure
    JEL: F41 Q43
    Date: 2008–04
  8. By: Antonio Falato
    Abstract: This paper constructs a simple dynamic asset pricing model which incorporates recent evidence on the influence of immediate emotions on risk preferences. Investors derive direct utility from both consumption and financial wealth and, consistent with the happiness maintenance feature documented by Isen (1999) and others, become more cautious toward their wealth in good times. Mild pro-cyclical changes in risk aversion over wealth cause large pro-cyclical fluctuations in the current price-dividend ratio which, due to general equilibrium restrictions, translate into counter-cyclical variation in the current consumption-wealth ratio and, in turn, in expected future returns. With a realistic consumption growth process and reasonable preference parameters, the model generates a sizable equity premium, a low and stable risk-free rate, volatile and predictable stock returns, and price-dividend and Sharpe ratios in line with the data.
    Date: 2008
  9. By: Ellen R. McGrattan; Edward C. Prescott
    Abstract: The U.S. Bureau of Economic Analysis (BEA) estimates the return on investments of foreign subsidiaries of U.S. multinational companies over the period 1982–2006 averaged 9.4 percent annually after taxes; U.S. subsidiaries of foreign multinationals averaged only 3.2 percent. Two factors distort BEA returns: technology capital and plant-specific intangible capital. Technology capital is accumulated know-how from intangible investments in R&D, brands, and organizations that can be used in foreign and domestic locations. Used abroad, it generates profits for foreign subsidiaries with no foreign direct investment (FDI). Plant-specific intangible capital in foreign subsidiaries is expensed abroad, lowering current profits on FDI and increasing future profits. We develop a multicountry general equilibrium model with an essential role for FDI and apply the BEA’s methodology to construct economic statistics for the model economy. We estimate that mismeasurement of intangible investments accounts for over 60 percent of the difference in BEA returns.
    Date: 2008
  10. By: Canova, Fabio
    Abstract: This chapter highlights the problems that structural methods and SVAR approaches have when estimating DSGE models and examining their ability to capture important features of the data. We show that structural methods are subject to severe identification problems due, in large part, to the nature of DSGE models. The problems can be patched up in a number of ways, but solved only if DSGEs are completely reparametrized or respecified. The potential misspecification of the structural relationships give Bayesian methods an hedge over classical ones in structural estimation. SVAR approaches may face invertibility problems but simple diagnostics can help to detect and remedy these problems. A pragmatic empirical approach ought to use the flexibility of SVARs against potential misspecification of the structural relationships but must firmly tie SVARs to the class of DSGE models which could have have generated the data.
    Keywords: DSGE models; Identification; Invertibility; SVAR models
    JEL: C10 C52 E32 E50
    Date: 2008–04
  11. By: Emine Boz; Christian Daude; Ceyhun Bora Durdu
    Abstract: The data reveal that emerging markets do not differ from developed countries with regards to the variance of permanent TFP shocks relative to transitory. They do differ, however, in the degree of uncertainty agents face when formulating expectations. Based on these observations, we build an equilibrium business cycle model in which the agents cannot perfectly distinguish between the permanent and transitory components of TFP shocks. When formulating expectations, they assign some probability to TFP shocks being permanent even when they are purely transitory. This is sufficient for the model to produce "permanent-like" effects in response to transitory shocks. The imperfect information model calibrated to Mexico predicts a higher variability of consumption relative to output and a strongly negative correlation between the trade balance and output, without the predominance of trend shocks. The same model assuming perfect information and calibrated to Canada accounts for developed country business cycle regularities. The estimated relative variance of trend shocks in these two models is similar.
    Date: 2008
  12. By: Stéphane Auray; Samuel Danthine
    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 and hours worked (per capita and per worker), (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. 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, employment and part-time work 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 taxtion has a lower GDP per capita and a higher GDP per hour than the economy with low rigidity and low taxation. In this configuration, the level of employment is similar in both economies but the share of part-time work is larger. The model accounts well qualitatively for the facts, and a plausible calibration accounts well qualitatively for the differences between the US, French and Dutch economies.
    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
  13. By: Enrique Martinez-Garcia
    Abstract: Greater openness has become an almost universal feature of modern, developed economies. This paper develops a workhorse international model, and explores the role of standard monetary policy rules applied to an open economy. For this purpose, I build a two-country DSGE model with monopolistic competition, sticky prices, and pricing-to-market. I also derive the steady state and a log-linear approximation of the equilibrium conditions. The paper provides a lengthy explanation of the steps required to derive this benchmark model, and a discussion of: (a) how to account for certain well-known anomalies in the international literature, and (b) how to start "thinking" about monetary policy in this environment.
    Keywords: Monetary policy ; Equilibrium (Economics) ; Globalization ; Macroeconomics ; International finance ; Mathematical models
    Date: 2008
  14. By: Rajnish Mehra; Facundo Piguillem; Edward C. Prescott
    Abstract: A large amount of intermediated borrowing and lending takes place between households. The average difference in these rates is over 2 percent. In this paper, we develop a model economy that displays these facts and matches not only the returns on assets but also their quantities. The heterogeneity giving rise to borrowing and lending and differences in equity holdings results from differences in preferences for making bequests. In equilibrium, lenders are annuity holders and borrowers are equity holders. The borrowing rate and return on equity are the same in our model, which has no aggregate uncertainty. With intermediation costs, the lending rate is less than the borrowing rate and there is an equity premium. Within age cohorts, human capital endowments and inheritances are identical. As a result, there is almost no dispersion in consumption, yet there is a sizable dispersion in net worth and a huge dispersion in equity holdings.
    Date: 2008
  15. By: Viktor Winschel; Markus Krätzig
    Abstract: We present an object-oriented software framework allowing to specify, solve, and estimate nonlinear dynamic general equilibrium (DSGE) models. The imple- mented solution methods for nding the unknown policy function are the standard linearization around the deterministic steady state, and a function iterator using a multivariate global Chebyshev polynomial approximation with the Smolyak op- erator to overcome the course of dimensionality. The operator is also useful for numerical integration and we use it for the integrals arising in rational expecta- tions and in nonlinear state space lters. The estimation step is done by a parallel Metropolis-Hastings (MH) algorithm, using a linear or nonlinear lter. Implemented are the Kalman, Extended Kalman, Particle, Smolyak Kalman, Smolyak Sum, and Smolyak Kalman Particle lters. The MH sampling step can be interactively moni- tored and controlled by sequence and statistics plots. The number of parallel threads can be adjusted to benet from multiprocessor environments. JBendge is based on the framework JStatCom, which provides a standardized ap- plication interface. All tasks are supported by an elaborate multi-threaded graphical user interface (GUI) with project management and data handling facilities.
    Keywords: Dynamic Stochastic General Equilibrium (DSGE) Models, Bayesian Time Series Econometrics, Java, Software Development
    JEL: C11 C13 C15 C32 C52 C63 C68 C87
    Date: 2008–04
  16. By: Louis Phaneuf; Nooman Rebei
    Abstract: We develop and estimate a DSGE model which realistically assumes that many goods in the economy are produced through more than one stage of production. Firms produce differentiated goods at an intermediate stage and a final stage, post different prices at both stages, and face stage-specific technological change. Wage-setting households are imperfectly competitive with respect to labor skills. Intermediate-stage technology shocks explain most of short-run output fluctuations, whereas final-stage technology shocks only have a small impact. Despite the dominance of technology shocks, the model predicts a near-zero correlation between hours worked and the return to work and mildly procyclical real wages. The factors mainly responsible for these findings are an input-output linkage between firms operating at the different stages and movements in the relative price of goods. We show that, depending the source, a technology improvement may either have a contractionary or expansionary impact on employment.
    Keywords: Business Cycles, Production Stages, Technological Change, Nominal Rigidities
    JEL: E32
    Date: 2008
  17. By: Emmanuel Farhi; Jean Tirole
    Abstract: We explore the link between liquidity and investment in a an overlapping generation model with a standard asynchronicity between firms' access to and need for cash. Imperfect pledgeability hinders the capacity of capital markets to resolve this asynchronicity, resulting in credit rationing and a net demand for stores of value -- liquidity -- by the corporate sector. At the heart of the model is a distinction between inside liquidity -- liquidity created within the private sector -- and outside liquidity -- assets that do not originate in private investment decisions. In the model, outside liquidity comes in two forms: rents and asset bubbles. We make four contributions. First, we show that imperfect pledgeability severs the link between dynamic efficiency and the level of the interest rate. Bubbles are possible even when the economy is dynamically efficient. Second, we demonstrate that the link between outside liquidity and investment is ambiguous: on the one hand, outside liquidity eases the asynchronicity problem of firms, boosting investment -- the liquidity effect; on the other hand it competes with inside liquidity, reduces the value of firms' collateral and lowers investment -- the competition effect. We characterize precisely the conditions under which outside liquidity and investment are complements or substitutes. Third, we explore the possibility of stochastic bubbles. We show that they trade at a liquidity discount. Bubble bursts can be endogenously triggered by bad shocks to corporate balance sheets and have potentially amplified effects on investment through liquidity dry-ups. Fourth, in an extension where corporate governance is endogenously determined by a trade-off striked by firms between collateral and value, we show that bubbles are accompanied by loose corporate governance.
    JEL: E2 E44
    Date: 2008–04
  18. By: Kodama, Masahiro
    Abstract: Using a Dynamic General Equilibrium (DGE) model, this study examines the effects of monetary policy in economies where minimum wages are bound. The findings show that the monetary-policy effect on a binding-minimum-wage economy is relatively small and quite persistent. This result suggests that these two characteristics of monetary policy in the minimum-wage model are rather different from those in the union-negotiation model which is often assumed to account for industrial economies.
    Keywords: Monetary policy, Sticky wage, Business cycles, Developing countries, Minimum wages
    JEL: E32 E52 J3 O11
    Date: 2008–03
  19. By: Angela Redish; Warren E. Weber
    Abstract: Commodity money standards in medieval and early modern Europe were characterized by recurring complaints of small change shortages and by numerous debasements of the coinage. To confront these facts, we build a random matching monetary model with two indivisible coins with different intrinsic values. The model shows that small change shortages can exist in the sense that changes in the size of the small coin affect ex ante welfare. Further, the optimal ratio of coin sizes is shown to depend upon the trading opportunities in a country and a country’s wealth. Thus, coinage debasements can be interpreted as optimal responses to changes in fundamentals. Further, the model shows that replacing full-bodied small coins with tokens is not necessarily welfare-improving.
    Date: 2008
  20. By: Edoardo Gaffeo; Domenico Delli Gatti; Saul Desiderio; Mauro Gallegati
    Abstract: In this paper we present the basics of a research program aimed at providing microfoundations to macroeconomic theory on the basis of computational agentbased adaptive descriptions of individual behavior. To exemplify our proposal, a simple prototype model of decentralized multi-market transactions is offered. We show that a very simple agent-based computational laboratory can challenge more structured dynamic stochastic general equilibrium models in mimicking comovements over the business cycle.
    Keywords: Microfoundations of macroeconomics, Agent-based economics, Adaptive behavior
    JEL: C63 E10 O11
    Date: 2008
  21. By: Guillaume Rocheteau
    Abstract: I study random-matching economies where at money coexists with real assets, and no restrictions are imposed on payment arrangements. I emphasize informational asymmetries about asset fundamentals to explain the partial illiquidity of real assets and the usefulness of at money. The liquidity of the real asset, as measured by its transaction velocity, is shown to depend on the discrepancy of its dividend across states as well as policy. I analyze how monetary policy affects payment arrangements, asset prices, and welfare.
    Keywords: Money ; Monetary policy
    Date: 2008

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.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.