nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2008‒05‒10
ten papers chosen by
Christian Zimmermann
University of Connecticut

  1. Business Cycles in Small Developed Economies: The Role of Terms of Trade and Foreign Interest Rate Shocks By Jaime Guajardo
  2. The effects of population aging on optimal redistributive taxes in an overlapping generations model By Brett, Craig
  3. Essential Interest-Bearing Money (2008) By Andolfatto, David
  4. Income Taxation, Interest-Rate Control and Macroeconomic Stability with Balanced-Budget By Seiya Fujisaki; Kazuo Mino
  5. Calculating Welfare Costs of Inflation in a Search Model with Preference Heterogeneity: A Calibration Exercise By Pedro de Araujo
  6. Equilibrium Determinacy of Endogenous Growth with Generalized Taylor Rule: A Discrete-Time Analysis By Seiya Fujisaki
  7. Testing a DSGE model of the EU using indirect inference By David Meenagh; Patrick Minford; Michael Wickensy
  8. Aging, Inequality and Social Security By Ryo Arawatari; Tetsuo Ono
  9. Productive government expenditure and fiscal sustainability By Arai, Real
  10. Random Matching and Aggregate Uncertainty By Molzon, Robert; Puzzello, Daniela

  1. By: Jaime Guajardo
    Abstract: Empirical evidence for small developed economies finds that consumption is procyclical and as volatile as output, and real net exports are coutercyclical. Earlier studies have not been able to reproduce these regularities in a DSGE small open economy model when productivity shocks drive the business cycles and households have a normal intertemporal elasticity of substitution. Instead, these studies have reduced this elasticity to make consumption more procyclical and volatile and real net exports countercyclical. This paper shows that a standard model can reproduce these regularities, without lowering the intertemporal substitution, if the terms of trade and foreign interest rate are added as source of business cycle fluctuations. These shocks, compared to productivity shocks, make consumption and investment more volatile and procyclical relative to output, and make real net exports countercyclical.
    Date: 2008–04–04
  2. By: Brett, Craig
    Abstract: The impact of population aging on the steady state solution to a Ordover-Phelps (1979) overlapping generations optimal nonlinear income tax problem with two types of workers and quasilinear-in-leisure preferences is investigated. A decrease in the rate of population growth, which leads to an aging population, increases the relative price of consumption per person in retirement, which tends to decrease optimal consumption for retirees of both skill types. It is also shown that the optimal steady state rate of interest equals the rate of population growth. As a result, the steady state interest rate unambiguously declines when the rate of population growth declines. The resulting adjustments in production plans has an ambiguous effect on the aggregate wage rate. This article identifies factors contributing to an increase in the aggregate wage when the population ages, namely normality of consumption in retirement, complementarity between capital and labor in production, and a large capital deepening effect relative to the increase in dependency owing to demographic change. Depending on the sign of this wage effect, ambiguities may arise in the direction of change in the optimal steady state consumption and production plans. It is also shown that the optimal marginal income tax rates are independent of the rate of population growth.
    Keywords: optimal income taxation; overlapping generations model; population aging
    JEL: H21 D82
    Date: 2008–03–25
  3. By: Andolfatto, David
    Abstract: I consider a model of intertemporal trade where agents lack commitment, agent types are private information, there is an absence of recordkeeping, and societal penalties are infeasible. Despite these frictions, I demonstrate that policy can be designed to implement the first-best allocation as a (stationary) competitive monetary equilibrium. The optimal policy requires a strictly positive interest rate with the aggregate interest expenditure financed in part by an inflation tax and in part by an incentive-compatible lump-sum fee. An illiquid bond is essential only in the event that paying interest on money is prohibitively costly.
    JEL: E4
    Date: 2008–05–03
  4. By: Seiya Fujisaki (Graduate School of Economics, Osaka University); Kazuo Mino (Graduate School of Economics, Osaka University)
    Abstract: This paper studies stabilization effects of fiscal and monetary policy rules in the context of a standard real business cycle model with money. We assume that the fiscal authority adjusts the rate of income tax subject to the balanced-budget constraint, while the monetary authority controls the nominal interest rate by observing inflation. Inspecting macroeconomic stability of the steady state equilibrium of the model economy, we demonstrate that whether or not policy rules eliminate the possibility of sunspot-driven fluctuations critically depends upon the appropriate combination of progressiveness of taxation and activeness of interest-rate control.
    Keywords: balanced budget, interest rate control, determinacy of equilibrium
    JEL: E52 E62 E63
    Date: 2008–04
  5. By: Pedro de Araujo (Indiana University Bloomington)
    Abstract: Using U.S. cross-sectional data, this paper calculates the welfare cost of a 10% inflation for different individuals and finds that the difference in cost between the poorest 10%, measured by their expenditure share on cash goods, and the richest 10% is in the order of 176%. That is, a poor person is on average willing to forgive 176% more of their total consumption in order to have inflation reduced from 10% to 0. In absolute terms this represents a cost of 2.687% of consumption for the poorest and 0.974% for the richest. I accomplish this by introducing preference heterogeneity in a monetary search model first developed by Lagos and Wright (2005), and calibrate the model to match the expenditure share on cash goods and total expenditures for each individual type using data from the Consumer Expenditure Survey (CEX) for the second quarter of 1996. I also show that this welfare difference increases to 210% (10.522% for the poorest 10% and 3.401% for the richest 10%) whenever frictions in the use of money are imposed (holdup problem). The ability to explicitly model these frictions is the advantage of using this model. Hence, inflation in this framework, as other studies have shown, acts as a regressive consumption tax; and this regressiveness is augmented with the holdup problem.
    Keywords: Inflation, welfare, search, holdup
    JEL: C63 C78 E41
    Date: 2008–04
  6. By: Seiya Fujisaki (Graduate School of Economics, Osaka University)
    Abstract: This paper examines equilibrium determinacy of a discrete-time AK growth model with a generalized Taylor rule under which interest rate responds to the growth rate of real income as well as to the rate of inflation. We use the standard money-in-the-utility formulation in which money is superneutral on the balanced-growth path. We show that even in such a simple environment, the generalized Taylor rule may yield indeterminacy of equilibrium easily. We also demonstrate that equilibrium determinacy depends on the timing of money holding of households as well.
    Keywords: equilibrium determinacy, the Taylor rules, endogenous growth, timing of money holdings
    JEL: O42 E52
    Date: 2008–04
  7. By: David Meenagh; Patrick Minford; Michael Wickensy
    Abstract: We use the method of indirect inference, using the bootstrap, to test the Smets and Wouters model of the EU against a VAR auxiliary equation describing their data; the test is based on the Wald statistic. We find that their model generates excessive variance compared with the data. If the errors are scaled down, then the original model marginally passes the Wald test. We compare a New Classical version of the model which passes the test but generates a combination of excessive inflation variance and inadequate output variance. If the large consumption and investment errors are removed as possibly due to low frequency events, then the New Classical version passes easily while the original version is strongly rejected.
    Keywords: Bootstrap, DSGE Model, VAR model, Model of EU, indirect inference, Wald statistic.
    JEL: C12 C32
    Date: 2008–03
  8. By: Ryo Arawatari (Graduate School of Economics, Osaka University); Tetsuo Ono (Graduate School of Economics, Osaka University)
    Abstract: This paper develops an overlapping-generations model including wage inequality within a generation and intra- and intergenerational resource reallocation via social security. Based on the concept of a stationary Markov perfect equilibrium, the paper focuses on the feedback mechanism between current individualsf decisions on saving and future voting on social security. The paper demonstrates the determination of social security via probabilistic voting and its consequence for consumption inequality within a generation. It is shown that when the elderly are politically powerful, (i) the economy attains an oscillatory path of inequality and social security, and (ii) aging may reduce consumption inequality.
    Keywords: Aging; Inequality; Social security; Political Economy; Stationary Markov Perfect Equilibrium
    JEL: D72 H55 J10
    Date: 2008–04
  9. By: Arai, Real
    Abstract: We consider an overlapping generations model in which public spending directly contributes to grow up productivity as Barro (1990) and a government comforms the constant spending-GDP and debtspending ratio rules. We analyse policy effects on fiscal sustainability, growth rate and welfare. This paper gives some remarks as follows: First, we demonstrate that when spending-GDP ratio rises it may be more sustainable fiscal policy. Second, we show analytically that if higher spending-GDP ratio is more sustainable fiscal policy, it brings higher growth rate in both short-term and long-term. Third, such policy change is Pareto improving. These remarks are not obtained in previous researches on fiscal sustainability.
    JEL: E62 H54 H63
    Date: 2008–05–02
  10. By: Molzon, Robert; Puzzello, Daniela
    Abstract: Random matching is often used in economic models as a means of introducing uncertainty in sequential decision problems. We show that random matching schemes that satisfy standard conditions on proportionality are not unique. Two examples show that in a simple growth model, radically di¤erent optimal behavior can result from distinct matching schemes satisfying identical proportionality conditions. That is, non-uniqueness has interesting economic implications since it a¤ects the reward and the transi- tion structures. We propose information entropy as a natural method for selecting unique matching structures for these models. Next, we give conditions on the reward and transition structures of sequential decision models under which the models are not a¤ected by non-uniqueness of the matching scheme.
    JEL: D83 C73
    Date: 2008

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