nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2008‒05‒17
fifteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Currency Substitution and Financial Repression By Rangan Gupta
  2. Taxation, aggregates and the household By Nezih Guner; Remzi Kaygusuz; Gustavo Ventura
  3. Optimal Taxation and (Female)-Labor Force Participation over the Cycle By Jung, Philip
  4. Monetary Non-Neutrality in a Multi-Sector Menu Cost Model By Emi Nakamura; Jon Steinsson
  5. Technology Capital and the U.S. Current Account By Ellen R. McGrattan; Edward C. Prescott
  6. Uncertainty, Inflation, and Welfare By Jonathan Chiu; Miguel Molico
  7. Testing a DSGE model of the EU using indirect inference By Meenagh, David; Minford, Patrick; Wickens, Michael
  8. Temporary price changes and the real effects of monetary policy By Patrick J. Kehoe; Virgiliu Midrigan
  9. Status, fertility, growth and the great transition By Tournemaine, Frederic; Tsoukis, Christopher
  10. Driving Forces of the Canadian Economy: An Accounting Exercise By Simona E. Cociuba; Alexander Ueberfeldt
  11. Specific Capital and Technological Variety By Boyan Jovanovic; Peter L. Rousseau
  12. International Job Search: Mexicans in and out of the U.S. By Silvio Rendon; Alfredo Cuecuecha
  13. Investing for the Old Age: Pensions, Children and Savings By Galasso, Vincenzo; Gatti, Roberta; Profeta, Paola
  14. Return Migration as Channel of Brain Gain By Karin Mayr; Giovanni Peri
  15. Optimal Nonlinear Income Taxation with Learning-by-Doing By Alan Krause

  1. By: Rangan Gupta (Department of Economics, University of Pretoria)
    Abstract: In this paper, we use a general equilibrium overlapping generations monetary endogenous growth model of a small open economy, to analyze whether financial repression, measured via the "high" mandatory reserve-deposit requirements of financial intermediaries, is an optimal response of a consolidated government following an increase in the degree of currency substitution. We find that higher currency substitution can yield higher reserve requirements, but, the result depends crucially on how the consumer weighs money in the utility function relative to domestic and foreign consumptions, and also the size of the government.
    Keywords: Currency Substitution, Endogenous Growth Models, Financial Repression, Small Open Economy, Public Finance
    JEL: E31 E44 E63 F43
    Date: 2008–04
  2. By: Nezih Guner; Remzi Kaygusuz; Gustavo Ventura
    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.
    Date: 2008
  3. By: Jung, Philip
    Abstract: Optimal labor tax results over the cycle are, quantitatively, typically driven by an estimate of the intratemporal elasticity of substitution that governs the reaction of hours worked to business cycle shocks and tax rate changes. A recent literature tries to decompose this intratemporal elasticity into its main components, the "Ins and Outs of Unemployment" (Shimer(2007)) to emphasize the importance of the extensive margin. This paper provides a model that a.) endogenizes all transition rates including firings and quits on the job as well as movements in and out of inactivity, b.) explains the fluctuations in these rates quantitatively while allowing for differences across gender and c.) remains tractable and open to Ramsey-optimal policy. We estimate the model on US-data for the years 1970:1 to 2004:4 and show that the model predicts all labor market flows very well. We apply our model to show that observed labor tax rates over the cycle correspond fairly closely to the implied Ramsey-optimal ones.
    Keywords: search theory; unemployment; hours worked
    JEL: E32 E31 E24
    Date: 2007–03–01
  4. By: Emi Nakamura; Jon Steinsson
    Abstract: Empirical evidence suggests that roughly 1/3 of the U.S. business cycle is due to nominal shocks. We calibrate a multi-sector menu cost model using new evidence on the cross-sectional distribution of the frequency and size of price changes in the U.S. economy. We augment the model to incorporate intermediate inputs. We show that the introduction of heterogeneity in the frequency of price change triples the degree of monetary non-neutrality generated by the model. We furthermore show that the introduction of intermediate inputs raises the degree of monetary non-neutrality by another factor of three, without adversely affecting the model's ability to match the large average size of price changes. Our multi-sector menu cost model with intermediate inputs generates variation in real output in response to calibrated aggregate nominal shocks that can account for roughly 26% of the U.S. business cycle.
    JEL: E30
    Date: 2008–05
  5. 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.
    JEL: F32
    Date: 2008–05
  6. By: Jonathan Chiu; Miguel Molico
    Abstract: This paper studies the welfare costs and the redistributive effects of inflation in the presence of idiosyncratic liquidity risk, in a micro-founded search-theoretical monetary model. We calibrate the model to match the empirical aggregate money demand and the distribution of money holdings across households, and study the effects of inflation under the implied degree of market incompleteness. We show that in the presence of imperfect insurance the estimated long-run welfare costs of inflation are on average 40% smaller compared to a complete markets, representative agent economy, and that inflation induces important redistributive effects across households. For example, the welfare gains of reducing inflation from 10% to 0% is 0.59% of income. Furthermore, we estimate that the long-run welfare gains of reducing the typical current inflation target of 2 to 1 percent to be 0.06% of income.
    Keywords: Inflation: costs and benefits; Monetary policy framework
    JEL: E40 E50
    Date: 2008
  7. By: Meenagh, David (Cardiff Business School); Minford, Patrick (Cardiff Business School); Wickens, Michael
    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: 2008–05
  8. By: Patrick J. Kehoe; Virgiliu Midrigan
    Abstract: the data, a large fraction of price changes are temporary. We provide a simple menu cost model which explicitly includes a motive for temporary price changes. We show that this simple model can account for the main regularities concerning temporary and permanent price changes. We use the model as a benchmark to evaluate existing shortcuts that do not explicitly model temporary price changes. One shortcut is to take the temporary changes out of the data and fit a simple Calvo model to it. If we do so prices change only every 50 weeks and the Calvo model overestimates the real effects of monetary shocks by almost 70%. A second shortcut is to leave the temporary changes in the data. If we do so prices change every 3 weeks and the Calvo model produces only 1/9 of the real effects of money as in our benchmark. We show that a simple Calvo model can generate the same real effects as our benchmark model if we set parameters so that prices change every 17 weeks.
    Date: 2008
  9. By: Tournemaine, Frederic; Tsoukis, Christopher
    Abstract: We develop an overlapping generation model to examine how the relationship between status concerns, fertility and education affect growth performances. Results are threefold. First, we show that stronger status motives heighten the desire of parents to have fewer but better educated children, which may foster economic development. Second, government should sometimes postpone the introduction of an economic policy in order to maintain the process of economic development, although such a policy aims to implement the social optimum. Third, status can alter the dynamic path of the economy and help to explain the facts about fertility during the "great transition".
    Keywords: social status; fertility; education; economic policy.
    JEL: O41
    Date: 2008–02–08
  10. By: Simona E. Cociuba; Alexander Ueberfeldt
    Abstract: This paper analyses the Canadian economy for the post 1960 period. It uses an accounting procedure developed in Chari, Kehoe, and McGrattan (2006). The procedure identifies accounting factors that help align the predictions of the neoclassical growth model with macroeconomic variables observed in the data. The paper finds that total factor productivity and the consumptionleisure trade-off -- the productivity and labor factors -- are key to understanding the changes in output, labor supply and labor productivity observed in the Canadian economy. The paper performs a decomposition of the labor factor for Canada and the United States. It finds that the decline in the gender wage gap is a major driving force of the decrease in the labor market distortions. Moreover, the milder reduction in the labor market distortions observed in Canada, compared to the US, is due to a relative increase in effective labor taxes in Canada.
    Keywords: Labour markets; Potential output; Productivity
    JEL: E65 E24
    Date: 2008
  11. By: Boyan Jovanovic; Peter L. Rousseau
    Abstract: Growth of technological variety offers more scope for the division of labor. And when a division of labor requires some specific training, the technological specificity of human capital grows and, with it, probably the firm specificity of that capital. We build a simple model that captures this observation. The model implies that a rising specialization of human and physical capital raises the rents in the average match between a firm and its human and physical capital. We document that in the last 40 years the firm’s share of those rents has also grown, and we use the model to explain why this shift may have taken place.
    JEL: O0 O4
    Date: 2008–05
  12. By: Silvio Rendon (Centro de Investigacion Economica (CIE), Instituto Tecnologico Autonomo de Mexico (ITAM)); Alfredo Cuecuecha (Centro de Investigacion Economica (CIE), Instituto Tecnologico Autonomo de Mexico (ITAM))
    Abstract: It is argued that migration from Mexico to the US and return migration are determined by international wage differentials and preferences for origin. We use a model of job search, savings and migration to show that job turnover is a crucial determinant of the migration process. We estimate this model by Simulated Method of Moments (SMM) and find that migration practically disappears if Mexico has American arrival rates while employed. Doubling migration costs reduces migration rates in half, while subsidizing return migration in $300 reduces migration rates of older migrants but increases migration rates of younger migrants.
    Keywords: International Migration, Job Search, Job Turnover, Savings, Structural Estimation
    JEL: F22 J64 E20
    Date: 2007–12
  13. By: Galasso, Vincenzo; Gatti, Roberta; Profeta, Paola
    Abstract: In the last century most countries have experienced both an increase in pension spending and a decline in fertility. We argue that the interplay of pension generosity and development of capital markets is crucial to understand fertility decisions. Since children have traditionally represented for parents a form of retirement saving, particularly in economies with limited or non-existent capital markets, an exogenous increase of pension spending provides a saving technology alternative to children, thus relaxing financial (saving) constraints and reducing fertility. We build a simple two-period OLG model to show that an increase in pensions is associated with a larger decrease in fertility in countries in which individuals have less access to financial markets. Cross-country regression analysis supports our result: an interaction between various measures of pension generosity and a proxy for the development of financial markets consistently enters the regressions positively and significantly, suggesting that in economies with limited financial markets, children represent a (if not the only) way for parents to save for old age, and that increases in pensions amount effectively to relaxing these constraints.
    Keywords: fertility; financial markets; intergenerational transfers; PAYG pension systems
    JEL: H55 J13
    Date: 2008–05
  14. By: Karin Mayr (Johannes Kepler University, Linz); Giovanni Peri (UC Davis and NBER)
    Abstract: Recent theoretical and empirical studies have emphasized the fact that the prospect of international migration increases the expected returns to skills in poor countries, linking the possibility of migrating (brain drain) with incentives to higher education (brain gain). If emigration is uncertain and some of the highly educated remain, such a channel may, at least in part, counterbalance the negative effects of brain drain. Moreover, recent empirical evidence seems to show that temporary migration is widespread among highly skilled migrants (such as Eastern Europeans inWestern Europe and Asians in the U.S.). This paper develops a simple tractable overlapping generations model that provides an economic rationale for return migration and which predicts who will migrate and who will return among agents with heterogeneous abilities. We use parameter values from the literature and the data on return migration to calibrate our model and simulate and quantify the effects of increased openness on human capital and wages of the sending countries. We find that, for plausible values of the parameters, the return migration channel is very important and combined with the incentive channel reverses the brain drain into significant brain gain for the sending country.
    Keywords: Skilled Migration, Return Migration, Returns to Education.
    JEL: F22 J61 O15
    Date: 2008–04
  15. By: Alan Krause
    Abstract: This paper examines a two-period model of optimal nonlinear income taxation with learning-by-doing, in which second-period wages are an increasing function of first-period labour supply. We consider the cases when the government can and cannot commit to its second-period tax policy. In both cases, the canonical Mirrlees/Stiglitz results regarding optimal marginal tax rates no longer apply. In particular, if the government cannot commit and skill-type information is revealed, it is optimal to distort the high-skill consumer's labour supply downwards through a positive marginal tax rate to relax the incentive-compatibility constraint. Alternatively, if the government cannot commit and skill-type information is concealed, it is optimal to distort the high-skill consumer's labour supply upwards to relax the incentive-compatibility constraint, but due to some other factors at work the high-skill consumer's marginal tax rate cannot be signed. Our analysis therefore identifies a setting in which a positive marginal tax rate on the highest-skill individual can be justified, despite its depressing effect on labour supply and wages.
    Keywords: Income taxation, learning-by-doing, commitment.
    JEL: H21 H2
    Date: 2008–05

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