nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2008‒08‒31
fifteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Resurrecting the Participation Margin By Monique Ebell
  2. Effects of Patent Policy on Income and Consumption Inequality in an R&D-Growth Model By Chu, Angus C.
  3. Productivity, Preferences and UIP Deviations in an Open Economy Business Cycle Model By Jagjit S. Chadha
  4. Experience vs. Obsolescence: A Vintage-Human-Capital Model By Kredler, Matthias
  5. Robust Equilibrium Yield Curves By Isaac Kleshchelski; Nicolas Vincent
  6. Optimal Public Policy with Endogenous Mortality By Rangan Gupta; Emmanuel Ziramba
  7. Price-Level versus Inflation Targeting with Financial Market Imperfections By Francisco Covas; Yahong Zhang
  8. Financial Accelerator Mechanism in a Small Open By Martha R. López; Juan D. Prada; Norberto Rodríguez Niño
  9. Uncertainty and the Politics of Employment Protection By Vindigni, Andrea
  10. Real Origins of the Great Depression: Monopoly Power, Unions and the American Business Cycle in the 1920s By Monique Ebell; Albrecht Ritschl
  11. Product Market Deregulation and the U.S. Employment Miracle By Monique Ebell; Christian Haefke
  12. Euro area money demand and international portfolio allocation - a contribution to assessing risks to price stability By Roberto A. De Santis; Carlo A. Favero; Barbara Roffia
  13. Annuities and Aggregate Mortality Risk By Justin van de Ven; Martin Weale
  14. On the Need for a New Approach to Analyzing Monetary Policy By Andrew Atkeson; Patrick J. Kehoe
  15. Inventory-Theoretic Model of Money Demand, Multiple Goods, and Price Dynamics By Hirokazu Ishise; Nao Sudo

  1. By: Monique Ebell
    Abstract: This paper considers a real business cycle model with search frictions in the labor market andlabor supply which is elastic along the extensive (participation) margin. Previous authorshave found that such models generate counterfactually procyclical unemployment and apositively-sloped Beveridge curve. This paper presents a calibrated model which does indeedgenerate countercyclical unemployment and a negatively-sloped Beveridge curve despite thepresence of a participation margin.
    Keywords: Unemployment, Business Cycles, Labor Force Participation
    JEL: E24 E32 J21 J64
    Date: 2008–06
  2. By: Chu, Angus C.
    Abstract: What are the effects of strengthening patent protection on income and consumption inequality? To analyze this question, this paper incorporates heterogeneity in the initial wealth of households into a canonical quality-ladder growth model with endogenous labor supply. In this model, I firstly show that the aggregate economy always jumps immediately to a unique and stable balanced-growth path. Given the balanced-growth behavior of the aggregate economy and an exogenous distribution of initial wealth, I then show that the endogenous distribution of assets in subsequent periods is stationary and equal to its initial distribution. The model predicts that strengthening patent protection increases (a) economic growth by stimulating R&D investment and (b) income inequality by raising the return on assets. However, whether it also increases consumption inequality depends on the elasticity of intertemporal substitution. If and only if this elasticity is less (greater) than unity, strengthening patent protection increases (decreases) consumption inequality. For standard parameter values, strengthening patent protection leads to a larger increase in income inequality than consumption inequality.
    Keywords: endogenous growth; heterogeneity; income inequality; patent policy
    JEL: D31 O41 O34
    Date: 2008–08
  3. By: Jagjit S. Chadha
    Abstract: We show that a flex-price two-sector open economy DSGE model can explain the poor degree of international risk sharing and exchange rate disconnect. We use a suite of model evaluation measures and examine the role of (i) traded and non-traded sectors; (ii) financial market incompleteness; (iii) preference shocks; (iv) deviations from UIP condition for the exchange rates; and (v) creditor status in net foreign assets. We find that there is a good case for both traded and non-traded productivity shocks as well as UIP deviations in explaining the puzzles.
    Keywords: current account dynamics; real exchange rates; incomplete markets; financial frictions
    JEL: E32 F32 F41
    Date: 2008–08
  4. By: Kredler, Matthias
    Abstract: I combine an infinite-horizon version of Ben-Porath’s (1967) model of human-capital accumulation with a vintage structure as in Chari & Hopenhayn (1991). Different skill levelsinside a vintage are complementary in production. Vintage-specific human capital is accumulated based on workers’ optimal strategies and is lost when the technology is phased out by an endogenous firm decision. I establish equivalence between competitive equilibrium and a planner’s problem. It is shown that returns to skill are highest in young vintages. Accelerated technological change shortens the life cycle of a technology and speeds up obsolescence; the premium on tenure rises because more workers are concentrated in young technologies with high skill premia. A calibration exercise comparing two steady states shows that the model quantitatively accounts for the changes in the experience premium, earnings dispersion and earnings turbulence in German data.
    Keywords: Vintage human capital; age-earnings profiles; partial differential equations
    JEL: E24 C63 J01
    Date: 2008–07–28
  5. By: Isaac Kleshchelski; Nicolas Vincent (IEA, HEC Montréal)
    Abstract: This paper studies the quantitative implications of the interaction between robust control and stochastic volatility for key asset pricing phenomena. We present an equilibrium term structure model with a representative agent and an output growth process that is conditionally heteroskedastic. The agent does not know the true model of the economy and chooses optimal policies that are robust to model misspecification. The choice of robust policies greatly amplifies the effect of conditional heteroskedasticity in consumption growth, improving the model’s ability to explain asset prices. In a robust control framework, stochastic volatility in consumption growth generates both a state-dependent market price of model uncertainty and a stochastic market price of risk. We estimate the model using data from the bond and equity markets, as well as consumption data. We show that the model is consistent with key empirical regularities that characterize the bond and equity markets. We also characterize empirically the set of models the robust representative agent entertains, and show that this set is ?small?. That is, it is statistically difficult to distinguish between models in this set.
    Keywords: Yield curves, Market price of Uncertainty, Robust control.
    JEL: D81 E43 G11 G12
    Date: 2007–11
  6. By: Rangan Gupta (Department of Economics, University of Pretoria); Emmanuel Ziramba (Department of Economics, University of South Africa)
    Abstract: Using a monetary pure-exchange overlapping generations model, where the probability of survival of the young agents depends upon share of government expenditure on health, education and infrastructure, we analyze the welfare-maximizing policy mix between explicit and implicit taxation. We show that increases in the survival probability lead to an increase in the reliance on seigniorage as a welfare maximizing outcome. However, for our results to hold, the seigniorage tax base must be large enough for the benevolent planner to use the inflation tax.
    Keywords: Monetary Pure Exchange Overlapping Generations Model; Probability of Survival; Welfare Maximizing Policy Mix
    JEL: H2 H51 I1 I18
    Date: 2008–08
  7. By: Francisco Covas; Yahong Zhang
    Abstract: This paper compares price-level-path targeting (PT) with inflation targeting (IT) in a sticky-price, dynamic, general equilibrium model augmented with imperfections in both the debt and equity markets. Using a Bayesian approach, we estimate this model for the Canadian economy. We show that the model with both debt and equity market imperfections fits the data better and use it to compare PT versus the estimated current IT regime. We find that in general PT outperforms the current IT regime. However, the gain is lower when financial market imperfections are taken into account.
    Keywords: Monetary policy framework; Inflation targets; Economic models
    JEL: E40 E50
    Date: 2008
  8. By: Martha R. López; Juan D. Prada; Norberto Rodríguez Niño
    Abstract: Using Bayesian estimation techniques, we estimate a small open economy DSGE model with credit-market imperfections for the Colombian economy. Us- ing the estimated model we investigate what are the sources of business cycle °uctuations. We show that balance-sheet e®ects play an important role in ex- plaining recent Colombian business cycles. We then perform a counterfactual exercise that shows that ¯xed exchange rate regime could have exacerbated the ¯nancial distress in the economy between 1998-1999.
    Date: 2008–08–18
  9. By: Vindigni, Andrea (Princeton U)
    Abstract: This paper investigates the role that idiosyncratic uncertainty plays in shaping social preferences over the degree of labor market flexibility, in a general equilibrium model of dynamic labor demand where the productivity of firms evolves over time as a Geometric Brownian mo- tion. A key result demonstrated is that how the economy responds to shocks, i.e. unexpected changes in the drift and standard deviation of the stochastic process describing the dynamics of productivity, depends on the power of labor to extract rents and on the status quo level of firing costs. In particular, we show that when firing costs are relatively low to begin with, a transition to a rigid labor market is favored by all and only the employed workers with idiosyncratic productivity below some threshold value. A more volatile environment, and a lower rate of productivity growth, i.e. "bad times", increase the political support for more labor market rigidity only where labor appropriates relatively large rents. Moreover, we demonstrate that when the status quo level of firing costs is relatively high, the preservation of a rigid labor market is favored by the employed with intermediate productivity, whereas all other workers favor more flexibility. The coming of better economic conditions need not favor the demise of high firing costs in rigid high-rent economies, because "good times" cut down the support for flexibility among the least productive employed workers. The model provides some new insights on the comparative dynamics of labor market institutions in the U.S. and in Europe over the last few decades, shedding some new light both on the reasons for the original build-up of "Eurosclerosis", and for its the persistence up to the present day.
    JEL: D71
    Date: 2008–06
  10. By: Monique Ebell; Albrecht Ritschl
    Abstract: We attempt to explain the severe 1920-21 recession, the roaring 1920s boom, and the slide into theGreat Depression after 1929 in a unified framework. The model combines monopolistic productmarket competition with search frictions in the labor market, allowing for both individual andcollective wage bargaining. We attribute the extraordinary macroeconomic and financial volatility ofthis period to two factors: Shifts in the wage bargaining regime and in the degree of monopoly powerin the economy. A shift from individual to collective bargaining presents as a recession, involvingdeclines in output and asset values, and increases in unemployment and real wages. The pro-unionprovisions of the Clayton Act of 1914 facilitated the rise of collective bargaining after World War I,leading to the asset price crash and recession of 1920-21. A series of tough anti-union Supreme Courtdecisions in late 1921 induced a shift back to individual bargaining, leading the economy out of therecession. This, coupled with the lax anti-trust enforcement of the Coolidge and Hooveradministrations enabled a major rise in corporate profits and stock market valuations throughout the1920s. Landmark pro-union court decisions in the late 1920s, as well as political pressure on firms toadopt the welfare capitalism model of high wages, led to collapsing profit expectations, contributingsubstantially to the stock market crash. We model the onset of the Great Depression as an equilibriumswitch from individual wage bargaining to (actual or mimicked) collective wage bargaining. Thegeneral equilibrium effects of this regime change are consistent with large decreases in output,employment, and stock prices and moderate increases in real wages.
    Keywords: Trade unions, collective bargaining, Great Depression
    JEL: E24 E27 J51 J64 N12 N22
    Date: 2008–06
  11. By: Monique Ebell; Christian Haefke
    Abstract: We consider the dynamic relationship between product market entry regulation andequilibrium unemployment. The main theoretical contribution is combining a job matchingmodel with monopolistic competition in the goods market and individual bargaining. Wecalibrate the model to US data and perform a policy experiment to assess whether thedecrease in trend unemployment during the 1980's and 1990's could be attributed to productmarket deregulation. Under a traditional calibration, our results suggest that a decrease of lessthan two-tenths of a percentage point of unemployment rates can be attributed to productmarket deregulation, a surprisingly small amount. Under a small surplus calibration,however, product market deregulation can account for the entire decline in US trendunemployment over the 1980's and 1990's.
    Keywords: Product market competition, barriers to entry, wage bargaining
    JEL: E24 J63 L16 O00
    Date: 2008–06
  12. By: Roberto A. De Santis (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany); Carlo A. Favero (IGIER – Università Commerciale Luigi Bocconi, Via Salasco 5, 20136 Milan, Italy.); Barbara Roffia (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany)
    Abstract: The long-run relationship between money and prices in the euro area embedded in traditional money demand models with income and interest rates broke down after 2001. We develop a money demand model where investors hold a diversi?fied portfolio with money, domestic and foreign stocks and long-term bonds in which, in addition to the classical wealth effect, also a size and an international portfolio allocation effects arise. The estimated model identifi?es three cointegrating vectors stable over the sample 1980-2007 - a long-run money demand, which depends on income and all risky assets' returns, and two equilibria for the euro area and the US fi?nancial markets. Steady state equilibrium of nominal M3 growth is estimated to be about 7% in 2007 with large standard errors mainly due to uncertainty in asset prices. The gap between actual euro area M3 growth and model-based ?fitted or predicted values helps forecast euro area inflation. JEL Classification: E41, E44, E52, G11, G15.
    Keywords: Euro area money demand, inflation forecasts, monetary policy, portfolio allocation.
    Date: 2008–08
  13. By: Justin van de Ven; Martin Weale
    Abstract: This paper explores the effect of aggregate mortality risk on the pricing of annuities. It uses a two-period OLG model; in the first period, ‘young’ people have a zero probability of death, and in the second period ‘old’ people face an initially unknown risk of death. Old people can either carry their aggregate mortality risk, or buy annuities which are sold by young people. A market-clearing price for such annuities is established. The alternative where annuities are purchased from the government is also explored, and this is found to dominate the private market solution in welfare terms.
    Date: 2008–01
  14. By: Andrew Atkeson; Patrick J. Kehoe
    Abstract: We present a pricing kernel that summarizes well the main features of the dynamics of interest rates and risk in postwar U.S. data and use it to uncover how the pricing kernel has moved with the short rate in this data. Our findings imply that standard monetary models miss an essential link between the central bank instrument and the economic activity that monetary policy is intended to affect and thus we call for a new approach to monetary policy analysis. We sketch a new approach using an economic model based on our pricing kernel. The model incorporates the key relationships between policy and risk movements in an unconventional way: the central bank's policy changes are viewed as primarily intended to compensate for exogenous business cycle fluctuations in risk which threaten to push inflation off target. This model, while an improvement on standard models, is considered just a starting point for their revision. It leads to critical questions that researchers need to answer as they continue to revise their approach to monetary policy analysis.
    JEL: E5 E52 E58 E6
    Date: 2008–08
  15. By: Hirokazu Ishise (Department of Economics, Boston University (E-mail:; Nao Sudo (Corresponding author, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:
    Abstract: Despite the theoretical prediction based on sticky-price models, it is empirically suggested that the tie between the frequencies of price adjustment across goods and the relative price responses of goods (price index of specific goods over non-durable aggregate price index) to a monetary policy change is limited.We offer an alternative view of the price dynamics of goods. We develop a multi-sector extension of an inventory-theoretic model of money demand (segmented market model). In our model, the diversity in the characteristics of goods, that is, durability, luxuriousness and cash intensity (the portion of the payment that is paid by cash in the purchase of goods), yields the dispersion of relative prices responses to a monetary policy shock, across goods. The model implies that the relative prices of durables, luxuries and less cash-intensive goods tend to decline in a monetary contraction. We test the empirical plausibility of our model, using two approaches: a measure of monetary policy shock developed by Romer and Romer (2004), and a factor-augmented VAR used in Bernanke et al. (2005). In both econometric methodologies, we find that the data are consistent with our model, in terms of durability and luxuriousness.
    Keywords: Baumol-Tobin model, Durable; Luxury, Credit goods, Monetary policy
    JEL: E5 E6
    Date: 2008–08

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