nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2008‒09‒13
fourteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Human capital risk in life-cycle economies By Singh, Aarti
  2. The Dynamics of Inequality and Social Security in General Equilibrium By Song, Zheng
  3. Intergenerational interactions in human capital accumulation By Woźny, Łukasz; Growiec, Jakub
  4. Anticipated Tax Reforms and Temporary Tax Cuts: A General Equilibrium Analysis By Strulik, Holger; Trimborn, Timo
  5. Marriage matching, risk sharing and spousal labor supplies By Eugene Choo; Shannon Seitz; Aloysius Siow
  6. Optimal Tax and Expenditure Policy in the Presence of Migration - Are Credit Restrictions Important? By Backlund, Kenneth; Sjögren, Tomas; Stage, Jesper
  7. Indeterminate Equilibria in New Keynesian DSGE Model: An Application to the US Great Moderation By Erdemlioglu, Deniz M; Xiao, Wei
  8. Wage Posting Without Full Commitment By Matthew Doyle; Jacob Wong
  9. Calibrating the Equity Premium under Habit Formation and Catching up with the Joneses By LU, Zhentong
  10. Life expectancy and the environment By Fabio Mariani; Agustin Pérez-Barahona; Natacha Raffin
  11. New Keynesian Models: Not Yet Useful for Policy Analysis By V.V. Chari; Patrick J. Kehoe; Ellen R. McGrattan
  12. Contrasting two approaches in real options valuation: contingent claims versus dynamic programming By Margaret Insley; Tony Wirjanto
  13. Institutions-Augmented Solow Model And Club Convergence By Tebaldi, Edinaldo; Mohan, Ramesh
  14. Learning and Macroeconomics By George W. Evans; Seppo Honkapohja

  1. By: Singh, Aarti
    Abstract: I study the effect of market incompleteness on the aggregate economy in a model where agents face idiosyncratic, uninsurable human capital investment risk. The environment is a general equilibrium lifecycle model with a version of a Ben-Porath (1967) human capital accumulation technology, modified to incorporate risk. A CARA-normal specification keeps endogenous decisions independent of individual shock realizations. I study stationary equilibria of calibrated cases in which idiosyncratic uninsurable risk arises from specialization risk and career risk. Specialization risk is such that both mean and variance of the return from training are increasing in the endogenous decision to invest in human capital. In the case of career risk, however, only the mean return is increasing in the decision to invest in human capital. With career risk only, stationary equilibria resemble those studied by Aiyagari (1994), and one concludes that the impact of uninsurable idiosyncratic risk is relatively small. With a significant amount of specialization risk however, stationary equilibria are severely distorted relative to a complete markets benchmark. One aspect of this distortion is that human capital is only about 57 percent as large as its complete markets counterpart. This suggests that the two types of risk have very different and quantitatively significant general equilibrium implications. Keywords: Human capital risk, life-cycle, incomplete markets.
    JEL: E24 E21 E20
    Date: 2008–03
  2. By: Song, Zheng
    Abstract: This paper analyzes the dynamic politico-economic equilibrium of a model where repeated voting on social security and the evolution of household characteristics in general equilibrium are mutually affected over time. In particular, we incorporate within-cohort heterogeneity in a two-period Overlapping-Generation model to capture the intra-generational redistributive effect of social security transfers. Political decision-making is represented by a probabilistic voting à la Lindbeck and Weibull (1987). We analytically characterize the Markov perfect equilibrium, in which social security tax rates are shown to be increasing in wealth inequality. The dynamic interaction between inequality and social security leads to growing social security programs. We also perform some normative analysis, showing that the politico-economic equilibrium outcomes are fundamentally different from the Ramsey allocation.
    JEL: E62 H21 H55 E21
    Date: 2008–04–08
  3. By: Woźny, Łukasz; Growiec, Jakub
    Abstract: We analyze an economy populated by a sequence of generations who decide over their consumption levels and the levels of investment in human capital of their immediate descendants. The objective of the paper is to identify the impact of strategic interactions between consecutive generations on the time path of human capital accumulation. To this end, we characterize the Markov perfect equilibrium (MPE) in such an economy and derive the sufficient conditions for its existence and uniqueness. The equilibrium path is computed using a novel constructive approach: extending Reffett and Woźny (2008), we put forward an iterative procedure which converges to the MPE as its limit. To benchmark our results, we also calculate the optimal human capital accumulation paths for (i) a Ramsey-type model with dynastic optimization, and (ii) a model with joy-of-giving altruism. We prove analytically that human capital accumulation is unambiguously lower in the "strategic" model than in the Ramsey-type dynastic model. We complement our results with a series of numerical exercises.
    Keywords: human capital; intergenerational interactions; Markov perfect equilibrium; stochastic transition; constructive approach
    JEL: I20 J22 C73
    Date: 2008–07–20
  4. By: Strulik, Holger; Trimborn, Timo
    Abstract: Macroeconomic studies of tax policy in dynamic general equilibrium usually assume that reforms hit the economy unexpectedly and last forever. Here, we explore how previous results change when we allow policy changes to be pre-announced and of finite duration and when these facts are anticipated by households and firms. Quantitatively we demonstrate a headstart advantage from pre-announcement that is never caught up by a surprising reform. The welfare gain from announcement of a corporate tax cut, for example, is estimated to be around 10 percent of the total gain from the reform. We show that adjustment dynamics of important variables like firm value, dividend payout, and investment differs qualitatively depending on whether the reform comes expected or not. We are also able to demonstrate a genuine welfare gain from temporary tax cuts. Impulse responses generated by our numerical method can be retraced by phase diagram analysis which facilitates explanation and interpretation of the produced results.
    Keywords: tax reform, anticipation effects, investment, economic growth, welfare, corporate finance, capital taxation
    JEL: H20 H30 E62 O40
    Date: 2008–08
  5. By: Eugene Choo; Shannon Seitz; Aloysius Siow
    Abstract: This paper develops the collective marriage matching model, a behavioral and empirically flexible framework that incorporates both marriage matching and intrahousehold allocations. The model shows how marriage market equilibrium and bargaining power within the family are simultaneously determined. The framework provides a solution to the problem of incorporating substitute sex ratios in empirical models of spousal labor supplies. Using data from the US 2000 census, the empirical results show that changes in marriage market tightness, the ratio of unmarried men to unmarried women, have large estimated effects on spousal labor force participation rates, and smaller effects on hours of work and hours in home production. Controlling for variation in labor market conditions across marriage markets has substantive implications for the parameter estimates.
    Keywords: marriage matching, intrahousehold allocations, spousal labor supplies, collective model, Choo Siow
    JEL: J0
    Date: 2008–09–04
  6. By: Backlund, Kenneth (Department of Economics, Umeå University); Sjögren, Tomas (Department of Economics, Umeå University); Stage, Jesper (Department of Economics, Göteborg University)
    Abstract: This paper concerns optimal income taxation in the presence of emigration. The basic model is a two-period model where all agents are identical and live in the home country in the first period of life, but where some emigrate at the end of the first period. It is shown that with a binding credit restriction, the government will tax labor income in the first period at a higher rate than otherwise, whereas the labor income tax in the second period is unaffected by emigration. With heterogenous agents, the labor income tax in period two will be affected by emigration.
    Keywords: optimal taxation; labor mobility; intertemporal consumer choice
    JEL: D91 H21 J61
    Date: 2008–08–29
  7. By: Erdemlioglu, Deniz M; Xiao, Wei
    Abstract: This paper tests “Bad Policy” Hypothesis which refers to the Great Moderation in the US. We examine this hypothesis by simulating model based impulse response functions for the both pre-Volcker period and post 1982 period. Deriving and simulating standard New Keynesian DSGE Model explicitly, we find that while post 1982 policy i.e. active policy, is consistent with the unique stable equilibrium characteristics; pre-Volcker or passive monetary policy generates equilibrium indeterminacy. Moreover, our simulated-impulse response functions show that the response of inflation and the output gap in post 82 period is weaker than the macroeconomic responses of the pre-Volcker period.
    Keywords: The Great Moderation; Indeterminacy; Determinate Equilibrium; New Keynesian DSGE Model; Monetary Policy; Sunspot shocks.
    JEL: E0 E32 E52
    Date: 2008–05–15
  8. By: Matthew Doyle (Department of Economics, University of Waterloo); Jacob Wong (School of Economics, The University of Adelaide)
    Abstract: Wage posting models of job search typically assume that firms can commit to paying workers the posted wage. This paper investigates the consequences of relaxing this assumption. Under "downward" commitment firms can commit only to paying at least their advertised wage. We show that wage posting is always an equilibrium, although in special cases other equilibria can exist. Surprisingly, the wage posting equilibrium in our economy is identical to the equilibrium when firms can commit to paying exactly their posted wage. When firms cannot even commit to paying at least their advertised wage, equilibrium exhibits job auctions with wage dispersion which generally are not constrained efficient.
    Keywords: directed search, wage posting, job auctions, commitment
    JEL: C78 D40 J64
    Date: 2008–08
  9. By: LU, Zhentong
    Abstract: In this paper, I follow Mehra and Prescott's calibration procedure to simulate the equity premium under habit formation and "catching up with the Joneses". The experiment results shows that the model used in this paper can well fit the realistic economy given certain parameter values and the Equity Premium Puzzle is resolved in this sense. The calibration result also reveals that it is "catching up with the Joneses" but not habit formation which makes contribution to the resolving of the puzzle.
    JEL: C82 E44
    Date: 2008–09–05
  10. By: Fabio Mariani (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, Ecole d'économie de Paris - Paris School of Economics - Université Panthéon-Sorbonne - Paris I); Agustin Pérez-Barahona (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I); Natacha Raffin (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, Ecole d'économie de Paris - Paris School of Economics - Université Panthéon-Sorbonne - Paris I)
    Abstract: We present an OLG model in which life expectancy and environmental quality dynamics are jointly determined. Agents may invest in environmental quality, depending on how much they expect to live, but also in order to leave good environmental conditions to future generations. In turn, environmental conditions affects life expectancy.The model produces multiple steady states development regimes) and initial conditions do matter. In particular, some countries may be trapped in a low life expectancy /low environmental quality trap. This outcome is consistent with stylized facts relating life expectancy and environmental performance measures. Possible strategies to escape from this kind of trap are also discussed. Finally, this result is robust to the introduction of human capital through parental education expenditures.
    Keywords: Environmental quality; life expectancy; poverty traps.
    Date: 2008–09
  11. By: V.V. Chari; Patrick J. Kehoe; Ellen R. McGrattan
    Abstract: Macroeconomists have largely converged on method, model design, reduced-form shocks, and principles of policy advice. Our main disagreements today are about implementing the methodology. Some think New Keynesian models are ready to be used for quarter-to-quarter quantitative policy advice; we do not. Focusing on the state-of-the-art version of these models, we argue that some of its shocks and other features are not structural or consistent with microeconomic evidence. Since an accurate structural model is essential to reliably evaluate the effects of policies, we conclude that New Keynesian models are not yet useful for policy analysis.
    JEL: E32 E58
    Date: 2008–09
  12. By: Margaret Insley (Department of Economics, University of Waterloo); Tony Wirjanto (Department of Economics, University of Waterloo)
    Abstract: This paper compares two well-known approaches for valuing a risky investment using real options theory: contingent claims (CC) with risk neutral valuation and dynamic programming (DP) using a constant risk adjusted discount rate. Both approaches have been used in valuing forest assets. A proof is presented which shows that, except under certain restrictive assumptions; DP using a constant discount rate and CC will not yield the same answers for investment value. A few special cases are considered for which CC and DP with a constant discount rate are consistent with each other. An optimal tree harvesting example is presented to illustrate that the values obtained using the two approaches can differ whcn we depart from these special cases to a more realistic scenariio. Further, the implied risk adjusted discount rate calculated from CC is found to vary with the stochastic state variable and stand age. We conclude that for real options problems the CC approach should be used.
    Keywords: optimal tree harvesting, real options, contingent claims, dynamic programming
    Date: 2008–08
  13. By: Tebaldi, Edinaldo; Mohan, Ramesh
    Abstract: Growth economists still face challenges and limitations to incorporate institutions into the standard growth framework. This article develops a simple augmented Solow growth model that accounts for the interactions between institutions and factor-productivity and examine the impacts of the quality of institutions on levels and growth rates of output. The institutions augmented growth model shows that differences in the quality of institutions preclude convergence and determine both the level and the growth rate of output per worker. The model also shows that poor institutions induce poverty traps. Furthermore, the income gap between rich and poor countries will increase if poor countries’ institutions do not improve relative to their rich counterpart.
    Keywords: Solow Model; Institutions; Club Convergence; Poverty Traps
    JEL: O43 I3
    Date: 2008–08
  14. By: George W. Evans (University of Oregon Economics Department); Seppo Honkapohja (University of Cambridge)
    Abstract: Expectations play a central role in modern macroeconomic theories. The econometric learning approach models economic agents as forming expectations by estimating and updating forecasting models in real time. The learning approach provides a stability test for rational expectations and a selection criterion in models with multiple equilibria. In addition, learning provides new dynamics if older data is discounted, models are misspecified or agents choose between competing models. This paper describes the E-stability principle and the stochastic approximation tools used to assess equilibria under learning. Applications of learning to a number of areas are reviewed, including the design of monetary and fiscal policy, business cycles, self-fulfilling prophecies, hyperinflation, liquidity traps, and asset prices.
    Keywords: E-stability, least-squares, stochastic approximation, persistent learning dynamics, business cycles, monetary policy, asset prices, sunspots.
    JEL: E32 D83 D84 C62
    Date: 2008–07–11

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