nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2008‒09‒29
twenty-one papers chosen by
Christian Zimmermann
University of Connecticut

  1. Variable Search Intensity in an Economy with Coordination Unemployment By Kaas, Leo
  2. Demographic Uncertainty and Welfare in a Life-cycle Model under Alternative Public Pension Systems By M Saifur Rahman
  3. Equilibrium asset prices and bubbles in a continuous time OLG model By Brito, Paulo
  4. Learning, adaptive expectations, and technology shocks By Kevin X.D. Huang; Zheng Liu; Tao Zha
  5. Human Capital, Multiple Income Risk and Social Insurance By Schindler, Dirk
  6. Tax Treatment of Owner Occupied Housing and Wealth Inequality By Sang-Wook Stanley Cho; Johanna Francis
  7. Understanding international prices: customers as capital By Lukasz A. Drozd; Jaromir B. Nosal
  8. A Model of Capital and Crises By Zhiguo He; Arvind Krishnamurthy
  9. What drives housing prices? By James A. Kahn
  10. Returns to Education and Increasing Wage Inequality in Latin America By Chiara Binelli
  11. Intermediated Quantities and Returns By Rajnish Mehra; Facundo Piguillem; Edward C. Prescott
  12. Indian Economic Growth: Lessons for the Emerging Economies By Chakraborty, Suparna
  13. Intangible Capital and International Income Differences By Aamir Rafique Hashmi
  14. Should Dynamic Scoring be done with Heterogeneous Agent-Based Models? Challenging the Conventional Wisdom By M Saifur Rahman
  15. Explaining the Joint Behavior of Employment, Unemployment and Nonparticipation By Moon, Weh-Sol
  16. Towards a monetary policy evaluation framework. By Stéphane Adjemian; Matthieu Darracq Pariès; Stéphane Moyen
  17. Wage Risk and Employment Risk over the Life Cycle By Low, Hamish; Meghir, Costas; Pistaferri, Luigi
  18. Matching Theory and Data: Bayesian Vector Autoregression and Dynamic Stochastic General Equilibrium Models By Alexander Kriwoluzky
  19. Lumpy Labor Adjustment as a Propagation Mechanism of Business Cycles By Fang Yao
  20. Labor supply response in macroeconomic models: Assessing the empirical validity of the intertemporal labor supply response from a stochastic overlapping generations model with incomplete markets By Contreras, Juan; Sinclair, Sven
  21. Labor Market Policy Evaluation in Equilibrium: Some Lessons of the Job Search and Matching Model By Cahuc, Pierre; Le Barbanchon, Thomas

  1. By: Kaas, Leo (University of Konstanz)
    Abstract: This paper analyzes an urn-ball matching model in which workers decide how intensively they sample job openings and apply at a stochastic number of suitable vacancies. Equilibrium is not constrained efficient; entry is excessive and search intensity can be too high or too low. Moreover, an inefficient discouraged-worker effect among homogenous workers emerges under adverse labor market conditions. Unlike existing coordination-friction economies with fixed search intensity, the model can account for the empirical relation between the job-finding rate and the vacancy-unemployment ratio, provided that search costs are small and that search intensity is sufficiently procyclical.
    Keywords: matching function, coordination frictions, unemployment
    JEL: E24 J63 J64
    Date: 2008–09
  2. By: M Saifur Rahman (Indiana University Bloomington)
    Abstract: In this paper, I analyze consumption, aggregate savings, output and welfare implications of five different social security arrangements whenever there is demographic uncertainty. Following Bohn (2002), I analyze the effect of an uncertain population growth in an extended version of a modified Life-cycle model developed by Gertler (1999). Population growth dampens savings and output under all arrangements. Pay-as-you-go-Defined Benefit system appears to fare better than all other alternatives, falling short of the private annuity market with no pension system. But social security in general increases social welfare, with Fully Funded systems faring the best. Thus there appears to be a clear trade-off between growth and social welfare. The social security system also reduces the volatility of the economy.
    Date: 2008–09
  3. By: Brito, Paulo
    Abstract: In a Yaari-Blanchard overlapping generations endowment economy, and drawing on the equivalence between Radner (R) and Arrow-Debreu (AD) equi- libria, we prove that equilibrium AD prices have an explicit representation as a double integral equation. This allows for an analytic characterization of the relationship between life-cycle and cohort heterogeneity and asset prices. For a simple distribution, we prove that bubbles may exist, and derive conditions for ruling them out.
    Keywords: overlapping generations; asset pricing; bubbles; integral equations; LambertW function
    JEL: G12 D51
    Date: 2008–09–22
  4. By: Kevin X.D. Huang; Zheng Liu; Tao Zha
    Abstract: This study explores the macroeconomic implications of adaptive expectations in a standard real business cycle model. When rational expectations are replaced by adaptive expectations, we show that the self-confirming equilibrium is the same as the steady state rational expectations equilibrium for all admissible parameters, but that dynamics around the steady state are substantially different between the two equilibria. The differences are driven mainly by the dampened wealth effect and the strengthened intertemporal substitution effect, not by the escapes emphasized by Williams (2003). As a result, adaptive expectations can be an important source of frictions that amplify and propagate technology shocks and seem promising for generating plausible labor market dynamics.
    Keywords: Macroeconomics
    Date: 2008
  5. By: Schindler, Dirk (University of Konstanz)
    Abstract: We set up an OLG-model, where households both choose human capital investment and decide on investing their endogenous savings in a portfolio of riskless and risky assets, exposing them to (aggregate) wage and capital risks due to technological shocks. We derive the optimal public policy mix of taxation and education policy. We show that risks can be efficiently diversified between private and public consumption. This results hinges on that the government can apply a wide set of instruments, including differentiated wage and capital taxation. We also show that for sufficient risk aversion the (Northern) European way of relying on progressive wage taxation and granting education subsidies is an optimal response to wage and capital risks.
    Keywords: Optimal Income Taxation; Multiple Income Risks; Human Capital Investment; Portfolio Choice
    JEL: H21 I28 J24
    Date: 2008–09–22
  6. By: Sang-Wook Stanley Cho (University of New South Wales, School of Economics); Johanna Francis (Fordham University, Department of Economics)
    Abstract: In the U.S., mortgage interest deductibility provides a financial incentive for home ownership over renting as well as an incentive to “over-consume” housing since houses are not fungible. Home-ownership is also often promoted as a safe means of wealth creation. We construct and calibrate a quantitative general equilibrium lifecycle model with homeownership and mortgage decisions to investigate the degree to which the wealth inequality in the United States is driven by the home mortgage interest deduction and the untaxed nature of imputed rents from owner-occupied housing. As the tax treatment of housing will disproportionately create tax savings for the top deciles of the income distribution, we quantify how the tax deductibility contributes to the heavily skewed distribution of wealth in the United States using data from the Survey of Consumer Finances. Although the tax treatment of owner occupied housing alone is unlikely to produce the extreme wealth concentration at the far right tail of the distribution, we argue that it is re-enforced by a bequest motive. We find that removing mortgage interest deductibility and taxing imputed rents reduces the Gini coefficient by 0.04 points, caused by a re-allocation of wealth from the top 10 percentiles to the bottom 50 percentiles of the wealth distribution.
    Keywords: Mortgage interest deductibility, housing, wealth, inequality
    JEL: E21
    Date: 2008
  7. By: Lukasz A. Drozd; Jaromir B. Nosal
    Abstract: This paper develops a theory of pricing-to-market driven by marketing and bargaining frictions. Our key innovation is a capital theoretic model of marketing in which relations with customers are valuable. In our model, producers search and form long-lasting relations with their customers, and marketing helps overcome the search frictions involved in forming such matches. In the context of international business cycle patterns, the model accounts for observations that are puzzles for a large class of theories: (i) pricing-to-market, (ii) positive correlation of aggregate real export and import prices, (iii) excess volatility of the real exchange rate over the terms of trade, and (iv) low short-run and high long-run price elasticity of international trade flows. The behavior of quantities is shown to be on par with standard international business cycle theories that, in contrast to our model, assume low intrinsic elasticity of substitution between domestic and foreign goods.
    Keywords: Business cycles ; Prices ; International business enterprises
    Date: 2008
  8. By: Zhiguo He; Arvind Krishnamurthy
    Abstract: We develop a model in which the capital of the intermediary sector plays a critical role in determining asset prices. The model is cast within a dynamic general equilibrium economy, and the role for intermediation is derived endogenously based on optimal contracting considerations. Low intermediary capital reduces the risk-bearing capacity of the marginal investor. We show how this force helps to explain patterns during financial crises. The model replicates the observed rise during crises in Sharpe ratios, conditional volatility, correlation in price movements of assets held by the intermediary sector, and fall in riskless interest rates. In a dynamic context, we show that aversion to drops in intermediary capital can generate a two-factor asset pricing model with a role for both a market factor and a liquidity factor.
    JEL: E44 G12 G18 G2
    Date: 2008–09
  9. By: James A. Kahn
    Abstract: This paper develops a growth model with land, housing services, and other goods that is capable of explaining a substantial portion of the movements in housing prices over the past forty years. Under certainty, the model exhibits a balanced aggregate growth, but with underlying sectoral change. The paper introduces a Markov regime-switching specification for productivity growth in the nonhousing sector and shows that such regime switches are a plausible candidate for explaining - both qualitatively and quantitatively - the large low-frequency changes in housing price trends. In particular, the model shows how housing prices can have a "bubbly" appearance in which housing wealth rises faster than income for an extended period, then collapses and experiences an extended decline. The paper also uses micro data to calibrate a key cross-elasticity parameter that governs the relationship between productivity growth and home price appreciation. Combined with a realistic model of learning about the productivityprocess, the model is able to capture the medium- and low-frequency fluctuations of both price and quantity from the residential sector. Finally, the model suggests that the current downturn in the housing sector was triggered by a productivity slowdown that may have begun in 2004, an event that could reasonably have been viewed as highly unlikely by investors and mortgage issuers in the early part of the decade.
    Keywords: Housing - Prices ; Productivity ; Econometric models ; Markov processes
    Date: 2008
  10. By: Chiara Binelli (Oxford University, UK; Institute for Fiscal Studies, UK and The Rimini Centre for Economic Analysis, Italy)
    Abstract: This paper studies a central feature that characterized the changes in wage inequality in Latin America in the 1990s: log wages became a convex function of the level of education. The wage gap between Higher and Intermediate Education increased and the one between Intermediate and Basic Education declined. The double change in the wage di¤erentials was driven by a signicant drop in the mean wage at Intermediate. I develop and simulate a dynamic general equilibrium model of savings and educational choices under credit constraints and uninsurable earningsrisk in which ability is an important component of individual wages. I estimate the parameters of the model using micro data from Mexico. The results show that the convexication was the result of changes in the prices of education due to changes in its supply. Absent the general equilibrium price e¤ects, the changes in ability composition by education needed to produce the convexication would have been unrealistically high.
    Keywords: Latin America, Wage Inequality, Education Choices, General Equilibrium filtering
    JEL: J23 J24 J31 C68
    Date: 2008–01
  11. By: Rajnish Mehra; Facundo Piguillem; Edward C. Prescott
    Abstract: The difference between average borrowing and lending rates in the United States is over 2 percent. In spite of this large difference, there is over 1.7 times GNP in 2007 of intermediated borrowing and lending between households. In this paper a model is developed consistent with these facts. The only difference within an age cohort is preferences for bequests. Individuals with little or no bequest motive are lenders, while individuals with strong bequest motive are borrowers and owners of productive capital. Given no aggregate uncertainty, the return on equity is the same as the household borrowing rate. The government can borrow at the household lending rate, so there is a 2 percent equity premium in our world with no aggregate uncertainty. We examine the distribution and life cycle patterns of asset holding and consumption and find there is large dispersion in asset holdings and little in consumption.
    JEL: E2 E44 E6 G1 G11 G12 G23
    Date: 2008–09
  12. By: Chakraborty, Suparna
    Abstract: Can we use neoclassical growth model to single out the important transmission channels through which external factors or ?primitives? affected the Indian economy and caused the remarkable growth of the period 1982?2002? In this paper, we answer the question by applying the new technique of business cycle accounting to the Indian economy. Our results show us that the primary conduit of policies that brought about significant growth in India was productivity that registered an unprecedented increase particularly in the 1990s. Our results further indicate that changes in labour market frictions and investment market frictions did not play a significant role, though increased government consumption aided growth by propping up demand. In addition, we examine the effective tax rates in India and find that while investment taxes barely fluctuated, income tax rates were increasing throughout. We suspect other positive developments in the Indian economy overwhelmed the negative effect of increasing labour income taxes on growth. Our result suggests that any emerging country that aims to replicate the Indian experience would do well to formulate policies that target productivity, a lesson that seems consistent with the Japanese experience since the Second World War.
    Keywords: business cycle accounting, India, growth, wedges, neoclassical growth, taxes
    Date: 2008
  13. By: Aamir Rafique Hashmi (Department of Economics, National University of Singapore)
    Abstract: I add intangible capital to a variant of the neoclassical growth model and study the implications for cross-country income differences. I calibrate the parameters associated with intangible capital by using new estimates of investment in intangibles by Corrado et al. (2006). When intangible capital is added to the model, the TFP elasticity of output increases from 2.14 to 2.64. This finding implies that the addition of intangible capital increases the ability of the neoclassical growth model to explain international income differences by more than a factor of two.
    Keywords: International Income Differences; Intangible Capital
    JEL: O33 O41 O47
    Date: 2008–06
  14. By: M Saifur Rahman (Indiana University Bloomington)
    Abstract: Traditionally, Dynamic Scoring calculations experiments are carried out using representative agent based macroeconomic models. Existing literature does not provide any objection to this approach. In this paper, I develop a heterogeneous agent model similar to the Saver-Spenders model of Mankiw (2000). But spenders in my model are merely credit constrained and not rule-of-thumb consumers. Both groups are intertemporal optimizers because of the existence of Internal Habit Persistence. Transition path of most of the macro and fiscal variables for various tax cuts under alternative financing scheme shows pattern which are significantly different and sometimes contrasting to the representative agent model. Dynamic scoring calculations reveal a downward bias of the representative agent model. Underestimation of the dynamic response could be as large as 45%. Finally, steady state results indicate smaller impact of contractionary policies on major fiscal variables such as net tax revenue and tax base. Over all, the paper argues that the need to use heterogeneous agent based model in dynamic fiscal calculations is not only desirable, but also essential.
    JEL: E62 H2 H3 H6
    Date: 2008–09
  15. By: Moon, Weh-Sol
    Abstract: This paper argues that existing matching models with unemployment as an active search and nonparticipation as an inactive search predict counterfactual results: the unemployment rate is at most two times as volatile as the employmentpopulation ratio; only 20 percent of the actual volatility of the unemployment rate is accounted for; and the labor market variables are perfectly correlated with each other. This paper proposes a modified matching model in which workers are classified after matches take place. The modified model generates the direct transition from nonparticipation to employment with no assumption that nonparticipation is an inactive search and without adjusting the time period of the model. The model also explains the important cyclical features of the U.S. labor market.
    Keywords: Search and Matching; Business Cycles; Unemployment; Labor Force Participation
    JEL: E32 E24 J64
    Date: 2008–02
  16. By: Stéphane Adjemian (Université du Maine, GAINS & CEPREMAP. Contact address: Facultéde Droit et de Sciences Économiques, 72085 LE MANS Cedex 9, France.); Matthieu Darracq Pariès (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Stéphane Moyen (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: Advances in the development of Dynamic Stochastic General Equilibrium (DSGE) models towards medium-scale structural frameworks with satisfying data coherence have considerably enhanced the range of analytical tools well-suited for monetary policy evaluation. The present paper intends to make a step forward in this direction: using US data over the Volker-Greenspan sample, we perform a DGSE-VAR estimation of a medium-scale DSGE model very close to Smets and Wouters [2007] specification, where monetary policy is set according to a Ramsey-planner decision problem. Those results are then contrasted with the DSGE-VAR estimation of the same model featuring a Taylortype interest rate rule. Our results show in particular that the restrictions imposed by the welfare-maximizing Ramsey policy deteriorates the empirical performance with respect to a Taylor rule specification. However, it turns out that, along selected conditional dimensions, and notably for productivity shocks, the Ramsey policy and the estimated Taylor rule deliver similar economic propagation. JEL Classification: E4, E5, F4.
    Keywords: DSGE models, Optimal monetary policy, Bayesian estimation.
    Date: 2008–09
  17. By: Low, Hamish (University of Cambridge); Meghir, Costas (University College London); Pistaferri, Luigi (Stanford University)
    Abstract: We specify a structural life-cycle model of consumption, labour supply and job mobility in an economy with search frictions that allows us to distinguish between different sources of risk and to estimate their effects. The sources of risk are shocks to productivity, job destruction, the process of job arrival when employed and unemployed and match level heterogeneity. Our model allows for four main social insurance programmes. In contrast to simpler models that attribute all income fluctuations to shocks, our framework allows us to disentangle the effects of the shocks from the responses to these shocks. Estimates of productivity risk, once we control for employment risk and for individual labour supply choices, are substantially lower than estimates that attribute all wage variation to productivity risk. Increases in productivity risk impose a considerable welfare loss on individuals and induce substantial precautionary saving. Increases in employment risk have large effects on output and, primarily through this channel, affect welfare. The welfare value of government programs such as food stamps which partially insure productivity risk is greater than the value of unemployment insurance which provides (partial) insurance against employment risk and no insurance against persistent shocks.
    Keywords: uncertainty, life-cycle models, unemployment, precautionary savings
    JEL: D91 H31 J64
    Date: 2008–09
  18. By: Alexander Kriwoluzky
    Abstract: This paper shows how to identify the structural shocks of a Vector Autore- gression (VAR) while at the same time estimating a dynamic stochastic general equilibrium (DSGE) model that is not assumed to replicate the data generating process. It proposes a framework to estimate the parameters of the VAR model and the DSGE model jointly: the VAR model is identified by sign restrictions derived from the DSGE model; the DSGE model is estimated by matching the corresponding impulse response functions.
    Keywords: Bayesian Model Estimation, Vector Autoregression, Identification.
    JEL: C51
    Date: 2008–09
  19. By: Fang Yao
    Abstract: I explore the aggregate effects of micro lumpy labor adjustment in a prototypical RBC model, which embeds a stochastic labor duration mechanism in the spirit of Calvo(1983), and it extends this approach by introducing a Weibull-distributed labor adjustment process to capture the increasing hazard function corroborated by the micro data. My principal findings are: The aggregate labor demand equation derived from the baseline Calvostyle model corresponds to the same reduced form as the quadratic-adjustment-cost model and deep parameters have a one-to-one mapping. However, this result does not hold in general. When introducing the Weibull labor adjustment, the aggregate dynamics vary with the extent of increasing hazard function, e.g., the volatility of aggregate labor is increasing, but the persistence is decreasing in degree of the increasing hazard of the labor adjustment.
    Keywords: business cycles; heterogeneous labor rigidity; increasing hazard function; Weibull distribution
    JEL: E32 E24 C68
    Date: 2008–08
  20. By: Contreras, Juan; Sinclair, Sven
    Abstract: We evaluate the labor supply response in a stochastic overlapping generations model with incomplete markets and a non separable utility function in labor and consumption. Using a simulated panel from the model, we calculate the labor supply response to anticipated changes in wages (holding the marginal utility of wealth constant-that is, the Frisch elasticity) and to unanticipated change in wages (which describes the effect of uncertainty in labor supply responses). The model's Frisch elasticity estimate is 0.33, which is slightly higher than the empirical estimates in the earlier literature but somewhat lower than more recent estimates. The paper also shows that the borrowing constraints in the model reduce substantially the estimates of the Frisch elasticity. The labor supply response to an unanticipated change in wages is small because of large wealth effects. Having all the variables required and no measurement error, we calculate the omitted variable bias of not controlling for the level and variance (risk) of the unexpected changes in wages. Omitting both variables biases the estimates of the Frisch elasticity downward by a factor of 8; omitting measures of wage risk alone biases it by a factor of 1.4
    Keywords: labor supply; intertemporal substitution; Frisch elasticity; stochastic GE models
    JEL: D91 J22 D58
    Date: 2008–09–17
  21. By: Cahuc, Pierre (Ecole Polytechnique, Paris); Le Barbanchon, Thomas (CREST-INSEE)
    Abstract: We analyze the consequences of counseling provided to job seekers in a standard job search and matching model. It turns out that neglecting equilibrium effects induced by counseling can lead to wrong conclusions. In particular, counseling can increase steady state unemployment although counseled job seekers exit unemployment at a higher rate than the non-counseled. Dynamic analysis shows that permanent and transitory policies can have effects of opposite sign on unemployment.
    Keywords: evaluation, equilibrium effect, labor market policy
    JEL: J64 J68
    Date: 2008–09

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