nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2008‒10‒07
sixteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Existence of competitive equilibrium in an optimal growth model with heterogeneous agents and endogenous leisure By Cuong Le Van; Manh-Hung Nguyen
  2. The Cross-Section of Output and Inflation in a Dynamic Stochastic General Equilibrium Model with Sticky Prices By Michael Funke; Sebastian Weber; Jörg Döpke; Sean Holly
  3. Can Time-Varying Risk of Rare Disasters Explain Aggregate Stock Market Volatility? By Jessica Wachter
  4. The Role of Bank Capital in the Propagation of Shocks By Césaire Meh; Kevin Moran
  5. Direction and intensity of technical change: a micro-founded growth model By zamparelli, luca
  6. Monopoly Power and Endogenous Product Variety: Distortions and Remedies By Florin O. Bilbiie; Fabio Ghironi; Marc J. Melitz
  7. Country Portfolios in Open Economy Macro Models By Michael B. Devereux; Alan Sutherland
  9. Macroeconomic Effects of Pension Reform in Russia By David Hauner
  10. On the need for a new approach to analyzing monetary policy By Andrew Atkeson; Patrick J. Kehoe
  11. DSGE model-based forecasting of non-modelled variables By Frank Schorfheide; Keith Sill; Maxym Kryshko
  12. Learning, adaptive expectations, and technology shocks By Kevin X.D. Huang; Zheng Liu; Tao Zha
  13. Monopolistic Competition and the Dependent Economy Model By Romain Restout
  14. Default and the maturity structure in sovereign bonds By Cristina Arellano; Ananth Ramanarayanan
  15. Government funds and demographic transition – alleviating ageing costs in a small open economy By Kinnunen, Helvi
  16. A Small BVAR-DSGE Model for Forecasting the Australian Economy By Andrew Hodge; Tim Robinson; Robyn Stuart

  1. By: Cuong Le Van (Centre d'Economie de la Sorbonne, Universite Paris-1, France); Manh-Hung Nguyen (INRA-LERNA, Toulouse School of Economics)
    Abstract: This paper proves the existence of competitive equilibrium in a single sector dynamic economy with heterogeneous agents and elastic labor supply. The method of proof relies on some recent results concerning the existence of Lagrange multipliers in inï¬nite dimensional spaces and their representation as a summable sequence and a direct application of the Brouwer ï¬xed point theorem.
    Keywords: Optimal growth model, Lagrange multipliers, Competitive equilibrium, Elastic labor supply
    JEL: C61 D51 E13 O41
    Date: 2008–06
  2. By: Michael Funke; Sebastian Weber; Jörg Döpke; Sean Holly
    Abstract: In a standard dynamic stochastic general equilibrium framework, with sticky prices, the cross sectional distribution of output and inflation across a population of firms is studied. The only form of heterogeneity is confined to the probability that the ith firm changes its prices in response to a shock. In this Calvo setup the moments of the cross sectional distribution of output and inflation depend crucially on the proportion of firms that are allowed to change their prices. We test this model empirically using German balance sheet data on a very large population of firms. We find a significant counter-cyclical correlation between the skewness of output responses and the aggregate economy. Further analysis of sectoral data for the US suggests that there is a positive relationship between the skewness of inflation and aggregates, but the relation with output skewness is less sure. Our results can be interpreted as indirect evidence of the importance of price stickiness in macroeconomic adjustment.
    JEL: D12 E52 E43
    Date: 2008–09
  3. By: Jessica Wachter
    Abstract: This paper introduces a model in which the probability of a rare disaster varies over time. I show that the model can account for the high equity premium and high volatility in the aggregate stock market. At the same time, the model generates a low mean and volatility for the government bill rate, as well as economically significant excess stock return predictability. The model is set in continuous time, assumes recursive preferences and is solved in closed-form. It is shown that recursive preferences, as well as time-variation in the disaster probability, are key to the model's success.
    JEL: G12
    Date: 2008–10
  4. By: Césaire Meh; Kevin Moran
    Abstract: Recent events in financial markets have underlined the importance of analyzing the link between the financial health of banks and real economic activity. This paper contributes to this analysis by constructing a dynamic general equilibrium model in which the balance sheet of banks affects the propagation of shocks. We use the model to conduct quantitative experiments on the economy's response to technology and monetary policy shocks, as well as to disturbances originating within the banking sector, which we interpret as episodes of distress in financial markets. We show that, following adverse shocks, economies whose banking sectors remain well-capitalized experience smaller reductions in bank lending and less pronounced downturns. Bank capital thus increases an economy's ability to absorb shocks and, in doing so, affects the conduct of monetary policy. The model is also used to shed light on the ongoing debate over bank capital regulation.
    Keywords: Transmission of monetary policy; Financial institutions; Financial system regulation and policies; Economic models
    JEL: E44 E52 G21
    Date: 2008
  5. By: zamparelli, luca
    Abstract: This paper develops a growth model combining elements of endogenous growth and induced innovation literatures. In a standard induced innovation model firms select at no cost innovations from an innovation possibilities frontier describing the trade-off between increasing capital or labor productivity. The model proposed allows firms to choose not only the direction but also the size of innovation by representing the innovation possibilities through a cost function of capital and labor augmenting innovations. By so doing, it provides a micro-foundation both of the intensity and of the direction of technical change. The policy analysis implies that an increase in subsidies to R&D as opposed to capital accumulation raises per capita steady state growth, employment rate and wage share.
    Keywords: Induced innovation; endogenous growth; direction of technical change
    JEL: O33 O31 O40
    Date: 2008–02
  6. By: Florin O. Bilbiie; Fabio Ghironi; Marc J. Melitz
    Abstract: We study the efficiency properties of a dynamic, stochastic, general equilibrium, macroeconomic model with monopolistic competition and firm entry subject to sunk costs, a time-to-build lag, and exogenous risk of firm destruction. Under inelastic labor supply and linearity of production in labor, the market economy is efficient if and only if symmetric, homothetic preferences are of the C.E.S. form studied by Dixit and Stiglitz (1977). Otherwise, efficiency is restored by properly designed sales, entry, or asset trade subsidies (or taxes) that induce markup synchronization across time and states, and align the consumer surplus and profit destruction effects of firm entry. When labor supply is elastic, heterogeneity in markups across consumption and leisure introduces an additional distortion. Efficiency is then restored by subsidizing labor at a rate equal to the markup in the market for goods. Our results highlight the importance of preserving the optimal amount of monopoly profits in economies in which firm entry is costly. Inducing marginal cost pricing restores efficiency only when the required sales subsidies are financed with the optimal split of lump-sum taxation between households and firms.
    JEL: D42 H32 L16
    Date: 2008–10
  7. By: Michael B. Devereux; Alan Sutherland
    Abstract: This paper develops a simple approximation method for computing equilibrium portfolios in dynamic general equilibrium open economy macro models. The method is widely applicable, simple to implement, and gives analytical solutions for equilibrium portfolio positions in any combination or types of asset. It can be used in models with any number of assets, whether markets are complete or incomplete, and can be applied to stochastic dynamic general equilibrium models of any dimension, so long as the model is amenable to a solution using standard approximation methods. We first illustrate the approach using a simple two-asset endowment economy model, and then show how the results extend to the case of any number of assets and general economic structure.
    JEL: F3 F41
    Date: 2008–10
  8. By: Gaetano Bloise; Pietro Reichlin
    Abstract: In this paper, we consider economies with (possibly endogenous) solvency constraints under uncertainty. Constrained ine±ciency corresponds to a feasible redistribution yielding a welfare improvement beginning from ev- ery contingency reached by the economy. A sort of Cass Criterion (Cass [10]) completely characterizes constrained ine±ciency. This criterion involves only observable prices and requires low interest rates in the long-run, exactly as in economies with overlapping generations. In addition, when quantitative limits to liabilities arise from participation constraints, a feasible welfare im- provement, subject to participation, coincides with the introduced notion of constrained ine±ciency.
    Keywords: Private debt; solvency constraints; default; Cass Criterion; asset
    JEL: D50 D52 D61 E44 G13
    Date: 2008–01
  9. By: David Hauner
    Abstract: Putting the pension system on a sustainable footing arguably remains the biggest challenge in Russia's economic policies. The debate about the policy options was hitherto constrained by the absence of general equilibrium analysis. This paper fills this gap by simulating their macroeconomic effects in a DSGE model calibrated to Russia's economy-the first of its kind to the best of our knowledge. The results suggest that a minimum benefit level in the public system should optimally be financed through lower government consumption, while higher taxation of labor and capital should be avoided. Reducing public investment spending is superior to increasing consumption taxes unless investment generates high rates of return.
    Keywords: Russian Federation , Pensions , Economic reforms , Private savings , Tax policy , Public investment , Consumption taxes , Aging , Population , Value added tax , Working Paper ,
    Date: 2008–08–22
  10. 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. 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 that threaten to push inflation off target. This model, while an improvement over standard models, is considered just a starting point for their revision.
    Keywords: Asset pricing ; Risk ; Taylor's rule
    Date: 2008
  11. By: Frank Schorfheide; Keith Sill; Maxym Kryshko
    Abstract: This paper develops and illustrates a simple method to generate a DSGE model-based forecast for variables that do not explicitly appear in the model (non-core variables). The authors use auxiliary regressions that resemble measurement equations in a dynamic factor model to link the non-core variables to the state variables of the DSGE model. Predictions for the non-core variables are obtained by applying their measurement equations to DSGE model- generated forecasts of the state variables. Using a medium-scale New Keynesian DSGE model, the authors apply their approach to generate and evaluate recursive forecasts for PCE inflation, core PCE inflation, and the unemployment rate along with predictions for the seven variables that have been used to estimate the DSGE model.
    Date: 2008
  12. 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.
    Date: 2008
  13. By: Romain Restout (GATE - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - Ecole Normale Supérieure Lettres et Sciences Humaines)
    Abstract: This paper explores the consequences of introducing a monopolistic competition in an intertemporal two-sector small open economy model which produces traded and non traded goods. It is assumed that the non traded sector is the locus of the imperfectly competition. Our analysis shows that markup depends on the composition of aggregate non traded demand and is therefore endogenously determined in the model. Calibrating the model with OECD parameters, the effects of fiscal and technological shocks are simulated. Our findings are as follows. First, the model is consistent with the observed saving-investment correlations found in the data. Second, unlike the perfectly framework and in accordance with empirical studies, fiscal shocks cause real appreciation of the relative price of non traded goods, which in turn enlarges the responses of current account and investment. Third, the model is consistent with the empirical report that technological shocks result in current account deficits and investment rises. Fourth, the strength of the relative price appreciation following sector productivity differentials, i.e. the Balassa-Samuelson effect, is affected by the monopolistic competition hypothesis. Assume perfect competition when it is not, biases upward estimates of the Balassa-Samuelson effect.
    Keywords: fiscal policy ; monopolistic competition ; productivity
    Date: 2008
  14. By: Cristina Arellano; Ananth Ramanarayanan
    Abstract: This paper studies the maturity composition and the term structure of interest rate spreads of government debt in emerging markets. We document that in Argentina, Brazil, Mexico, and Russia, when interest rate spreads rise, debt maturity shortens and the spread on short-term bonds is higher than on long-term bonds. To account for this pattern, we build a dynamic model of international borrowing with endogenous default and multiple maturities of debt. Short-term debt can deliver higher immediate consumption than long-term debt; large longterm loans are not available because the borrower cannot commit to save in the near future towards repayment in the far future. However, issuing long-term debt can insure against the need to roll-over short-term debt at high interest rate spreads. The trade-off between these two benefits is quantitatively important for understanding the maturity composition in emerging markets. When calibrated to data from Brazil, the model matches the dynamics in the maturity of debt issuances and its comovement with the level of spreads across maturities.
    Keywords: Bonds ; Debt ; Default (Finance) ; Emerging markets ; International finance
    Date: 2008
  15. By: Kinnunen, Helvi (Bank of Finland Research)
    Abstract: This paper investigates public pension funding using a dynamic general equilibrium macroeconomic model (DSGE) that facilitates investigation of distortionary effects of fiscal and pension policy responses to ageing. The model is calibrated to the Finnish economy, which will encounter substantial ageing pressures in the near future. During the transition to an older population structure ageing costs can be substantially lowered by allowing public funds to smooth out the tax responses. Cutting down on pension prefunding at a time when the pace of ageing is at its peak reduces the necessary tax hikes and stimulates labour supply growth at the moment when the labour market is tightest. With smaller funding needs, ageing leads to a slower growth in labour costs, a better employment conditions and faster production growth.
    Keywords: ageing; general equilibrium; public finance; government funds
    JEL: E13 H55 J11 J26
    Date: 2008–09–23
  16. By: Andrew Hodge (Reserve Bank of Australia); Tim Robinson (Reserve Bank of Australia); Robyn Stuart (Reserve Bank of Australia)
    Abstract: This paper estimates a small structural model of the Australian economy, designed principally for forecasting the key macroeconomic variables of output growth, underlying inflation and the cash rate. In contrast to models with purely statistical foundations, which are often used for forecasting, the Bayesian Vector Autoregressive Dynamic Stochastic General Equilibrium (BVAR-DSGE) model uses the theoretical information of a DSGE model to offset in-sample over-fitting. We follow the method of Del Negro and Schorfheide (2004) and use a variant of the small open economy DSGE model of Lubik and Schorfheide (2007) to provide prior information for the VAR. The forecasting performance of the model is competitive with benchmark models such as a Minnesota VAR and an independently estimated DSGE model.
    Keywords: BVAR-DSGE; forecasting
    JEL: C11 C53 E37
    Date: 2008–09

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