nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2008‒10‒13
seventeen papers chosen by
Christian Zimmermann
University of Connecticut

  1. The High Cross-Country Correlations of Prices and Interest Rates By Henriksen, Espen; Kydland, Finn; Sustek, Roman
  2. The Farm, the City, and the Emergence of Social Security By Caucutt, Elizabeth M.; Cooley, Thomas F.; Guner, Nezih
  3. Effects of TRIPS on Growth, Welfare and Income Inequality in an R&D-Growth Model By Chu, Angus C.; Peng, Shin-Kun
  4. Wage Rigidity and Job Creation By Haefke, Christian; Sonntag, Marcus; van Rens, Thijs
  5. On the Golden Rule of capital accumulation under endogenous longevity By David de la Croix; Grégory Ponthière
  6. Consumption Externalities and Equilibrium Dynamics with Heterogenous Agents By Kazuo Mino; Yasuhiro Nakamoto
  7. Prudence and Robustness as Explanations for Precautionary Savings; an Evaluation By Nick Draper
  8. Growth and Competition in a Model of Human Capital Accumulation and Research By Bianco, Dominique
  9. Accounting for Productivity Growth When Technical Change is Biased By James Bessen
  10. The Evolution of Education: A Macroeconomic Analysis By Diego Restuccia; Guillaume Vandenbroucke
  11. On the Macroeconomics of Microfi?nance By Soyolmaa Batbekh and; Keith Blackburn
  12. Human Capital Investment with Competitive Labor Search By Kaas, Leo; Zink, Stefan
  13. Sudden Stops, Sectoral Reallocations, and the Real Exchange Rate By Timothy J. Kehoe; Kim J. Ruhl
  14. More Machines or Better Machines? By James Bessen
  15. Nontraded Goods, Market Segmentation, and Exchange Rates By Michael Dotsey; Margarida Duarte
  16. Market Work, Home Work and Taxes: A Cross Country Analysis By Richard Rogerson
  17. Temporary Price Changes and the Real Effects of Monetary Policy By Patrick J. Kehoe; Virgiliu Midrigan

  1. By: Henriksen, Espen; Kydland, Finn; Sustek, Roman
    Abstract: We document that, at business cycle frequencies, fluctuations in nominal variables, such as aggregate price levels and nominal interest rates, are substantially more synchronized across countries than fluctuations in real output. To the extent that domestic nominal variables are determined by domestic monetary policy, and central banks generally attempt to keep the domestic nominal environment stable, this might seem surprising. We ask if a parsimonious international business cycle model can account for this aspect of cross-country aggregate fluctuations. It can. Due to spillovers of technology shocks across countries, expected future responses of national central banks to fluctuations in domestic output and inflation generate movements in current prices and interest rates that are synchronized across countries even when output is not. Even modest spillovers produce cross-country correlations such as those in the data.
    Keywords: International business cycles; prices; interest rates.
    JEL: E43 F42 E32 E31
    Date: 2008–09–12
  2. By: Caucutt, Elizabeth M. (University of Western Ontario); Cooley, Thomas F. (New York University); Guner, Nezih (Universidad Carlos III, Madrid)
    Abstract: In this paper we study the social, demographic and economic origins of social security. The data for the U.S. and for a cross section of countries make it clear that urbanization and industrialization are strongly associated with the rise of social insurance. We describe a model economy in which demographics, technology, and social security are linked together. We study an economy with two locations (sectors), the farm (agricultural) and the city (industrial). The decision to migrate from rural to urban locations is endogenous and linked to productivity differences between the two locations and survival probabilities. Furthermore, the level of social security is determined by majority voting. We show that a calibrated version of this economy is consistent with the historical transformation in the United States. Initially a majority of voters live on the farm and do not want to implement social security. Once a majority of the voters move to the city, the median voter prefers a positive social security tax. In the model social security emerges and is sustained over time as a political and economic equilibrium. Modeling the political economy of social security within a model of structural change leads to a rich economic environment in which the median voter is identified by both age and location.
    Keywords: social security, political economy, structural change, migration
    JEL: H55 H3 D72
    Date: 2008–09
  3. By: Chu, Angus C.; Peng, Shin-Kun
    Abstract: What are the effects of the WTO's TRIPS Agreement on growth, welfare and income inequality? To analyze this question, we develop an open-economy R&D-driven endogenous-growth model with wealth heterogeneity. Under TRIPS, the North experiences higher growth and welfare at the expense of higher income inequality. As for the South, it experiences higher growth at the expense of lower welfare and higher income inequality. Also, there exists a critical degree for the domestic importance of foreign goods below which global welfare decreases under TRIPS. In light of our findings, we discuss policy implications on China’s accession to the WTO in 2001.
    Keywords: endogenous growth; heterogeneity; income inequality; patent policy; TRIPS
    JEL: D31 F13 O34
    Date: 2008–09
  4. By: Haefke, Christian (IHS - Institute for Advanced Studies, Vienna); Sonntag, Marcus (University of Bonn); van Rens, Thijs (Universitat Pompeu Fabra)
    Abstract: Standard macroeconomic models underpredict the volatility of unemployment fluctuations. A common solution is to assume wages are rigid. We explore whether this explanation is consistent with the data. We show that the wage of newly hired workers, unlike the aggregate wage, is volatile and responds one-to-one to changes in labor productivity. In order to replicate these findings in a search model, it must be that wages are rigid in ongoing jobs but flexible at the start of new jobs. This form of wage rigidity does not affect job creation and thus cannot explain the unemployment volatility puzzle.
    Keywords: wage rigidity, search and matching model, business cycle
    JEL: E24 E32 J31 J41 J64
    Date: 2008–09
  5. By: David de la Croix; Grégory Ponthière
    Abstract: This note derives the Golden Rule of capital accumulation in a Chakraborty-type economy, i.e. a two-period OLG economy where longevity is endogenous. It is shown that the capital per worker maximizing steady-state consumption per head is inferior to the Golden Rule capital level prevailing under exogenous longevity. We characterize also the Lifetime Golden Rule, that is, the capital per worker maximizing steady-state expected lifetime consumption per head, and show that this tends to exceed the standard Golden Rule capital level.
    Date: 2008
  6. By: Kazuo Mino (Graduate School of Economics, Osaka University); Yasuhiro Nakamoto (Graduate School of Economics, Osaka University)
    Abstract: This paper explores the effect of consumption externalities on equilibrium dynamics of a standard neoclassical growth model in which there are two types of agents. To emphasize the presence of heterogenous agents, we distinguish intergroup consumption externalities from intragroup consumption externalities. We show that if the intragroup externalities dominates the intrergroup external effects, then the steady state equilibrium satisfies saddle-point stability and the equilibrium path of the economy is uniquely determined. In contrast, if the intergroup external effects of consumption are strong enough, the steady-state equilibrium is either unstable or locally indeterminate. Based on the analytical as well as numerical considerations, we give intuitive implications of stability conditions.
    Keywords: Consumption externalities, Equilibrium determinacy, Heterogeneous agents, Progressive taxation
    JEL: E52 O42
    Date: 2008–09
  7. By: Nick Draper
    Abstract: This paper evaluates approximation methods to make manageable the numerical solution of overlapping generation models with aggregate risk. The paper starts with a model in which households maximize expected utility over their life cycle. Instantaneous utility is characterized by constant relative risk aversion. Prudence, a characteristic of the utility function, leads to precautionary saving. The first-order conditions include expectations. One source of uncertainty is not prohibitive for numerical integration of the expectation term. Because of its accuracy numerical integration results are used as a bench mark. Taylor series approximations can lead to the same results dependent on the linearization point. A linear quadratic approximation of the household model is evaluated subsequently. Alternatively, precautionary saving effects can be the result of robust decision making. This approach leads to linear policy functions and gives a rather good approximation of the bench mark model, although not as good as the Taylor series approximation.
    Keywords: Precautionary saving; Robustness; Prudence
    JEL: E21 D81 C61
    Date: 2008–04
  8. By: Bianco, Dominique
    Abstract: The aim of this paper is to analyze the relationship between competition and growth in a model of human capital accumulation and research by disentangling the monopolistic mark-up in the intermediate goods sector and the returns to specialization in order to have a better measure of competition. We find that the steady-state output growth rate depends on the parameters describing preferences, human capital accumulation technology and R&D activity. We also show that the relationship between competition and growth is inverse U shaped. This result that seems to be in line this empirical results (Aghion and Gri±th (2005)) is explained by the resource allocation effect.
    Keywords: Endogenous growth; Horizontal differentiation; Technological change; Imperfect competition; Human capital
    JEL: L16 O41 J24 O31 D43
    Date: 2008–10–06
  9. By: James Bessen (Research on Innovation, Boston University School of Law)
    Abstract: Solow (1957) decomposed labor productivity growth into two components that are independent under Hicks neutrality: input growth and the residual, representing technical change. However, when technical change is Hicks biased, input growth is no longer independent of technical change, leading to ambiguous interpretation. Using Solow’s model, I decompose output per worker into globally independent sources. Adding a simple calculation to Solow’s framework, I show that technical bias directly contributes to labor productivity growth above what is captured in the Solow residual. This contribution is sometimes large, leading to rates of total technical change that substantially exceed the Solow residual.
    Date: 2008
  10. By: Diego Restuccia; Guillaume Vandenbroucke
    Abstract: Between 1940 and 2000 there has been a substantial increase of educational attainment in the United States. What caused this trend? We develop a model of schooling decisions in order to assess the quantitative contribution of technological progress in explaining the evolution of education. We use earnings across educational groups and growth in gross domestic product per worker to restrict technological progress. These restrictions imply substantial skill-biased technical change (SBTC). We find that changes in relative earnings through SBTC can explain the bulk of the increase in educational attainment. In particular, a calibrated version of the model generates an increase in average years of schooling of 48 percent compared to 27 percent in the data. This strong effect of changes in relative earnings on educational attainment is robust to relevant variations in the model and is consistent with empirical estimates of the long-run income elasticity of schooling. We also find that the substantial increase in life expectancy observed during the period contributes little to the change in educational attainment in the model.
    Keywords: educational attainment, schooling, skill-biased technical progress, human capital
    JEL: E1 O3 O4
    Date: 2008–10–05
  11. By: Soyolmaa Batbekh and; Keith Blackburn
    Abstract: Microfinance (small scale lending to the poor) is integrated into a dynamic macroeconomic model of income distribution. Two-period-lived agents, belonging to overlapping generation of dynastic families, choose between three alternative occupations - subsistence production, small-scale project investment and large-scale project investment. Subsistence activity is costless and riskless, whilst project investment is the opposite and may require external funding from financial institutions with imperfect powers of contract enforcement. In the absence of microfinance, only large-scale, collateralised loans are available through the traditional banking sector. Under such circumstances, initial inequalities persist as only the wealthy are able to acquire these loans, and as the small-scale enterprise is either not feasible or not profitable. With the introduction of microfinance, this venture is made both possible and attractive through the provision of non-collateralised loans and other features of microlending arrangements. Poverty and inequality are reduced as a result.
    Date: 2008
  12. By: Kaas, Leo (University of Konstanz); Zink, Stefan (University of Konstanz)
    Abstract: We study human capital accumulation in an environment of competitive search. Given that unemployed workers can default on their education loans, skilled individuals with a larger debt burden prefer riskier but better paid careers than is socially desirable. A higher level of employment risk in turn depresses the skill premium and the incentives to invest in education. The equilibrium allocation is characterized by too much unemployment, underinvestment by the poor, and too little investment in skill-intensive technologies. A public education system funded by graduate taxes can restore efficiency. More generally, differences in education funding can account for cross-country variations in wage inequality.
    Keywords: directed search, investment, education finance
    JEL: I22 J24 J31
    Date: 2008–09
  13. By: Timothy J. Kehoe; Kim J. Ruhl
    Abstract: A sudden stop of capital flows into a developing country tends to be followed by a rapid switch from trade deficits to surpluses, a depreciation of the real exchange rate, and decreases in output and total factor productivity. Substantial reallocation takes place from the nontraded sector to the traded sector. We construct a multisector growth model, calibrate it to the Mexican economy, and use it to analyze Mexico's 1994-95 crisis. When subjected to a sudden stop, the model accounts for the trade balance reversal and the real exchange rate depreciation, but it cannot account for the decreases in GDP and TFP. Extending the model to include labor frictions and variable capital utilization, we still find that it cannot quantitatively account for the dynamics of output and productivity without losing the ability to account for the movements of other variables.
    JEL: E13 F34 F41
    Date: 2008–10
  14. By: James Bessen (Research on Innovation, Boston University School of Law)
    Abstract: Using an engineering production function and detailed information on major inventions in nineteenth century cotton weaving, this paper explores how much of the rapid growth in labor productivity arose from capital-labor substitution and how much from technical change. I find that labor-saving technical change accounts for almost all of the growth. However, much of the labor-saving bias arose not from inventions, but from acquisition of new knowledge and skills by weavers. Moreover, this was endogenous, influenced by wages and prices. This provides a technology-based explanation for the persistent association between economic growth and capital deepening.
    Date: 2008
  15. By: Michael Dotsey; Margarida Duarte
    Abstract: Empirical evidence suggests that movements in international relative prices are large and persistent. Nontraded goods, both in the form of final consumption goods and as an input into the production of final tradable goods, are an important aspect driving international relative price movements. In this paper we show that nontraded goods play an important role in the context of an otherwise standard open-economy macromodel. Our quantitative study with nontraded goods generates implications along several dimensions that are more closely in line with the data relative to the model that abstracts from nontraded goods. In addition, contrary to a large literature, standard alternative assumptions about the currency in which firms price their goods are virtually inconsequential for the properties of aggregate variables in our model, other than the terms of trade.
    Keywords: exchange rates; nontraded goods; distribution services; incomplete asset markets.
    JEL: F3 F41
    Date: 2008–10–01
  16. By: Richard Rogerson
    Abstract: This paper uses a simple model of labor supply extended to allow for home production to understand the extent to which differences in taxes can account for differences in time allocations between the US and Europe. Once home production is included, the elasticity of substitution between consumption and leisure is almost irrelevant in determining the response of market hours to higher taxes. But to account for observed differences in leisure and time spent in home production, one requires a large elasticity of substitution between consumption and leisure, and a small elasticity of substituion betwen time and goods in home production.
    JEL: E60 H20 J22
    Date: 2008–10
  17. By: Patrick J. Kehoe; Virgiliu Midrigan
    Abstract: In the data, prices change both temporarily and permanently. Standard Calvo models focus on permanent price changes and take one of two shortcuts when confronted with the data: drop temporary changes from the data or leave them in and treat them as permanent. We provide a menu cost model that includes motives for both types of price changes. Since this model accounts for the main regularities of price changes, its predictions for the real effects of monetary policy shocks are useful benchmarks against which to judge existing shortcuts. We find that neither shortcut comes close to these benchmarks. For monetary policy analysis, researchers should use a menu cost model like ours or at least a third, theory-based shortcut: set the Calvo model's parameters so that it generates the same real effects from monetary shocks as does the benchmark menu cost model. Following either suggestion will improve monetary policy analysis.
    JEL: E12 E5 E58
    Date: 2008–10

This nep-dge issue is ©2008 by Christian Zimmermann. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.