nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2008‒12‒01
eight papers chosen by
Christian Zimmermann
University of Connecticut

  1. Unemployment Dynamics and the Cost of Business Cycles By Hairault, Jean-Olivier; Langot, François; Osotimehin, Sophie
  2. Growth and the Ageing Joneses By Fisher, Walter H.; Heijdra, Ben J.
  3. Taxation and Income Distribution Dynamics in a Neoclassical Growth Model By Cecilia Garcìa-Peñalosa; Stephen J. Turnovsky
  4. Heterogeneous Risk Preferences and the Welfare Cost of Business Cycles By Sam Schulhofer-Wohl
  5. Banks' Precautionary Capital and Credit Crunches By Fabian Valencia
  6. Illiquidity and Under-Valuation of Firms By Douglas Gale; Piero Gottardi
  7. Maximum Principle for Boundary Control Problems Arising in Optimal Investment with Vintage Capital By Silvia Faggian
  8. Optimal monetary policy and the transmission of oil-supply shocks to the euro area under rational expectations. By Stéphane Adjemian; Matthieu Darracq Pariès

  1. By: Hairault, Jean-Olivier (University of Paris 1); Langot, François (University of Le Mans); Osotimehin, Sophie (CREST & Université Paris 1 Panthéon-Sorbonne)
    Abstract: In this paper, we investigate whether business cycles can imply sizable effects on average unemployment. First, using a reduced-form model of the labor market, we show that job finding rate fluctuations generate intrinsically a non-linear effect on unemployment: positive shocks reduce unemployment less than negative shocks increase it. For the observed process of the job finding rate in the US economy, this intrinsic asymmetry is enough to generate substantial welfare implications. This result also holds when we allow the job finding rate to be endogenous, provided the structural model is able to reproduce the volatility of the job finding rate. Moreover, the matching model embeds other non-linearities which alter the average job finding rate and so the business cycle cost.
    Keywords: business cycle costs, unemployment dynamics
    JEL: E32 J64
    Date: 2008–11
  2. By: Fisher, Walter H. (Department of Economics and Finance, Institute for Advanced Studies, Vienna, Austria); Heijdra, Ben J. (Department of Economics, University of Groningen, Groningen, The Netherlands, and Institute for Advanced Studies, Netspar, CESifo)
    Abstract: We incorporate Keeping-up-with-the-Joneses (KUJ) preferences into the Blanchard-Yaari (BY) framework and develop, using an AK technology, a model of balanced growth. In this context we investigate status preference, demographic, and pension policy shocks. We find that a higher degree of KUJ lowers economic growth, while, in contrast, a decrease in the fertility and mortality rates increase it. In the second part of the paper we extend the model by incorporating a Pay-as-you-go (PAYG) pension system with a statutory retirement date. This introduces a life-cycle in human wealth earnings and implies that the growth rate is higher under PAYG. We also consider the implications of an increase in the retirement date under both defined benefit and defined contribution schemes.
    Keywords: Relative consumption, OLG, Endogenous growth, Pension reform
    JEL: D91 E21 H55
    Date: 2008–11
  3. By: Cecilia Garcìa-Peñalosa (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille II - Université Paul Cézanne - Aix-Marseille III - Ecole des Hautes Etudes en Sciences Sociales - CNRS : UMR6579); Stephen J. Turnovsky (University of Washington - University of Washington)
    Abstract: We examine how changes in tax policies affect the dynamics of the distributions of wealth and income in a Ramsey model in which agents differ in their initial capital endowment. The endogeneity of the labor supply plays a crucial role in determining inequality, as tax changes that affect hours of work will affect the distribution of wealth and income, reinforcing or offsetting the direct redistributive impact of taxes. Our results indicate that tax policies that reduce the labor supply are associated with lower output but also with a more equal distribution of after-tax income. We illustrate these effects by examining the impact of recent tax changes observed in the US and in European economies.
    Keywords: taxation; wealth distribution; income distribution; endogenous labor supply; transitional dynamics
    Date: 2008–11–24
  4. By: Sam Schulhofer-Wohl (Princeton University)
    Abstract: I study the welfare cost of business cycles in a complete-markets economy where some people are more risk averse than others. Relatively more risk-averse people buy insurance against aggregate risk, and relatively less risk-averse people sell insurance. These trades reduce the welfare cost of business cycles for everyone. Indeed, the least risk-averse people benet from business cycles. Moreover, even innitely risk-averse people suer only nite and, in my empirical estimates, very small welfare losses. In other words, when there are complete insurance markets, aggregate uctuations in consumption are essentially irrelevant not just for the average person { the surprising nding of Lucas (1987) { but for everyone in the economy, no matter how risk averse they are. If business cycles matter, it is because they aect productivity or interact with uninsured idiosyncratic risk, not because aggregate risk per se reduces welfare.
    Keywords: business cycles; risk aversion; risk sharing; heterogeneity
    JEL: E32 E21
    Date: 2008–01
  5. By: Fabian Valencia
    Abstract: Periods of banking distress are often followed by sizable and long-lasting contractions in bank credit. They may be explained by a declined demand by financially impaired borrowers (the conventional financial accelerator) or by lower supply by capital-constrained banks, a "credit crunch". This paper develops a bank model to study credit crunches and their real effects. In this model, banks maintain a precautionary level of capital that serves as a smoothing mechanism to avert disruptions in the supply of credit when hit by small shocks. However, for larger shocks, highly persistent credit crunches may arise even when the impulse is a one time, non-serially correlated event. From a policy perspective, the model justifies the use of public funds to recapitalize banks following a significant deterioration in their capital position.
    Keywords: Banking crisis , Bank credit , External shocks , Liquidity management , Financial risk , Economic models ,
    Date: 2008–10–28
  6. By: Douglas Gale (New York University); Piero Gottardi (University Of Venice Cà Foscari)
    Abstract: We study a competitive model in which debt-financed firms may default in some states of nature. Incomplete markets prevent firms from hedging the risk of asset firesales when markets are illiquid. This is the only friction in the model and the only cost of default. The anticipation of such losses alone may distort firms' investment decisions. We characterize the conditions under which competitive equilibria are inefficient and the form the inefficiency takes. We also show that endogenous financial crises may arise as a result of pure sunspot events. Finally, we examine alternative interventions to restore the efficiency of equilibria.
    Keywords: illiquid markets, default, incomplete markets, price distortions, inefficient investment
    JEL: D5 D8 G1 G33
    Date: 2008
  7. By: Silvia Faggian (Department of Applied Mathematics, University of Venice)
    Abstract: The paper concerns the study of the Pontryagin Maximum Principle for an infinite dimensional and infinite horizon boundary control problem for linear partial differential equations. The optimal control model has already been studied both in finite and infinite horizon with Dynamic Programming methods in a series of papers by the same author et al. [26, 27, 28, 29, 30]. Necessary and sufficient optimality conditions for open loop controls are established. Moreover the co-state variable is shown to coincide with the spatial gradient of the value function evaluated along the trajectory of the system, creating a parallel between Maximum Principle and Dynamic Programming. The abstract model applies, as recalled in one of the first sections, to optimal investment with vintage capital.
    Keywords: Linear convex control, Boundary control, Hamilton–Jacobi–Bellman equations, Optimal investment problems, Vintage capital
    JEL: C61 C62 E22
    Date: 2008–11
  8. By: Stéphane Adjemian (Université du Maine, Avenue Olivier Messiaen, 72085 Le Mans Cedex 9, France.); Matthieu Darracq Pariès (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper presents first the estimation of a two-country DSGE model for the euro area and the rest-of-the-world including relevant oil-price channels. We then investigate the optimal resolution of the policy tradeoffs emanating from oil-price disturbances. Our simulations show that the inflationary forces related to the use of oil as an intermediate good seem to require specific policy actions in the optimal allocation. However, the direct effects of oil prices should be allowed to exert their mechanical influence on CPI inflation and wage dynamics through the indexation schemes. We also illustrate that any fine-tuning strategy which tries to counteract the direct effects of oil-price changes in headline inflation would prove counter-productive both in terms to stabilization of underlying inflation and by causing unnecessary volatility in the macroeconomic landscape. Finally, it appears that perfect foresight on future oil price developments allows a more rapid absorption of the steady state decline in purchasing power and real national income in the optimal allocation. Through the various expectation channels, economic agents facilitate the necessary adjustments and optimal monetary policy can still tolerate the direct effects of oil price changes on CPI inflation as well as some degree of underlying inflationary pressures in the view of easing partly the burden of downward real wage shifts. Our monetary policy prescriptions have been derived in a modeling framework where oil-price fluctuations are essentially exogenous to policy actions and where expectations are formed under the rational expectations paradigm. Notably, the extension of such conclusions to imperfect knowledge and weak central bank credibility configurations remain challenging fields for further research. JEL Classification: E4, E5, F4.
    Keywords: Oil prices, Optimal monetary policy, New open economy macroeconomics, Bayesian estimation.
    Date: 2008–11

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