nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2008‒12‒14
twenty-one papers chosen by
Christian Zimmermann
University of Connecticut

  1. Labor-Market Volatility in the Search-and-Matching Model: The Role of Investment-Specific Technology Shocks By Renato Faccini; Salvador Ortigueira
  2. On the Golden Rule of capital accumulation under endogenous longevity By David, DE LA CROIX
  3. Estimating the Dynamics of R&D-based Growth Models By Yuri, YATSENKO; Raouf, BOUCEKKINE; Natali, HRITONENKO
  4. Optimal income taxation with endogenous participation and search unemployment By Etienne, LEHMANN; Alexis, PARMENTIER; Bruno, VAN DER LINDEN
  5. US Volatility Cycles of Output and Inflation, 1919-2004: A Money and Banking Approach to a Puzzle By Benk, Szilárd; Gillman, Max; Kejak, Michal
  6. Inventories, liquidity, and the macroeconomy By Yi Wen
  7. Financial Development, Technological Change in Emerging Countries and Global Imbalances By Kenza Benhima
  8. Estimating DGSE models with long memory dynamics By Gianluca, MORETTI; Giulio, NICOLETTI
  9. Intermediary Asset Pricing By Zhiguo He; Arvind Krishnamurthy
  10. Reconnecting Money to Inflation: The Role of the External Finance Premium By Chadha, J.S.; Corrado, L.; Holly, S.
  11. Intergenerational Transfers of Time and Public Long-term Care with an Aging Population By Atsue Mizushima
  12. Regional Debt in Monetary Unions: Is it Inflationary ? By Russell Cooper; Hubert Kempf; Dan Peled
  13. The Cross-Section of Output and Inflation in a Dynamic Stochastic General Equilibrium Model with Sticky Prices By Döpke, J.; Funke, M.; Holly, S.; Weber, S.
  14. The Suspension of the Gold Standard as Sustainable Monetary Policy By Newby, E.
  15. A Note on the Accuracy of Extended-Path Solution Methods for Dynamic General Equilibrium Economies. By David R.F. Love
  16. A Reappraisal of the Allocation Puzzle through the Portfolio Approach By Kenza Benhima
  17. Immigration and the macroeconomy By Federico S. Mandelman; Andrei Zlate
  18. What do majority-voting politics say about redistributive taxation of consumption and factor income? Not much. By Jim Dolmas
  19. Dynamic Globalization and Its Potentially Alarming Prospects for Low-Wage Workers By Hans Fehr; Sabine Jokisch; Laurence J. Kotlikoff
  20. Dynamics of externalities: a second-order perspective By Yi Wen; Huabin Wu
  21. Delegation, Time Inconsistency and Sustainable Equilibrium By Basso, Henrique S

  1. By: Renato Faccini; Salvador Ortigueira
    Abstract: Shocks to investment-specific technology have been identified as a main source of U.S. aggregate output volatility. In this paper we assess the contribution of these shocks to the volatility of labor market variables, namely, unemployment, vacancies, tightness and the job-finding rate. Thus, our paper contributes to a recent body of literature assessing the ability of the search-and-matching model to account for the large volatility observed in labor market variables. To this aim, we solve a neoclassical economy with search and matching in the labor market, where neutral and investment-specific technologies are subject to shocks. The three key features of our model economy are: i) Firms are large, in the sense that they employ many workers. ii) Adjusting capital and labor is costly. iii) Wages are the outcome of an intra-firm Nash-bargaining problem between the firm and its workers. In our calibrated economy, we find that shocks to investment-specific technology explain 40 percent of the observed volatility in U.S. labor productivity. Moreover, these shocks generate relative volatilities in vacancies and the workers' job finding rate which match those observed in U.S. data. Relative volatilities in unemployment and labor market tightness are 55 and 75 percent of their empirical values, respectively.
    Keywords: Business Cycles; Labor Market Fluctuations; Investment-Specific Technical Change; Search and Matching; Adjustment Costs; Wage Bargaining.
    JEL: E22 E24 E32 J41 J64 O33
    Date: 2008
  2. By: David, DE LA CROIX (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES))
    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.
    Keywords: Golden Rule, longevity, OLG models
    JEL: E13 E21 E22 I12
    Date: 2008–12–02
  3. By: Yuri, YATSENKO; Raouf, BOUCEKKINE (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES)); Natali, HRITONENKO
    Abstract: Several R&D-based models of endogenous economic growth are investigated under the Solow-like assumption of fixed allocation of resources across activities. We identify model parameters that lead to explosive dynamics and analyse various economic techniques to avoid it. The techniques include adding stricter constraints on model trajectories and limiting factors in technology equation. In particular, we demonstrate that our vintage version of the well-known R&D-based model of economic growth (Jones, 1955) exhibits the same balanced dynamics as the original model
    Keywords: Vintage capital models, Endogenous technological change, R&D investment, Explosive dynamics, Nonlinear Volterra integral equations
    JEL: E20 O40 C60
    Date: 2008–12–03
  4. By: Etienne, LEHMANN; Alexis, PARMENTIER; Bruno, VAN DER LINDEN (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES))
    Abstract: This paper characterizes the optimal redistributive taxation when individuals are heterogeneous in two exogenous dimensions : Their skills and their values of non-market activities. Search-matching frictions on the labor markets create unemployment. Wages, labor demand and participation are endogenous. The government only observed wage levels. Under a Maximin objective, if the elasticity of participation decreases along the distribution of skills, at the optimum, the average tax rate is increasing, marginal tax rates are positive everywhere, while wages, unemployment rates and participation rates are distorted downwards compared to their laissez-farie values. A simulation exercise confirms some of these properties under a general utilitarian objective. Taking account of the wage-cum-labor demand margin deeply changes the equity-efficiency trade-off.
    Keywords: Non-linear taxation, Redistribution, Adverse selection, Random participation, Unemployment, Labor market frictions
    JEL: D82 H21 J64
    Date: 2008–12–04
  5. By: Benk, Szilárd; Gillman, Max (Cardiff Business School); Kejak, Michal
    Abstract: The post-1983 moderation coincided with an ahistorical divergence in the money aggregate growth and velocity volatilities away from the downward trending GDP and inflation volatilities. Using an endogenous growth monetary DSGE model, with micro-based banking production, enables a contrasting characterization of the two great volatility cycles over the historical period of 1919-2004, and enables this puzzle to be addressed more easily. The volatility divergence is explained by the upswing in the credit volatility that kept money supply variability from translating into inflation and GDP volatility.
    Keywords: Volatility; money and credit shocks; growth; inflation
    JEL: E13 E32 E44
    Date: 2008–11
  6. By: Yi Wen
    Abstract: It is widely believed in the literature that inventory fluctuations are destabilizing to the economy. This paper re-assesses this view by developing an analytically-tractable general-equilibrium model of inventory dynamics based on a precautionary stockout-avoidance motive. The model's predictions are broadly consistent with the U.S. business cycle and key features of inventory behavior, including (i) a large inventory stock-to-sales ratio and a small inventory investment-to-sales ratio in the long run, (ii) excess volatility of production relative to sales, (iii) procyclical inventory investment but countercyclical stock-to-sales ratio over the business cycle, and (iv) more volatile input inventories than output inventories. However, contrary to common beliefs, the model predicts that inventories are stabilizing, rather than destabilizing. The volatility of aggregate output could rise by 30% if inventories were eliminated from the economy. Key to this seemingly counter-intuitive result is that a stockout-avoidance motive leads to procyclical liquidity-value of inventories (hence, procyclical relative prices of final goods), which acts as an automatic stabilizer that discourages final sales in a boom and encourages final sales during a recession, thereby reducing the variability of GDP.
    Keywords: Inventories ; Liquidity (Economics) ; Business cycles
    Date: 2008
  7. By: Kenza Benhima
    Abstract: The paper shows that in a general equilibrium model with two countries, characterized by different levels of financial development, and two technologies, one more productive and more financially demanding than the other, the following stylized facts can be replicated: 1) the persistent US current account deficits since the beginning of the 90’s; 2) growth of output per worker in developing countries in relative terms with the US during the same period; 3) relative capital accumulation and 4) TFP growth in these countries, also relative to the US. The more productive technology takes more time to implement and is subject to liquidity shocks, while the less productive one, along with external bond assets, can be used as a hoard to finance those liquidity shocks. As a result, after financial globalization, if the emerging economy is capital scarce and if its financial market is sufficiently incomplete, it experiences an increase in net foreign assets that coincides with a fall in the less productive investment and a rise in the more productive one. Convergence towards the steady state implies then both a better allocation of capital that generates endogenous aggregate TFP gains and a rise in aggregate investment that translates into higher growth.
    Keywords: Growth, Capital flows, Credit constraints, financial globalization, technological change
    JEL: F36 F43 O16 O33
    Date: 2008
  8. By: Gianluca, MORETTI; Giulio, NICOLETTI
    Abstract: Recent literature clams that key variables such as aggregate productivity and inflation display long memory dynamics. We study the impllications of this high degree of persistence on the estimation of Dynamic Stochastic General Equilibrium (DGSE) models. We show that long memory data produce substantial bias in the deep parameter estimates when a standard Kalman Filter-MLE procedure is used. We propose a modification of the Kalman Filter procedure, we mainly augment the state space, which deals with this problem. By the means of the augmented state space we can consistently estimate the model parameters as well as produce more accurate out-of-sample forecasts compared to the standard Kalman filter.
    Date: 2008–12–04
  9. By: Zhiguo He; Arvind Krishnamurthy
    Abstract: We present a model to study the dynamics of risk premia during crises in asset markets where the marginal investor is a financial intermediary. Intermediaries face a constraint on raising equity capital. When the constraint binds, so that intermediaries' equity capital is scarce, risk premia rise to reflect the capital scarcity. We calibrate the model and show that it does well in matching two aspects of crises: the nonlinearity of risk premia during crisis episodes; and, the speed of adjustment in risk premia from a crisis back to pre-crisis levels. We use the model to quantitatively evaluate the effectiveness of a variety of central bank policies, including reducing intermediaries' borrowing costs, infusing equity capital, and directly intervening in distressed asset markets. All of these policies are effective in aiding the recovery from a crisis. Infusing equity capital into intermediaries is particularly effective because it attacks the equity capital constraint that is at the root of the crisis in our model.
    JEL: G2 G28
    Date: 2008–12
  10. By: Chadha, J.S.; Corrado, L.; Holly, S.
    Abstract: We re-connect money to in.ation using Goodfriend and McCallum's (2007) model where banks supply loans to cash-in-advance constrained consumers on the basis of the value of collateral provided and the monitoring skills of banks. We show that when shocks to monitoring and collateral dominate those to goods productivity and the velocity of money demand, money and the external finance premium become closely linked. This is because increases in asset prices allow banks to raise the supply of loans leading to an expansion in aggregate demand, via a compression of financial interest rates spreads, which in turn tends to be inflationary. Thus money and financial spreads are negatively correlated when banking sector shocks dominate. We suggest a simple augmented stabilising monetary policy rule that exploits the joint information from money and the external finance premium.
    Keywords: money, DSGE, policy rules, external finance premium.
    JEL: E31 E40 E51
    Date: 2008–11
  11. By: Atsue Mizushima
    Abstract: Although a large number of studies have been done on intergenerational transfers of goods, little is known about intergenerational transfers of time. In step with an increase in the aging of the population, the demand for time-intensive transfers in health care and other health services increases. Using an overlapping generations model which incorporates uncertain longevity, we set up a model which incorporates intergenerational transfers of time and examine the macroeconomic effect of public long-term care policy (LTC). Using the model, we show that LTC decreases the steady state level of capital, but that it enhances the welfare level when the rate of tax is sufficiently small.
    Keywords: time transfers, household production, overlapping generations model
    JEL: E60 I12 J14 J22
    Date: 2008
  12. By: Russell Cooper (University of Texas - Department of Economics); Hubert Kempf (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, Banque de France - Direction de la Recherche); Dan Peled (University of Haifa - Department of Economics)
    Abstract: This paper studies the inflationary implications of interest bearing regional debt in a monetary union. Is this debt simply backed by future taxation with non inflationary consequences ? Or will the circulation of region debt induce monetization by a central bank ? We argue here that both outcomes can arise in equilibrium. In the model economy, there are multiple equilibria which reflect the perceptions of agents regarding the manner in which the debt obligations will be met. In one equilibrium, termed Ricardian, the future obligations are met with taxation by a regional government while in the other, termed Monetization, the central bank is induced to print money to finance the region's obligations. The multiplicity of equilibria reflects a commitment problem of the central bank. A key indicator of the selected equilibrium is the distribution of the holdings of the regional debt. We show that regional governments, anticipating central bank financing of their debt obligations, have an incentive to create excessively large deficits. We use the model to assess the impact of policy measures within a monetary union.
    Keywords: Monetary union ; inflation tax ; seigniorage ; public debt
    Date: 2008–11
  13. By: Döpke, J.; Funke, M.; Holly, S.; Weber, S.
    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
  14. By: Newby, E.
    Abstract: This paper models the gold standard as a state contingent commitment rule that is only feasible during peace. It shows that monetary policy during war, when the gold convertibility rule is suspended, can still be credible, if the policy maker's plan is to resume the gold standard at the old par value in the future. The DGE model developed in this paper suggests that the resumption of the gold standard was a sustainable plan, which replaced the gold standard as a commitment rule and made monetrary policy time consistent. The equilibrium is supported by trigger strategies, where private agents retaliate if a policy maker defaults its policy plan to resume the gold standard rule.
    Keywords: Gold standard, Time consistency, Monetary policy, Monetary regimes.
    JEL: C61 E31 E4 E5 N13
    Date: 2008–11
  15. By: David R.F. Love (Department of Economics, Brock University)
    Abstract: We show that the deterministic Extended-Path (EP) method of Fair and Taylor (1983) solves standard dynamic stochastic general equilibrium models with similar accuracy to the best results reported in the literature for alternative methods. The EP method demands more computer time than other methods but has offsetting benefits in terms of simplicity and generality that make it an attractive choice.
    Keywords: Dynamic stochastic equilibrium, computational methods, non-linear solutions
    JEL: E10 E30 E37
    Date: 2008–04
  16. By: Kenza Benhima
    Abstract: The neoclassical growth model predicts that emerging countries with higher TFP growth should receive larger capital inflows. Gourinchas and Jeanne (2007) document that, in fact, countries that exhibited higher productivity catch-up received less capital inflows, even though they invested more in their domestic technology. This is the allocation puzzle. I show that introducing investment risk in the same neoclassical framework reverses the predictions in terms of capital flows: countries with higher TFP growth invest more in their own production but they have to hold more external bonds in order to self-insure against investment risk, which is consistent with the data. Indeed, the introduction of risky investment makes the portfolio composition matters: instead of being identical assets, bond holdings and private capital become imperfect substitutes inside the portfolio.
    Keywords: Growth accounting, Capital flows, Investment risk, Financial globalization, Portfolio choice
    JEL: F21 F43 G11 O16
    Date: 2008
  17. By: Federico S. Mandelman; Andrei Zlate
    Abstract: We analyze the dynamics of labor migration and the insurance role of remittances in a two-country, real business cycle framework. Emigration increases with the expected stream of future wage gains but is dampened by the sunk cost reflecting border enforcement. During booms in the destination economy, the scarcity of established immigrants lessens capital accumulation, labor productivity, and the native wage. The welfare gain from the inflow of unskilled labor increases with the complementarity between skilled and unskilled labor and the share of the skilled among native labor. The model matches the cyclical dynamics of the unskilled immigration from Mexico.
    Date: 2008
  18. By: Jim Dolmas
    Abstract: Tax rates on labor income, capital income and consumption-and the redistributive transfers those taxes finance-differ widely across developed countries. Can majority-voting methods, applied to a calibrated growth model, explain that variation? The answer I fund is yes, and then some. In this paper, I examine a simple growth model, calibrated roughly to U.S. data, in which the political decision is over constant paths of taxes on factor income and consumption, used to finance a lump-sum transfer. I first look at outcomes under probabilistic voting, and find that equilibria are extremely sensitive to the specification of uncertainty. I then consider other ways to restrict the range of majority-rule outcomes, looking at the model's implications for the shape of the Pareto set and the uncovered set, and the existence or non-existence of a Condorcet winner. Solving the model on discrete grid of policy choices, I find that no Condorcet winner exists and that the Pareto and uncovered sets, while small relativeto the entire issue space, are large relative to the range of tax policies we see in data for a collection of 20 OECD countries. Taking that data as the issue space, I find that none of the 20 can be ruled out on effciency grounds, and that 10 of the 20 are in the uncovered set. Those 10 encompass policies as diverse as those of the US, Norway and Austria. One can construct a Condorcet cycle including all 10 countries' tax vectors. ; The key features of the model here, as compared to other models on the endogenous determination of taxes and redistribution, is that the issue space is multidimensional and, at the same time, no one voter type is suffciently numerous to be decisive. I conclude that the sharp predictions of papers in this literature may not survive an expansion of their issue spaces or the allowance for a slightly less homogeneous electorate.
    Keywords: Taxation ; Consumption (Economics) ; Income tax ; Fiscal policy
    Date: 2008
  19. By: Hans Fehr; Sabine Jokisch; Laurence J. Kotlikoff
    Abstract: Will incomes of low and high skilled workers continue to diverge? Yes says our paper's dynamic, six-good, five-region -- U.S., Europe, N.E. Asia (Japan, Korea, Taiwan, Hong Kong), China, and India -- general equilibrium, life-cycle model. The model predicts a near doubling of the ratio of high- to low-skilled wages over the century. Increasing wage inequality arises from a traditional source -- a rising worldwide relative supply of unskilled labor, reflecting Chinese and Indian productivity improvements. But China's and India's education policies matter. If successive Chinese and Indian cohorts become more skilled, major exacerbation of inequality will be precluded.
    JEL: F0 F20 H0 H3 J20 O0 O23
    Date: 2008–12
  20. By: Yi Wen; Huabin Wu
    Abstract: We show that increasing returns to scale (due to production externalities) may induce a strong degree of asymmetric income effects and nonlinear dynamics that are not fully appreciated by linear approximation methods. For example, hump-shaped output dynamics can emerge even when externalities are significantly below the threshold level required for indeterminacy, and output expansion tends to be smoother and longer while contraction tends to be deeper but shorter-lived. Thus, mild degree of externalities without triggering indeterminacy can potentially explain the asymmetric property of the business cycle and the hump-shaped output dynamics found in the empirical literature. Our results also suggest exercising caution when using linear approximation methods to analyze the local dynamics of models with market frictions and non-convexities.
    Keywords: Externalities (Economics)
    Date: 2008
  21. By: Basso, Henrique S (Department of Economics)
    Abstract: This paper analyzes the effectiveness of delegation in solving the time inconsistency problem of monetary policy using a microfounded general equilibrium model where delegation and reappointment are explicitly included into the government's strategy. The method of Chari and Kehoe (1990) is applied to characterize the entire set of sustainable outcomes. Countering McCallum's (1995) second fallacy, delegation is able to eliminate the time inconsistency problem, with the commitment policy being sustained under discretion for any intertemporal discount rate.
    Keywords: Central Bank; Monetary Policy; Institutional Design
    JEL: E52 E58 E61
    Date: 2008–10–31

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