nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2008‒12‒21
ten papers chosen by
Christian Zimmermann
University of Connecticut

  1. A Medium-scale Open Economy Model of Australia By Jarkko Jääskelä; Kristoffer Nimark
  2. A Small Open Economy DSGE Model for Pakistan By Bukhari, Syed Adnan Haider Ali Shah; Khan, Safdar Ullah
  3. The Effects of Labour Market Policies in an Economy with an Informal Sector By James Albrecht; Lucas Navarro; Susan Vroman
  4. S-shaped utility, subprime crash and the black swan By de Farias Neto, Joao Jose
  5. Forecast with judgment and models By Francesca Monti
  6. Can Structural Small Open Economy Models Account for the Influence of Foreign Disturbances? By Alejandro Justiniano; Bruce Preston
  7. Monetary policies and low-frequency manifestations of the quantity theory By Sargent, Thomas; Surico, Paolo
  8. On Discounted Dynamic Programming with Unbounded Returns By Matkowski, Janusz; Nowak, Andrzej S.
  9. Imperfect Competition in Financial Markets and Capital Controls: A Model and a Test. By Pasricha, Gurnain Kaur
  10. Recursive utilities with a variable bound on impatience By Jaśkiewicz, Anna; Matkowski, Janusz; Nowak, Andrzej

  1. By: Jarkko Jääskelä (Reserve Bank of Australia); Kristoffer Nimark (Reserve Bank of Australia)
    Abstract: We estimate an open economy dynamic stochastic general equilibrium (DSGE) model of Australia with a number of shocks, frictions and rigidities, matching a large number of observable time series. We find that both foreign and domestic shocks are important drivers of the Australian business cycle. We also find that the initial impact on inflation of an increase in demand for Australian commodities is negative, due to an improvement in the real exchange rate, though there is a persistent positive effect on inflation that dominates at longer horizons.
    Keywords: monetary policy
    JEL: C11 E40 E52
    Date: 2008–12
  2. By: Bukhari, Syed Adnan Haider Ali Shah; Khan, Safdar Ullah
    Abstract: This paper estimates a small open economy Dynamic Stochastic General Equilibrium (DSGE) model for Pakistan using Bayesian simulation approach. Model setup is based on new Keynesian framework, characterized by nominal rigidity in prices with habit formation in household’s consumption. The core objective is to study whether an estimated small open economy DSGE model provides a realistic behavior about the structure Pakistan economy with fully articulated description of the monetary policy transmission mechanism vis-à-vis domestic firm’s price setting behavior. To do so, we analyze the impulse responses of key macro variables; domestic inflation, imported inflation, output, consumption, interest rate, exchange rate, term of trade to different structural/exogenous shocks. From several interesting results, few are; (a) high inflation in Pakistan do not hit domestic consumption significantly; (b) Central bank of Pakistan responds to high inflation by increasing the policy rate by 100 to 200 bps; (c) exchange rate appreciates in both the cases of high domestic and imported inflation; (d) tight monetary policy stance helps to curb domestic inflation as well as imported inflation but appreciates exchange rate significantly (f) pass through of exchange rate to domestic inflation is very low; finally parameter value of domestic price stickiness shows that around 24 percent domestic firms do not re-optimize their prices which implies averaged price contract is about two quarters.
    Keywords: New-Keynesian economics; open economy DSGE models; nominal rigidities; monetary policy transmission mechanism; Bayesian Approach
    JEL: F37 E32 E52 F47 E47
    Date: 2008–11–18
  3. By: James Albrecht (Georgetown University and IZA); Lucas Navarro (ILADES-Georgetown University, Universidad Alberto Hurtado); Susan Vroman (Georgetown University and IZA)
    Abstract: In this paper, we build an equilibrium search and matching model of an economy with an informal sector. Our model extends Mortensen and Pissarides (1994) by allowing for ex ante worker heterogeneity with respect to formal-sector productivity. We use the model to analyze the effects of labour market policy on informal-sector and formal sector output, on the division of the workforce into unemployment, informal-sector employment and formal-sector employment, and on wages. Finally, we examine the distributional implications of labour market policy; specifically, we analyse how labour market policy affects the distributions of wages and productivities across formal-sector matches. Keywords: Informality and Labour Market Policy
    JEL: E26 J64 O17
    Date: 2008–09
  4. By: de Farias Neto, Joao Jose
    Abstract: I propose an S-shaped utility function of consumption which, combined with an heterogeneous agents and external habit setting, fits well the first order moments of the American financial and macroeconomic time series relevant for the equity premium puzzle in the second half of XX century. The average relative risk aversion of the agents remains in the 0-3 range. A "black swan"-kind phenomenon makes two of the 50 years considered (the two oil shocks) responsible for half the average of the stochastic discount factor, thus bringing the annual subjective discount factor to a very low level, around 0.5, which solves the risk-free puzzle. The shape of the relative risk aversion function of consumption suggests an explanation for the 2008 suprime crash akin to the breaking of waves on a beach in a lifecycle overlapping generations model.
    Keywords: financial puzzles; subprime crash; black swan; S-shaped utility
    JEL: G12 D91 E44
    Date: 2008–12–12
  5. By: Francesca Monti (ECARES, Université Libre de Bruxelles)
    Abstract: This paper proposes a simple and model-consistent method for combining forecasts generated by structural micro-founded models and judgmental forecasts. The method also enables the judgmental forecasts to be interpreted through the lens of the model. We illustrate the proposed methodology with a real-time forecasting exercise, using a simple neo-Keynesian dynamic stochastic general equilibrium model and prediction from the Survey of Professional Forecasters
    Keywords: forecasting, judgment, structural models, Kalman Filter, real time
    JEL: C32 C53
    Date: 2008–12
  6. By: Alejandro Justiniano; Bruce Preston
    Abstract: This paper demonstrates that an estimated, structural, small open economy model of the Canadian economy cannot account for the substantial influence of foreign-sourced disturbances identified in numerous reduced-form studies. The benchmark model assumes uncorrelated shocks across countries and implies that U.S. shocks account for less than 3 percent of the variability observed in several Canadian series, at all forecast horizons. Accordingly, model-implied cross-correlation functions between Canada and U.S. are essentially zero. Both findings are at odds with the data. A specification that assumes correlated cross-country shocks partially resolves this discrepancy, but still falls well short of matching reduced-form evidence.
    JEL: F41
    Date: 2008–12
  7. By: Sargent, Thomas (New York University); Surico, Paolo (Monetary Policy Committee Unit, Bank of England)
    Abstract: To detect the quantity theory of money, we follow Lucas (1980) by looking at scatter plots of filtered time series of inflation and money growth rates and interest rates and money growth rates. Like Whiteman (1984), we relate those scatter plots to sums of two-sided distributed lag coefficients constructed from fixed-coefficient and time-varying VARs for US data from 1900-2005. We interpret outcomes in terms of population values of those sums of coefficients implied by two DSGE models. The DSGE models make the sums of coefficients depend on the monetary policy rule via cross-equation restrictions of a type that Lucas (1972) and Sargent (1971) emphasised in the context of testing the natural unemployment rate hypothesis. When the US data are extended beyond Lucas's 1955-75 period, the scatter plots mutate in ways that we attribute to prevailing monetary policy rules.
    Keywords: Quantity theory; policy regimes; time-varying VAR
    JEL: E40 E42 E51 E52 N10
    Date: 2008–12–08
  8. By: Matkowski, Janusz; Nowak, Andrzej S.
    Abstract: In this paper, we apply the idea of $k$-local contraction of \cite{zec, zet} to study discounted stochastic dynamic programming models with unbounded returns. Our main results concern the existence of a unique solution to the Bellman equation and are applied to the theory of stochastic optimal growth. Also a discussion of some subtle issues concerning k-local and global contractions is included.
    Keywords: Stochastic dynamic programming; Bellman functional equation; contraction mapping; stochastic optimal growth
    JEL: D90 D91 C61
    Date: 2008–10–13
  9. By: Pasricha, Gurnain Kaur
    Abstract: This paper explores the implications of financial repression, specifically, imperfect competition in the financial sector and capital controls for equilibrium interest rates and current account imbalances; and the implications of liberalization. I find that (1) interest differentials between home and foreign markets exist and are higher the fewer the number of domestic financial institutions (2) liberalization of the domestic financial sector - i.e. increasing the number of players - exacerbates current account imbalances in growing economies and reduces revenues from repression (3) revenues from financial repression decline when capital controls become porous (which may be a consequnce of trade liberalization), making liberalization of domestic financial sector more palatable to the domestic governments. An empirical exercise validates several predictions of the model.
    Keywords: Financial Repression; Capital Controls; Imperfect Competition in Financial Markets; Domestic Financial Liberalization; Interest Differentials
    JEL: F4 F32 D43
    Date: 2008–12–11
  10. By: Jaśkiewicz, Anna; Matkowski, Janusz; Nowak, Andrzej
    Abstract: Abstract: In this paper we study a new class of recursive utilities in dynamic choice processes in a stochastic environment. The basic idea is to introduce a variable measure of impatience for an economic agent. In the literature, this kind of measure is presented by a Lipschitz constant (often a contraction coefficient) concerning the aggregator. In this paper, on the other hand, the contraction property is described by some increasing real-valued function. When this function is linear, then our theory coincides with the well-known case. We make use of an extension of the Banach contraction principle given by Matkowski to derive recursive utilities and solve the associated dynamic programming problem. We present two approaches in order to take into account randomness of future outcomes. Our first approach is in spirit of the von Neumann-Morgenstern concept and is based on the notion of expectation. We construct a recursive utility on the space of trajectories of the process and then take its expected value. It turns out that the associated optimization problem leads to a non-stationary dynamic programming and an infinite system of Bellman equations, which result in obtaining persistently optimal policies. In our second approach, we construct recursive utilities on the space of policies of an agent that have a natural interpretation. The associated optimization problem leads to a solution of a single Bellman equation and deriving a stationary optimal policy for the agent. Our theory is enriched by various applications , e.g., to many growth stochastic models.
    Keywords: Koopmans' equation; Recursive utility; Nonlinear contraction mapping theorem; Dynamic programming; Bellman equation
    JEL: C60
    Date: 2008–11–29

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