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on Dynamic General Equilibrium |
| By: | Alejandro Justiniano; Giorgio E. Primiceri; Andrea Tambalotti |
| Abstract: | Shocks to the marginal efficiency of investment are the most important drivers of business cycle fluctuations in US output and hours. Moreover, these disturbances drive prices higher in expansions, like a textbook demand shock. We reach these conclusions by estimating a DSGE model with several shocks and frictions. We also find that neutral technology shocks are not negligible, but their share in the variance of output is only around 25 percent, and even lower for hours. Labor supply shocks explain a large fraction of the variation of hours at very low frequencies, but not over the business cycle. Finally, we show that imperfect competition and, to a lesser extent, technological frictions are the key to the transmission of investment shocks in the model. |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedhwp:wp-08-12&r=dge |
| By: | Glenn Rudebusch; Eric Swanson |
| Abstract: | The term premium on nominal long-term bonds in the standard dynamic stochastic general equilibrium (DSGE) model used in macroeconomics is far too small and stable relative to empirical measures obtained from the data--an example of the ''bond premium puzzle.'' However, in models of endowment economies, researchers have been able to generate reasonable term premiums by assuming that investors have recursive Epstein-Zin preferences and face long-run economic risks. We show that introducing Epstein-Zin preferences into a canonical DSGE model can also produce a large and variable term premium without compromising the model's ability to fit key macroeconomic variables. Long-run real and nominal risks further improve the model's ability to fit the data with a lower level of household risk aversion. |
| Keywords: | Interest rates ; Econometric models |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:2008-31&r=dge |
| By: | Julio Dávila (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, CORE - Université Catholique de Louvain) |
| Abstract: | I show in this paper that in an overlapping generations economy with production à la Diamond (1970) in which the agents can only save in terms of capital (i.e. with not asset bubbles à la Tirole (1985) or public debt as in Diamond (1965)), there is a period-by-period balanced fiscal policy supporting a steady state allocation that Pareto-improves upon the laissez-faire competitive equilibrium steady state (whithout having to resort to intergenerational transfers) if there is no first generation or the economy starts there. A transition from the competitive equilibrium steady state to this other allocation is also Pareto-improving if the former is dynamically inefficient, but even in the dynamically efficient case if the elasticity of output to capital is high enough. This intervention allows every subsequent generation to attain, as a competitive equilibrium outcome, the highest utility attainable at a steady state through the existing markets for the consumption good and the production factors. The active fiscal policy consists of taxing (or subsidizing, in the dynamically efficient case) linearly the returns to capital, while balancing the budget period by period through a lump-sum transfer (or tax, respectively) on second period income. This policy does not finance any public spending, since there is none in the model. The only purpose of the intervention is to decentralize as a competitive equilibrium the steady state allocation that maximizes the utility of the representative agent among all steady state allocations attainable through the existing markets. |
| Keywords: | Taxation of capital, overlapping generations. |
| Date: | 2008–11 |
| URL: | http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-00348923_v1&r=dge |
| By: | Zheng Liu; Louis Phaneuf |
| Abstract: | A commonly held view is that nominal rigidities are important for the transmission of monetary policy shocks. We argue that they are also important for understanding the dynamic effects of technology shocks, especially on labor hours, wages, and prices. Based on a dynamic general equilibrium framework, our closed-form solutions reveal that a pure sticky-price model predicts correctly that hours decline following a positive technology shock, but fails to generate the observed gradual rise in the real wage and the near-constance of the nominal wage; a pure sticky-wage model does well in generating slow adjustments in the nominal wage, but it does not generate plausible dynamics of hours and the real wage. A model with both types of nominal rigidities is more successful in replicating the empirical evidence about hours, wages and prices. This finding is robust for a wide range of parameter values, including a relatively small Frisch elasticity of hours and a relatively high frequency of price reoptimization that are consistent with microeconomic evidence. |
| Date: | 2008–11 |
| URL: | http://d.repec.org/n?u=RePEc:emo:wp2003:0812&r=dge |
| By: | Zheng Liu; Daniel F. Waggoner; Tao Zha |
| Abstract: | We study the sources of the Great Moderation by estimating a variety of medium-scale DSGE models that incorporate regime switches in shock variances and in the inflation target. The best-fit model, the one with two regimes in shock variances, gives quantitatively different dynamics in comparison with the benchmark constant-parameter model. Our estimates show that three kinds of shocks accounted for most of the Great Moderation and business-cycle fluctuations: capital depreciation shocks, neutral technology shocks, and wage markup shocks. In contrast to the existing literature, we find that changes in the inflation target or shocks in the investment-specific technology played little role in macroeconomic volatility. Moreover, our estimates indicate much less nominal rigidities than those suggested in the literature. |
| Date: | 2008–11 |
| URL: | http://d.repec.org/n?u=RePEc:emo:wp2003:0811&r=dge |
| By: | Aoki, Takaaki |
| Abstract: | This article summarizes some propositions regarding economic dynamics and implications of two-way altruism, on the basis of the human-capital-based OLG model of Ehrlich and Lui (1991) and Ehrlich and Kim (2007) with application of a modified, fertility-endogenized definition of linearly separable two-way altruism examined by Abel (1987) and Altig and Davis (1993). Some properties in both a transition process and a steady state, and the effect of unfunded social security on an equilibrium path are also discussed. My calibration results and analyses show that (1) the combination of altruism toward parents and children is crucial for determining a threshold level of initial human capital and productivity in a transition process (stagnant to growth or growth to stagnant), and the generation’s attained utility, (2) dynamic consistency might not necessarily be the best choice to overpass the stumbling block against growth regime, (3) in this human-capital-based OLG model, a regular recursive induction approach might still cause inefficiency in terms of an ex-post Pareto optimality criterion as of two periods later, even if strategic effects for after children (two generations later) are appropriately taken account of, and (4) unfunded social security tax, which involves actuarially fair insurance as well as certainty premium transfer, does affect critical values for a regime change as well as dynamic equilibrium paths and corresponding subsequent life strategies, even in two-way altruistic economy. |
| Keywords: | Two way altruism; Dynamic consistency; Dynamic efficiency; Unfunded social security; Human capital; Fertility; Overlapping generation model |
| JEL: | O10 D10 H00 D60 |
| Date: | 2008–04 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:12492&r=dge |
| By: | Zheng Liu; Daniel F. Waggoner; Tao Zha |
| Abstract: | This study explores theoretical and macroeconomic implications of the self-confirming equilibrium in a standard growth model. When rational expectations are replaced by adaptive expectations, we prove that the self-confirming equilibrium is the same as the steady state rational expectations equilibrium, but that dynamics around the steady state are substantially different between the two equilibria. We show that, in contrast to Williams (2003), the differences are driven mainly by the lack of the wealth effect and the strengthening of the intertemporal substitution effect, not by escapes. As a result, adaptive expectations substantially alter the amplification and propagation mechanisms and allow technology shocks to exert much more impact on macroeconomic variables than do rational expectations. |
| Date: | 2008–05 |
| URL: | http://d.repec.org/n?u=RePEc:emo:wp2003:0803&r=dge |
| By: | Mireille Chiroleu-Assouline (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); Mouez Fodha (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) |
| Abstract: | This paper analyzes the environmental tax policy issues within an overlapping generations models framework. The objective is to analyze whether an environmental tax policy can respect the two equity principles simultaneously, the vertical as well the horizontal one. We characterize the necessary conditions for the obtaining of a Pareto improving shift when the revenue of the pollution tax is recycled by a change in the labor tax rate or by a change in the distributive properties of the labor tax. We show that, depending on the production function elasticities and on the heterogeneity characteristics of labor supply, an appropriate policy mix could be designed in order to leave each workers' class unharmed by the environmental tax reform. It will consist in an increase of the progressivity of the labor tax together with a decrease of the minimal wage tax rate. |
| Keywords: | Environmental tax, double dividend, tax progressivity, overlapping generations model. |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-00348891_v1&r=dge |
| By: | Edward C. Prescott; Timothy J. Kehoe |
| Abstract: | Three of the arguments made by Temin (2008) in his review of Great Depressions of the Twentieth Century are demonstrably wrong: that the treatment of the data in the volume is cursory; that the definition of great depressions is too general and, in particular, groups slow growth experiences in Latin America in the 1980s with far more severe great depressions in Europe in the 1930s; and that the book is an advertisement for the real business cycle methodology. Without these three arguments — which are the results of obvious conceptual and arithmetical errors, including copying the wrong column of data from a source — his review says little more than that he does not think it appropriate to apply our dynamic general equilibrium methodology to the study of great depressions, and he does not like the conclusion that we draw: that a successful model of a great depression needs to be able to account for the effects of government policy on productivity. |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmsr:418&r=dge |
| By: | J. Christina Wang; Susanto Basu; John G. Fernald |
| Abstract: | This paper addresses the proper measurement of financial service output that is not priced explicitly. It shows how to impute nominal service output from financial intermediaries' interest income, and how to construct price indices for those financial services. We model financial intermediaries as providers of financial services which resolve asymmetric information between borrowers and lenders. We embed these intermediaries in a dynamic, stochastic, general-equilibrium model where assets are priced competitively according to their systematic risk, as in the standard consumption-based capital-asset-pricing model. In this environment, we show that it is critical to take risk into account in order to measure financial output accurately. We also show that even using a risk-adjusted reference rate does not solve all the problems associated with measuring nominal financial service output. Our model allows us to address important outstanding questions in output and productivity measurement for financial firms, such as: (1) What are the correct "reference rates" to use in calculating bank output? In particular, should they take account of risk? (2) If reference rates need to be risk-adjusted, should they be ex ante or ex post rates of return? (3) What is the right price deflator for the output of financial firms? Is it just the general price index? (4) When--if ever--should we count capital gains of financial firms as part of financial service output? |
| JEL: | E01 E44 G21 G32 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:14616&r=dge |
| By: | Aurélien Saidi |
| Abstract: | It has been shown that under perfect competition and constant returns-to-scale, a one-sector growth model may exhibit local indeterminacy when income tax rates are endogenously determined by a balanced-budget rule while government expendi- tures are fixed. This paper shows that the associated aggregate instability does not ensue from the local indeterminacy of a specific stationary equilibrium but from the multiplicity of the stationary equilibria and persists under local determinacy of all of them. We provide a global analysis of the Schmitt-Grohe and Uribe model [1997] and study specific cases that were not investigated in the original paper, when aggregate instability is inherited from the coexistence of two saddle-path equilibria on one hand and from the connection of the two steady states on the other hand. |
| Keywords: | Balanced-budget rule, Increasing returns, Indeterminacy, Saddle-sink connection |
| JEL: | E32 E4 E62 H61 O42 O47 |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:drm:wpaper:2008-44&r=dge |
| By: | Edward S. Knotek II; Stephen Terry |
| Abstract: | We use simulation-based techniques to compare and contrast two methods for solving state-dependent pricing models: discretization, which solves and simulates the model on a grid; and collocation, which relies on Chebyshev polynomials. While both methods produce qualitatively similar results, statistically significant quantitative differences do arise. We present evidence favoring discretization over collocation in this context, given a lack of robustness in the latter. |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedkrw:rwp08-10&r=dge |
| By: | Antonella Tutino |
| Abstract: | This paper studies the implications of information-processing limits on the consumption and savings behavior of households through time. It presents a dynamic model in which consumers rationally choose the size and scope of the information they want to process concerning their financial possibilities, constrained by a Shannon channel. The model predicts that people with higher degrees of risk aversion rationally choose more information. This happens for precautionary reasons since, with finite processing rate, risk averse consumers prefer to be well informed about their financial possibilities before implementing a consumption plan. Moreover, numerical results show that consumers with processing capacity constraints have asymmetric responses to shocks, with negative shocks producing more persistent effects than positive ones. This asymmetry results in more savings. I show that the predictions of the model can be effectively used to study the impact of tax reforms on consumers spending. |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2008-62&r=dge |
| By: | Richard Dennis |
| Abstract: | Consumption-habits have become an integral component in new Keynesian models. However, consumption-habits can be modeled in a host of different ways and this diversity is reflected in the literature. I examine whether different approaches to modeling consumption habits have important implications for business cycle behavior. Using a standard new Keynesian business cycle model, I show that, to a first-order log-approximation, the consumption Euler equation associated with the additive functional form for habit formation encompasses the multiplicative function form. Empirically, I show that whether consumption habits are internal or external has little effect on the model's business cycle characteristics. |
| Keywords: | Business cycles |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:2008-35&r=dge |
| By: | Nutahara, Kengo |
| Abstract: | In many applications of habit persistence to macroeconomics, it is of little significance whether habits are internal or external. In this paper, it is shown that the distinction between internal and external habits is important in a situation wherein a shock is news about the future. An internal habit can be a source of news-driven business cycles, positive comovement in consumption, labor, investment, and output from the news about the future, whereas an external habit cannot. |
| Keywords: | Habit persistence; internal habit; external habit; news-driven business cycles |
| JEL: | E32 E21 |
| Date: | 2009–01–06 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:12550&r=dge |
| By: | Michael Woodford |
| Abstract: | I present a generalization of the standard (full-information) model of state-dependent pricing in which decisions about when to review a firm's existing price must be made on the basis of imprecise awareness of current market conditions. The imperfect information is endogenized using a variant of the theory of "rational inattention" proposed by Sims (1998, 2003, 2006). This results in a one-parameter family of models, indexed by the cost of information, which nests both the standard state-dependent pricing model and the Calvo model of price adjustment as limiting cases (corresponding to a zero information cost and an unboundedly large information cost respectively). For intermediate levels of the information cost, the model is equivalent to a "generalized Ss model" with a continuous "adjustment hazard" of the kind proposed by Caballero and Engel (1993a, 1993b), but provides an economic motivation for the hazard function and very specific predictions about its form. For high enough levels of the information cost, the Calvo model of price-setting is found to be a reasonable approximation to the exact equilibrium dynamics, except in the case of (infrequent) large shocks. When the model is calibrated to match the frequency and size distribution of price changes observed in microeconomic data sets, prices are found to be much less flexible than in a full-information state-dependent pricing model, and only about 20 percent more flexible than under a Calvo model with the same average frequency of price adjustment. |
| JEL: | E31 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:14620&r=dge |
| By: | Ethan Cohen-Cole; Enrique Martinez-Garcia |
| Abstract: | In this paper, we study the role of the credit channel of monetary policy in a synthesis model of the economy. Through the use of a well-specified banking sector and a regulatory capital constraint on lending, we provide an alternate mechanism that can potentially explain the periods of asymmetry in monetary policy without appealing to ad-hoc central bank preferences. This is accomplished through the characterization of the external finance premium that includes bank leverage and systemic risk. |
| Keywords: | Monetary policy |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedbqu:qau08-7&r=dge |
| By: | Patrick J. Kehoe; V. V. Chari; Andrew Atkeson |
| Abstract: | The Ramsey approach to policy analysis finds the best competitive equilibrium given a set of available instruments but is silent about unique implementation, namely, designing policies so that the associated competitive equilibrium is unique. This silence is particularly problematic in monetary policy environments, where many ways of specifying policy lead to indeterminacy. We show that sophisticated policies, which depend on the history of private actions and can differ on and off the equilibrium path, can uniquely implement any desired competitive equilibrium. A large literature has argued that monetary policy should adhere to the Taylor principle to eliminate indeterminacy. We show that adherence to the Taylor principle on these grounds is unnecessary for either determinacy or efficiency. We also show that sophisticated policies are robust to imperfect information. |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmsr:419&r=dge |
| By: | Jeremy Greenwood; Juan M. Sanchez; Cheng Wang |
| Abstract: | To address how technological progress in financial intermediation affects the economy, a costly-state verification framework is embedded into the standard growth model. The framework has two novel features. First, firms differ in the risk/return combinations that they offer. Second, the efficacy of monitoring depends upon the amount of resources invested in the activity. A financial theory of firm size results. Undeserving firms are over financed, deserving ones under funded. Technological advance in intermediation leads to more capital accumulation and a redirection of funds away from unproductive firms toward productive ones. Quantitative analysis suggests that finance is important for growth. |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedrwp:08-08&r=dge |
| By: | Michael Dotsey; Andreas Hornstein |
| Abstract: | Currently there is a growing literature exploring the features of optimal monetary policy in New Keynesian models under both commitment and discretion. This literature usually solves for the optimal allocations that are consistent with a rational expectations market equilibrium, but it does not study how the policy can be implemented given the available policy instruments. Recently, however, King and Wolman (2004) have shown that a time-consistent policy cannot be implemented through the control of nominal money balances. In particular, they find that equilibria are not unique under a money stock regime. The authors of this paper find that King and Wolman's conclusion of non-uniqueness of Markov-perfect equilibria is sensitive to the instrument of choice. Surprisingly, if, instead, the monetary authority chooses the nominal interest rate there exists a unique Markov-perfect equilibrium. The authors then investigate under what conditions a time-consistent planner can implement the optimal allocation by just announcing his policy rule in a decentralized setting. |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:08-30&r=dge |