nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2009‒01‒24
fourteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Dynamics of the price distribution in a general model of state-dependent pricing By James Costain; Antón Nákov
  2. Volatility, Growth and Labour Elasticity By Barbara Annicchiarico; Luisa Corrado; Alessandra Pelloni
  3. Can a Representative-Agent Model Represent a Heterogeneous-Agent Economy? By Sungbae An; Yongsung Chang; Sun-Bin Kim
  4. Is Volatility Good for Growth? By Elena Andreou; Marianne Sensier; Alessandra Pelloni
  5. Labor Supply Elasticities: Can Micro Be Misleading for Macro? By Riccardo Fiorito; Giulio Zanella
  6. Heterogeneity and Cyclical Unemployment By Mark Bils; Yongsung Chang; Sun-Bin Kim
  7. The Long-run Effects of Household Liquidity Constraints and Taxation on Fertility, Education, Saving and Growth By Papagni, Erasmo
  8. A Small Open Economy DSGE Model for Pakistan By Haider, Adnan; Khan, Safdar Ullah
  9. Technological Change and the Roaring Twenties: A Neoclassical Perspective By Sharon Harrison; Mark Weder
  10. Public and Private Expenditures on Health in the Presence of Inequality and Endogenous Mortality: A Political Economy Perspective By Radhika Lahiri; Elizabeth Richardson
  11. Riots, Battles and Cycles By Stéphane Auray; Aurélien Eyquem; Frédéric Jouneau-Sion
  12. Existence of Singularity Bifurcation in an Euler-Equations Model of the United States Economy: Grandmont was Right By Barnett, William A.; He, Susan
  13. Fiat Money and the Value of Binding Portfolio Constraints By Mário R. Páscoa; Myrian Petrassi; Juan Pablo Torres-Martínez
  14. The Benefit of Exchange Rate Flexibility, Trade Openness and Extensive Margin By Kanda Naknoi

  1. By: James Costain (Banco de España); Antón Nákov (Banco de España)
    Abstract: This paper analyzes the effects of monetary shocks in a DSGE model that allows for a general form of smoothly state-dependent pricing by firms. As in Dotsey, King, and Wolman (1999) and Caballero and Engel (2007), our setup is based on one fundamental property: firms are more likely to adjust their prices when doing so is more valuable. The exogenous timing (Calvo 1983) and fixed menu cost (Golosov and Lucas 2007) models are nested as limiting cases of our setup. Our model is calibrated to match the steady-state distribution of price adjustments in microdata; realism calls for firm-specific shocks. Computing a dynamic general equilibrium requires us to calculate how the distribution of prices and productivities evolves over time. We solve the model using the method of Reiter (2008), which is well-suited to this type of problem because it combines a fully nonlinear treatment of firm-level state variables with a linearization of the aggregate dynamics. We compute impulse responses to iid and autocorrelated money growth shocks, and decompose the inflation impact into 'intensive margin', 'extensive margin' and 'selection' components. Under our most successful calibration, increased money growth causes a persistent rise in inflation and output. The real effects are substantially larger if money growth is autocorrelated. In contrast, if we instead impose a fixed menu cost specification, money growth shocks cause a sharp spike in inflation (via the selection component) so that the real effects are small and short-lived, especially if money growth is iid. An increase in aggregate productivity raises consumption but causes labor to fall. Also, impulse responses differ depending on the distribution at the time the shock occurs. In particular, increased money growth has different effects starting from the steady state distribution than it does if all firms have recently received an economy-wide productivity shock.
    Keywords: price stickiness, state-dependent pricing, stochastic menu costs, generalized (S,s), heterogeneous agents, distributional dynamics
    JEL: E31 E52 D81
    Date: 2009–01
  2. By: Barbara Annicchiarico (University of Rome ‘Tor Vergata’. Italy); Luisa Corrado (University of Cambridge, UK and University of Rome ‘Tor Vergata’, Italy); Alessandra Pelloni (University of Rome ‘Tor Vergata’ and The Rimini Centre of Economic Analisys, Italy)
    Abstract: We study the relationship between growth and variability in a DSGE model with nominal rigidities and growth driven by learning-by-doing. We show that this relationship may be positive or negative depending on the impulse source of fluctuations A key role is also played by the Frisch elasticity of labour supply and by institutional features of the labour market. Our general findings are that monetary shocks volatility will generally have a negative effect on growth, while the opposite tends to be true for fiscal and productivity shocks. These findings are somehow consistent with the existing empirical evidence: data show, in fact, a somewhat ambiguous relationship between output growth and real variability, but a generally negative relationship between output growth and nominal variability.
    Keywords: Growth; Volatility; Monetary and Real Shocks; Labour Supply Elasticity; Second-Order Approximation Methods
    JEL: O42 E30 C63
    Date: 2008–01
  3. By: Sungbae An (Singapore Management University); Yongsung Chang (University of Rochester); Sun-Bin Kim (Korea University)
    Abstract: Accounting for observed fluctuations in aggregate employment, consumption, and real wage using the optimality conditions of a representative household often requires preferences that are incompatible with economic priors (e.g., Mankiw, Rotemberg, and Summers 1985). This discrepancy between the equilibrium model and the aggregate data is often viewed as evidence of the failure of labor-market clearing. We argue that such a conclusion is premature. We construct a model economy where all prices are flexible and all markets clear at all times but household decisions are not readily aggregated because of incomplete capital markets and the indivisible nature of the labor supply. We demonstrate that if we were to explain the model-generated aggregate time series using decisions of a fictitious" stand-in household, such a household is likely to have a non-concave or unstable utility. Our analysis suggests that the representative-agent model often fails to represent an equilibrium outcome of a heterogeneous-agent economy.
    Keywords: Representative-agent model, Aggregation, Heterogeneity, Incomplete Markets, Indivisible Labor, GMM Estimation
    JEL: E24 E32 J21 J22
    Date: 2008–09
  4. By: Elena Andreou (University of Cyprus, Cyprus); Marianne Sensier (The University of Manchester, UK); Alessandra Pelloni (University of Rome ‘Tor Vergata’ and The Rimini Centre of Economic Analisys, Italy)
    Abstract: We provide empirical support for a DSGE model with nominal wage stickiness where growth is driven by learning-by-doing and money shocks and their variance are allowed to impact on long-run output growth. In our theoretical model the variance of monetary shocks has a negative effect on growth, while output volatility is good for growth as a positive relationship exists. Utilising a bivariate GARCH-M model we test the empirical conditional mean and variance relationships of nominal money and production growth rates in the G7 countries. We corroborate the theoretical model predictions with evidence from Bonferroni multiple tests across the G7.
    Keywords: growth uncertainty, learning-by-doing, monetary uncertainty, multivariate GARCH-in-mean, nominal rigidity.
    JEL: C32 E32 O42
    Date: 2008–01
  5. By: Riccardo Fiorito; Giulio Zanella
    Abstract: In this paper we compare “micro” and “macro” labor supply elasticities in a MaCurdy-type equation. Using PSID data, we obtain the micro elasticity from standard panel techniques, and the macro elasticity from the time series generated by aggregating individuals every year. This procedure relies on the exact aggregation of first-order conditions in a life-cycle model with home production. We find an individual elasticity of about 0.1, a low value in line with mainstream microeconometric studies, and an aggregate elasticity of about 1, a much larger value often assumed in calibration studies. This discrepancy is not due to aggregation bias: it is due to the fact that individual and total hours are different variables, with the extensive margin that empirically dominates. A broader implication of our result is that micro evidence is not always appropriate for calibrating an aggregate model economy
    Keywords: elasticity of labor supply, aggregation, calibration
    JEL: E13 E32 J22
    Date: 2008–11
  6. By: Mark Bils (University of Rochester); Yongsung Chang (University of Rochester); Sun-Bin Kim (Korea University)
    Abstract: We model worker heterogeneity in the rents from being employed in a Diamond-Mortensen-Pissarides model of matching and unemployment. We show that heterogeneity, reflecting differences in match quality and worker assets, reduces the extent of fluctuations in separations and unemployment. We find that the model faces a trade-off-it cannot produce both realistic dispersion in wages across workers and realistic cyclical fluctuations in unemployment.
    Date: 2008–10
  7. By: Papagni, Erasmo
    Abstract: This paper investigates economic growth under liquidity constraints by taking into account the choices of fertility, human capital and saving. In a model of four overlapping generations, parents are altruistic towards their offspring and finance their education investment. The government provides education subsidies to young adult parents and levies taxes on income of the adult generation. Sensitivity analysis on borrowing limits and tax parameters highlights effects with opposite sign on the main endogenous variables at steady state. A lift in liquidity constraints decreases savings and capital accumulation and this effect is responsible for the ambiguous sign of comparative statics on the rate of fertility and on human capital investment. From model simulation, we derive an inverted U-shaped curve relating the borrowing limit with fertility, education and growth, meaning that financial reforms in the less developed countries have positive effects on the economy in the long-run, even if they raise fertility and reduce savings. Greater government subsidies to human capital investments and lower income taxes have positive effects on savings and fertility. The same parameters present ambiguous effects on education investments and growth. Numerical simulations show that a) human capital investment has an inverted U-shaped relation with income taxes and education subsidies ; b) economic growth decreases with greater income taxes and increases with higher education subsidies. Jel codes: O40, O16, J13, D91.
    Keywords: Borrowing constraints; taxation; endogenous population; economic growth
    JEL: J13 D91 O16 O40
    Date: 2008–05
  8. By: Haider, Adnan; 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: 2008–11–06
  9. By: Sharon Harrison; Mark Weder
    Abstract: In this paper, we address the causes of the Roaring Twenties in the United States. In particular, we use a version of the real business cycle model to test the hypothesis that an extraordinary pace of productivity growth was the driving factor. Our motivation comes from the abundance of evidence of signi?cant technological progress during this period, fed by innovations in manufacturing and the widespread introduction of electricity. Our estimated total factor productivity series generate arti?cial model output that shows high conformity with the data: the model economy sucessfully replicates the boom years from 1922-1929.
    Keywords: Real Business Cycles, Roaring Twenties.
    JEL: E32 N12
    Date: 2009–01
  10. By: Radhika Lahiri; Elizabeth Richardson
    Abstract: In this paper we study an overlapping-generations model in which agents’ mortality risks, and consequently impatience, are endogenously determined by private and public investment in health care. The proportion of revenues allocated for public health care is also endogenous, determined as the outcome of a voting process. Higher substitutability between public and private health is associated with a “crowding-out” effect which leads to lower public expenditures on health care in the political equilibrium. This in turn impacts on mortality risks and impatience leading to a greater persistence in inequality and long run distributions of wealth that are bimodal.
    Keywords: health; inequality; political economy; income distribution dynamics
    JEL: I12 I20 O5
    Date: 2008–12–15
  11. By: Stéphane Auray (Université Lille 3 (GREMARS), Université de Sherbrooke (GREDI) and CIRPÉE); Aurélien Eyquem (GATE, UMR 5824, Université de Lyon and Ecole Normale Supérieure Lettres et Sciences Humaines, France); Frédéric Jouneau-Sion (EQUIPPE (EA 4018), Université Lille Nord de France)
    Abstract: This paper proposes a conceptual framework to investigate the impact of military conflicts on business cycles, as well as defense policies through enrolment mechanisms. Our framework is a variation of a Real Business Cycle model first proposed by Hercowitz and Sampson (1991) that admits explicit solutions. We extend and estimate the initial model on US data to account for specific shocks that destroy the stock of capital and that may be as large as desired. We consider two types of dynamics on the depreciation rate of capital: short-term shocks, that may be interpreted as riots and captured by a Moving Average specification, and mid-term shocks, that may be interpreted as wars and captured by a Markov Switching process. Destructions may be limited by publicly decided enrolment, which allows to question the goals defense policies should aim at. First our model reproduces usual business cycle facts. Second, it allows to characterize the macroeconomic dynamics after shocks on the depreciation rate of capital. Finally, it provides a simple framework to quantify the welfare effects of alternative (simple) defense technologies.
    Keywords: military policy, Real Business Cycle model, random coefficient autoregressive model
    JEL: E13 E32 H56
    Date: 2009
  12. By: Barnett, William A.; He, Susan
    Abstract: Abstract: Grandmont (1985) found that the parameter space of the most classical dynamic general-equilibrium macroeconomic models are stratified into an infinite number of subsets supporting an infinite number of different kinds of dynamics, from monotonic stability at one extreme to chaos at the other extreme, and with all forms of multiperiodic dynamics between. But Grandmont provided his result with a model in which all policies are Ricardian equivalent, no frictions exist, employment is always full, competition is perfect, and all solutions are Pareto optimal. Hence he was not able to reach conclusions about the policy relevance of his dramatic discovery. As a result, Barnett and He (1999, 2001, 2002) investigated a Keynesian structural model, and found results supporting Grandmont’s conclusions within the parameter space of the Bergstrom-Wymer continuous-time dynamic macroeconometric model of the UK economy. That prototypical Keynesian model was produced from a system of second order differential equations. The model contains frictions through adjustment lags, displays reasonable dynamics fitting the UK economy’s data, and is clearly policy relevant. In addition, results by Barnett and Duzhak (2008,2009) demonstrate the existence of Hopf and flip (period doubling) bifurcation within the parameter space of recent New Keynesian models. Lucas-critique criticism of Keynesian structural models has motivated development of Euler equations models having policy-invariant deep parameters, which are invariant to policy rule changes. Hence, we continue the investigation of policy-relevant bifurcation by searching the parameter space of the best known of the Euler equations general-equilibrium macroeconometric models: the path-breaking Leeper and Sims (1994) model. We find the existence of singularity bifurcation boundaries within the parameter space. Although never before found in an economic model, singularity bifurcation may be a common property of Euler equations models, which often do not have closed form solutions. Our results further confirm Grandmont’s views. Beginning with Grandmont’s findings with a classical model, we continue to follow the path from the Bergstrom-Wymer policy-relevant Keynesian model, to New Keynesian models, and now to Euler equations macroeconomic models having deep parameters.
    Keywords: Bifurcation; inference; dynamic general equilibrium; Pareto optimality; Hopf bifurcation; Euler equations; Leeper and Sims model; singularity bifurcation; stability.
    JEL: E32 C14 C52 E52 C22 E37 E61
    Date: 2009–01–16
  13. By: Mário R. Páscoa; Myrian Petrassi; Juan Pablo Torres-Martínez
    Abstract: It is well known that, under uniform impatience, positive net supply assets are free of bubbles for non-arbitrage kernel deflators that yield finite present values of wealth. However, this does not mean that prices cannot be above the series of deflated dividends for the deflators given by the agents' marginal rates of substitution, which also yield finite present values of wealth. In particular, binding no-short-sales constraints lead to positive prices of fiat money. These monetary equilibria are Pareto improvements but they are still inefficient.
    Date: 2009–01
  14. By: Kanda Naknoi
    Abstract: The literature on optimum currency areas argues that in the presence of countryspecific real shocks, the cost of fixing exchange rates is decreasing in the degree of trade openness. This study uses a stochastic dynamic general equilibrium model of endogenous specialization to assess the benefit of exchange rate flexibility. The benefit of exchange rate flexibility consists of the benefit along the extensive margin through adjustment in the composition of trade, and the benefit along the intensive margin through adjustment in the relative prices. Openness is found to influence these two benefits differently. Thus, the model predicts a non-monotonic relationship between openness and the benefit of exchange rate flexibility.
    Keywords: Exchange rate regimes, Trade costs, Openness
    JEL: F41 F42
    Date: 2008–11

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