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on Dynamic General Equilibrium |
| By: | Consolo, Agostino; Favero, Carlo A; Paccagnini, Alessina |
| Abstract: | Dynamic Stochastic General Equilibrium (DSGE) models are now considered attractive by the profession not only from the theoretical perspective but also from an empirical standpoint. As a consequence of this development, methods for diagnosing the fit of these models are being proposed and implemented. In this article we illustrate how the concept of statistical identification, that was introduced and used by Spanos(1990) to criticize traditional evaluation methods of Cowles Commission models, could be relevant for DSGE models. We conclude that the recently proposed model evaluation method, based on the DSGE-VAR(ë), might not satisfy the condition for statistical identification. However, our application also shows that the adoption of a FAVAR as a statistically identified benchmark leaves unaltered the support of the data for the DSGE model and that a DSGE-FAVAR can be an optimal forecasting model. |
| Keywords: | Bayesian analysis; Dynamic stochastic general equilibrium model; Factor-Augmented Vector Autoregression; Model evaluation |
| JEL: | C11 C52 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7176&r=dge |
| By: | Adolfson, Malin; Laséen, Stefan; Lindé, Jesper; Svensson, Lars E O |
| Abstract: | This paper studies the transmission of shocks and the trade-offs between stabilizing CPI inflation and alternative measures of the output gap in Ramses, the Riksbank's empirical dynamic stochastic general equilibrium (DSGE) model of a small open economy. The main results are, first, that the transmission of shocks depends substantially on the conduct of monetary policy, and second, that the trade-off between stabilizing CPI inflation and the output gap strongly depends on which concept of potential output in the output gap between output and potential output is used in the loss function. If potential output is defined as a smooth trend this trade-off is much more pronounced compared to the case when potential output is defined as the output level that would prevail if prices and wages were flexible. |
| Keywords: | impulse responses; instrument rules; open-economy DSGE models; Optimal monetary policy; output gap; potential output |
| JEL: | E52 E58 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7070&r=dge |
| By: | Fernández-Villaverde, Jesús |
| Abstract: | In this paper, I review the literature on the formulation and estimation of dynamic stochastic general equilibrium (DSGE) models with a special emphasis on Bayesian methods. First, I discuss the evolution of DSGE models over the last couple of decades. Second, I explain why the profession has decided to estimate these models using Bayesian methods. Third, I briefly introduce some of the techniques required to compute and estimate these models. Fourth, I illustrate the techniques under consideration by estimating a benchmark DSGE model with real and nominal rigidities. I conclude by offering some pointers for future research. |
| Keywords: | Bayesian Methods; DSGE Models; Likelihood Estimation |
| JEL: | C11 C13 E30 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7157&r=dge |
| By: | Heer, Burkhard; Irmen, Andreas |
| Abstract: | We study the effect of a declining labor force on the incentives to engage in labor-saving technical change and ask how this effect is influenced by institutional characteristics of the pension scheme. When labor is scarcer it becomes more expensive and innovation investments that increase labor productivity are more profitable. We incorporate this channel in a new dynamic general equilibrium model with endogenous economic growth and heterogeneous overlapping generations. We calibrate the model for the US economy. First, we establish that the net effect of a decline in population growth on the growth rate of per-capita magnitudes is positive and quantitatively significant. Second, we find that the pension system matters both for the growth performance and for individual welfare. Third, we show that the assessment of pension reform proposals may be different in an endogenous growth framework as opposed to the standard framework with exogenous growth. |
| Keywords: | capital accumulation; demographic transition; growth; pension reform |
| JEL: | C68 D31 D91 O11 O41 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7172&r=dge |
| By: | Benk, Szilárd; Gillman, Max; 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 en dogenous 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: | Growth; Inflation; Money and credit shocks; Volatility |
| JEL: | E13 E32 |
| Date: | 2009–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7150&r=dge |
| By: | O'Rourke, Kevin H; Rahman, Ahmed; Taylor, Alan M |
| Abstract: | Technological change was unskilled-labor-biased during the early Industrial Revolution, but is skill-biased today. This is not embedded in extant unified growth models. We develop a model which can endogenously account for these facts, where factor bias reflects profit maximizing decisions by innovators. Endowments dictate that the early Industrial Revolution be unskilled-labor-biased. Increasing basic knowledge causes a growth takeoff, an income-led demand for fewer educated children, and the transition to skill-biased technological change. The simulated model tracks British industrialization in the 18th and 19th centuries and generates a demographic transition without relying on either rising skill premia or exogenous educational supply shocks. |
| Keywords: | demography; endogenous growth; unified growth theory |
| JEL: | J13 J24 N10 O31 O33 |
| Date: | 2008–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7045&r=dge |
| By: | Heathcote, Jonathan; Perri, Fabrizio |
| Abstract: | In simple one-good international macro models, the presence of non-diversifiable labor income risk means that country portfolios should be heavily biased toward foreign assets. The fact that the opposite pattern of diversification is observed empirically constitutes the international diversification puzzle. We embed a portfolio choice decision in a frictionless two-country, two-good version of the stochastic growth model. In this environment, which is a workhorse for international business cycle research, we fully characterize equilibrium country portfolios. These are biased towards domestic assets, as in the data. Home bias arises because endogenous international relative price fluctuations make domestic assets a good hedge against non-diversifiable labor income risk. We then use our theory to link openness to trade to the level of diversification, and find that it offers a quantitatively compelling account for the patterns of international diversification observed across developed economies in recent years. |
| Keywords: | Country portfolios; Home bias; International business cycles |
| JEL: | F36 F41 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6982&r=dge |
| By: | Bertrand Gruss; Silvia Sgherri |
| Abstract: | The ongoing financial turmoil has triggered a lively debate on ways of containing systemic risk and lessening the likelihood of future boom-and-bust episodes in credit markets. Particularly, it has been argued that banking regulation might attenuate procyclicality in lending standards by affecting the behavior of banks capital buffers. This paper uses a two-country DSGE model with financial frictions to illustrate how procyclicality in borrowing limits reinforces the ”overreaction” of asset prices to shocks described by Aiyagari and Gertler (1999), and to quantify the stabilization gains from policies aimed at smoothing cyclical swings in credit conditions. Results suggest that, in financially constrained economies, the ensuing volatility reduction in equity prices, investment, and external imbalances would be sizable. In the presence of cross-border spillovers, gains would be even higher. |
| Keywords: | Credit Cycles; Collateral Constraints; DSGE Models |
| JEL: | E32 F42 F36 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2009/07&r=dge |
| By: | Meenagh, David; Minford, Patrick; Wickens, Michael R |
| Abstract: | We use the method of indirect inference, using the bootstrap, to test the Smets and Wouters model of the EU against a VAR auxiliary equation describing their data; the test is based on the Wald statistic. We find that their model generates excessive variance compared with the data. But their model passes the Wald test easily if the errors have the properties assumed by SW but scaled down. We compare a New Classical version of the model which also passes the test easily if error properties are chosen using New Classical priors (notably excluding shocks to preferences). Both versions have (different) difficulties fitting the data if the actual error properties are used. |
| Keywords: | Bootstrap; DSGE Model; Indirect inference; Model of EU; VAR model; Wald statistic |
| JEL: | C12 C32 |
| Date: | 2008–06 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6838&r=dge |
| By: | Beetsma, Roel; Bovenberg, A Lans; Romp, Ward E |
| Abstract: | We explore intergenerational and international risk sharing in a general equilibrium multiple-country model with two-tier pensions systems. The exact design of the funded tier is key for the way in which risks are shared over the various generations. The laissez-faire market solution fails to provide an optimal allocation because the young cannot share in the risks. However, the existence of wage-indexed bonds combined with a pension system with a fully-funded second tier that pays defined wage-indexed benefits can reproduce the first best. If wage-indexed bonds are not available, mimicking the first best is not possible, except under special circumstances. We also explore whether national pension funds want to deviate from the first best by increasing domestic equity holdings. With wage-indexed bonds this incentive is absent, while there is indeed such an incentive when wage-indexed bonds do not exist. |
| Keywords: | defined wage-indexed benefits; funded pensions; overlapping generations; risk sharing; wage-indexed bonds |
| JEL: | E2 F42 G23 H55 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7106&r=dge |
| By: | Arce, Oscar; López-Salido, J David |
| Abstract: | In this paper we use the notion of a housing bubble as an equilibrium in which some investors hold houses only for resale purposes and not for the expectation of a dividend, either in the form of rents or utility. We provide a life-cycle model where households face collateral constraints that tie their credit capacity to the value of their houses and examine the conditions under which housing bubbles can emerge. In such equilibria, the total housing stock is held by owners that extract utility from their homes, landlords that obtain rents, and investors. We show that an economy with tighter collateral constraints is more prone to bubbles which, in turn, tend to have a larger size but are less fragile in face of fund-draining shocks. Our environment also allows for pure bubbles on useless assets. We find that multiple equilibria in which the economy moves endogenously from a pure bubble to a housing bubble regime and vice versa are possible. This suggests that high asset price volatility may be a natural consequence of asset shortages (or excess funding) that depress interest rates sufficiently so as to sustain an initial bubble. We also examine some welfare implications of the two types of bubbles and discuss some mechanisms to rule out equilibria with housing bubbles. |
| Keywords: | buy-to-let investment; collateral constraints; housing bubbles; switching |
| JEL: | G21 R21 |
| Date: | 2008–08 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6932&r=dge |
| By: | Piero Gottardi; Felix Kubler |
| Abstract: | In this paper we identify conditions under which the introduction of a pay-as-you-go social security system is ex ante Pareto-improving in a stochastic overlapping generations economy with capital accumulation and land. We argue that these conditions are consistent with many calibrations of the model used in the literature. In our model financial markets are complete and competitive equilibria are interim Pareto e¢ cient. Therefore, a welfare improvement can only be obtained if agents' welfare is evaluated exante, and arises from the possibility of inducing, through social security, an improved level of intergenerational risk sharing. We will also examine the optimal size of a given social security system as well as its optimal reform. The analysis will be carried out in a relatively simple set-up, where the various effects of social security, on the prices of long-lived assets and the stock of capital, and hence on output, wages and risky rates of returns, can be clearly identified. |
| Keywords: | Intergenerational Risk Sharing, Social Security, Ex Ante Welfare Improvements, Social Security Reform, Price E¤ects |
| JEL: | H55 E62 D91 D58 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2009/12&r=dge |
| By: | Coeurdacier, Nicolas; Kollmann, Robert; Martin, Philippe |
| Abstract: | Despite the liberalization of capital flows among OECD countries, equity home bias remains sizable. We depart from the two familiar explanations of equity home bias: transaction costs that impede international diversification, and terms of trade responses to supply shocks that provide risk sharing, so that there is little incentive to hold diversified portfolios. We show that the interaction of the following ingredients generates a realistic equity home bias: capital accumulation, shocks to the efficiency of physical investment, as well as international trade in stocks and bonds. In our model, domestic stocks are used to hedge fluctuations in local wage income. Terms of trade risk is hedged using bonds denominated in local goods and in foreign goods. In contrast to related models, the low level of international diversification does not depend on strongly countercyclical terms of trade. The model also reproduces the cyclical dynamics of foreign asset positions and of international capital flows. |
| Keywords: | capital accumulation; capital flows; current account; international equity and bond portfolios; terms of trade; valuation effects |
| JEL: | F2 F3 G1 |
| Date: | 2008–07 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6902&r=dge |
| By: | Bing Li (Indiana University Bloomington) |
| Abstract: | To estimate a single-equation scal policy rule by Ordinary Least Squares (OLS) method has been one of the common approaches to identify scal policy behavior. However, OLS regression on the scal policy rule is subject to simultaneity bias because the scal rule is isolated from a system of equations implied by general equilibrium theory. This paper investigates the simultaneity bias problem within a simple Dynamic Stochastic General Equilibrium (DSGE) model. We derive the analytical form of the simultaneity bias, which turns out to extensively exist in the parameter space. Consequently, structural interpretation of the OLS estimator of the scal policy rule may be misleading and the corresponding identication of scal policy behavior may be unreliable. We calibrate the model to the U.S. data and use Monte Carlo experiments for illustration. The simultaneity bias problem examined here is inherent in general equilibrium framework, which should call for extra caution of the empirical macroeconomists. |
| JEL: | E62 H2 H3 H6 |
| Date: | 2008–11 |
| URL: | http://d.repec.org/n?u=RePEc:inu:caeprp:2008-026&r=dge |
| By: | Gregory de Walque (National Bank of Belgium, Research Department; University of Namur); Olivier Pierrard (Central Bank of Luxembourg; Catholic University of Louvain); Henri Sneessens (Catholic University of Louvain); Raf Wouters (National Bank of Belgium, Research Department; University of Louvain) |
| Abstract: | We consider a model with frictional unemployment and staggered wage bargaining where hours worked are negotiated for each period. The workers' bargaining power in the working time negotiations affects both unemployment volatility and inflation persistence. The closer to zero this parameter, (i) the more firms tend to adjust on the intensive margin, reducing employment volatility, (ii) the lower the effective workers' bargaining power for wages and (iii) the more important the hourly wage in determining the marginal cost. This set-up produces realistic labour market figures together with inflation persistence. Distinguishing the probability to bargain the wage rate for existing and new jobs, we show that the intensive margin helps reduce the new entrants' wage rigidity required to match observed unemployment volatility. |
| Keywords: | DSGE, Search and Matching, Nominal Wage Rigidity, Monetary Policy |
| JEL: | E31 E32 E52 J64 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:nbb:reswpp:200902-19&r=dge |
| By: | Brian Petereson (Indiana University Bloomington) |
| Abstract: | Theory predicts that the effects of search frictions on house prices from temporary movements in demand should be temporary, while the data suggests it is permanent. The latter implies that movements in demand coupled with search frictions create higher volatility in prices than theory would predict, amplifying price changes, leading to bubbles and depressions. To generate permanent price changes from temporary demand shocks, a textbook search model is combined with a behavioral assumption where house buyers and sellers ignore the effects of search frictions on past prices. The estimated model implies that over half of the real price growth from the housing bubble starting in 1998 is due to the behavioral assumption where households are ‘Fooled by Search.’ When trend growth of prices is removed, the behavioral assumption explains almost three-fourths of the housing bubble. The estimated model also provides several other results. (1) There is a large inefficiency in the search process of the housing market: buyers have very little bargaining power relative to their impact on creating sales, i.e. the Hosios condition is not met by an order of magnitude. (2) There is evidence of a rise in the fundamental value of houses from 1998 to 2005 that mirrors the loose monetary policy under the Greenspan Federal Reserve. (3) Analysis of the boom and bust of the housing market from 1975 to 1982 suggests that buyers who are choosing to not enter the housing market are rational. Using the last observation to make a back of the envelope projection for the current crisis, turnover will have to fall to its 1982 level and remain there until 2011 before a recovery can begin, driving house prices down to their real levels of 2002-2003 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:inu:caeprp:2009-004&r=dge |
| By: | Holger Kraft; Claus Munk |
| Abstract: | We provide explicit solutions to life-cycle utility maximization problems simultaneously involving dynamic decisions on investments in stocks and bonds, consumption of perishable goods, and the rental and the ownership of residential real estate. House prices, stock prices, interest rates, and the labor income of the decision-maker follow correlated stochastic processes. The preferences of the individual are of the Epstein-Zin recursive structure and depend on consumption of both perishable goods and housing services. The explicit consumption and investment strategies are simple and intuitive and are thoroughly discussed and illustrated in the paper. For a calibrated version of the model we find, among other things, that the fairly high correlation between labor income and house prices imply much larger life-cycle variations in the desired exposure to house price risks than in the exposure to the stock and bond markets. We demonstrate that the derived closed-form strategies are still very useful if the housing positions are only reset infrequently and if the investor is restricted from borrowing against future income. Our results suggest that markets for REITs or other financial contracts facilitating the hedging of house price risks will lead to non-negligible but moderate improvements of welfare. |
| JEL: | G11 D14 D91 C6 |
| Date: | 2009–02 |
| URL: | http://d.repec.org/n?u=RePEc:fra:franaf:197&r=dge |
| By: | Menzio, Guido; Moen, Espen R |
| Abstract: | We consider a frictional labor market in which firms want to insure their senior employees against income fluctuations and, at the same time, want to recruit new employees to fill their vacant positions. Firms can commit to a wage schedule, i.e. a schedule that specifies the wage paid by the firm to its employees as function of their tenure and other observables. However, firms cannot commit to the employment relationship with any of their workers, i.e. firms can dismiss workers at will. We find that, because of the firm's limited commitment, the optimal schedule prescribes not only a rigid wage for senior employees, but also a downward rigid wage for new hires. Moreover, we find that, while the rigidity of the wage of senior workers does not affect the allocation of labor, the rigidity of the wage of new hires magnifies the response of unemployment and vacancies to negative shocks to the aggregate productivity of labor. |
| Keywords: | Business Cycles; Competitive Search; Risk Sharing; Unemployment |
| JEL: | E24 E32 J64 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7075&r=dge |
| By: | Horii, Ryo; Ono, Yoshiyasu |
| Abstract: | This paper presents a simple model in which the learning behavior of agents generates fluctuations in money demand and possibly causes a prolonged depression. We consider a stochastic Money-in-Utility model, where agents receive utility from holding money only when a liquidity shock (e.g., a bank run) occurs. Households update the subjective probability of the shock based on the observation and change their money demand accordingly. In this setting, we first derive a stationary cycles under perfect price adjustment, which is characterized by periods of gradual inflation and sudden sporadic falls of the price level. When the nominal stickiness is introduced, the liquidity shock is followed by a period of low output. We show that the adverse effects of the shocks are largest when they occur in succession in an economy which has enjoyed a long period of stability. |
| Keywords: | Bayesian Learning; Money Demand; Hamilton-Jacobi-Bellman Equations; Markov Modulated Poisson Processes; Partial Delay Differential Equations |
| JEL: | E32 D83 E41 |
| Date: | 2009–02–18 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:13485&r=dge |
| By: | Horii, Ryo; Sasaki, Masaru |
| Abstract: | This paper constructs an overlapping generations model with a frictional labor market to explain persistent low education in developing countries. When parents are uneducated, their children often face difficulties in finishing school and therefore are likely to remain uneducated. Moreover, if children expect that other children of the same generation will not receive an education, they expect that firms will not create enough jobs for educated workers, and thus are further discouraged from schooling. These intergenerational and intragenerational mechanisms reinforce each other, creating a serious poverty trap. Escape from the trap requires the well-organized and combined implementation of a subsidy for schooling, the provision of free education, support for disadvantaged children, and public awareness programs. |
| Keywords: | overlapping generations model; education; poverty trap; job search; coordination failure. |
| JEL: | O11 J62 J23 |
| Date: | 2008–11–23 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:13484&r=dge |
| By: | De Paoli, Bianca (Bank of England); Zabczyk, Pawel (Bank of England) |
| Abstract: | Empirical evidence suggests that risk premia are higher at business cycle troughs than they are at peaks. Existing asset pricing theories ascribe moves in risk premia to changes in volatility or risk aversion. Nevertheless, in a simple general equilibrium model, risk premia can be procyclical even though the volatility of consumption is constant and despite a countercyclically varying risk aversion coefficient. We show that agents' expectations about future prospects also influence premium dynamics. In order to generate countercyclically varying premia, as found in the data, one requires a combination of hump-shaped consumption dynamics or highly persistent shocks and habits. Our results, thus, suggest that factors which help match activity data may also help along the asset pricing dimension. |
| Date: | 2009–02–16 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:0361&r=dge |
| By: | Hafedh Bouakez; Emanuela Cardia; Francisco J. Ruge-Murcia |
| Abstract: | In this paper, we study the macroeconomic implications of sectoral heterogeneity and, in particular, heterogeneity in price setting, through the lens of a highly disaggregated multi-sector model. The model incorporates several realistic features and is estimated using a mix of aggregate and sectoral U.S. data. The frequencies of price changes implied by our estimates are remarkably consistent with those reported in micro-based studies, especially for non-sale prices. The model is used to study (i) the contribution of sectoral characteristics to the observed cross sectional heterogeneity in sectoral output and inflation responses to a monetary policy shock, (ii) the implications of sectoral price rigidity for aggregate output and inflation dynamics and for cost pass-through, and (iii) the role of sectoral shocks in explaining secotral prices and quantities. |
| Keywords: | Multi-sector models, price stickiness, simulated method of moments, sectoral shocks, monetary policy |
| JEL: | E3 E4 E5 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:lvl:lacicr:0906&r=dge |
| By: | Song, Zheng Michael; Storesletten, Kjetil; Zilibotti, Fabrizio |
| Abstract: | This paper constructs a growth model that is consistent with salient features of the Chinese growth experience since 1992: high output growth, sustained returns on capital investments, extensive reallocation within the manufacturing sector, falling labor share and accumulation of a large foreign surplus. The theory makes only minimal deviations from a neoclassical growth model. Its building blocks are financial imperfections and reallocation among firms with heterogeneous productivity. Some firms use more productive technologies than others, but low-productivity firms survive because of better access to credit markets. Due to the financial imperfections, high-productivity firms - which are run by entrepreneurs - must be financed out of internal savings. If these savings are sufficiently large, the high-productivity sector outgrows the low-productivity sector, and attracts an increasing employment share. During the transition, low wage growth sustains the return to capital. The downsizing of the financially integrated sector forces a growing share of domestic savings to be invested in foreign assets, generating a foreign surplus. We test some auxiliary implications of the theory and find robust empirical support. |
| Keywords: | China; Economic Growth; Entrepreneurs; Foreign Surplus; Investment; Productivity Heterogeneity; Rate of Return on Capital; Reallocation; State-Owned Firms. |
| JEL: | G18 O11 O16 O47 O53 P31 |
| Date: | 2009–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7149&r=dge |
| By: | Casarico, Alessandra; Sommacal, Alessandro |
| Abstract: | This paper studies the effects of labour income taxation on growth in an OLG model where both formal schooling and child care enter the human capital production function as complements. We compare them with the effects obtained in a model where only formal schooling matters for skill formation. Using a numerical analysis we find that the omission of child care from the technology of skills' formation can significantly bias the results related to the effects of labour income taxation on growth. |
| Keywords: | child care; growth; human capital; labour supply; taxation |
| JEL: | H31 J22 |
| Date: | 2008–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7039&r=dge |
| By: | Buiter, Willem H |
| Abstract: | A fall in house prices due to a change in fundamental value redistributes wealth from those long housing (for whom the fundamental value of the house they own exceeds the present discounted value of their planned future consumption of housing services) to those short housing. In a representative agent model and in the Yaari-Blanchard OLG model used in the paper, there is no pure wealth effect on consumption from a change in house prices if this represents a change in fundamental value. There is a pure wealth effect on consumption from a change in house prices if this reflects a change in the speculative bubble component of house prices. Two other channels through which house prices can affect aggregate consumption are (1) redistribution effects if the marginal propensity to spend out of wealth differs between those long housing and those short housing and (2) collateral or credit effects due to the collateralisability of housing wealth and the non-collateralisability of human wealth. A decline in house prices reduces the scope for mortgage equity withdrawal. For given sequences of future after-tax labour income and interest rates, this may depress consumption in the short run while boosting it in the long run. |
| Keywords: | house prices; speculative bubbles; wealth effect |
| JEL: | E2 E3 E5 E6 G1 |
| Date: | 2008–07 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6920&r=dge |
| By: | D'Amato, Marcello; Galasso, Vincenzo |
| Abstract: | In a stochastic two-period OLG model, featuring an aggregate shock to the economy, ex-ante optimality requires intergenerational risk sharing. We compare the level of time-consistent intergenerational risk sharing chosen by a social planner and by office seeking politicians. In the political setting, the transfer of resources across generations — a PAYG pension system — is determined as a Markov equilibrium of a probabilistic voting game. Negative shocks represented by low realized returns on the risky asset induce politicians to compensate the old through a PAYG system. Unless the young are crucial to win the election, this political system generates more intergenerational risk sharing than the (time consistent) social optimum. In particular, these transfers are more persistent and less responsive to the realization of the shock than optimal. This is because politicians anticipate their current transfers to the elderly to be compensated through offsetting transfers by future politicians, and thus have an incentive to overspend. Perhaps surprisingly, aging increases the socially optimal transfer but makes politicians less likely to overspend, by making it more costly for future politicians to compensate the current young. |
| Keywords: | Markov equilibria; Pension Systems; social optimum |
| JEL: | D72 H55 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6972&r=dge |
| By: | Den Haan, Wouter |
| Abstract: | This paper shows that the R² and the standard error have fatal flaws and are inadequate as accuracy tests for models with heterogeneous agents and aggregate risk. Using data from a Krusell-Smith economy, I show that approximations for the law of motion of aggregate capital for which the true standard deviation of aggregate capital is up to 14% (119%) higher than the implied value (and which are thus clearly inaccurate) can have an R² as high as 0.9999 (0.99). Key in generating a more powerful test is to not update the aggregate law of motion with the aggregated simulated individual data, but to use as the explanatory variable the value predicted by the aggregate law of motion itself. |
| Keywords: | approximations; numerical solutions; simulations |
| JEL: | C63 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6971&r=dge |
| By: | Den Haan, Wouter; Rendahl, Pontus |
| Abstract: | We construct a method to solve models with heterogeneous agents and aggregate uncertainty that is simpler than existing algorithms; the aggregate law of motion is obtained neither by simulation nor by parameterization of the cross-sectional distribution, but by explicitly aggregating the individual policy rule. This establishes a link between the individual policy rule and the set of necessary aggregate state variables. In particular, the cross-sectional average of each basis function in the individual policy rule is a state variable. That is, if the individual capital stock, k, (or k²) enters the policy function then the mean of k (or the mean of k²) is a state variable. The laws of motions for these aggregate state variables are obtained by explicit aggregation of separate individual policy functions for the different elements. |
| Keywords: | numerical solutions; projection methods |
| JEL: | C63 D52 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6963&r=dge |