nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2009‒03‒28
eighteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Financial (In)stability, Supervision and Liquidity Injections: A Dynamic General Equilibrium Approach By de Walque, Gregory; Pierrard, Olivier; Rouabah, Abdelaziz
  2. Fiscal policy and default risk in emerging markets By Gabriel Cuadra; Juan M. Sanchez; Horacio Sapriza
  3. Intergenerational Complementarities in Education and the Relationship between Growth and Volatility By Theodore Palivos; Dimitrios Varvarigos
  4. The Volatility Costs of Procyclical Lending Standards:An Assessment Using a DSGE Model By Silvia Sgherri; Bertrand Gruss
  5. The International Diversification Puzzle when Goods Prices are Sticky: It's Really about Exchange-Rate Hedging, not Equity Portfolios By Charles Engel; Akito Matsumoto
  6. What’s News in Business Cycles By Schmitt-Grohé, Stephanie; Uribe, Martín
  7. Foreign exchange rate risk in a small open economy By De Paoli, Bianca; Sondergaard, Jens
  8. When does Lumpy Factor Adjustment Matter for Aggregate Dynamics? By Stephan Fahr; Fang Yao
  9. Back to square one: identification issues in DSGE models By Canova, Fabio; Sala, Luca
  10. Fluctuations in Overlapping Generations Economies By Mich Tvede
  11. When nature rebels: international migration, climate change and inequality By Luca Marchiori; Ingmar Schumacher
  12. Monetary and Fiscal Rules in an Emerging Small Open Economy By Nicoletta Batini; Paul Levine; Joseph Pearlman
  13. Optimal sticky prices under rational inattention. By Bartosz Maćkowiak; Mirko Wiederholt
  14. On Impatience and Policy Effectiveness By Silvia Sgherri; Tamim Bayoumi
  15. The Child is Father of the Man: Implications for the Demographic Transition By Omar Licandro; David de la Croix
  16. Real Estate Prices and the Importance of Bequest Taxation By Giorgio Bellettini; Filippo Taddei
  17. Commuting, Wages and Bargaining Power By Peter Rupert, Elena Stancanelli, Etienne Wasmer
  18. Long Run Evidence on Money Growth and Inflation. By Luca Benati

  1. By: de Walque, Gregory; Pierrard, Olivier; Rouabah, Abdelaziz
    Abstract: We develop a dynamic stochastic general equilibrium model with an heterogeneous banking sector. We introduce endogenous default probabilities for both firms and banks, and allow for bank regulation and liquidity injection into the interbank market. Our aim is to understand the interactions between the banking sector and the rest of the economy, as well as the importance of supervisory and monetary authorities to restore financial stability. The model is calibrated against real US data and used for simulations. We show that Basel regulation reduces the steady state but improves the resilience of the economy to shocks, and that moving from Basel I to Basel II is procyclical. We also show that liquidity injections relieve financial instability but have ambiguous effects on output fluctuations.
    Keywords: banking sector; central bank; default risk; DSGE; supervision
    JEL: E13 E20 G21 G28
    Date: 2009–03
  2. By: Gabriel Cuadra; Juan M. Sanchez; Horacio Sapriza
    Abstract: Emerging market economies typically exhibit a procyclical fiscal policy: public expenditures rise (fall) in economic expansions (recessions), whereas tax rates rise (fall) in bad (good) times. Additionally, the business cycle of these economies is characterized by countercyclical default risk. In this paper we develop a quantitative dynamic stochastic small open economy model with incomplete markets, endogenous fiscal policy and sovereign default where public expenditures and tax rates are optimally procyclical. The model also accounts for the dynamics of other key macroeconomic variables in emerging economies.
    Keywords: Business cycles ; Macroeconomics
    Date: 2009
  3. By: Theodore Palivos; Dimitrios Varvarigos
    Abstract: We construct an overlapping generations model in which parents vote on the tax rate that determines publicly provided education and offspring choose their effort in learning activities. The technology governing the accumulation of human capital allows these decisions to be strategic complements. In the presence of coordination failure, indeterminacy and, possibly, growth cycles emerge. In the absence of coordination failure, the economy moves along a uniquely determined balanced growth path. We argue that such structural differences can account for the negative correlation between volatility and growth.
    Keywords: Human Capital; Economic Growth; Volatility
    JEL: O41
    Date: 2009–03
  4. By: Silvia Sgherri; Bertrand Gruss
    Abstract: The ongoing financial turmoil has triggered a lively debate on ways of containing systemic risk and lessening the likelihood of 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: Business cycles , Borrowing , External shocks , Spillovers , Credit ceilings , Capital markets , Asset prices , Financial risk , Economic models ,
    Date: 2009–03–11
  5. By: Charles Engel; Akito Matsumoto
    Abstract: This paper develops a two-country monetary DSGE model in which households choose a portfolio of home and foreign equities, and a forward position in foreign exchange. Some nominal goods prices are sticky. Trade in these assets achieves the same allocations as trade in a complete set of nominal state-contingent claims in our linearized model. When there is a high degree of price stickiness, we show that not much equity diversification is required to replicate the complete-markets equilibrium when agents are able to hedge foreign exchange risk sufficiently. Moreover, temporarily sticky nominal goods prices can have large effects on equity portfolios even when dividend processes are very persistent.
    Keywords: Private investment , Foreign exchange , Commodity prices , Capital markets , Asset management , Economic models ,
    Date: 2009–01–23
  6. By: Schmitt-Grohé, Stephanie; Uribe, Martín
    Abstract: In this paper, we perform a structural Bayesian estimation of the contribution of anticipated shocks to business cycles in the postwar United States. Our theoretical framework is a real-business-cycle model augmented with four real rigidities: investment adjustment costs, variable capacity utilization, habit formation in consumption, and habit formation in leisure. Business cycles are assumed to be driven by permanent and stationary neutral productivity shocks, permanent investment-specific shocks, and government spending shocks. Each of these driving forces is buffeted by four types of structural innovations: unanticipated innovations and innovations anticipated one, two, and three quarters in advance. We find that anticipated shocks account for more than two thirds of predicted aggregate fluctuations.
    Keywords: anticipated shocks; Bayesian estimation; sources of aggregate fluctuations
    JEL: C11 C51 E13 E32
    Date: 2009–03
  7. By: De Paoli, Bianca (Bank of England); Sondergaard, Jens (Bank of England)
    Abstract: Resolving the forward premium puzzle requires a volatile foreign exchange rate risk premium that covaries negatively with the expected depreciation rate. Earlier work has shown how models featuring consumption habits can generate such premia when either trade costs or 'deep habits' are assumed. We show that as long as consumption habits are slow-moving and shocks are highly persistent, a standard small open endowment economy - without any additional features - can address the puzzle. Moreover endogenising the labour supply decision in the small open economy can improve the model's ability to match risk premia observations so long as it makes business cycles less synchronised.
    Date: 2009–03–20
  8. By: Stephan Fahr (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Fang Yao (Institute for Economic Theory, Humboldt University of Berlin, Spandauer Strasse 1, D-10178 Berlin, Germany.)
    Abstract: We analyze the dynamic effects of lumpy factor adjustments at the firm level onto the aggregate economy. We find that distinguishing between capital and labour as lumpy factors within the production function result in very different dynamics for aggregate output, investment and labour in an otherwise standard real business cycle model. Lumpy capital leaves the RBC dynamics mainly unchanged, while lumpy labour allows for persistence and an inner propagation within the model in form of hump-shaped impulse responses. In addition, when modeling lumpy adjustments on both investment and labour, the aggregate effects are even stronger. We investigate the mechanisms underlying these results and identify the elasticity of factor supply as the most important element in accounting for these differences. JEL Classification: E32, E22, E24.
    Keywords: Lumpy labor adjustment, Lumpy investment, Business cycles, Elasticity of supply.
    Date: 2009–03
  9. By: Canova, Fabio; Sala, Luca
    Abstract: We investigate identification issues in DSGE models and their consequences for parameter estimation and model evaluation when the objective function measures the distance between estimated and model-based impulse responses. Observational equivalence, partial and weak identification problems are widespread and typically produced by an ill-behaved mapping between the structural parameters and the coefficients of the solution. Different objective functions affect identification and small samples interact with parameters identification. Diagnostics to detect identification deficiencies are provided and applied to a widely used model.
    Keywords: DSGE models; Identification; Impulse Responses; small samples.
    JEL: C10 C52 E32 E50
    Date: 2009–03
  10. By: Mich Tvede (Department of Economics, University of Copenhagen)
    Abstract: In the present paper stationary pure-exchange overlapping generations economies with l goods per date and m consumers per generation are considered. It is shown that for an open and dense set of utility functions there exist endowment vectors such that n-cycles exist for n ≤ l +1 and l ≤ m. The approach to existence of endogenous fluctuations is basic in the sense that the prime ingredients are the implicit function theorem and linear algebra. Moreover the approach is applied to show that for an open and dense set of utility functions there exist endowment vectors such that sunspot equilibria, where prices at every date only depends on the state at that date, exist.
    Keywords: cycles; overlapping generations economies; sunspot equilibria
    JEL: D51 E32
    Date: 2009–03
  11. By: Luca Marchiori (IRES - Université Catholique de Louvain); Ingmar Schumacher (Department of Economics - University of Trier, Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X)
    Abstract: This article analyzes the link between climate change and international migration. We use a two-country overlapping generations model with endogenous climate change, in which the production in the North generates climate change which negatively affects the productivity of the South. Our main findings are: (i) climate change will increase migration; (ii) small impacts of climate change have significant impacts on the number of migrants; (iv) a laxer immigration policy increases long- run migration, reduces climate change, increases North-South inequality if DRTS are significant; (v) a greener technology reduces long-run migration, provides a double- dividend in favor of the environment, reduces inequality if the migrants' impact to overall climate change is large. The preference over the policies thus depends on whether the policy maker targets inequality, wealth, the number of migrants or the environment, but the qualitative ranking between the policies does not change if the policies are costly.
    Keywords: climate change, migration, North-South model, overlapping generations, inequality.
    Date: 2009–01
  12. By: Nicoletta Batini; Paul Levine; Joseph Pearlman
    Abstract: We develop a optimal rules-based interpretation of the 'three pillars macroeconomic policy framework': a combination of a freely floating exchange rate, an explicit target for inflation, and a mechanism than ensures a stable government debt-GDP ratio around a specified long run. We show how such monetary-fiscal rules need to be adjusted to accommodate specific features of emerging market economies. The model takes the form of two-blocs, a DSGE emerging small open economy interacting with the rest of the world and features, in particular, financial frictions It is calibrated using Chile and US data. Alongside the optimal Ramsey policy benchmark, we model the three pillars as simple monetary and fiscal rules including and both domestic and CPI inflation targeting interest rate rules alongside a 'Structural Surplus Fiscal Rule' as followed recently in Chile. A comparison with a fixed exchange rate regime is made. We find that domestic inflation targeting is superior to partially or implicitly (through a CPI inflation target) or fully attempting to stabilizing the exchange rate. Financial frictions require fiscal policy to play a bigger role and lead to an increase in the costs associated with simple rules as opposed to the fully optimal policy.
    Keywords: Emerging markets , External shocks , Monetary policy , Interest rate policy , Fiscal policy , Economic models ,
    Date: 2009–02–06
  13. By: Bartosz Maćkowiak (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Mirko Wiederholt (Northwestern University, 633 Clark Street, Evanston, IL 60208, USA.)
    Abstract: This paper presents a model in which price setting firms decide what to pay attention to, subject to a constraint on information flow. When idiosyncratic conditions are more variable or more important than aggregate conditions, firms pay more attention to idiosyncratic conditions than to aggregate conditions. When we calibrate the model to match the large average absolute size of price changes observed in micro data, prices react fast and by large amounts to idiosyncratic shocks, but prices react only slowly and by small amounts to nominal shocks. Nominal shocks have strong and persistent real effects. We use the model to investigate how the optimal allocation of attention and the dynamics of prices depend on the firms’ environment. JEL Classification: E3, E5, D8.
    Keywords: rational inattention, sticky prices, real effects of nominal shocks.
    Date: 2009–02
  14. By: Silvia Sgherri; Tamim Bayoumi
    Abstract: An increasing body of evidence suggests that the behavior of the economy has changed in many fundamental ways over the last decades. In particular, greater financial deregulation, larger wealth accumulation, and better policies might have helped lower uncertainty about future income and lengthen private sectors' planning horizon. In an overlapping-generations model, in which individuals discount the future more rapidly than implied by the market rate of interest, we find indeed evidence of a falling degree of impatience, providing empirical support for this hypothesis. The degree of persistence of "windfall" shocks to disposable income also appears to have varied over time. Shifts of this kind are shown to have a key impact on the average marginal propensity to consume and on the size of policy multipliers.
    Keywords: Fiscal policy , Income distribution , Private sector , Interest rates , Monetary policy , Consumption , Economic models ,
    Date: 2009–01–28
  15. By: Omar Licandro; David de la Croix
    Abstract: We propose a new theory of the demographic transition based on the evidence that body development during childhood is an important predictor of adult life expectancy. This theory is embodied in an OLG framework where fertility, longevity and education all result from individual decisions. The model displays different regimes, allowing the economy to move slowly from an initial Malthusian regime towards the Modern era. The dynamics reproduces the key features of the demographic transition, including the permanent increase in life expectancy, resulting from improvements in body development, the hump in both population growth and fertility, and a late increase in secondary educational attainments.
    Keywords: Life Expectancy, Height, Education, Fertility, Mortality
    JEL: J11 I12 N30 I20 J24
    Date: 2009–03–10
  16. By: Giorgio Bellettini; Filippo Taddei
    Abstract: Taxation of bequests and donations is an important determinant of real estate prices. We show that, ceteris paribus, a decrease in taxes on inter vivos donations and bequests brings about an increase in real estate prices. We provide a general equilibrium rationalization in the context of OLG economies featuring intergenerational altruism. This has relevant policy implications. We test the predictions of our theory employing a unique policy shock: the abolition of bequest and donation taxation that took place in Italy in 2001. Considering this policy shift provides the first evidence that a drastic reduction in bequest and donation taxation significantly increased real estate prices. Our estimates suggest that the 2001 abolition of taxation on bequests and donations alone led to an appreciation of residential real estate in excess of 10%.
    JEL: E60 E65 H24
    Date: 2009
  17. By: Peter Rupert, Elena Stancanelli, Etienne Wasmer (University of California, Santa Barbara, CNRS, THEMA, University Cergy,(Sciences-Po, OFCE, IZA and CEPR)
    Abstract: A search model of the labor market is augmented to include commuting time to work. The theory posits that wages are positively related to commute distance, by a factor itself depending negatively on the bargaining power of workers. Since not all combinations of distance and wages are accepted, there is non-random selection of accepted job offers. We build on these ingredients to explore in the data the relationship between wages and commute time . We find that neglecting to account for this selection will bias downward the wage impact of commuting, and marginally affect the coefficients on education, age and gender. The correlation between the residuals of the selectivity equation and the distance equation is -0.70, showing the large impact of commute time on job acceptance decisions. We also use the theory to calculate the bargaining power of workers which largely varies depending on demographic groups: it appears to be much larger for men than that for women and that the bargaining power of women with oung children is essentially zero.
    Date: 2009
  18. By: Luca Benati (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: Over the last two centuries, the cross-spectral coherence between either narrow or broad money growth and inflation at the frequency ω=0 has exhibited little variation–being, most of the time, close to one–in the U.S., the U.K., and several other countries, thus implying that the fraction of inflation’s long-run variation explained by long-run money growth has been very high and relatively stable. The cross-spectral gain at ω=0, on the other hand, has exhibited significant changes, being for long periods of time smaller than one. The unitary gain associated with the quantity theory of money appeared in correspondence with the inflationary outbursts associated with World War I and the Great Inflation–but not World War II–whereas following the disinflation of the early 1980s the gain dropped below one for all the countries and all the monetary aggregates I consider, with one single exception. I propose an interpretation for this pattern of variation based on the combination of systematic velocity shocks and infrequent inflationary outbursts. Based on estimated DSGE models, I show that velocity shocks cause, ceteris paribus, comparatively much larger decreases in the gain between money growth and inflation at ω=0 than in the coherence, thus implying that monetary regimes characterised by low and stable inflation exhibit a low gain, but a still comparatively high coherence. Infrequent inflationary outbursts, on the other hand, boost both the gain and coherence towards one, thus temporarily revealing the one-for-one correlation between money growth and inflation associated with the quantity theory of money, which would otherwise remain hidden in the data. JEL Classification: E30, E32.
    Keywords: Quantity theory of money, inflation, frequency domain, cross-spectral analysis, band-pass filtering, DSGE models, Bayesian estimation, trend inflation.
    Date: 2009–03

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