nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2009‒05‒23
nineteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. On rational exuberance. By Stefano Bosi; Thomas Seegmuller
  2. MEDEA: A DSGE Model for the Spanish Economy By Pablo Burriel; Jesús Fernández-Villaverde; Juan F. Rubio-Ramírez
  3. The Tradeoff Between Growth and Redistribution: ELIE in an Overlapping Generations Model By David De La Croix; Michel Lubrano
  4. The Long-run Effects of Household Liquidity Constraints and Taxation on Fertility, Education, Saving, and Growth By Erasmo Papagni
  5. Global Aging and Fiscal Policy with International Labor Mobility: A Political Economy Perspective By Tosun, Mehmet S.
  6. "Stationary Monetary Equilibria with Strictly Increasing Value Functions and Non-Discrete Money Holdings Distributions: An Indeterminacy Result" By Kazuya Kamiya; Takashi Shimizu
  7. "Welfare Impact of a Ban on Child Labor" By Jorge Soares
  8. Lumpy Investment and State-Dependent Pricing in General Equilibrium By Reiter, Michael; Sveen, Tommy; Weinke, Lutz
  9. Brain drain and Brain Return: Theory and Application to Eastern-Western Europe By Karin Mayr; Giovanni Peri
  10. Financial development and economic volatility: a unified explanation By Pengfei Wang; Yi Wen
  11. Macroeconomic Implications of Demography for the Environment: A Life-Cycle Perspective By Xavier Pautrel
  12. Inflation dynamics with labour market matching : assessing alternative specifications By Kai Christoffel; James Costain; Gregory de Walque; Keith Kuester; Tobias Linzert; Stephen Millard; Olivier Pierrard
  13. Environmental health and education : Towards sustainable growth. By Natacha Raffin
  14. Capital taxation during the U.S. Great Depression By Ellen R. McGrattan
  15. What Drives the Term Structure in the Euro Area? Evidence from a Model with Feedback By Zagaglia, Paolo
  16. Noisy Business Cycles By George-Marios Angeletos; Jennifer La'O
  17. A Search-Theoretic Model of the Retail Market for Illicit Drugs By Manolis Galenianos; Rosalie Liccardo Pacula; Nicola Persico
  18. AIDS and Dualism: Ethiopia's Burden under Rational Expectations By Clive Bell; Anastasios Koukoumelis
  19. "Computing Densities and Expectations in Stochastic Recursive Economies: Generalized Look-Ahead Techniques" By Richard Anton Braun; Huiyu Li; John Stachurski

  1. By: Stefano Bosi (EQUIPPE - Université de Lille 1 et EPEE - Université d'Evry); Thomas Seegmuller (Centre d'Economie de la Sorbonne - Paris School of Economics)
    Abstract: In his seminal contribution, Tirole (1985) shows that an overlapping generations economy may monotonically converges to a steady state with a positive rational bubble, characterized by the dynamically efficient golden rule. The issue we address is whether this monotonic convergence to an efficient long-run equilibrium may fail, while the economy experiences persistent endogenous fluctuations around the golden rule. Our explanation leads on the features of the credit market. We consider a simple overlapping generations model with three assets : money, capital and a pure bubble (bonds). Collateral matters because increasing his portfolio in capital and bubble, the household reduces the share of his consumption paid by cash. From a positive point of view, we show that the bubbly steady state can be locally indeterminate under arbitrarily small credit market imperfections and, thereby, persistent expectation-driven fluctuations of equilibria with (rational) bubbles can arise. From a normative point of view, monetary policies that are not too expansive, are recommended in order to rule out the occurence of sunspot fluctuations and enhance the welfare evaluated at the steady state.
    Keywords: Bubbles, collaterals, indeterminacy, cash-in-advance constraint, overlapping generations.
    JEL: D91 E32 E50
    Date: 2009–01
  2. By: Pablo Burriel; Jesús Fernández-Villaverde; Juan F. Rubio-Ramírez
    Abstract: In this paper, we provide a brief introduction to a new macroeconometric model of the Spanish economy named MEDEA (Modelo de Equilibrio Dinámico de la Economía EspañolA). MEDEA is a dynamic stochastic general equilibrium (DSGE) model that aims to describe the main features of the Spanish economy for policy analysis, counterfactual exercises, and forecasting. MEDEA is built in the tradition of New Keynesian models with real and nominal rigidities, but it also incorporates aspects such as a small open economy framework, an outside monetary authority such as the ECB, and population growth, factors that are important in accounting for aggregate fluctuations in Spain. The model is estimated with Bayesian techniques and data from the last two decades. Beyond describing the properties of the model, we perform different exercises to illustrate the potential of MEDEA, including historical decompositions, long-run and short-run simulations, and counterfactual experiments.
    Date: 2009–05
  3. By: David De La Croix (CORE - Department of Economics - Université Catholique de Louvain); Michel Lubrano (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille II - Université Paul Cézanne - Aix-Marseille III - Ecole des Hautes Etudes en Sciences Sociales - CNRS : UMR6579)
    Abstract: The ELIE scheme of Kolm taxes labour capacities instead of labour income in order to circumvent the distortionary effect of taxation on labour supply. Still, Kolm does not study the impact of ELIE on human capital formation and investment. In this paper, we build an overlapping generations (OLG) model with heterogenous agents and endogenous growth driven by investment in human capital. We study the effect of ELIE on education investment and other aggregate economic variables. Calibrating the model to French data, we highlight a tradeoff between growth and redistribution. With a perfect credit market, ELIE is successful in reducing inequalities and poverty, but it is at the expense of lower investment in education and slower growth. In an economy with an imperfect credit market where individuals cannot borrow to educate, the tradeoff between growth and redistribution is not overturned but is less severe. However, it is possible to overturn completely that trade-off simply by changing the base of taxation for the young generation which is equivalent to subsidising education.
    Keywords: Education, Growth, Redistribution, Kolm
    Date: 2009–05–07
  4. By: Erasmo Papagni (-)
    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.
    Keywords: -
    JEL: O40 O16 J13 D91
    Date: 2008–09–30
  5. By: Tosun, Mehmet S. (University of Nevada, Reno)
    Abstract: This paper uses an overlapping generations model with international labor mobility and a politically responsive fiscal policy to examine aging in developed and developing regions. Migrant workers change the political structure composed of young and elderly voters in both labor-receiving and labor-sending countries. Numerical simulations show that the developed region benefits more from international labor mobility through the contribution of migrant workers as laborers, savers, and voters. The developing region experiences significant growth in all specifications but benefit more under international capital mobility. Restricting political participation of migrant workers in the developed region produces inferior growth results.
    Keywords: population aging, overlapping generations, endogenous fiscal policy, international labor mobility, international capital mobility
    JEL: E62 F21 F22 F43 H30 J10
    Date: 2009–05
  6. By: Kazuya Kamiya (Faculty of Economics, University of Tokyo); Takashi Shimizu (Faculty of Economics, Kansai University)
    Abstract: In this paper, we present a search model with divisible money in which there exists a continuum of monetary equilibria with strictly increasing continuous value functions and with non-discrete money holdings distributions.
    Date: 2009–03
  7. By: Jorge Soares (Department of Economics,University of Delaware)
    Abstract: This paper presents a new rationale for imposing restrictions on child labor. In a standard overlapping generations model where parental altruism results in transfers that children allocate to consumption and education, the Nash-Cournot equilibrium results in sub-optimal levels of parental transfers and does not maximize the average level of utility of currently living agents. A ban on child labor decreases children's income and generates an increase in parental transfers bringing their levels closer to the optimum, raising children's welfare as well as average welfare in the short-run and in the long-run. Moreover, the inability to work allows children to allocate more time to education, and it leads to an increase in human capital. Besides, to increase transfers, parents decrease savings and, hence, physical capital accumulation. When prices are flexible, these effects diminish the positive welfare impact of the ban on child labor.
    Keywords: child labor, altruism, overlapping generations, welfare.
    JEL: D91 E21
    Date: 2009
  8. By: Reiter, Michael (Department of Economics and Finance, Institute for Advanced Studies, Vienna, Austria); Sveen, Tommy (Monetary Policy Department, Norges Bank, Oslo, Norway); Weinke, Lutz (Department of Economics, Duke University, Durham, NC, USA and Department of Economics and Finance, Institute for Advanced Studies, Vienna, Austria)
    Abstract: The lumpy nature of plant-level investment is generally not taken into account in the context of monetary theory (see, e.g., Christiano et al. 2005 and Woodford 2005). We formulate a generalized (S,s) pricing and investment model which is empirically more plausible along that dimension. Surprisingly, our main result shows that the presence of lumpy investment casts doubt on the ability of sticky prices to imply a quantitatively relevant monetary transmission mechanism.
    Keywords: Lumpy investment, Sticky prices
    JEL: E22 E31 E32
    Date: 2009–05
  9. By: Karin Mayr; Giovanni Peri
    Abstract: Recent empirical evidence seems to show that temporary migration is a widespread phenomenon, especially among highly skilled workers who return to their countries of origin when these begin to grow. This paper develops a simple, tractable overlapping generations model that provides a rationale for return migration and predicts who will migrate and who returns among agents with heterogeneous abilities. The model also incorporates the interaction between the migration decision and schooling: the possibility of migrating, albeit temporarily, to a country with high returns to skills produces positive schooling incentive eects. We use parameter values from the literature and data on return migration to simulate the model for the Eastern-Western European case. We then quantify the eects that increased openness (to migrants) would have on human capital and wages in Eastern Europe. We nd that, for plausible values of the parameters, the possibility of return migration combined with the education incentive channel reverses the brain drain into a signicant brain gain for Eastern Europe.
    JEL: F22 J61 O15
    Date: 2009–05
  10. By: Pengfei Wang; Yi Wen
    Abstract: Empirical studies showed that firm-level volatility has been increasing but the aggregate volatility has been decreasing in the US for the post-war period. This paper proposes a unified explanation for these diverging trends. Our explanation is based on a story of financial development - measured by the reduction of borrowing constraints because of greater access to external financing and options for risk sharing. By constructing a dynamic stochastic general-equilibrium model of heterogenous firms facing borrowing constraints and investment irreversibility, it is shown that financial liberalization increases the lumpiness of firm-level investment but decreases the variance of aggregate output. Hence, the model predicts that financial development leads to a larger firm-level volatility but a lower aggregate volatility. In addition, our model is also consistent with the observed decline in volatility of private held firms which do not have (or have only limited) access to external funds.
    Keywords: Financial institutions ; Business cycles
    Date: 2009
  11. By: Xavier Pautrel (Nantes Atlantique Université)
    Abstract: This article studies how demography affects the outcome of the environmental policy in a macro-economic perspective, incorporating age-earning profiles in an OLG model à la Blanchard (1985) to capture the age structure effect of the demographic shocks. It first demonstrates, conversely to previous works of the related literature that a decrease in the birth rate may lower the steady-state per capita stock of physical capital even if the aggregate labor supply is exogenous. It also demonstrates that the ageing of population influences the macro-economic impact of the environmental policy according to the cause of the ageing and the life-cycle earnings assumption. Thus, with decreasing age-earning profiles, a lower birth rate reduces the detrimental impact of the environmental policy on the steady-state per capita stock of physical capital for low values of this birth rate, while a reduction of the mortality rate reinforces the negative outcome of the environmental policy. When earnings profiles are independent of age, ageing always strengthens the negative impact of the environmental policy.
    Keywords: Demography, Environment
    JEL: Q56
    Date: 2009–01
  12. By: Kai Christoffel (European Central Bank); James Costain (División de Investigación, Servicio de Estudios, Banco de España); Gregory de Walque (Research Department, National Bank of Belgium); Keith Kuester (Research Department, Federal Reserve Bank of Philadelphia); Tobias Linzert (European Central Bank); Stephen Millard (Bank of England); Olivier Pierrard (Banque Centrale du Luxembourg)
    Abstract: This paper reviews recent approaches to modeling the labour market, and assesses their implications for inflation dynamics through both their effect on marginal cost and on price-setting behavior. In a search and matching environment, we consider the following modeling setups: right-to-manage bargaining vs. efficient bargaining, wage stickiness in new and existing matches, interactions at the firm level between price and wage-setting, alternative forms of hiring frictions, search on-the-job and endogenous job separation. We find that most specifications imply too little real rigidity and, so, too volatile inflation. Models with wage stickiness and right-to-manage bargaining or with firm-specific labour emerge as the most promising candidates
    Keywords: Inflation Dynamics, Labour Market, Business Cycle, Real Rigidities
    JEL: E E E J
    Date: 2009–05
  13. By: Natacha Raffin (Centre d'Economie de la Sorbonne - Paris School of Economics)
    Abstract: This article aims at investigating the interplay between environmental quality, health and development. We consider an OLG model, where human capital dynamics depend on the current environment, through its impact on children's school attendance. In turn, environmental quality dynamics depend on human capital, through maintenance and pollution. This two-way causality generates a co-evolution of human capital and environmental quality and may induce the emergence of an environmental poverty trap characterized by a low level of human capital and deteriorated environmental quality. Our results are consistent with empirical observation about the existence of Environmental Kuznets Curve. Finally, the model allows for the assessment of an environmental policy that would allow to escape the trap.
    Keywords: Education, environmental quality, growth, health.
    JEL: D90 H51 I20 Q01
    Date: 2009–04
  14. By: Ellen R. McGrattan
    Abstract: Previous studies quantifying the effects of increased capital taxation during the U.S. Great Depression find that its contribution is small, both in accounting for the downturn in the early 1930s and in accounting for the slow recovery after 1934. This paper confirms that the effects are small in the case of taxation of business profits, but finds large effects in the case of taxation of dividend income. Tax rates on dividends rose dramatically during the 1930s and, when fed into a general equilibrium model, imply significant declines in investment and equity values and nontrivial declines in gross domestic product (GDP) and hours of work. The results are amplified if businesses make intangible investments which can be expensed from taxable capital income.
    Date: 2009
  15. By: Zagaglia, Paolo (Dept. of Economics, Stockholm University)
    Abstract: I study a general-equilibrium model of the term structure where bond prices are an integral part of the monetary transmission mechanism. The model is estimated on quarterly Euro area data. I show that, besides shocks to the inflation target, also exogenous variations in money demand and bond supply can explain movements in long-term interest rates. I also find that taking into account the impact of bond yields on the macroeconomy generates superior in-sample and out-of-sample forecasts for output, inflation and for bond yields.
    Keywords: Monetary policy; yield curve; monetary transmission mechanism
    JEL: E43 E44 E52
    Date: 2009–05–13
  16. By: George-Marios Angeletos; Jennifer La'O
    Abstract: This paper investigates a real-business-cycle economy that features dispersed information about the underlying aggregate productivity shocks, taste shocks, and, potentially, shocks to monopoly power. We show how the dispersion of information can (i) contribute to significant inertia in the response of macroeconomic outcomes to such shocks; (ii) induce a negative short-run response of employment to productivity shocks; (iii) imply that productivity shocks explain only a small fraction of high-frequency fluctuations; (iv) contribute to significant noise in the business cycle; (v) formalize a certain type of demand shocks within an RBC economy; and (vi) generate cyclical variation in observed Solow residuals and labor wedges. Importantly, none of these properties requires significant uncertainty about the underlying fundamentals: they rest on the heterogeneity of information and the strength of trade linkages in the economy, not the level of uncertainty. Finally, none of these properties are symptoms of inefficiency: apart from undoing monopoly distortions or providing the agents with more information, no policy intervention can improve upon the equilibrium allocations.
    JEL: C7 D6 D8
    Date: 2009–05
  17. By: Manolis Galenianos; Rosalie Liccardo Pacula; Nicola Persico
    Abstract: A search-theoretic model of the retail market for illegal drugs is developed. Trade occurs in bilateral, potentially long-lived matches between sellers and buyers. Buyers incur search costs when experimenting with a new seller. Moral hazard is present because buyers learn purity only after a trade is made. The model produces testable implications regarding the distribution of purity offered in equilibrium, and the duration of the relationships between buyers and sellers. These predictions are consistent with available data. The effectiveness of different enforcement strategies is evaluated, including some novel ones which leverage the moral hazard present in the market.
    JEL: J64 K14 K42
    Date: 2009–05
  18. By: Clive Bell (South Asia Institute, University of Heidelberg); Anastasios Koukoumelis (South Asia Institute, University of Heidelberg, and Max Planck Institute of Economics, Strategic Interaction Group, Jena)
    Abstract: An AIDS epidemic threatens Ethiopia with a long wave of premature adult mortality, and thus with an enduring setback to capital formation and economic growth. The authors develop a two-sector model with three overlapping generations and intersectorally mobile labor, in which young adults allocate resources under rational expectations. They calibrate the model to the demographic and economic data, and perform simulations for the period ending in 2100 under alternative assumptions about mortality with and without the epidemic. Although the epidemic does not bring about a catastrophic economic collapse, which is hardly possible in view of Ethiopia's poverty and high background adult mortality, it does cause a permanent, downward displacement of the path of output per head, amounting to 10 percent in 2100. An externally funded program to combat the disease is socially very pro?table.
    Keywords: HIV/AIDS, Growth, Dualism, Ethiopia
    JEL: I10 I20 O11 O41
    Date: 2009–05–12
  19. By: Richard Anton Braun (Faculty of Economics, University of Tokyo); Huiyu Li (Graduate School of Economics, University of Tokyo); John Stachurski (Institute of Economic Research, Kyoto University)
    Abstract: We propose a generalized look-ahead estimator for computing densities and expectations in economic models. We provide conditions under which the estimator converges globally with probability one, and exhibit the asymptotic distribution of the error. Our estimator is more efficient than other Monte Carlo based approaches. Numerical experiments indicate that the estimator can provide large increases in accuracy and speed relative to traditional methods. Particular applications we consider are the stochastic growth model and an income fluctuation problem.
    Date: 2009–05

This nep-dge issue is ©2009 by Christian Zimmermann. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.