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on Dynamic General Equilibrium |
| By: | Leena Rudanko (Boston University, Department of Economics) |
| Abstract: | Economists face difficulties explaining the strong cyclicality of US unemployment. This paper contributes both by developing modeling tools and evaluating a potentially important explanation. The paper develops a parsimonious equilibrium model of job search with aggregate productivity shocks, where i) workers face incomplete markets, and ii) wages are determined via optimal long-term contracts. Despite the large state space associated with long-term contracting, the equilibrium has a simple representation as a small system of differential equations. Incomplete markets amplify fluctuations in unemployment, and the results suggest an upper bound on how far they can go in explaining unemployment cyclicality. |
| Keywords: | Unemployment, Wages, Business Cycles, Search, Dynamic Contracts, Incomplete Markets |
| JEL: | D52 E24 E32 J41 J64 |
| Date: | 2008–07 |
| URL: | http://d.repec.org/n?u=RePEc:bos:wpaper:wp2008-009&r=dge |
| By: | François Gourio (Department of Economics, Boston University); Jianjun Miao (Department of Economics, Boston University) |
| Abstract: | To study the long-run effect of dividend taxation on aggregate capital accumulation, we build a dynamic general equilibrium model in which there is a continuum of firms subject to idiosyncratic productivity shocks. We find that a dividend tax cut raises aggregate productivity by reducing the frictions in the reallocation of capital across firms. Our baseline model simulations show that when both dividend and capital gains tax rates are cut from 25 and 20 percent, respectively, to the same 15 percent level permanently, the aggregate long-run capital stock increases by about 4 percent. |
| Keywords: | firm heterogeneity, finance regime, dividend tax reform, general equilibrium |
| JEL: | E22 E62 G31 G35 H32 |
| Date: | 2008–11 |
| URL: | http://d.repec.org/n?u=RePEc:bos:wpaper:wp2008-002&r=dge |
| By: | Leena Rudanko (Boston University) |
| Abstract: | Recent research seeking to explain the strong cyclicality of US unemployment emphasizes the role of wage rigidity. This paper proposes a micro-founded model of wage rigidity – an equilibrium business cycle model of job search, where risk neutral firms post optimal long-term contracts to attract risk averse workers. Equilibrium contracts feature wage smoothing, limited by the inability of parties to commit to contracts. The model is consistent with aggregate wage data if neither worker nor firm can commit, producing too rigid wages otherwise. Wage rigidity does not lead to a substantial increase in the cyclical volatility of unemployment. |
| Keywords: | wage rigidity, unemployment fluctuations, long-term wage contracts, limited commitment, directed search |
| JEL: | E24 E32 J41 J64 |
| Date: | 2008–12 |
| URL: | http://d.repec.org/n?u=RePEc:bos:wpaper:wp2008-003&r=dge |
| By: | Hajime Tomura |
| Abstract: | This paper introduces heterogeneous beliefs among households in a small open economy model for the Canadian economy. The model suggests that simultaneous boom-bust cycles in house prices, output, investment, consumption and hours worked emerge when credit-constrained mortgage borrowers expect that future house prices will rise and this expectation is neither shared by savers nor realized ex-post. With sticky prices and a standard monetary policy rule, the model shows that the nominal policy interest rate and the CPI inflation rate decline during housing booms and rise as house prices fall. These results replicate the stylized features of housing-market boom-bust cycles in industrialized countries. Policy experiments demonstrate that stronger policy responses to inflation amplify housing-market boom-bust cycles. Also, higher loan-to-value ratios amplify housing-market boom-bust cycles by encouraging speculative housing investments by mortgage borrowers during housing booms and increasing liquidation of housing collateral during housing busts. |
| Keywords: | Credit and credit aggregates; Financial stability; Inflation targets |
| JEL: | E44 E52 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:09-15&r=dge |
| By: | Yili Chien; Junsang Lee |
| Abstract: | We study optimal capital income taxation with a Ramsey problem and relate this optimal taxation problem to the question that has been asked in the asset pricing literature, which is why the risk free interest rate is too low. We show that the Ramsey planner chooses the optimal level of capital stock to be one that satisfies the modified golden rule in the steady state under some conditions. The conditions include sufficient government tax instruments and ability to issue bonds. We argue that the optimal capital level is different from that chosen in a competitive equilibrium unless the competitive equilibrium risk free interest rate is same as the time discount rate in the steady state. This difference in the choice of capital motivates imposing a positive capital income tax (or subsidy) on households to induce them to invest at the socially optimal amount. As examples, we investigate optimal capital taxation in a decentralized economy with limited commitment and one with private information. However, the result still holds in various types of economies with risk free interest rate that is too low. |
| JEL: | D86 E23 E44 E62 |
| Date: | 2009–01 |
| URL: | http://d.repec.org/n?u=RePEc:acb:camaaa:2009-05&r=dge |
| By: | Yili Chien; Junsang Lee |
| Abstract: | We study optimal capital taxation under limited commitment. We prove that the optimal tax rate on capital income should be positive in steady state provided that full risk-sharing is not feasible. In a limited commitment environment, a one unit increase of capital investment by an agent increases all individuals' autarky values in the economy and generates externality costs in the economy. This externality cost provides a rationale for positive capital taxation even in the absence of government expenditure. Moreover, we show that both this externality cost of capital investment and the optimal tax rate are potentially much bigger than one might expect. |
| Date: | 2009–01 |
| URL: | http://d.repec.org/n?u=RePEc:acb:camaaa:2009-06&r=dge |
| By: | Jianjun Miao (Department of Economics, Boston University) |
| Abstract: | This paper presents an analytically tractable continuous-time general equilibrium model with investment irreversibility and fixed adjustment costs. In the model, there is a continuum of firms that are subject to idiosyncratic shocks to capital. Although the presence of investment frictions lowers consumer welfare, it may raise or reduce the long-run average capital stock, depending on the degree of idiosyncratic uncertainty. An increase in this uncertainty may raise equilibrium aggregate capital, but reduce welfare. An unexpected permanent change in the corporate income tax rate affects the investment trigger and target values, and hence the size and rate of capital adjustment. Following this tax policy, the percentage changes in equilibrium quantities are larger when fixed adjustment costs are larger. These changes are significantly smaller in a general equilibrium model than in a partial equilibrium model. |
| Keywords: | irreversibility, fixed costs, heterogeneity, tax policy, general equilibrium |
| JEL: | D92 E22 E62 |
| Date: | 2009–04 |
| URL: | http://d.repec.org/n?u=RePEc:bos:iedwpr:dp-181&r=dge |
| By: | Yongsung Chang (University of Rochester); Sun-Bin Kim (Department of Economics, Korea University); Jaewoo Lee (International Monetary Fund) |
| Abstract: | We undertake a quantitative analysis of the dispersion of current accounts in an open economy version of incomplete insurance model, incorporating important market frictions in trade and financial flows. Calibrated with conventional parameter values, the stochastic stationary equilibrium of the model with limited borrowing can account for about two-thirds of the global dispersion of current accounts. The easing of financial frictions can explain nearly all changes in the current account dispersion in the past four decades whereas the easing of trade frictions has almost no impact on the current account dispersion. |
| Keywords: | Distribution of Current Account, Incomplete Markets, Frictions. |
| JEL: | F3 F4 |
| Date: | 2009–05 |
| URL: | http://d.repec.org/n?u=RePEc:roc:rocher:548&r=dge |
| By: | François Gourio (Boston University, Department of Economics) |
| Abstract: | A capital income tax cut must in general be financed by increasing other taxes, and thus will have redistributive effects. This paper studies analytically the redistribution implied by a capital income tax cut in the Ramsey-Cass-Koopmans neoclassical growth model when agents differ in wealth and human capital and markets are frictionless. A few parameters a¤ect the efficiency benefits and redistributive costs of capital taxation, and determine the set of agents who are in favor of a capital income tax cut. For plausible parameter values, a majority would lose from the tax cut, i.e. high capital taxes may be politically sustainable. |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:bos:wpaper:wp2008-001&r=dge |
| By: | Lena Calahorrano (RWTH Aachen University, Faculty of Business and Economics, Templergraben 64, 52062 Aachen, Germany); Oliver Lorz (RWTH Aachen University, Faculty of Business and Economics, Templergraben 64, 52062 Aachen, Germany) |
| Abstract: | In this note we analyze how aging affects immigration policy. We set up a dynamic political-economy model of representative democracy in which the government of the destination country sets the immigration level to maximize aggregate welfare of the constituency. Aging, i.e. a decline in the growth rate of the native population, has an expansionary effect on immigration. This immigration effect may even overcompensate the initial decline in population growth such that the total labor force grows more strongly and the capital stock per worker declines. We also compare our results to the social planner allocation and to the median-voter equilibrium. |
| Keywords: | Demographic change, political economy, immigration policy |
| JEL: | D78 F22 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:mar:magkse:200926&r=dge |
| By: | Zagaglia, Paolo (Dept. of Economics, Stockholm University) |
| Abstract: | This paper studies the forecasting performance of the general equilibrium model of bond yields of Marzo, Söderström and Zagaglia (2008), where long-term interest rates are an integral part of the monetary transmission mechanism. The model is estimated with Bayesian methods on Euro area data. I investigate the out-of-sample predictive performance across different model specifications, including that of De Graeve, Emiris and Wouters (2009). The accuracy of point forecasts is evaluated through both univariate and multivariate accuracy measures. I show that taking into account the impact of the term structure of interest rates on the macroeconomy generates superior out-of-sample forecasts for both real variables, such as output, and inflation, and for bond yields. |
| Keywords: | Monetary policy; yield curve; general equilibrium; bayesian estimation |
| JEL: | E43 E44 E52 |
| Date: | 2009–05–20 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:sunrpe:2009_0014&r=dge |
| By: | Moser, Christoph; Stähler, Nikolai |
| Abstract: | Labor market studies on the effects of minimum wages are typically confined to the sector or worker group directly affected. We present a two-sector search model in which one sector is more productive than the other one and thus, pays higher wages. In such a framework, setting a minimum wage in the unproductive sector to reduce the wage gap causes a negative spillover effect on the productive sector. While the effect on job creation in the (targeted) unproductive sector is ambiguous, job creation in the (non-targeted) productive sector unambiguously decreases. This is driven by the fact that a minimum wage increases the outside option of unemployed workers - contributing to wage determination in the productive sector. Welfare effects are ambiguous. In principle, we cannot exclude that a minimum wage in a two-sector search model is welfare enhancing due to the possibility of an above optimal level of productive employment since firms do not take into account the effects of their individual job creation on aggregated search costs. |
| Keywords: | minimum wages, matching models, two sectors, unemployment, welfare |
| JEL: | E24 J31 J60 J64 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bubdp1:7570&r=dge |
| By: | Hui Chen (MIT Sloan School of Management); Jianjun Miao (Department of Economics, Boston University); Neng Wang (Columbia Business School and National Bureau of Economic Research) |
| Abstract: | Entrepreneurs face significant non-diversifiable business risks. We build a dynamic incompletemarkets model of entrepreneurial finance to demonstrate the important implications of nondiversifiable risks for entrepreneurs’ interdependent consumption, portfolio allocation, financing, investment, and business exit decisions. The optimal capital structure is determined by a generalized tradeoff model where leverage via risky non-recourse debt provides significant diversification benefits. More risk-averse entrepreneurs default earlier, but also choose higher leverage, even though leverage makes his equity more risky. Non-diversified entrepreneurs demand both systematic and idiosyncratic risk premium. Cash-out option and external equity further improve diversification and raise the entrepreneur’s valuation of the firm. Finally, entrepreneurial risk aversion can overturn the risk-shifting incentives induced by risky debt. |
| Keywords: | Default, diversification benefits, entrepreneurial risk aversion, incomplete markets, private equity premium, hedging, capital structure, cash-out option, precautionary saving |
| JEL: | G11 G31 E2 |
| Date: | 2009–03 |
| URL: | http://d.repec.org/n?u=RePEc:bos:iedwpr:dp-180&r=dge |
| By: | François Gourio (Boston University, Department of Economics) |
| Abstract: | This paper studies whether the Rietz–Barro “disaster” model, extended for a time-varying probability of disaster, can match the empirical evidence on predictability of stock returns. It is shown that when utility is CRRA, the model cannot replicate this evidence, regardless of parameter values. This motivates extending the disaster model to allow for Epstein–Zin utility. Analytical results show that when the probability of disaster is i.i.d., the model with Epstein–Zin utility can match the evidence on predictability qualitatively if the intertemporal elasticity of substitution is greater than unity. The case of a persistent probability of disaster is studied numerically, with partial success. |
| Keywords: | Rare events, Jumps, Disasters, Equity premium, Return predictability |
| JEL: | E43 E44 G11 G12 |
| Date: | 2008–01 |
| URL: | http://d.repec.org/n?u=RePEc:bos:wpaper:wp2008-016&r=dge |
| By: | Hui Chen (MIT Sloan School of Management); Nengjiu Ju (Department of Finance, the Hong Kong University of Science and Technology); Jianjun Miao (Department of Economics, Boston University) |
| Abstract: | We study an investor's optimal consumption and portfolio choice problem when he confronts with two possibly misspecified submodels of stock returns: one with IID returns and the other with predictability. We adopt a generalized recursive ambiguity model to accommodate the investor's aversion to model uncertainty. The investor deals with specification doubts by slanting his beliefs about submodels of returns pessimistically, causing his investment strategy to be more conservative than the Bayesian strategy. This effect is large for extreme values of the predictive variable. Unlike in the Bayesian framework, model uncertainty induces a hedging demand, which may cause the investor to decrease his stock allocations sharply and then increase with his prior probability of IID returns. Adopting suboptimal investment strategies by ignoring model uncertainty can lead to sizable welfare costs. |
| Keywords: | generalized recursive ambiguity utility, ambiguity aversion, model uncertainty, learning, portfolio choice, robustness, return predictability |
| JEL: | D81 D83 G11 E21 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:bos:iedwpr:dp-179&r=dge |
| By: | Mark Bils (University of Rochester); Yongsung Chang (University of Rochester); Sun-Bin Kim (Department of Economics, Korea University) |
| Abstract: | We model unemployment allowing workers to differ by comparative advantage in market work. Workers with comparative advantage are identified by who works more hours when employed. This enables us to test the model by grouping workers based on their long-term wages and hours from panel data. The model captures the greater cyclicality of employment for workers with low comparative advantage. But the model fails to explain the magnitude of countercyclical separations for high-wage workers or the magnitude of procyclical findings for high-hours workers. As a result, it only captures the cyclicality of the extensive, employment margin for low-wage, low-hours workers. |
| Date: | 2009–05 |
| URL: | http://d.repec.org/n?u=RePEc:roc:rocher:547&r=dge |
| By: | Ivan Petrella (University of Cambridge); Emiliano Santoro (Department of Economics, University of Copenhagen) |
| Abstract: | This paper deals with the implications of factor demand linkages for monetary policy design. We develop a dynamic general equilibrium model with two sectors that produce durable and non-durable goods, respectively. Part of the output produced in each sector is used as an intermediate input of production in both sectors, according to an input-output matrix calibrated on the US economy. As shown in a number of recent contributions, this roundabout technology allows us to reconcile standard two-sector New Keynesian models with the empirical evidence showing co-movement between durable and non-durable spending in response to a monetary policy shock. A main result of our monetary policy analysis is that strategic complementarities generated by factor demand linkages amplify social welfare loss. As the degree of interconnection between sectors increases, the cost of misperceiving the correct production technology of each sector can rise substantially. In addition, the transmission of different sources of exogenous perturbation is altered, compared to what is commonly observed in standard two-sector models without factor demand linkages. In this respect, the role of the relative price of non-durable goods is crucial, as this does not only influence the user cost of durables through the conventional demand channel, but also affects in opposite directions the real marginal cost of production in either sector through the intermediate input channel. |
| Keywords: | input-output interactions, durable goods, optimal monetary policy |
| JEL: | E23 E32 E52 |
| Date: | 2009–05 |
| URL: | http://d.repec.org/n?u=RePEc:kud:epruwp:09-04&r=dge |
| By: | Jeremy Greenwood (Department of Economics University of Pennsylvania); Nezih Guner (Department of Economics, Universidad Carlos III de Madrid) |
| Abstract: | In 1900 only six percent of unwed females engaged in premarital sex. Now, three quarters do. The sexual revolution is studied here using an equilibrium matching model, where the costs of premarital sex fall over time due to technological improvement in contraceptives. Individuals differ in their desire for sex. Given this, people tend to circulate in social groups where prospective partners share their views on premarital sex. To the extent that a society's customs and mores reflect the aggregation of decentralized decision making by its members, shifts in the economic environment may induce changes in what is perceived as culture. |
| Keywords: | Social change, the sexual revolution, technological progress in contraceptives, bilateral search. |
| JEL: | E1 J1 O3 |
| Date: | 2009–05 |
| URL: | http://d.repec.org/n?u=RePEc:roc:rocher:550&r=dge |