nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2009‒07‒28
seventeen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Endogenous income taxes in OLG economies By Zhang, Yan; Chen, Yan
  2. The Tradeoff Between Growth and Redistribution: ELIE in an Overlapping Generations Model By David, DE LA CROIX; Michel LUBRANO
  3. Heterogeneity and Cyclical Unemployment By Mark Bils; Yongsung Chang; Sun-Bin Kim
  4. Optimal Irrational Behavior By James Feigenbaum; Frank N. Caliendo; Emin Gahramanov
  5. Search in the ProductMarket and the Real Business Cycle By Thomas, Y. MATH€; Olivier, PIERRARD
  6. Overborrowing and Systemic Externalities in the Business Cycle By Bianchi, Javier
  7. Dynamics of Fiscal Financing in the United States By Eric M. Leeper; Michael Plante; Nora Traum
  8. Estimation of DSGE Models When the Data are Persistent By Yuriy Gorodnichenko; Serena Ng
  9. Housing Finance and Monetary Policy. By Alessandro Calza; Tommaso Monacelli; Livio Stracca
  10. Quantitative Significance of Collateral Constraints as an Amplification Mechanism By INABA Masaru; KOBAYASHI Keiichiro
  11. A Stochastic Growth Model with Income Tax Evasion: Implications for Australia By Ratbek Dzhumashev; Emin Gahramanov
  12. Some Unpleasant General Equilibrium Implications of Executive Incentive Compensation Contracts By John B. Donaldson; Natalia Gershun; Marc P. Giannoni
  13. On the Distributional Consequences of Epidemics By Raouf,BOUCEKKINE; Jean-Pierre, LAFFARGUE
  14. Monetary Policy Activism and Price Responsiveness to Aggregate Shocks under Rational Inattention By Paciello, Luigi
  15. Brain drain in globalization A general equilibrium analysis from the sending countriesÕ perspective By Luca, MARCHIORI; I-Ling SHEN; FrŽdŽric, DOCQUIER
  16. General Pattern Formation in Recursive Dynamical Systems Models in Economics By Anastasios Xepapadeas; William Brock
  17. Climate Change Feedback on Economic Growth: Explorations with a Dynamic General Equilibrium Model By Fabio Eboli; Ramiro Parrado; Roberto Roson

  1. By: Zhang, Yan; Chen, Yan
    Abstract: This paper introduces fiscal increasing returns, through endogenous labor income tax rates as in Schmitt-Grohe and Uribe (1997), into the overlapping generations model with endogenous labor and consumption in both periods of life (for example, Cazzavillan and Pintus (2004)). We show that under numerical calibrations of the parameters, in particular a reasonable share of first period consumption over the wage income, local indeterminacy can easily occur with small distortionary taxes, provided that the elasticity of capital-labor substitution is less than the share of capital in total income and the wage elasticity of the labor supply is large enough. More important is the fact that increasing the size of tax distortions enlarges the range of values of the consumption--to--wage ratio associated with multiple equilibria, because of two conflicting effects on savings that operate through wage and interest rate.
    Keywords: Indeterminacy; Endogenous labor income tax rate.
    JEL: E32 C62
    Date: 2009–07–22
  2. By: David, DE LA CROIX (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES) and Center for Operations Research and Econometrics (CORE)); Michel LUBRANO (GREQAM and CNRS)
    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
    JEL: O41 H20 I38
    Date: 2009–06–09
  3. By: Mark Bils; Yongsung Chang; Sun-Bin Kim
    Abstract: We model worker heterogeneity in the rents from being employed in a Diamond-Mortensen-Pissarides model of matching and unemployment. We show that heterogeneity, reflecting differences in match quality and worker assets, reduces the extent of fluctuations in separations and unemployment. We find that the model faces a trade-off--it cannot produce both realistic dispersion in wage growth across workers and realistic cyclical fluctuations in unemployment.
    JEL: E2 E32
    Date: 2009–07
  4. By: James Feigenbaum; Frank N. Caliendo; Emin Gahramanov
    Abstract: Contrary to the usual presumption that welfare is maximized if consumers behave rationally, we show in a two-period overlapping generations model that there always exists a rule of thumb that can weakly improve upon the lifecycle/permanent-income rule in general equilibrium with irrational households. The market-clearing mechanism introduces a pecuniary externality that individual rational households do not consider when making decisions, but a publically shared rule of thumb can exploit this effect. For typical calibrations, the improvement of the welfare of irrational households is robust to the introduction of rational agents. Generalizing to a more realistic lifecycle model, we find in particular that the Save More Tomorrow Plan can confer higher lifetime utility than the permanent-income rule in general equilibrium.
    Keywords: consumption, saving, coordination, lifecycle/permanent income hypothesis, SMarT Plan, general equilibrium, rules of thumb, pecuniary externality
    JEL: C61 D11 E21
    Date: 2009–02–10
  5. By: Thomas, Y. MATH€ (CENTRAL BANK OF LUXEMBOURG, Economics and Research Department); Olivier, PIERRARD (CENTRAL BANK OF LUXEMBOURG, Economics and Research Department and UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES))
    Abstract: Empirical evidence suggests thatmost firms operate in imperfectly competitivemarkets. We develop a search-matching model between wholesalers and retailers. Firms face search costs and formlong-termrelationships. Price bargain results in both wholesaler and retailer markups, depending on firmsÕ relative bargaining power. We simulate themodel to explore the role of product market search frictions in business cycles. We show that the way search costs are modelled is crucial to provide a realistic picture of firmsÕ business environment and improve the cyclical properties of an otherwise standard real business cycle model.
    Keywords: Business cycle, Frictions, Product market, Price bargain
    JEL: E10 E31 E32
    Date: 2009–07
  6. By: Bianchi, Javier
    Abstract: Credit constraints that link a private agent's debt to market-determined prices embody a systemic credit externality that drives a wedge between competitive and (constrained) socially optimal equilibria, which induces private agents to ``overborrow". We quantify the effects of this externality in a two-sector DSGE model of a small open economy calibrated to emerging markets. Debt is denominated in units of tradable goods, and is constrained not to exceed a fraction of income, including nontradables income valued at the relative price of nontradables. The externality arises because agents fail to internalize the price effects of their individual borrowing, and hence the adverse debt-deflation amplification effects of negative income shocks that trigger a binding credit constraint. Quantitatively, the credit externality causes a modest increase in average debt, of about 2 percentage points of GDP, but it triples the probability of financial crises and doubles the average current account and consumption reversals caused by these crises.
    Keywords: Financial Crises, Business Cycles, Amplification Effects, Sudden Stops, Systemic Externalities
    JEL: D62 F20 E32 F32 F30 F41
    Date: 2009–04–28
  7. By: Eric M. Leeper; Michael Plante; Nora Traum
    Abstract: Dynamic stochastic general equilibrium models that include policy rules for government spending, lump-sum transfers, and distortionary taxation on labor and capital income and on consumption expenditures are fit to U.S. data under a variety of specifications of fiscal policy rules. We obtain several results. First, the best fitting model allows a rich set of fiscal instruments to respond to stabilize debt. Second, responses of aggregate variables to fiscal policy shocks under rich fiscal rules can vary considerably from responses that allow only non-distortionary fiscal instruments to finance debt. Third, based on estimated policy rules, transfers, capital tax rates, and government spending have historically responded strongly to government debt, while labor taxes have responded more weakly. Fourth, all components of the intertemporal condition linking debt to expected discounted surpluses---transfers, spending, tax revenues, and discount factors---display instances where their expected movements are important in establishing equilibrium. Fifth, debt-financed fiscal shocks trigger long lasting dynamics so that short-run multipliers can differ markedly from long-run multipliers, even in their signs.
    JEL: C11 E32 E62
    Date: 2009–07
  8. By: Yuriy Gorodnichenko; Serena Ng
    Abstract: Dynamic Stochastic General Equilibrium (DSGE) models are often solved and estimated under specific assumptions as to whether the exogenous variables are difference or trend stationary. However, even mild departures of the data generating process from these assumptions can severely bias the estimates of the model parameters. This paper proposes new estimators that do not require researchers to take a stand on whether shocks have permanent or transitory effects. These procedures have two key features. First, the same filter is applied to both the data and the model variables. Second, the filtered variables are stationary when evaluated at the true parameter vector. The estimators are approximately normally distributed not only when the shocks are mildly persistent, but also when they have near or exact unit roots. Simulations show that these robust estimators perform well especially when the shocks are highly persistent yet stationary. In such cases, linear detrending and first differencing are shown to yield biased or imprecise estimates.
    JEL: E3 F4 O4
    Date: 2009–07
  9. By: Alessandro Calza (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Tommaso Monacelli (IGIER, Università Bocconi, Via Sarfatti, 25 Milano, Italy.); Livio Stracca (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: We study how the structure of housing finance affects the transmission of monetary policy shocks. We document three main facts: first, the features of residential mortgage markets differ markedly across industrialized countries; second, and according to a wide range of indicators, the transmission of monetary policy shocks to residential investment and house prices is significantly stronger in those countries with larger flexibility/development of mortgage markets; third, the transmission to consumption is stronger only in those countries where mortgage equity release is common and mortgage contracts are predominantly of the variable-rate type. We build a two-sector DSGE model with price stickiness and collateral constraints and analyze how the response of consumption and residential investment to monetary policy shocks is affected by alternative values of two institutional features: (i) down-payment rate; (ii) interest rate mortgage structure (variable vs. fixed rate). In line with our empirical evidence, the sensitivity of both variables to monetary policy shocks increases with lower values of the down-payment rate and is larger under a variable- rate mortgage structure. JEL Classification: E21, E44, E52.
    Keywords: Housing finance, mortgage markets, collateral constraint, monetary policy.
    Date: 2009–07
  10. By: INABA Masaru; KOBAYASHI Keiichiro
    Abstract: Do large fluctuations arise from small shocks through financial frictions? In previous literature it is shown that a collateral constraint on intertemporal debt for consumption smoothing does not have a quantitatively significant effect on the response of output to unexpected shocks. We additionally focus on the collateral constraint on intratemporal debt for wage payments and examine the amplification of output. We find that output is significantly amplified in a standard functional form and parameter region. We also find that the region of the parameters for which the output is amplified is wider than that of previous literature.
    Date: 2009–07
  11. By: Ratbek Dzhumashev; Emin Gahramanov
    Abstract: In this paper we develop a stochastic endogenous growth model augmented with income tax evasion. Our model avoids some existing discrepancies between empirical evidence and theoretical predictions of traditional tax evasion models. Further, we show that: i) productive government expenditures play an important role in affecting economy's tax evasion rate; ii) the average marginal income tax rate in Australia come close to the optimal; and iii) the phenomenon of tax evasion is not an excuse for a productive government to advocate an excessive income taxation.
    Keywords: Tax evasion; Economic growth; Public services
    JEL: H26 D91 O41
    Date: 2009–04–15
  12. By: John B. Donaldson; Natalia Gershun; Marc P. Giannoni
    Abstract: We consider a simple variant of the standard real business cycle model in which shareholders hire a self-interested executive to manage the firm on their behalf. Delegation gives rise to a generic conflict of interest mediated by a convex (option-like) compensation contract which is able to align the interests of managers and their shareholders. With such a compensation contract, a given increase in the firm's output generated by an additional unit of physical investment results in a more than proportional increase in the manager's income. We find that incentive contracts of this form can easily result in an indeterminate general equilibrium, with business cycles driven by self-fulfilling fluctuations in the manager's expectations. These expectations are unrelated to fundamentals. Arbitrarily large fluctuations in macroeconomic variables may possibly result.
    JEL: E32 J33
    Date: 2009–07
  13. By: Raouf,BOUCEKKINE (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES) and Center for Operations Research and Econometrics (CORE)); Jean-Pierre, LAFFARGUE (University Paris I, CES and CEPREMAP)
    Abstract: We develop a tractable general theory for the study of the economic and demographic impact of epidemics, and notably its distributional consequences. To this end, we develop a three-period overlapping generations model where altruistic parents choose optimal health expenditures for their children and themselves. The survival probability of (junior) adults and children depends on such investments. Agents can be skilled or unskilled. The model emphasizes the role of orphans. Orphans are not only penalized in the face of death, they are also penalized in the access to education. Epidemics are modeled as one period exogenous shocks to the survival rates. We specifically study the consequence of a negative shock on adult survival rates in the first period. We prove that while the epidemic has no permanent effect on income distribution, it can perfectly alter it in the short and medium run. In particular, the epidemic may imply a worsening in the short and medium run of both economic performance and income distribution. Two opposite mechanisms are isolated: first, the survival rate of children at the end of the first period decreases relatively more in poor than in wealthy families. This decreases the proportion of junior adults with a low endowment of human capital in period 2. Secondly, the number of orphans in period 1 increases in both families. This decreases the proportion of junior adults with a low endowment of human capital in period 2. Therefore, the proportion of the unskilled will necessarily increase in the medium run if orphans are too penalized in the access to a high level of education.
    Keywords: Epidemics, orphans, income distribution, endogenous survival, medium-term dynamics
    JEL: O1 D9 I1 I2
    Date: 2009–05
  14. By: Paciello, Luigi
    Abstract: This paper presents a general equilibrium model that is consistent with recent empirical evidence showing that the U.S. price level and inflation are much more responsive to aggregate technology shocks than to monetary policy shocks. The model of this paper builds on recent work by Mackowiak and Wiederholt (2009), who show that models of endogenous attention allocation deliver prices to be more responsive to more volatile shocks as, everything else being equal, firms pay relatively more attention to more volatile shocks. In fact, according to the U.S. data, aggregate technology shocks are more volatile than monetary policy shocks inducing in this paper, firms to pay more attention to the former than to the latter. However, most important, this work adds to the literature by showing that the ability of the model of this paper to account for observed price dynamics crucially depends on monetary policy. In particular, this paper shows how interest rate feedback rules affect the incentives faced by firms in allocating attention. A policy rate responding more actively to expected inflation and output fluctuations induces firms to pay relatively more attention to more volatile shocks. This new mechanism of transmission of monetary policy helps rationalizing the observed behavior of prices in response to technology and monetary policy shocks, and implies novel predictions about the impact of changes in Taylor rules coefficients on economic fluctuations.
    Keywords: Rational inattention; monetary policy; technology shocks; prices
    JEL: E5 E3
    Date: 2009–07–18
  15. By: Luca, MARCHIORI (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES) and UNIVERSITY OF LUXEMBOURG, Faculty of Law, Economics and Finance); I-Ling SHEN (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES), UNIVERSITY OF GENEVA, Department of Econometrics and Institute for the Study of Labor (IZA)); FrŽdŽric, DOCQUIER (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES), Belgian National Fund of Scientific Research and Institute for the Study of Labor (IZA))
    Abstract: The paper assesses the global effects of brain drain on developing economies and quantifies the relative sizes of various static and dynamic impacts. By constructing a unified generic framework characterized by overlappinggenerations dynamics and calibrated to real data, this study incorporates many direct impacts of brain drain whose interactions, along with other indirect effects, are endogenously and dynamically generated. Our findings suggest that the short-run impact of brain drain on resident human capital is extremely crucial, as it does not only determine the number of skilled workers available to domestic production, but it also affects the sending economyÕs capacity to innovate or to adopt modern technologies. The latter impact plays an important role particularly in a globalized economy where capital investments are made in places with higher production efficiencies ceteris paribus. Hence, in spite of several empirically documented positive feedback effects, those countries with high skilled emigration rates are the most candid victims to brain drain since they are least likely to benefit from the Òbrain gainÓ effect, and thus suffering from declines of their resident human capital.
    Keywords: Brain Drain, Capital Flow, Development, Human Capital, Remittances
    JEL: F22 J24 O15
    Date: 2009–06
  16. By: Anastasios Xepapadeas (Athens University of Economics and Business and Beijer Fellow); William Brock (University of Wisconsin and Beijer Fellow)
    Abstract: This paper presents a fairly general treatment of recursive infinite horizon forward looking optimizing systems on infinite dimensional spatial domains. It includes optimal control, an analysis of local stability of spatially flat optimal steady states and development of techniques to compute spatially heterogeneous optimal steady states. The paper also develops a concept of rational expectations equilibrium, a local stability analysis for spatially homogeneous rational expectations steady states, and computational techniques for spatially heterogeneous rational expectations steady states.
    Keywords: Pattern Formation, Spatial Spillovers, Optimal Control, Spillover Induced Instability, Growth Models
    JEL: C61
    Date: 2009–06
  17. By: Fabio Eboli (Fondazione Eni Enrico Mattei); Ramiro Parrado (Fondazione Eni Enrico Mattei and Ca’ Foscari University); Roberto Roson (Ca’ Foscari University, Venice)
    Abstract: Human-generated greenhouse gases depend on the level of economic activity. Therefore, most climate change studies are based on models and scenarios of economic growth. Economic growth itself, however, is likely to be affected by climate change impacts. These impacts affect the economy in multiple and complex ways: changes in productivity, resource endowments, production and consumption patterns. We use a new dynamic, multi-regional Computable General Equilibrium (CGE) model of the world economy to answer the following questions: Will climate change impacts significantly affect growth and wealth distribution in the world? Should forecasts of human-induced greenhouse gases emissions be revised, once climate change impacts are taken into account? We found that, even though economic growth and emission paths do not change significantly at the global level, relevant differences exist at the regional and sectoral level. In particular, developing countries appear to suffer the most from climate change impacts.
    Keywords: Computable General Equilibrium Models, Climate Change, Economic Growth
    JEL: C68 E27 O12 Q54 Q56
    Date: 2009–06

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