nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2009‒08‒02
24 papers chosen by
Christian Zimmermann
University of Connecticut

  1. On Rational Exuberance By Stefano Bosi; Thomas Seegmuller
  2. Business cycle implications of internal consumption habit for new Keynesian models By Takashi Kano; James M. Nason
  3. Numerical simulation of nonoptimal dynamic equilibrium models By Zhigang Feng; Jianjun Miao; Adrian Peralta-Alva; Manuel S. Santos
  4. Evaluating a monetary business cycle model with unemployment for the euro area By Nicolas Groshenny
  5. Inventory accelerator in general equilibrium By Pengfei Wang; Yi Wen
  6. When does heterogeneity matter? By Yi Wen
  7. Fiscal Policy, Maintenance Allowances and Expectation-Driven Business Cycles By Nicolas L. Dromel
  8. Liquidity and welfare in a heterogeneous-agent economy By Yi Wen
  9. A note on sunspots with heterogeneous agents By Daniel R. Carroll; Eric R. Young
  10. Environmental health and education : Towards sustainable growth By Natacha Raffin
  11. Capital misallocation and aggregate factor productivity By Costas Azariadis; Leo Kaas
  12. Financial development and economic volatility: a unified explanation By Pengfei Wang; Yi Wen
  13. Speculative bubbles and financial crisis By Pengfei Wang; Yi Wen
  14. Credit Constraints and the Persistence of Unemployment By Nicolas L. Dromel; Elie Kolakez; Etienne Lehmann
  15. Estate taxation with warm-glow altruism By Carlos Garriga; Fernando Sánchez-Losada
  16. Existence of competitive equilibrium in an optimal growth model with elastic labor supply and smoothness of the policy function By GOENKA Aditya; NGUYEN Manh-Hung
  17. Incomplete Financial Markets and Jumps in Asset Prices By Hervé Crès; Tobias Markeprand; Mich Tvede
  18. Inter-temporal and Inter-Industry Effects of Population Ageing: A General Equilibrium Assessment for Canada By Annabi, Nabil; Fougère, Maxime; Harvey, Simon
  19. An analytical approach to buffer-stock saving By Yi Wen
  20. The sensitivity of DSGE models' results to data detrending By Simona Delle Chiaie
  21. A Dynamic Explanation of the Crisis of the Welfare State By Christophe Hachon
  22. Technological Progress and Population Growth: Do we have too few children? By Koichi Futagami; Takeo Hori
  23. The dynamics of knowledge diversity and economic growth By Berliant, Marcus; Fujita, Masahisa
  24. A simple model of trading and pricing risky assets under ambiguity: any lessons for policy-makers? By Massimo Guidolin; Francesca Rinaldi

  1. By: Stefano Bosi (EQUIPPE - Université de Lille I, EPEE - Université d'Evry-Val d'Essonne); Thomas Seegmuller (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    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.
    Date: 2009–01
  2. By: Takashi Kano; James M. Nason
    Abstract: This paper studies the implications of internal consumption habit for propagation and monetary transmission in New Keynesian dynamic stochastic general equilibrium (NKDSGE) models. We use Bayesian methods to evaluate the role of internal consumption habit in NKDSGE model propagation and monetary transmission. Simulation experiments show that internal consumption habit often improves NKDSGE model fit to output and consumption growth spectra by dampening business cycle periodicity. Nonetheless, habit NKDSGE model fit is vulnerable to nominal rigidity, the choice of monetary policy rule, the frequencies used for evaluation, and spectra identified by permanent productivity shocks.
    Date: 2009
  3. By: Zhigang Feng; Jianjun Miao; Adrian Peralta-Alva; Manuel S. Santos
    Abstract: In this paper we present a recursive method for the computation of dynamic competitive equilibria in models with heterogeneous agents and market frictions. This method is based on a convergent operator over an expanded set of state variables. The fixed point of this operator defines the set of all Markovian equilibria. We study approximation properties of the operator as well as the convergence of the moments of simulated sample paths. We apply our numerical algorithm to two growth models, an overlapping generations economy with money, and an asset pricing model with financial frictions.
    Keywords: Econometric models
    Date: 2009
  4. By: Nicolas Groshenny (Reserve Bank of New Zealand, Economics department)
    Abstract: This paper estimates a medium-scale DSGE model with search unemployment by matching model and data spectra. Price mark-up shocks emerge as the main source of business-cycle fluctuations in the euro area. Key factors in the propagation of these disturbances are a high degree of inflation indexation and a persistent response of monetary policy to deviations from the inflation target
    Keywords: DSGE models, business cycles, frequency-domain analysis
    JEL: E32 C51 C52
    Date: 2009–07
  5. By: Pengfei Wang; Yi Wen
    Abstract: We develop a general-equilibrium model of inventories with explicit micro-foundations by embedding the production-cost-smoothing motive (e.g., Eichenbaum, AER 1989) into an otherwise standard DSGE model. We show that firms facing idiosyncratic cost shocks have incentives to bunch production and smooth sales by carrying inventories. The optimal inventory target of a firm is derived explicitly. The model is broadly consistent with many of the observed stylized facts of aggregate inventory fluctuations, such as the procyclical inventory investment and the countercyclical inventory-sales ratio. In addition, the model yields novel predictions for the role of inventories in macroeconomic stability: Inventories may not only greatly amplify but also propagate the business cycle. That is, the incentive to accumulate inventories under the cost-smoothing motive can give rise to hump-shaped output dynamics and significantly higher volatility of GDP. Such predictions are in sharp contrast to the implications of the recent general-equilibrium inventory literature (e.g., Khan and Thomas, 2007; and Wen, 2008), which shows that inventory investment induced by traditional mechanisms (e.g., the stockout-avoidance motive and the (S,s) rule) does not increase the variance of aggregate output.
    Keywords: Equilibrium (Economics) ; Business cycles ; Inventories
    Date: 2009
  6. By: Yi Wen
    Abstract: How do movements in the distribution of income affect the macroeconomy? Krusell and Smith (1998) analyzed this question in a neoclassical growth model, and their results show that the representative-agent assumption provides a good approximation for aggregate behaviors of heterogeneous agents. This paper extends their analysis to a cash-in-advance model with heterogeneous money demand. It is shown that movements in the distribution of monetary income can have significant impact on the macroeconomy. For example, the dynamic responses of aggregate output to monetary shocks behave very differently from those of a representative agent; the welfare costs of moderate inflation are much higher than previously thought, up to 20% of consumption when the inequality of cash distribution is sufficiently large. This is in sharp contrast to the findings of Cooley and Hansen (1989) and Lucas (2000) based on representative-agent models.
    Keywords: Liquidity (Economics) ; Money theory
    Date: 2009
  7. By: Nicolas L. Dromel (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: Firms devote significant resources to maintain and repair thei existing capital. Within a real business cycle model featuring arguably small aggregate increasing returns, this paper assesses the stabilizing effects of fiscal policies with a maintenance expenditure allowance. In this setup, firms are authorized to deduct their maintenance expenditures from revenues in calculating pre-tax profits, as in many prevailing tax codes. While flat-rate taxation does not prove useful to insulate the economy from self-fulfilling beliefs, a progressive tax can render the equilibrium unique. However, we show that the required progressivity to protect the economy against sunspot-driven fluctuations is increasing in the maintenance-to-GDP ratio. Taking into account the maintenance and repair activity of firms, and the tax deductibility of the related expenditures, would then weaken the expected stabilizing properties of progressive fiscal schedules.
    Keywords: Business cycles, maintenance and repair allowances, capital utilization, progressive income taxes, local indeterminacy and sunspots.
    Date: 2009–05
  8. By: Yi Wen
    Abstract: This paper reconsiders the welfare costs of inflation and the welfare gains from financial intermediation in a heterogeneous-agent economy where money is held as a store of value (as in Bewley, 1980). The dynamic stochastic general equilibrium model recaptures some essential features of the liquidity-preference theory of Keynes (1930, 1936). Because of heterogeneous liquidity demand, transitory lump-sum money injections can have persistent expansionary effects despite flexible prices, and such effects can be greatly amplified by the banking system through the credit channel. However, permanent money growth can be extremely costly: With log utility functions, consumers are willing to reduce consumption by 15% (or more) to avoid a 10% annual inflation. For the same reason, financial intermediation can significantly improve welfare: The welfare costs of a collapse of the banking system is estimated as about 10-68% of aggregate output. These welfare implications differ dramatically from those of the existing literature.
    Keywords: Liquidity (Economics)
    Date: 2009
  9. By: Daniel R. Carroll; Eric R. Young
    Abstract: This paper studies sunspot fluctuations in a model with heterogeneous households. We find that wealth inequality reduces the degree of increasing returns needed to produce indeterminacy, while wage inequality increases it. When the model is calibrated to match the joint distribution of hours, income, and wealth, the required degree of increasing returns to scale is still much too high to be supported empirically (although smaller than similar homogeneous agent economies). We also find that the model robustly predicts only one sunspot, despite having 1,262 predetermined state variables.
    Keywords: Wealth ; Wages
    Date: 2009
  10. By: Natacha Raffin (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    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.
    Date: 2009–04
  11. By: Costas Azariadis; Leo Kaas
    Abstract: We propose a sectoral–shift theory of aggregate factor productivity for a class of economies with AK technologies, limited loan enforcement, a constant production possibilities frontier, and finitely many sectors producing the same good. Both the growth rate and total factor productivity in these economies respond to random and persistent endogenous fluctuations in the sectoral distribution of physical capital which, in turn, responds to persistent and reversible exogenous shifts in relative sector productivities. Surplus capital from less productive sectors is lent to more productive ones in the form of secured collateral loans, as in Kiyotaki–Moore (1997), and also as unsecured reputational loans suggested in Bulow–Rogoff (1989). Endogenous debt limits slow down capital reallocation, preventing the equalization of risk– adjusted equity yields across sectors. Economy–wide factor productivity and the aggregate growth rate are both negatively correlated with the dispersion of sectoral rates of return, sectoral TFP and sectoral growth rates. If sector productivities follow a symmetric two–state Markov process, many of our economies converge to a limit cycle alternating between mild expansions and abrupt contractions. We also find highly periodic and volatile limit cycles in economies with small amounts of collateral.
    Keywords: Industrial productivity
    Date: 2009
  12. 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
  13. By: Pengfei Wang; Yi Wen
    Abstract: Why are asset prices so much more volatile and so often detached from their fundamentals? Why does the burst of financial bubbles depress the real economy? This paper addresses these questions by constructing an infinite-horizon heterogeneous-agent general-equilibrium model with speculative bubbles. We show that agents are willing to invest in asset bubbles even though they have positive probability to burst. We prove that any storable goods, regardless of their intrinsic values, may give birth to bubbles with market prices far exceeding their fundamental values. We also show that perceived changes in the bubbles probability to bust can generate boom-bust cycles and produce asset price movements that are many times more volatile than the economy's fundamentals, as in the data.
    Keywords: Financial crises ; Speculation ; Asset pricing
    Date: 2009
  14. By: Nicolas L. Dromel (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Elie Kolakez (ERMES - TEPP - Université Paris II Panthéon-Assas); Etienne Lehmann (CREST - Centre de Recherche en Économie et Statistique - INSEE - École Nationale de la Statistique et de l'Administration Économique, IZA - Institute for the Study of Labor)
    Abstract: In this paper, we argue that credit market imperfections impact not only the level of unemployment, but also its persistence. For this purpose, we first develop a theoretical model based on the equilibrium matching framework of Mortensen and Pissarides (1999) and Pissarides (2000) where we introduce credit constraints. We show these credit constraints not only increase steady-state unemployment, but also slow down the transitional dynamics. We then provide an empirical illustration based on a country panel dataset of 19 OECD countries. Our results suggest that credit market imperfections would significantly increase the persistence of unemployment.
    Keywords: Credit markets, labor markets, unemployment, credit constraints, search frictions.
    Date: 2009–05
  15. By: Carlos Garriga; Fernando Sánchez-Losada
    Abstract: This article examines the properties of the optimal fiscal policy in an economy with warm-glow altruism (utility interdependence) and heterogeneous individuals. We propose a new efficiency concept, D-efficiency, that considers an implicit constraint in the act of giving: donors cannot bequeath to donees more than their existing resources. Considering this constraint, we show that the market equilibrium is not socially efficient. The efficient level of bequest transfers can be implemented by the market with estate and labor-income subsidies and a capital-income tax. In the absence of lump-sum taxation, the government faces a trade-off between minimizing distortions and eliminating external effects. The implied tax policy differs from Pigovian taxation since the government's ability to correct the external effects is limited. Finally, we show that the efficiency-equity trade-off does not affect the qualitative features of the optimal distortionary fiscal policy.
    Keywords: Altruism ; Taxation
    Date: 2009
  16. By: GOENKA Aditya; NGUYEN Manh-Hung
    Date: 2009–07
  17. By: Hervé Crès (Sciences Po, Paris); Tobias Markeprand (Department of Economics, University of Copenhagen); Mich Tvede (Department of Economics, University of Copenhagen)
    Abstract: A dynamic pure-exchange general equilibrium model with uncertainty is studied. Fundamentals are supposed to depend continuously on states of nature. It is shown that: 1. if financial markets are complete, then asset prices vary continuously with states of nature, and; 2. if financial markets are incomplete, jumps in asset prices may be unavoidable. Consequently incomplete financial markets may increase volatility in asset prices significantly.
    Keywords: general equilibrium; financial markets; jumps in asset prices
    JEL: D52 D53 G12
    Date: 2009–06
  18. By: Annabi, Nabil; Fougère, Maxime; Harvey, Simon
    Abstract: The objective of this paper is to examine the inter-industry and labour market occupational effects of population ageing in Canada, using a computable general equilibrium overlapping-generations model. The model is calibrated along a balanced-growth path, taking into account labour-augmenting (Harrod-neutral) technical progress. It also accounts for heterogeneity at the household level, using 25 occupation-specific earnings profiles. In addition to the impact of slower labour force growth, the model captures the shift in sectoral composition of final demand. The latter is due to different consumption preferences of older individuals. Moreover, a wage curve is introduced to explore the impact of population ageing on the unemployment rate. The simulation results indicate that the growth in real GDP per capita could decline by nearly one percentage point between 2006 and 2050. Besides, the production of services, in percent of total GDP, is projected to increase in the long-run, although the analysis shows more modest changes in production shares than in previous studies. The results also suggest that the equilibrium unemployment rate is likely to decline by more than 2 percentage points in the long run. The impact also varies quite significantly at the occupational level.
    Keywords: Population ageing, growth, general equilibrium model, overlapping generations, Canada
    JEL: D58 J11 O40 O51
    Date: 2009–07–22
  19. By: Yi Wen
    Abstract: The profession has been longing for closed-form solutions to consumption functions under uncertainty and borrowing constraints. This paper proposes an analytical approach to solving buffer-stock saving models with both idiosyncratic and aggregate uncertainties. It is shown analytically that an individual’s optimal consumption plan under uncertainty follows the rule of thumb: Consumption is proportional to a target wealth with the marginal propensity to consume depending on the state of the macroeconomy. The method is applied to addressing two long- standing puzzles: the "excess smoothness" and "excess sensitivity" of consumption with respect to income changes. Some of my findings sharply contradict the conventional wisdom.
    Keywords: Saving and investment ; Income
    Date: 2009
  20. By: Simona Delle Chiaie (Oesterreichische Nationalbank, Economic Studies Division, P.O. Box 61, A-1010 Vienna,)
    Abstract: This paper aims to shed light on potential pitfalls of di¤erent data filtering and detrending procedures for the estimation of stationary DSGE models. For this purpose, a medium-sized New Keynesian model as the one developed by Smets and Wouters (2003) is used to assess the sensitivity of the structural estimates to preliminary data transformations. To examine the question, we focus on two widely used detrending and filtering methods, the HP filter and linear detrending. After comparing the properties of business cycle components, we estimate the model through Bayesian techniques using in turn the two different sets of transformed data. Empirical findings show that posterior distributions of structural parameters are rather sensitive to the choice of detrending. As a consequence, both the magnitude and the persistence of theoretical responses to shocks depend upon preliminary filtering.
    Keywords: DSGE models; Filters; Trends; Bayesian estimates
    JEL: E3
    Date: 2009–07–20
  21. By: Christophe Hachon (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I)
    Abstract: Although the crisis of the Welfare State has been evoked for quite a long time, figures show that such a phenomenon has arisen only recently. Furthermore, it is not a common feature in all developed countries. This paper aims at explaining these two empirical facts. We use an overlapping generations model in which agents decide to educate themselves or not endogenously. Furthermore, at each date, the working population vote on the size of a redistributive policy. Firstly, we show that the share of the educated population can be the engine of the crisis of the Welfare State. Moreover, our paper emphasizes that the expectations of agents about the size of redistributive policies, can explain the timing differential in the crisis of the Welfare State between developed countries.
    Keywords: Welfare State ; Indeterminacy ; Education ; Redistribution
    Date: 2009–03–26
  22. By: Koichi Futagami (Graduate School of Economics, Osaka University); Takeo Hori (zDepartment of Economics, Hitotsubashi University)
    Abstract: Do we have too few children? We intend to address this question. In developed countries, the fertility rate has declined since WWII. This may cause a slowdown in the growth of GDP in developed countries. However, important factors for the well-being of individuals are per capita variables, like per capita growth and per capita consumption. In turn, the rate of technological progress determines the growth rates of per capita variables. If the population size is increasing, the labour inputs for R&D activity increase, and thus speed up technological progress. As individuals do not take account of this positive effect when deciding the number of their own children, the number of children may become smaller than the socially optimal number of children. However, an increase in the number of children reduces the assets any one child owns: that is, there is a capital dilution effect. This works in the opposite direction. We examine this issue using an endogenous growth model where the head of a dynastic family decides the number of children.
    Keywords: Technological Progress, Fertility, R&D
    JEL: J1 O30
    Date: 2009–07
  23. By: Berliant, Marcus; Fujita, Masahisa
    Abstract: How is long run economic growth related to the endogenous diversity of knowledge? We formulate and study a microeconomic model of knowledge creation, through the interactions among a group of heterogeneous R & D workers, embedded in a growth model to address this question. In contrast with the traditional literature, in our model the composition of the research work force in terms of knowledge heterogeneity matters, in addition to its size, in determining the production of new knowledge. Moreover, the heterogeneity of the work force is endogenous. Income to these workers accrues as patent income, whereas transmission of newly created knowledge to all such workers occurs due to public transmission of patent information. Knowledge in common is required for communication, but differential knowledge is useful to bring originality to the endeavor. Whether or not the system reaches the most productive state depends on the strength of the public knowledge transmission technology. Equilibrium paths are found analytically. Long run economic growth is positively related to both the effectiveness of pairwise R & D worker interaction and to the effectiveness of public knowledge transmission.
    Keywords: knowledge creation; knowledge externalities; microfoundations of endogenous growth; knowledge diversity and growth
    JEL: D90 D83 O31
    Date: 2009–07–27
  24. By: Massimo Guidolin; Francesca Rinaldi
    Abstract: The 2007-2008 financial crises has made it painfully obvious that markets may quickly turn illiquid. Moreover, recent experience has taught us that distress and lack of active trading can jump "around" between seemingly unconnected parts of the financial system contributing to transforming isolated shocks into systemic panic attacks. We develop a simple two-period model populated by both standard expected utility maximizers and by ambiguity-averse investors that trade in the market for a risky asset. We show that, provided there is a sufficient amount of ambiguity, market break-downs where large portions of traders withdraw from trading are endogenous and may be triggered by modest re-assessments of the range of possible scenarios on the performance of individual securities. Risk premia (spreads) increase with the proportion of traders in the market who are averse to ambiguity. When we analyze the effect of policy actions, we find that when a market has fallen into a state of impaired liquidity, bringing the market back to orderly functioning through a reduction in the amount of perceived ambiguity may cause further reductions in equilibrium prices. Finally, our model provides stark indications against the idea that policy makers may be able to "inflate" their way out of a financial crisis.
    Keywords: Risk ; Capital assets pricing model ; Financial crises ; Federal Reserve System
    Date: 2009

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