New Economics Papers
on Dynamic General Equilibrium
Issue of 2009‒08‒08
seventeen papers chosen by

  1. Search in the Product Market and the Real Business Cycle. By Thomas Y. Mathä; Olivier Pierrard
  2. Sequential bargaining in a new-Keynesian model with frictional unemployment and staggered ware negotiation. By Gregory de Walque; Olivier Pierrard; Henri Sneessens; Raf Wouters
  3. The external and domestic side of macroeconomic adjustment in China. By Roland Straub; Christian Thimann
  4. When does Lumpy Factor Adjustment Matter for Aggregate Dynamics? By Stephan Fahr; Fang Yao
  5. Macroeconomic Implications of Alternative Tax Regimes: The Case of Greece By Dimitris Papageorgiou
  6. 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
  7. Local and global indeterminacy in two-sector models of endogenous growth By Paulo Brito; Alain Venditti
  8. Housing Finance and Monetary Policy. By Alessandro Calza; Tommaso Monacelli; Livio Stracca
  9. Dynamic Tax Competition under Asymmetric Productivity of Public Capital By Tanaka, H.; Hidaka, M.
  10. Downward wage rigidity and optimal steady-state inflation. By Gabriel Fagan; Julián Messina
  11. Pension Reform in an OLG Model with Multiple Social Security Systems By Çagaçan Deger
  12. Credit Frictions and the Comovement between Durable and Non-durable Consumption By Vincent Sterk
  13. Efficient Labor Force Participation with Search and Bargaining By Bryan Engelhardt; David L. Fuller
  14. Monetary Policy and Inflationary Shocks Under Imperfect Credibility. By Matthieu Darracq Pariès; Stéphane Moyen
  15. Optimal sticky prices under rational inattention. By Bartosz Maćkowiak; Mirko Wiederholt
  16. A Monetary Model of Banking Crises By KOBAYASHI Keiichiro
  17. Job Search with Bidder Memories By Carrillo-Tudela, Carlos; Menzio, Guido; Smith, Eric

  1. By: Thomas Y. Mathä (Central Bank of Luxembourg, 2 bd. Royal, L-2983 Luxembourg.); Olivier Pierrard (Central Bank of Luxembourg, 2 bd. Royal, L-2983 Luxembourg.)
    Abstract: We develop a search-matching model, where firms search for customers (e.g. in form of advertising). Firms use long-term contracts and bargain over prices, resulting in a price mark up above marginal cost, which is procyclical and depends on firms’ relative bargaining power. Product market frictions decrease the steady state equilibrium, improve the cyclical properties of the model and provide a more realistic picture of firms’ business environment. This suggests that product market frictions may well be crucial in explaining business cycle fluctuations. Finally, we also show that welfare costs of price rigidities are negligible relative to welfare costs of frictions. JEL Classification: E10, E31, E32.
    Keywords: Business cycle, Frictions, Product market, Price bargain.
    Date: 2009–03
  2. By: Gregory de Walque (National Bank of Belgium, Boulevard de Berlaimont 14, B-1000 Brussels, Belgium.); Olivier Pierrard (Central Bank of Luxembourg, 2 boulevard Royal, L–2983 Luxembourg, Luxembourg.); Henri Sneessens (Central Bank of Luxembourg, Economics and Research Department, 2 boulevard Royal, L–2983 Luxembourg, Luxembourg.); Raf Wouters (National Bank of Belgium, Boulevard de Berlaimont 14, B-1000 Brussels, Belgium.)
    Abstract: We consider a model with frictional unemployment and staggered wage bargaining where hours worked are negotiated every period. The workers’ bargaining power in the hours negotiation affects both unemployment volatility and inflation persistence. The closer to zero this parameter, (i) the more firms adjust on the intensive margin, reducing employment volatility, (ii) the lower the effective workers’ bargaining power for wages and (iii) the more important the hourly wage in the marginal cost determination. This set-up produces realistic labor market statistics together with inflation persistence. Distinguishing the probability to bargain the wage of the existing and the new jobs, we show that the intensive margin helps reduce the new entrants wage rigidity required to match observed unemployment volatility. JEL Classification: E31, E32, E52, J64.
    Keywords: DSGE, Search and Matching, Nominal Wage Rigidity, Monetary Policy.
    Date: 2009–02
  3. By: Roland Straub (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Christian Thimann (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: This paper sheds new light on the external and domestic dimension of China’s exchange rate policy. It presents an open economy model to analyse both dimensions of macroeconomic adjustment in China under both flexible and fixed exchange rate regimes. The model-based results indicate that persistent current account surpluses in China cannot be rationalized, under general circumstances, by the occurrence of permanent technology or labour supply shocks. As a result, the understanding of the macroeconomic adjustment process in China requires to mimic the effects of potential inefficiencies, which induce the subdued response of domestic absorption to permanent income shocks causing thereby the observed positive unconditional correlation of trade balance and output. The paper argues that these inefficiencies can be potentially seen as a by-product of the fixed exchange rate regime, and can be approximated by a stochastic tax on domestic consumption or time varying transaction cost technology related to money holdings. Our results indicate that a fixed exchange regime with financial market distortions, as defined above, might induce negative effects on GDP growth in the medium-term compared to a more flexible exchange rate regime. JEL Classification: E32, E62.
    Keywords: DSGE modelling, China, current account.
    Date: 2009–03
  4. By: Stephan Fahr (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Fang Yao (Institute for Economic Theory, Humboldt University of Berlin, Spandauer Strasse 1, D-10178 Berlin, Germany.)
    Abstract: We analyze the dynamic effects of lumpy factor adjustments at the firm level onto the aggregate economy. We find that distinguishing between capital and labour as lumpy factors within the production function result in very different dynamics for aggregate output, investment and labour in an otherwise standard real business cycle model. Lumpy capital leaves the RBC dynamics mainly unchanged, while lumpy labour allows for persistence and an inner propagation within the model in form of hump-shaped impulse responses. In addition, when modeling lumpy adjustments on both investment and labour, the aggregate effects are even stronger. We investigate the mechanisms underlying these results and identify the elasticity of factor supply as the most important element in accounting for these differences. JEL Classification: E32, E22, E24.
    Keywords: Lumpy labor adjustment, Lumpy investment, Business cycles, Elasticity of supply.
    Date: 2009–03
  5. By: Dimitris Papageorgiou (Athens University of Economics and Business)
    Abstract: This paper uses a Dynamic General Equilibrium model that incorporates a detailed fiscal policy structure to examine how changes in the tax mix influence economic activity and welfare in the Greek economy. The results suggest that tax reforms that reduce the labour and capital income tax rates and increase the consumption tax rate lead to higher levels of output, consumption and private investment. If the goal of tax policy is to promote economic growth by changing the tax mix, then it should reduce the capital income tax rate and increase the consumption tax rate. In contrast, a lifetime welfare promoting policy would be to cut the labour income tax rate and increase the consumption tax rate.
    Keywords: Fiscal Policy; Transitional dynamics; Economic growth; Welfare
    JEL: E62
    Date: 2009–05
  6. By: Kai Christoffel (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); James Costain (Banco de España, Alcalá 50, E-28014 Madrid, Spain.); Gregory de Walque (Banque Nationale de Belgique, Boulevard de Berlaimont 14, B-1000 Brussels, Belgium.); Keith Kuester (Federal Reserve Bank of Philadelphia, Ten Independence Mall, Philadelphia, PA 19106-1574, USA.); Tobias Linzert (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Stephen Millard (Bank of England, Threadneedle Street, London EC2R 8AH, UK.); Olivier Pierrard (Banque Centrale du Luxembourg, 2 boulevard Royal, L-2983 Luxembourg, 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 behaviour. 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. JEL Classification: E31, E32, E24, J64.
    Keywords: Inflation Dynamics, Labour Market, Business Cycle, Real Rigidities.
    Date: 2009–05
  7. By: Paulo Brito (ISEG - Technical University of Lisbon, UECE - UECE); Alain Venditti (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: In this paper we consider a two-sector endogenous growth model where the productions of the final good and human capital require economy-wide external effects. Assuming constant returns to scale at the private and social levels, we show that local and global indeterminacy of equilibrium paths are compatible with any values for the elasticity of intertemporal substitution in consumption and any sign for the capital intensity difference across the two sectors.
    Keywords: Two-sector model, endogenous growth, economy-wide externalities, local and global indeterminacy
    Date: 2009–07–28
  8. 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
  9. By: Tanaka, H.; Hidaka, M.
    Abstract: We here expand the static tax competition models in symmetric small regions, which were indicated by Zodrow and Mieszkowski (1986) and Wilson (1986), to a dynamic tax competition model in large regions, taking consideration of the regional asymmetry of productivity of public capital and the existence of capital accumulation. The aim of this paper is to verify how the taxation policy affects asymmetric equilibrium based on a simulation analysis using an overlapping generations model in two regions. It is assumed that the public capital as a public input is formed on the basis of the capital tax of local governments and the lump-sum tax of the central government. As demonstrated in related literature, the optimal capital tax rate should become zero when the lump-sum tax is imposed only on older generations, however, the optimal tax rate may become positive when it is imposed proportionally on younger and older generations. In the asymmetric equilibrium, several cooperative solutions can possibly exist which can achieve a higher welfare standard than the actualized cooperative solution either in Region1 or 2..
    Keywords: Tax competition, Capital taxation, Capital accumulation, Public inputs, Infrastructure
    JEL: H21 H42 H71 H77 R13 R53
    Date: 2009–07–30
  10. By: Gabriel Fagan (Directorate General Research, European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Julián Messina (Universitat de Girona, Plaça Sant Domènec, 3, IT-17071 Girona, Italy; IZA and FEDEA.)
    Abstract: This paper examines the impact of downward wage rigidity (nominal and real) on optimal steady-state inflation. For this purpose, we extend the workhorse model of Erceg, Henderson and Levin (2000) by introducing asymmetric menu costs for wage setting. We estimate the key parameters by simulated method of moments, matching key features of the cross-sectional distribution of individual wage changes observed in the data. We look at five countries(the US, Germany, Portugal, Belgium and Finland). The calibrated heterogeneous agent models are then solved for different steady state rates of inflation to derive welfare implications. We find that, across the European countries considered, the optimal steady-state rate of inflation varies between zero and 2%. For the US, the results depend on the dataset used, with estimates of optimal inflation varying between 2% and 5%. JEL Classification: E31, E52, J4.
    Keywords: Downward wage rigidity, DSGE models, optimal inflation.
    Date: 2009–04
  11. By: Çagaçan Deger (Department of Economics, METU)
    Abstract: Primarily due to financial sustainability problems, social security reforms have been on the policy agenda of both developed and developing countries for the last decade. Research literature on the subject tends to use overlapping generations (OLG) models with single representative household and presents reforms as shock to the constructed model. This study presents an OLG model with three separate social security institutions where the heterogeneity is through different benefit payments and contribution rates. Convergence across various institutions is enabled by a replacement ratio shock and model dynamics are discussed.
    JEL: C68 D91 I38
    Date: 2008–10
  12. By: Vincent Sterk
    Abstract: According to Monacelli (2009), a standard New-Keynesian model augmented with credit frictions solves the outstanding challenge to generate a joint decline of durable and non-durable consumption during a monetary tightening. This paper shows that his success in generating positive comovement between durables and non-durables is solely due to assumptions about price-stickiness in the durable goods sector and that the introduction of credit frictions actually makes the comovement problem harder to solve.
    Keywords: New-Keynesian models, financial frictions, general equilibrium
    JEL: E44 E52
    Date: 2009–04
  13. By: Bryan Engelhardt (Department of Economics, College of the Holy Cross); David L. Fuller (Carnegie Mellon University)
    Abstract: A fixed wage is inefficient in a standard search model when workers endogenously separate from employment. We derive an efficient employment contract that involves agents paying a hiring fee (or bond) upon the formation of a match. We estimate the fixed wage and efficient contract assuming the hiring fee is unobservable and find evidence to reject the efficient contract in favor of the fixed wage rule. A counterfactual experiment reveals the current level of labor force participation to be 13% below the efficient level, and a structural shift to the efficient contract improves welfare by 22%.
    Keywords: labor supply, unemployment, matching, efficiency wages
    JEL: J0 J41 J64
    Date: 2009–07
  14. By: Matthieu Darracq Pariès (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Stéphane Moyen (Deutsche Bundesbank, Taunusanlage 5, D-60329 Frankfurt am Main, Germany.)
    Abstract: This paper quantifies the deterioration of achievable stabilization outcomes when monetary policy operates under imperfect credibility and weak anchoring of long-term expectations. Within a medium-scale DSGE model, we introduce through a simple signal extraction problem, an imperfect knowledge configuration where price and wage setters wrongly doubt about the determination of the central bank to leave unchanged its long-term inflation objective in the face of inflationary shocks. The magnitude of private sector learning has been calibrated to match the volatility of US inflation expectations at long horizons. Given such illustrative calibrations, we find that the costs of maintaining a given inflation volatility under weak credibility could amount to 0.25 pp of output gap standard deviation. JEL Classification: E4, E5, F4.
    Keywords: Monetary policy; Imperfect credibility; Signal extraction.
    Date: 2009–06
  15. By: Bartosz Maćkowiak (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Mirko Wiederholt (Northwestern University, 633 Clark Street, Evanston, IL 60208, USA.)
    Abstract: This paper presents a model in which price setting firms decide what to pay attention to, subject to a constraint on information flow. When idiosyncratic conditions are more variable or more important than aggregate conditions, firms pay more attention to idiosyncratic conditions than to aggregate conditions. When we calibrate the model to match the large average absolute size of price changes observed in micro data, prices react fast and by large amounts to idiosyncratic shocks, but prices react only slowly and by small amounts to nominal shocks. Nominal shocks have strong and persistent real effects. We use the model to investigate how the optimal allocation of attention and the dynamics of prices depend on the firms’ environment. JEL Classification: E3, E5, D8.
    Keywords: rational inattention, sticky prices, real effects of nominal shocks.
    Date: 2009–02
  16. By: KOBAYASHI Keiichiro
    Abstract: We propose a new model for policy analysis of banking crises (or systemic bank runs) based on the monetary framework developed by Lagos and Wright (2005). If banks cannot enforce loan repayment and have to secure loans by collateral, a banking crisis due to coordination failure among depositors can occur in response to a sunspot shock, and the banks become insolvent as a result of the bank runs. The model is tractable and easily embedded into a standard business cycle model. The model naturally makes a distinction between money and goods, while most of the existing banking models do not. This distinction enables us to clarify further the workings of banking crises and crisis management policies. In particular, we may be able to use this framework to compare the efficacy of fiscal stimulus, monetary easing, and bank reforms as recovery efforts from the current global financial crisis.
    Date: 2009–07
  17. By: Carrillo-Tudela, Carlos (University of Leicester); Menzio, Guido (University of Pennsylvania); Smith, Eric (University of Essex)
    Abstract: This paper revisits the no-recall assumption in job search models with take-it-or-leave-it offers. Workers who can recall previously encountered potential employers in order to engage them in Bertrand bidding have a distinct advantage over workers without such attachments. Firms account for this difference when hiring a worker. When a worker first meets a firm, the firm offers the worker a sufficient share of the match rents to avoid a bidding war in the future. The pair share the gains to trade. In this case, the Diamond paradox no longer holds.
    Keywords: job search, recall, wage determination, Diamond paradox
    JEL: J24 J42 J64
    Date: 2009–07

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