nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2009‒09‒26
twenty-one papers chosen by
Christian Zimmermann
University of Connecticut

  1. Matching Theory and Data: Bayesian Vector Autoregression and Dynamic Stochastic General Equilibrium Models By Alexander Kriwoluzky
  2. Nonconvex Margins of Output Adjustment and Aggregate Fluctuations By Sustek, Roman
  3. Price level targeting and stabilization policy By Aleksander Berentsen; Christopher J. Waller
  4. Random matching and money in the neoclassical growth model: some analytical results By Christopher J. Waller
  5. Money and capital: a quantitative analysis By S. Boragan Aruoba; Christopher J. Waller; Randall Wright
  6. Optimal stabilization policy with endogenous firm entry By Aleksander Berentsen; Christopher J. Waller
  7. Dynamic taxation, private information and money By Christopher J. Waller
  8. Oligopolistic Competition and Optimal Monetary Policy By Ester Faia
  9. Methods versus Substance: Measuring the Effects of Technology Shocks on Hours By José-Víctor Ríos-Rull; Frank Schorfheide; Cristina Fuentes-Albero; Maxym Kryshko; Raül Santaeulàlia-Llopis
  10. Monetary Aggregates and the Business Cycle By Sustek, Roman
  11. Asset markets can achieve efficiency in the directed search framework By Shoko Morimoto
  12. Credit spreads and monetary policy By Vasco Cúrdia; Michael Woodford
  13. Asset Prices and Monetary Policy By Ichiro Fukunaga; Masashi Saito
  14. Nominal Rigidities, Monetary Policy and Pigou Cycles By Stephane Auray; Paul Gomme; Shen Guo
  15. Fertility and public debt By Fanti Luciano e Spataro Luca
  16. Competitive Pressure and Lying in Search Markets By Matthew Baker; Ingmar Nyman
  17. Vacancy posting, job separation and unemployment fluctuations By Regis Barnichon
  18. Financial Innovation and Endogenous Growth By Stelios Michalopoulos; Luc Laeven; Ross Levine
  19. Intergenerational Transmission of Inflation Aversion: Theory and Evidence By Farvaque, Etienne; Mihailov, Alexander
  20. The Economic and Policy Consequences of Catastrophes By Robert S. Pindyck; Neng Wang
  21. Problems in the numerical simulation of models with heterogeneous agents and economic distortions By Adrian Peralta-Alva; Manuel S. Santos

  1. By: Alexander Kriwoluzky
    Abstract: This paper shows how to identify the structural shocks of a Vector Autoregression (VAR) while simultaneously estimating a dynamic stochastic general equilibrium (DSGE) model that is not assumed to replicate the data-generating process. It proposes a framework for estimating the parameters of the VAR model and the DSGE model jointly: the VAR model is identified by sign restrictions derived from the DSGE model; the DSGE model is estimated by matching the corresponding impulse response functions.
    Keywords: Bayesian Model Estimation, Vector Autoregression, Identification
    JEL: C51
    Date: 2009
  2. By: Sustek, Roman
    Abstract: In most manufacturing industries output is adjusted in a lumpy way along three margins: shiftwork, weekend work, and closing a plant temporarily down. We incorporate such decisions into a dynamic general equilibrium model and study: (i) if such micro-level nonconvexities magnify business cycles; and (ii) if the aggregate effects of changes in firms' borrowing costs due to monetary policy shocks vary over the cycle. Calibrated to industrial observations, the model implies that aggregate output is in fact 25% less volatile than in an economy without such features, and monetary policy shocks have similar effects on output in recessions as in expansions.
    Keywords: Nonconvexities; business cycles; capacity utilization; monetary policy; asymmetries
    JEL: E32 E22 E23 E52
    Date: 2009–09–01
  3. By: Aleksander Berentsen; Christopher J. Waller
    Abstract: We construct a dynamic stochastic general equilibrium model to study optimal monetary stabilization policy. Prices are fully flexible and money is essential for trade. Our main result is that if the central bank pursues a price-level target, it can control inflation expectations and improve welfare by stabilizing short-run shocks to the economy. The optimal policy involves smoothing nominal interest rates which effectively smooths consumption across states.
    Keywords: Monetary policy ; Econometric models
    Date: 2009
  4. By: Christopher J. Waller
    Abstract: I use the monetary version of the neoclassical growth model developed by Aruoba, Waller and Wright (2008) to study the properties of the model when there is exogenous growth. I first consider the planner's problem, then the equilibrium outcome in a monetary economy. I do so by first using proportional bargaining to determine the terms of trade and then consider competitive price taking. I obtain closed form solutions for the balanced growth path of all variables in all cases. I then derive closed form solutions for the transition paths under the assumption of full depreciation and, in the monetary economy, a non-stationary interest rate policy.
    Keywords: Monetary policy ; Econometric models
    Date: 2009
  5. By: S. Boragan Aruoba; Christopher J. Waller; Randall Wright
    Abstract: We study the effects of money (anticipated inflation) on capital formation. Previous papers on this topic adopt reduced-form approaches, putting money in the utility function or imposing cash in advance, but use otherwise frictionless models. We follow a literature that is more explicit about the frictions making money essential. This introduces several new elements, including a two-sector structure with centralized and decentralized markets, stochastic trading opportunities, and bargaining. We show how these elements matter qualitatively and quantitatively. Our numerical results differ from findings in the reduced-form literature. The analysis reduces the previously large gap between mainstream macro and monetary theory.
    Keywords: Money ; Monetary theory ; Capital ; Search theory
    Date: 2009
  6. By: Aleksander Berentsen; Christopher J. Waller
    Abstract: We study optimal monetary stabilization policy in a dynamic stochastic general equilibrium model where money is essential for trade and firm entry is endogenous. We do so when all prices are flexible and also when some are sticky. Due to an externality affecting firm entry, the central bank deviates from the Friedman rule. Calibration exercises suggest that the nominal interest rate should have been substantially smoother than the data if preference shocks were the main disturbance and much more volatile if productivity was the driving shock. This result is a direct consequence of policy actions to control entry.
    Keywords: Monetary policy ; Econometric models
    Date: 2009
  7. By: Christopher J. Waller
    Abstract: The objective of this paper is to study optimal fiscal and monetary policy in a dynamic Mirrlees model where the frictions giving rise to money as a medium of exchange are explicitly modeled. The framework is a three period OLG model where agents are born every other period. The young and old trade in perfectly competitive centralized markets. In middle age, agents receive preference shocks and trade amongst themselves in an anonymous manner. Since preference shocks are private information, in a record-keeping economy, the planner's constrained allocation trades off efficient risk sharing against production efficiency in the search market. In the absence of record-keeping, the government uses flat money as a substitute for dynamic contracts to induce truthful revelation of preferences. Inflation affects agents' incentive constraints and so distortionary taxation of money may be needed as part of the optimal policy even if lump-sum taxes are available.
    Keywords: Money ; Taxation
    Date: 2009
  8. By: Ester Faia
    Abstract: The literature has shown that product market frictions and firms dynamic play a crucial role in reconciling standard DSGE with several stylized facts. This paper studies optimal monetary policy in a DSGE model with sticky prices and oligopolistic competition. In this model firms’ monopolistic rents induce both intra-temporal and intertemporal time-varying wedges which induce inefficient fluctuations of employment and consumption. The monetary authority faces a trade-off between stabilizing inflation and reducing inefficient fluctuations, which is resolved by using consumer price inflation as a state contingent sale subsidy. An analysis of the welfare gains of alternative rules show that targeting mark-ups and asset prices might improve upon a strict inflation targeting
    Keywords: product market frictions, oligopolistic competition, optimal monetary policy
    JEL: E3 E5
    Date: 2009–09
  9. By: José-Víctor Ríos-Rull; Frank Schorfheide; Cristina Fuentes-Albero; Maxym Kryshko; Raül Santaeulàlia-Llopis
    Abstract: In this paper, we employ both calibration and modern (Bayesian) estimation methods to assess the role of neutral and investment-specific technology shocks in generating fluctuations in hours. Using a neoclassical stochastic growth model, we show how answers are shaped by the identification strategies and not by the statistical approaches. The crucial parameter is the labor supply elasticity. Both a calibration procedure that uses modern assessments of the Frisch elasticity and the estimation procedures result in technology shocks accounting for 2% to 9% of the variation in hours worked in the data. We infer that we should be talking more about identification and less about the choice of particular quantitative approaches.
    JEL: C1 C8 E3
    Date: 2009–09
  10. By: Sustek, Roman
    Abstract: In the U.S. business cycle, a monetary aggregate consisting predominantly of sight deposits strongly leads output, time deposits strongly lag output, and a monetary aggregate consisting of both types of deposits tends to be coincident with the cycle. Such movements are observed both before and after the 1979 monetary policy change. Similar dynamics are obtained in a model with multi-stage production and purchase-size heterogeneity when agents optimally choose their mix of cash, checkable, and time deposits used in transactions. The causality in the model runs from real activity to money, rather than the other way around.
    Keywords: Monetary aggregates; business cycle; general equilibrium
    JEL: E32 E51 E41
    Date: 2009–09–02
  11. By: Shoko Morimoto (Graduate School of Economics, Osaka University)
    Abstract: Using a directed search model, modified from random matching, this paper investigates how trading frictions in asset markets affect portfolio choices, asset prices, and welfare. By solving the model numerically, it is demonstrated that the asset price increases (decreases) in the matching efficiency, if the relative risk aversion is smaller (larger) than unity. Efficient asset allocation is achieved in the directed search framework, while random matching is known not to achieve efficient allocation.
    Keywords: directed search, asset market, social welfare, intermediation
    JEL: G11 G12 G14 D83
    Date: 2009–09
  12. By: Vasco Cúrdia; Michael Woodford
    Abstract: We consider the desirability of modifying a standard Taylor rule for a central bank's interest rate policy to incorporate either an adjustment for changes in interest rate spreads (as proposed by Taylor [2008] and McCulley and Toloui [2008]) or a response to variations in the aggregate volume of credit (as proposed by Christiano et al. [2007]). We then examine how, under those adjustments, policy would respond to various types of economic disturbances, including those originating in the financial sector that increase equilibrium spreads and contract the supply of credit. We conduct our analysis using a simple DSGE model with credit frictions (Curdia and Woodford 2009), comparing the equilibrium responses to various disturbances under the modified Taylor rules with those under a policy that would maximize average expected utility. According to our model, a spread adjustment can improve on the standard Taylor rule, but the optimal size of the adjustment is unlikely to be as large as the one proposed, and the same type of adjustment is not desirable regardless of the source of variation in credit spreads. A response to credit is less likely to be helpful, and its desirable size (and even sign) is less robust to alternative assumptions about the nature and persistence of economic disturbances.
    Keywords: Taylor's rule ; Interest rates ; Monetary policy ; Credit
    Date: 2009
  13. By: Ichiro Fukunaga (Director, Research and Statistics Department, Bank of Japan (E-mail:; Masashi Saito (Deputy Director, Research and Statistics Department, Bank of Japan (E-mail:
    Abstract: How should central banks take into account movements in asset prices in the conduct of monetary policy? We provide an analysis to address this issue using a dynamic stochastic general equilibrium model incorporating both price rigidities and financial market imperfections. Our findings are twofold. First, in the presence of these two sources of distortion in the economy, central banks face a policy tradeoff between stabilizing inflation and the output gap. With this tradeoff, central banks could strike a better balance between both objectives if they took variables other than inflation, such as asset prices, into consideration. Second, these benefits decrease when central banks rely on limited information about the underlying sources of asset price movements and cannot judge which part of the observed asset price movements reflects inefficiencies in the economy.
    Keywords: asset prices, monetary policy, financial frictions, policy tradeoffs
    JEL: E44 E52
    Date: 2009–09
  14. By: Stephane Auray (EQUIPPE (EA 4018), Universités Lille Nord de France (ULCO), GREDI, Université de Sherbrooke and CIRP\Eacute;E.); Paul Gomme (Concordia University and CIREQ); Shen Guo (China Academy of Public Finance and Public Policy, Central University of Finance and Economics, Beijing, China)
    Abstract: A chief goal of the Pigou cycle literature is to generate a boom in response to news of a future increase in productivity, and a bust if this improvement does not in fact take place. We find that monetary policy can generate Pigou cycles in a two sector model with durables and non-durables, and nominal price rigidities -- even when the Ramsey-optimal policy displays no such cycles. Estimated interest rate rules are a good fit to data simulated under the Ramsey policy, implying that policymakers could come close to replicating the Ramsey-optimal policy.
    Keywords: Pigou cycles; monetary policy
    JEL: E3 E5 E4
    Date: 2009–07–02
  15. By: Fanti Luciano e Spataro Luca
    Abstract: Public debt and fertility are two issues of major concern in the current debate about economic policy, especially in countries with below replacement fertility and large debt. In this paper we show that public debt is in general harmful for fertility, in that debt issuing almost ever crowds out fertility. The relationship is reversed only if debt is sufficiently low and the share of capital (labor) in the economy is sufficiently low (high). Hence, our analysis would recommend that developed, capital intensive economies (such as OECD countries) aiming at a fertility recovery should reduce national debt, while developing, labor intensive economies, aiming at reducing fertility, should increase (reduce) national debt only if they are debt virtuous (vicious).
    Keywords: overlapping generations, endogenous fertility, debt.
    JEL: D91 E62 H63 J13
    Date: 2009–09–21
  16. By: Matthew Baker (Hunter College); Ingmar Nyman (Hunter College)
    Abstract: We study a labor market in which principals and agents must search for a trading partner, and agents have private information about the value of a match. We show that competitive pressure can induce agents to lie and overstate the value of the match. This leads to insufficient frictional unemployment and search, and lower average utility. The resulting social loss increases with the accuracy of the private information and the ease with which matches are created, and decreases with the time-value of money. An unemployment subsidy can eliminate the inefficiency. Changing how the surplus is split between principal and agent, by contrast, has no effect on the agents’ incentive to lie.
    Keywords: Search, Private Information, Competition
    JEL: D82 D83 J64
    Date: 2009
  17. By: Regis Barnichon
    Abstract: This paper studies the relative importance of the two main determinants of cyclical unemployment fluctuations: vacancy posting and job separation. Using a matching function to model the flow of new jobs, I draw on Shimer's (2007) unemployment flow rates decomposition and find that job separation and vacancy posting respectively account for about 40 and 60 percent of unemployment's variance. When considering higher-order moments, I find that job separation contributes to about 60 percent of unemployment steepness asymmetry, a stylized fact of the jobless rate. Finally, while vacancy posting is, on average, the most important contributor of unemployment fluctuations, the opposite is true around business cycle turning points, when job separation is responsible for most of unemployment movements.
    Date: 2009
  18. By: Stelios Michalopoulos; Luc Laeven; Ross Levine
    Abstract: We model technological and financial innovation as reflecting the decisions of profit maximizing agents and explore the implications for economic growth. We start with a Schumpeterian endogenous growth model where entrepreneurs earn monopoly profits by inventing better goods and financiers arise to screen entrepreneurs. A novel feature of the model is that financiers also engage in the costly, risky, and potentially profitable process of innovation: Financiers can invent more effective processes for screening entrepreneurs. Every existing screening process, however, becomes less effective as technology advances. Consequently, technological innovation and, thus, economic growth stop unless financiers continually innovate. Historical observations and empirical evidence are more consistent with this dynamic model of financial innovation and endogenous growth than with existing models of financial development and growth.
    JEL: G0 G3 O1 O31 O4
    Date: 2009–09
  19. By: Farvaque, Etienne (Université de Lille 1); Mihailov, Alexander (University of Reading)
    Abstract: This paper studies the transmission of preferences in an overlapping-generations model with heterogeneous mature agents characterized by different degrees of inflation aversion. We show how the dynamics of a society's degree of inflation aversion and the implied degree of central bank independence depend on the direction and speed of changes in the structure of the population's preferences, themselves a function of parent socialization efforts in response to observed inflation. We then construct a survey-based measure of inflation aversion and provide empirical support for our analytical and simulation results. Available cross-section evidence confirms that a nation's demographic structure, in particular variation in the share of retirees as a proxy for the more inflation-averse type, is a key determinant of inflation aversion, together with experience with past inflation and the resulting collective memory embodied in monetary institutions.
    Keywords: intergenerational transmi; evolving preferences ; inflation aversion ; central bank independence ; collective memory
    JEL: D72 D83 E31 E58 H41
    Date: 2009–09
  20. By: Robert S. Pindyck; Neng Wang
    Abstract: What is the likelihood that the U.S. will experience a devastating catastrophic event over the next few decades -- something that would substantially reduce the capital stock, GDP and wealth? What does the possibility of such an event imply for the behavior of economic variables such as investment, interest rates, and equity prices? And how much should society be willing to pay to reduce the probability or likely impact of such an event? We address these questions using a general equilibrium model that describes production, capital accumulation, and household preferences, and includes as an integral part the possible arrival of catastrophic shocks. Calibrating the model to average values of economic and financial variables yields estimates of the implied expected mean arrival rate and impact distribution of catastrophic shocks. We also use the model to calculate the tax on consumption society would accept to reduce the probability or impact of a shock.
    JEL: E20 H56
    Date: 2009–09
  21. By: Adrian Peralta-Alva; Manuel S. Santos
    Abstract: Our work has been concerned with the numerical simulation of dynamic economies with heterogeneous agents and economic distortions. Recent research has drawn attention to inherent difficulties in the computation of competitive equilibria for these economies: A continuous Markovian solution may fail to exist, and some commonly used numerical algorithms may not deliver accurate approximations. We consider a reliable algorithm set forth in Feng et al. (2009), and discuss problems related to the existence and computation of Markovian equilibria, as well as convergence and accuracy properties. We offer new insights into numerical simulation.
    Keywords: Econometric models
    Date: 2009

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