nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2009‒10‒03
nineteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Endogenous income taxes and indeterminacy in dynamic models: When Diamond meets Ramsey again. By Zhang, Yan; Chen, Yan
  2. The Quantitative Importance of News Shocks in Estimated DSGE Models By Hashmat Khan; John Tsoukalas
  3. Monetary Business Cycle Accounting By Sustek, Roman
  4. Optimal Monetary Policy and Downward Nominal Wage Rigidity in Frictional Labor Markets. By Abo-Zaid, Salem
  5. The Monetary Policy Implications of Behavioral Asset Bubbles By ap Gwilym, Rhys
  6. Investments and the holdup problem in a matching market By Bester, Helmut
  7. Liquidity, innovation and growth By Aleksander Berentsen; Mariana Rojas Breu; Shouyong Shi
  8. Inflation and unemployment in the long run By Aleksander Berentsen; Guido Menzio; Randall Wright
  9. Inflation, Human Capital and Tobin's <i>q</i> By Basu, Parantap; Gillman, Max; Pearlman, Joseph
  10. Money and capital as competing media of exchange in a news economy By David Andolfatto; Fernando M. Martin
  11. Saving and growth under borrowing constraints explaining the "high saving rate" puzzle By Yi Wen
  12. Outside versus inside bonds: A Modigliani-Miller type result for liquidity constrained economies By Aleksander Berentsen; Christopher Waller
  13. Essential interest-bearing money By David Andolfatto
  14. Modelling the Global Financial Crisis By Warwick J McKibbin; Andy Stoeckel
  15. Optimal Policy and Non-Scale Growth with R&D Externalities By Simone Valente
  16. Risk sharing, inequality, and fertility By Roozbeh Hosseini; Larry E. Jones; Ali Shourideh
  17. ENVIRONMENTAL PROTECTION AND ECONOMIC GROWTH By Kuhl Teles, Vladimir; A. Arraes, Ronaldo
  18. Can Second-Generation Endogenous Growth Models Explain The Productivity Trends and Knowledge Production In the Asian Miracle Economies? By Ang, James; Madsen, Jakob
  19. The Neoclassical Optimal Growth Model Revisited: An Explicit Equation for the Saddle path By Khelifi, Aymen A.

  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, consumption in both periods of life and homothetic preferences (e.g., Lloyd-Braga, Nourry and Venditti, 2007). We show that under numerical calibrations of the parameters, local indeterminacy can occur for distortionary tax rates that are empirically plausible for the U.S. economy, provided that the elasticity of capital-labor substitution and the wage elasticity of the labor supply are large enough, and the elasticity of intertemporal substitution in consumption is slightly greater than unity. These indeterminacy conditions are similar to those obtained within infinite horizon models and from this point of view, Diamond meets Ramsey again.
    Keywords: Indeterminacy; Endogenous labor income tax rate.
    JEL: E32 C62
    Date: 2009–10–01
  2. By: Hashmat Khan (Department of Economics, Carleton University); John Tsoukalas (Department of Economics, University of Nottingham)
    Abstract: We estimate a dynamic stochastic general equilibrium (DSGE) model with several frictions and shocks, including news shocks to total factor productivity (TFP) and investment-specic (IS) technology, using quarterly US data from 1954-2004 and Bayesian methods. When all types of shocks are considered, TFP news and IS news compete with other atemporal and intertemporal shocks and account for less than 1.5% and 0.15% of the unconditional variance of output growth, respectively. In the fleexible price-wage environment, the contributions of the two shocks are 2.4% and 0%, respectively. When we exclude an atemporal (price markup) shock, the role for TFP news rises but the t of that model is substantially poorer relative to the benchmark model. Based on the variance decompositions and impulse responses, our ndings suggest that news shocks are likely to be less important in estimated sticky price-wage DSGE models relative to perfectly competitive models.
    Keywords: News shocks, Business cycles, DSGE models
    JEL: E2 E3
    Date: 2009–09–22
  3. By: Sustek, Roman
    Abstract: This paper investigates the quantitative importance of various types of frictions for inflation and nominal interest rate dynamics by extending business cycle accounting to monetary models. Representing a variety of real and nominal frictions as `wedges' to standard equilibrium conditions allows a quantitative assessment of those frictions. Decomposing the data into movements due to these wedges shows that frictions that are equivalent to wedges in TFP and equilibrium conditions for asset markets are essential. In contrast, wedges in equilibrium conditions for capital accumulation and the resource constraint, and wedges capturing distortionary effects of sticky prices, play only a secondary role.
    Keywords: Business cycle accounting; inflation; nominal interest rate
    JEL: E43 E32 E31 E52
    Date: 2009–09–25
  4. By: Abo-Zaid, Salem
    Abstract: Recent empirical evidence suggests that nominal wages in the U.S. are downwardly rigid. This paper studies optimal monetary policy in a labor search and matching framework under the presence of Downward Nominal Wage Rigidity (DNWR). The study shows that when nominal wages are downwardly rigid, optimal monetary policy targets a positive inflation rate; the annual long-run inflation rate is around 2 percent. Positive inflation in this environment “greases the wheels” of the labor market by facilitating real wage adjustments, and hence it eases job creation and prevents excessive increase in unemployment. In addition, there is an asymmetry in the response of the economy to positive and negative productivity shocks, particularly those of large sizes. Finally, the optimal long-run inflation rate predicted by this study is considerably higher than in otherwise neoclassical labor markets, suggesting that the nature of the labor market in which DNWR is studied can matter for policy recommendations.
    Keywords: Downward Nominal Wage Rigidity; Optimal Monetary Policy; Long Run Inflation Rate; Labor Market Frictions; Labor Search and Matching.
    JEL: E5 E4 E3
    Date: 2009–09–24
  5. By: ap Gwilym, Rhys
    Abstract: I introduce behavioral asset pricing rules into a wider dynamic stochastic general equilibrium framework. Asset price bubbles emerge endogenously within the model. I find that in this model the only monetary policy that would be likely to enhance welfare is a counter-intuitive 'running with the wind' policy. I conclude that the optimal policy is highly dependent on the nature of the behavioral rules that are stipulated. Given that monetary authorities have limited information about the ways in which agents actually behave, a systematic monetary policy response to asset price misalignments is unlikely to enhance welfare.
    Date: 2009–09
  6. By: Bester, Helmut
    Abstract: This paper studies investment incentives in the steady state of a dynamic bilateral matching market. Because of search frictions, both parties in a match are partially locked-in when they bargain over the joint surplus from their sunk investments. The associated holdup problem depends on market conditions and is more important for the long side of the market. In the case of investments in homogenous capital only the agents on the short side acquire ownership of capital. There is always underinvestment on both sides of the market. But when market frictions become negligible, the equilibrium investment levels tend towards the first-best.
    Keywords: Holdup Problem,Matching Market,Investments
    JEL: C78 D23 D92
    Date: 2009
  7. By: Aleksander Berentsen; Mariana Rojas Breu; Shouyong Shi
    Abstract: Many countries simultaneously suffer from high rates of inflation, low growth rates of per capita income and poorly developed financial sectors. In this paper, we integrate a microfounded model of money and finance into a model of endogenous growth to examine the effects of inflation and financial development. A novel feature of the model is that the market for innovation goods is decentralized. Financial intermediaries arise endogenously to provide liquid funds to the innovation sector. We calibrate the model to address two quantitative issues. One is the effects of an exogenous improvement in the productivity of the financial sector on welfare and per capita growth. The other is the effects of inflation on welfare and growth. Consistent with the data but in contrast to previous work, reducing inflation generates large gains in the growth rate of per capita income as well as in welfare. Relative to reducing inflation, improving the efficiency of the financial market increases growth and welfare by much smaller amounts.
    Keywords: Money, Credit, Innovation, Growth
    Date: 2009–09
  8. By: Aleksander Berentsen; Guido Menzio; Randall Wright
    Abstract: We study the long-run relation between money, measured by inflation or interest rates, and unemployment. We first document in the data a positive relation between these variables at low frequencies. We then develop a framework where unemployment and money are both modeled using microfoundations based on search and bargaining theory, providing a unified theory for analyzing labor and goods markets. The calibrated model shows that money can account for a sizable fraction of trends in unemployment. We argue it matters, qualitatively and quantitatively, whether one uses monetary theory based on search and bargaining, or an alternative ad hoc specification.
    Date: 2009–09
  9. By: Basu, Parantap; Gillman, Max (Cardiff Business School); Pearlman, Joseph
    Abstract: A pervasive empirical finding for the US economy is that inflation is negatively correlated with the normalized market price of capital (Tobin's q) and growth. A dynamic stochastic general equilibrium model of endogenous growth is developed to explain these stylized facts. In this model, human capital is the principal driver of self-sustained growth. Long run comparative statics analysis suggests that inflation diverts scarce time resource to leisure which lowers human capital utilization. This impacts growth adversely and modulates capital adjustment cost downward resulting in a decline in Tobin's q. For the short run, a Tobin effect of inflation on growth weakens the negative association between inflation and q.
    Date: 2009–09
  10. By: David Andolfatto; Fernando M. Martin
    Abstract: Conventional theory suggests that fiat money will have value in capital-poor economies. We demonstrate that fiat money may also have value in capital-rich economies, if the price of capital is excessively volatile. Excess asset-price volatility is generated by news; information that has no social value, but is privately useful in forming forecasts over the short-run return to capital. One advantage of fiat money is that its expected return is not linked directly to news concerning the prospects of an underlying asset. When money and capital compete as media of exchange, excess volatility in the short-term returns of liquid asset portfolios is mitigated and welfare is improved. A legal restriction that prohibits the use of capital as a payment instrument renders the expected return to money perfectly stable and, as a consequence, may generate an additional welfare benefit.
    Keywords: Money theory ; Capital
    Date: 2009
  11. By: Yi Wen
    Abstract: Fast-growing economies tend to have extremely high saving rates. Empirical evidence suggests that this positive correlation holds largely because high growth leads to high saving, not the other way around. Such empirical evidence is inconsistent with the permanent-income hypothesis, but consistent with standard neoclassical growth theory, since high productivity growth raises the rate of returns to investment, hence stimulating saving through high real interest rates. However, fast-growing economies have not just high saving rates, but also low interest rates. Why would households save excessively to finance firms? investment when the interest rate on their savings is so low? This paper shows that precautionary saving under borrowing constraints can solve the puzzle. Borrowing constraints make an individual?s marginal propensity to consume negatively dependent on her permanent income, so that high growth can lead to substantially increased saving without high interest rates. In other words, precautionary saving is able to support a large spread between the deposit rate and the rate of returns to capital; consequently, fast-growing economies can exhibit not only astonishingly high saving rates despite low deposit rates, but also undiminished rates of return to capital despite large investment-to-output ratios.
    Keywords: Saving and investment ; Consumer behavior
    Date: 2009
  12. By: Aleksander Berentsen; Christopher Waller
    Abstract: When agents are liquidity constrained, two options exist — sell assets or borrow. We compare the allocations arising in two economies: in one, agents can sell government bonds (outside bonds) and in the other they can borrow (issue inside bonds). All transactions are voluntary, implying no taxation or forced redemption of private debt. We show that any allocation in the economy with inside bonds can be replicated in the economy with outside bonds but that the converse is not true. However, the optimal policy in each economy makes the allocations equivalent.
    Keywords: Liquidity, financial markets, monetary policy, search
    JEL: E4 E5
    Date: 2009–09
  13. By: David Andolfatto
    Abstract: I examine optimal monetary policy in a Lagos and Wright [A unified framework for monetary theory and policy analysis, J. Polit. Econ. 113 (2005) 463?484] model where trade is centralized and all exchange is voluntary. I identify a class of incentive feasible policies that improve welfare beyond what is achievable with zero intervention. Any policy in this class necessarily entails a non-negative inflation rate and a strictly positive nominal interest rate. Despite the absence of a lump-sum tax instrument, there exists an incentive-feasible policy that implements the first-best allocation.
    Keywords: Money theory ; Econometric models
    Date: 2009
  14. By: Warwick J McKibbin; Andy Stoeckel
    Abstract: This paper models the global financial crisis as a combination of shocks to global housing markets and sharp increases in risk premia of firms, households and international investors in an intertemporal (or DSGE) global model. The model has six sectors of production and trade in 15 major economies and regions. The paper shows that a ‘switching’ of expectations about risk premia shocks in financial markets can easily generate the severe economic contraction in global trade and production currently being experienced in 2009 and subsequent events. The results show that the future of the global economy depends critically on whether the shocks to risk are expected to be permanent or temporary. The best representation of the crisis may be one where initial long lasting pessimism about risk is unexpectedly revised to a more moderate scenario. This suggests a rapid recovery in countries not experiencing a balance sheet adjustment problem.
    Date: 2009–09
  15. By: Simone Valente (CER-ETH - Center of Economic Research at ETH Zurich, Switzerland)
    Abstract: An established result of the endogenous growth literature is that competitive equilibria in expanding-varieties models are suboptimal due to the rent-effect: monopolistic pricing drives the equilibrium quantity of each intermediate below the efficient level, implying that it is optimal to subsidize final producers. This paper shows that, if scale effects are eliminated by including R&D spillovers in the model, normative prescriptions change. Since the laissez-faire economy under-invests into R&D activity, the share of resources devoted to intermediates' production increases, and this reallocation effect contrasts the rent-effect. In many scenarios, including the polar case of logarithmic preferences, the reallocation effect surely dominates: the equilibrium quantity of each intermediate exceeds the optimal one, and the optimal policy consists of taxing final producers because fiscal authorities must internalize the overshooting mechanism generated by under-investment in R&D.
    Keywords: Endogenous Growth, Scale Effects, R&D Externalities, Optimal Policy
    JEL: O41 O31
    Date: 2009–08
  16. By: Roozbeh Hosseini; Larry E. Jones; Ali Shourideh
    Abstract: We use an extended Barro-Becker model of endogenous fertility, in which parents are heterogeneous in their labor productivity, to study the efficient degree of consumption inequality in the long run. In our environment a utilitarian planner allows for consumption inequality even when labor productivity is public information. We show that adding private information does not alter this result. We also show that the informationally constrained optimal insurance contract has a resetting property - whenever a family line experiences the highest shock, the continuation utility of each child is reset to a (high) level that is independent of history. This implies that there is a non-trivial, stationary distribution over continuation utilities and there is no mass at misery. The novelty of our approach is that the no-immiseration result is achieved without requiring that the objectives of the planner and the private agents disagree. Because there is no discrepancy between planner and private agents' objectives, the policy implications for implementation of the efficient allocation differ from previous results in the literature. Two examples of these are: 1) estate taxes are positive and 2) there are positive taxes on family size.
    Keywords: Taxation ; Contracts ; Risk
    Date: 2009
  17. By: Kuhl Teles, Vladimir; A. Arraes, Ronaldo
    Abstract: This paper explores the link between environmental policy and economic growth by employing an extension of the AK Growth Model. We include a state equation for renewable natural resources. We assume that the change in environmental regulations induces costs and that economic agents also derive some utility from capital stock accumulation vis-`a-vis the environment. Using the Hopf bifurcation theorem, we show that cyclical environmental policy strategies are optimal, providing theoretical support for the Environmental Kuznets Curve.
    Date: 2009–08–24
  18. By: Ang, James; Madsen, Jakob
    Abstract: Using data for six Asian miracle economies over the period from 1953 to 2006, this paper examines the extent to which growth has been driven by R&D and tests which second-generation endogenous growth model is most consistent with the data. The results give strong support to Schumpeterian growth theory but only limited support to semi-endogenous growth theory. Furthermore, it is shown that R&D has played a key role for growth in the Asian miracle economies.
    Keywords: Schumpeterian growth; semi-endogenous growth; Asian growth miracle
    JEL: O30 O40
    Date: 2009
  19. By: Khelifi, Aymen A.
    Abstract: The goal of the paper is to present an alternative version of the Ramsey-Cass-Koopmans model (1965), standing as an application of the formalised optimal growth theory. Inspired by the microeconomic theory of the consumer, the idea starts with a time preference rate deduced from relative preferences between consumption and savings, which are represented by a simple Cobb Douglas utility function. Such a maximising criterion in the dynamic program, allows an interesting application of the Pontryagin's Maximum Principle, and provides results of excellent quality: the model presents an extremely simple expression for the saddle path, and becomes both qualitative and quantitative with strong analogies to the exogenous one of R.Solow (1956). The analysis comes after a generated numerical example, and the two models are put in relationship through a discussion of the golden rule (E.Phelps, 1961). Effects of structural changes in parameters are also explored.
    Keywords: The Ramsey-Cass-Koopmans model; Saddle path; Saving proportion; Optimal Control Theory
    JEL: O41 D91 O40
    Date: 2009–09–17

This nep-dge issue is ©2009 by Christian Zimmermann. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.