New Economics Papers
on Dynamic General Equilibrium
Issue of 2009‒10‒10
fourteen papers chosen by

  1. Search in the Labor Market Under Imperfectly Insurable Income Risk By Mauro Roca
  2. Monetary Policy Trade-Offs in an Estimated Open-Economy DSGE Model By Adolfson, Malin; Laseén, Stefan; Lindé, Jesper; Svensson, Lars E.O.
  3. Liquidity, Innovation and Growth By Aleksander Berentsen; Mariana Rojas Breu; Shouyong Shi
  4. The Unemployment Volatility Puzzle: The Role of Matching Costs Revisited By Silva , José Ignacio; Toledo, Manuel
  5. Disasters Risk and Business Cycles By François Gourio
  6. Counterfactual analysis using a regional dynamic general equilibrium model with historical calibration By Federico Perali; Stefania Lovo
  7. Animal Spirits and the Composition of Innovation in a Lab-Equipment R&D Model By Pedro Rui Mazeda Gil
  8. Habit persistence and effectiveness of fiscal policy in an open economy By Olivier Cardi
  9. A bayesian estimation of a DSGE model with financial frictions By Rossana Merola
  10. A note on the crowding-out of investment by public spending By Olivier Cardi
  11. They Are Even Larger! More (on) Puzzling Labor Market Volatilities By Gartner, Hermann; Merkl, Christian; Rothe, Thomas
  12. Optimal Income Taxation, Outsourcing and Policy Cooperation in a Dynamic Economy By Aronsson, Thomas; Koskela, Erkki
  13. "What Should Inflation Targeting Countries Do When Oil Prices Rise and Drop Fast?" By Nicoletta Batini; Eugen Tereanu
  14. Ageing and Export Dependency By Vistesen, Claus

  1. By: Mauro Roca
    Abstract: This paper develops a general equilibrium model with unemployment and noncooperative wage determination to analyze the importance of incomplete markets when risk-averse agents are subject to idiosyncratic employment shocks. A version of the model calibrated to the U.S. shows that market incompleteness affects individual behavior and aggregate conditions: it reduces wages and unemployment but increases vacancies. Additionally, the model explains the average level of unemployment insurance observed in the U.S. A key mechanism is the joint influence of imperfect insurance and risk aversion in the wage bargaining. The paper also proposes a novel solution to solve this heterogeneous-agent model.
    Keywords: Consumption , Economic models , Employment , Financial risk , Income , Income distribution , Insurance , Labor markets , Private savings , Private sector , Unemployment , Wage bargaining , Wages ,
    Date: 2009–09–02
  2. By: Adolfson, Malin (Monetary Policy Department, Central Bank of Sweden); Laseén, Stefan (Monetary Policy Department, Central Bank of Sweden); Lindé, Jesper (Division of International Finance); Svensson, Lars E.O. (Executive Board)
    Abstract: This paper studies the transmission of shocks and the trade-offs between stabilizing CPI inflation and alternative measures of the output gap in Ramses, the Riksbank’s empirical dynamic stochastic general equilibrium (DSGE) model of a small open economy. The main results are, first, that the transmission of shocks depends substantially on the conduct of monetary policy, and second, that the trade-off between stabilizing CPI inflation and the output gap strongly depends on which concept of potential output in the output gap between output and potential output is used in the loss function. If potential output is defined as a smooth trend this trade-off is much more pronounced compared to the case when potential output is defined as the output level that would prevail if prices and wages were flexible.
    Keywords: Optimal monetary policy; instrument rules; open-economy DSGE models; propagation of shocks; impulse responses; output gap; potential output
    JEL: E52 E58
    Date: 2009–08–01
  3. 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; Growth; Innovation; Financial intermediation
    JEL: O4 E1 G00
    Date: 2009–09–24
  4. By: Silva , José Ignacio; Toledo, Manuel
    Abstract: Recently, Pissarides (2008) has argued that the standard search model with sunk fixed matching costs increases unemployment volatility without introducing an unrealistic wage response in new matches. We revise the role of matching costs and show that when these costs are not sunk and, therefore, can be partially passed on to new hired workers in the form of lower wages, the amplication mechanism of fixed matching costs is considerably reduced and wages in new hired positions become more sensitive to productivity shocks.
    Keywords: unemployment volatility puzzle; search and matching; matching costs
    JEL: E32 J32 J64
    Date: 2009–05–25
  5. By: François Gourio
    Abstract: To construct a business cycle model consistent with the observed behavior of asset prices, and study the effect of shocks to aggregate uncertainty, I introduce a small, time-varying risk of economic disaster in a standard real business cycle model. The paper establishes two simple theoretical results: first, when the probability of disaster is constant, the risk of disaster does not affect the path of macroeconomic aggregates - a "separation theorem" between macroeconomic quantities and asset prices in the spirit of Tallarini (2000). Second, shocks to the probability of disaster, which generate variation in risk premia over time, are observationally equivalent to preference shocks. An increase in the perceived probability of disaster leads to a collapse of investment and a recession, an increase in risk spreads, and a decrease in the yield on safe assets. To assess the empirical validity of the model, I infer the probability of disaster from observed asset prices and feed it into the model. The variation over time in this probability appears to account for a significant fraction of business cycle dynamics, especially sharp downturns in investment and output such as 2008-IV.
    JEL: E32 E44 G12
    Date: 2009–10
  6. By: Federico Perali (Department of Economics (University of Verona)); Stefania Lovo (Department of Economics (University of Verona))
    Abstract: This paper develops a regional dynamic general equilibrium model calibrated using two regional SAMs for the Italian region Valle D’Aosta for the years 1963 and 2002. A historical calibration procedure is performed over the 40 years period and a validation exercise ensures that the modelled tendencies closely approximate the actual observed growth patterns of the main regional macroeconomic variables. The dynamic general equilibrium model provides an original and powerful tool for historical counterfactual analysis not available using standard dynamic general equilibrium models. The model is used to compare the growth path followed by the region during the period of interest with different scenarios intended to rank the social desirability of alternative behaviours of the regional administration.
    Keywords: historical calibration, historical validation, regional dynamic general equilibrium model, historical counterfactual analysis
    JEL: C68 R13
    Date: 2009–09
  7. By: Pedro Rui Mazeda Gil (CEF.UP and Faculdade de Economia, Universidade do Porto)
    Abstract: We revisit the issue of self-fulfilling “waves of enthusiasm” as stationary rational expectations equilibrium outcomes in endogenous-growth models that merge the quality-ladders with the expanding-variety mechanism. By considering a lab-equipment specification with vertical-innovation intertemporal spillovers but no intersectoral spillovers, we extend previous results of a negative impact of animal spirits on both horizontal aggregate R&D and number of firms to a framework where decreasing returns to horizontal entry are not a necessary condition. In contrast, our general-equilibrium setting allows us to predict an effect of animal spirits on R&D composition impacting neither on aggregate growth nor on aggregate vertical R&D, as reduced outlays in “mature” industries compensate for the increased R&D intensity in newly-born industries.
    Keywords: endogenous growth, horizontal and vertical R&D, stationary sunspot equilibria
    JEL: O41 E32 D43 L16
    Date: 2009–09
  8. By: Olivier Cardi (ERMES - Equipe de recherche sur les marches, l'emploi et la simulation - CNRS : UMR7017 - Université Panthéon-Assas - Paris II, Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X)
    Abstract: An open economy version of the Baxter and King's [1993] model is constructed with habit formation to investigate the dynamic and steady-state effects of an expansionary budget policy. In line with empirical evidence, consumption is weakly responsive, investment is crowded out, the drop in savings drives the current account into deficit and government spending multipliers display small values. The sensitivity analysis shows that the effectiveness of the fiscal policy (1) decreases as habit persistence gets stronger, (2) increases with labor supply responsiveness, (3) falls with trade integration. Finally, we find that habit persistence weakens the connection between government spending multipliers and both the elasticity of labor supply and exports-to-GDP ratio.
    Keywords: Investment; Current Account; Habit Formation; Expenditure Multiplier.
    Date: 2009–09–28
  9. By: Rossana Merola (Université Catholique de Louvain la neuve)
    Abstract: Episodes of crises that have recently plagued many emerging market economies have lead to a wide-spread questioning of the two traditional generations of models of currency crises. Distressed banking system and adverse credit-markets conditions have been pointed as sources of serious macroeconomics contractions, so introducing these imperfections into standard economic models can help to explain the more recent crises. This paper introduces financial frictions à la Bernanke Gertler and Gilchrist in a two-sector small open economy, suited to analyze an emerging country. The model is estimated on simulated data applying both Bayesian techniques and maximum likelihood method and comparing the results under the two di¤erent estimation procedures. First, I analyze the influence of the prior on the estimation outcomes. Results seems to confirm that one of the main advantages of Bayesian approach is the ability of providing a framework for evaluating fundamentally mis-specified models. Second, I test the sensitivity of estimation outcomes to the sample size, showing how, for large samples, results under Bayesian estimation converges asymptotically to those obtained applying maximum likelihood. A further extension would be to perform the estimation on historical data for an emerging economy that have recently experienced a financial crisis.
    Keywords: DSGE models, Bayesian estimation, financial accelerator
    JEL: E30 E44 F34 F41
    Date: 2009–10–01
  10. By: Olivier Cardi (ERMES - Equipe de recherche sur les marches, l'emploi et la simulation - CNRS : UMR7017 - Université Panthéon-Assas - Paris II, Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X)
    Abstract: One of the most prominent and consistent findings of the recent empirical literature on fiscal policy is that investment expenditure is crowded-out by public spending in the short-run. In this contribution, we address this empirical fact using a dynamic general equilibrium model and show that the introduction of a habit-forming behavior plays a major role in accommodating the observed negative relationship between investment and government expenditure. Our numerical experiments point out the role of consumption inertia in determining the reactions of the open economy: as habit persistence gets stronger, a fiscal expansion crowds-out real consumption by a smaller amount and investment by a larger one, while the current account enters into a greater deficit.
    Keywords: Investment; Habit Formation; Current Account; Fiscal Expansion
    Date: 2009–09–28
  11. By: Gartner, Hermann (IAB, Nürnberg); Merkl, Christian (Kiel Institute for the World Economy); Rothe, Thomas (IAB, Nürnberg)
    Abstract: This paper shows that the German labor market is more volatile than the US labor market. Specifically, the volatility of the cyclical component of several labor market variables (e.g., the job-finding rate, labor market tightness, and job vacancies) divided by the volatility of labor productivity is roughly twice as large as in the United States. We derive and simulate a simple dynamic labor market model with heterogeneous worker productivity. This model is able to explain the higher German labor market volatilities by a longer expected job duration.
    Keywords: labor market volatilities, unemployment, worker flows, vacancies, job-finding rate, market tightness
    JEL: J6 E24 E32
    Date: 2009–09
  12. By: Aronsson, Thomas (Department of Economics, Umeå University); Koskela, Erkki (Department of Economics)
    Abstract: This paper concerns optimal income taxation in a two-country OLG economy, where each country is characterized by asymmetric information between the government and the private sector, and where one of the countries outsources part of its production to the other. In the country whose firms outsource production abroad, the government will respond to outsourcing by implementing a more progressive labor income tax structure and higher marginal capital income tax rates than it would have done in the absence of outsourcing. The tax policy response by the government in the country that receives foreign production capacity is, in general, ambiguous and depends on a tradeoff between wage-equality and factor income from abroad. By using the noncooperative Nash equilibrium as a reference case, we also consider tax policy cooperation leading to higher welfare.
    Keywords: Outsourcing; redistribution; optimal nonlinear taxation; intertemporal model
    JEL: H21 H25 J31 J62
    Date: 2009–10–02
  13. By: Nicoletta Batini; Eugen Tereanu
    Abstract: After a long period of global price stability, in 2008 inflation increased sharply following unprecedented increases in the price of oil and other commodities, notably food. Although inflation remained lower and growth higher in inflation targeting countries than elsewhere, almost everywhere price stability seemed in jeopardy as consumer prices kept surging and central banks struggled to maintain expectations anchored. The rapid drop in energy and food prices that later accompanied the world slowdown helped avert the worse, but inflation stayed high in many inflation targeting countries. This paper uses a small open-economy DSGE model to design the correct monetary policy response to a protracted supply shock of the kind observed today, and explains how to choose optimal policy horizons under such shock. Using a version of the model with Kalman learning, the paper also evaluates the implications of a loss of target credibility, showing how rules must be adjusted when the authorities' commitment to low inflation has been eroded. The appropriate response to future evolutions of the price of oil, including to a large downward correction as recently observed, is also evaluated.
    Keywords: Agricultural commodities , Agricultural prices , Central banks , Commodity price fluctuations , Consumer prices , Demand , Economic models , External shocks , Inflation , Inflation targeting , Monetary policy , Oil prices , Price stabilization ,
    Date: 2009–05–28
  14. By: Vistesen, Claus
    Abstract: The primary manifestation of the demographic transition in a modern economic context is through ageing and the primary transmission from ageing to the macro economy is through its effect on saving and investment behavior. These two effects taken together suggest a strong impact from the continuing process of ageing on international capital flows and global macroeconomic imbalances. This paper explores the potential relationship between ageing on a macroeconomic level and the reliance, or outright dependency, on exports and foreign asset income to achieve economic growth. The paper’s argument is both theoretical and empirical. Using a standard overlapping generation framework (OLG) in an open economy context this paper discusses whether the proposed relationship between a transition into old age and dissaving is feasible and desirable (or even optimal?). Finally, an empirical analysis is presented on Germany and Japan to show how these two economies, as the oldest in the world, may exactly be in a state of export dependency.
    Keywords: demographics; international capital flows; open economy macroeconomics; ageing; intertemporal choice;
    JEL: D91 F41 J11
    Date: 2009–10–01

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