nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2009‒10‒17
twenty-one papers chosen by
Christian Zimmermann
University of Connecticut

  1. Consumption, Housing Collateral, and the Canadian Business Cycle By Ian Christensen; Paul Corrigan; Caterina Mendicino; Shin-Ichi Nishiyama
  2. Inequality may retard growth but sometimes progressive redistribution makes it worse By DEBASIS BANDYOPADHYAY; XUELI TANG
  3. Money in a DSGE framework with an application to the Euro Zone By Benchimol, Jonathan; Fourçans, André
  4. What Drives the Skill Premium: Technological Change or Demographic Variation? By Hui He
  5. Medium Term Business Cycles in Developing Countries By Diego A. Comin; Norman Loayza; Farooq Pasha; Luis Serven
  6. Estimation of quasi-rational DSGE monetary models By Luca Fanelli
  7. Inflation Target Shocks and Monetary Policy Inertia in the Euro Area By Fève,P.; Materon,J.; Sahuc, J-G.
  8. R&D and Economic Growth in Slovenia: A Dynamic General Equilibrium Approach with Endogenous Growth By Verbic, Miroslav; Majcen, Boris; Cok, Mitja
  9. Risk Premium Shocks and the Zero Bound on Nominal Interest Rates By Robert Amano; Malik Shukayev
  10. A general equilibrium analysis of parental leave policies By Andrés Erosa; Luisa Fuster; Diego Restuccia
  11. Environmental policy, education and growth: A reappraisal when lifetime is finite By Xavier Pautrel
  12. Stochastic Growth in the United States and Euro Area By Peter N. Ireland
  13. A Tractable Model of Precautionary Reserves, Net Foreign Assets, or Sovereign Wealth Funds By Christopher D. Carroll; Olivier Jeanne
  14. Crises and Liquidity in Over-the-Counter Markets By Ricardo Lagos; Guillaume Rocheteau; Pierre-Olivier Weill
  15. Education and Economic Growth in Slovenia: A Dynamic General Equilibrium Approach with Endogenous Growth By Verbic, Miroslav; Majcen, Boris; Cok, Mitja
  16. Health Investment over the Life-Cycle By Timothy J. Halliday; Hui He; Hao Zhang
  17. Minimum Distance Estimation and Testing of DSGE Models from Structural VARs By Fève, P.; Matheron, J.; Sahuc, J-G.
  18. The Impact of Medical and Nursing Home Expenses and Social Insurance Policies on Savings and Inequality By Karen Kopecky; Tatyana Koreshkova
  19. Firm Dynamics Support the Importance of the Embodied Question By Alain Gabler; Omar Licandro
  20. How important is human capital? A quantitative theory assessment of world income inequality By Andrés Erosa; Tatyana Koreshkova; Diego Restuccia
  21. Why Have Girls Gone to College? A Quantitative Examination of the Female College Enrollment Rate in the United States: 1955-1980 By Hui He

  1. By: Ian Christensen; Paul Corrigan; Caterina Mendicino; Shin-Ichi Nishiyama
    Abstract: Using Bayesian methods, we estimate a small open economy model in which consumers face limits to credit determined by the value of their housing stock. The purpose of this paper is to quantify the role of collateralized household debt in the Canadian business cycle. Our findings show that the presence of borrowing constraints improves the performance of the model in terms of overall goodness of fit. In particular, the presence of housing collateral generates a positive correlation between consumption and house prices. Finally we find that housing collateral induced spillovers account for a large share of consumption growth during the housing market boom-bust cycle of the late 1980s.
    Keywords: Business fluctuations and cycles; Credit and credit aggregates; Transmission of monetary policy
    JEL: E21 E32 E44 E52 R21
    Date: 2009
  2. By: DEBASIS BANDYOPADHYAY (University of Auckland); XUELI TANG (Deakin University)
    Abstract: We provide an empirically plausible endogenous growth model to prove analytically that sometimes a progressive redistribution from rich to poor lowers the growth rate of consumption per capita in all subsequent periods. The model accommodates the growth retarding effect of income inequality by combining the assumptions of no credit market and a production technology with diminishing returns to the combined inputs of physical and human capital. Also, to make the model’s assumptions consistent with the evidence reported by leading labor economists, we assume that the parental human capital sufficiently improves the effectiveness of expenditure on a child’s education, in order to induce increasing returns to scale in the education technology. A reduction in the progressivity of redistribution, under such education technology, enhances the average human capital of all future cohorts of parents, which in turn boosts the growth rate of average human capital. The immediate resulting gain in the growth rate of consumption per capita sufficiently outweighs the subsequent growth loss due to the decline in TFP brought about by the associated increase in income inequality. Consequently, in our model, a policy of progressive redistribution is dynamically inefficient.
    Keywords: heterogeneous ability, education technology, endogenous growth, progressive income tax rate.
    JEL: D61 E24 E62 O11
    Date: 2009–10–02
  3. By: Benchimol, Jonathan (ESSEC Business School); Fourçans, André (ESSEC Business School)
    Abstract: In the current New Keynesian literature, the role of monetary aggregates is generally neglected. Yet it’s hard to imagine money completely “passive” to the rest of the system. By entering real money balances in a non-separable utility function, we introduce an explicit role for money via preference redefinition in a simple New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model. It involves new inflation and output gap specifications where money plays a significant role. We use the General Method of Moments (GMM) to calibrate our DSGE model of the Euro area and we show that the European Central Bank –ECB) should react more strongly to economic shocks as far as the role of money is found significant.
    Keywords: ECB; Inflation; Monetary Policy; Money
    JEL: E31 E51 E58
    Date: 2009–09
  4. By: Hui He (Department of Economics, University of Hawaii at Manoa)
    Abstract: This paper quantitatively examines the effects of two exogenous driving forces, investment-specific technological change (ISTC) and the demographic change known as “the baby boom and the baby bust,” on the evolution of the skill premium in the postwar U.S. economy. I develop an overlapping generations general equilibrium model with endogenous discrete schooling choice. The production technology features capital-skill complementarity as in Krusell et al. (2000). ISTC, through capital-skill complementarity, raises the relative demand for skilled labor, while demographic variation affects the skill premium through changing the age structure and hence relative supply of skilled labor. I find that demographic change is more important in shaping the skill premium before 1980. Since then, ISTC takes over to drive the dramatic increase in the skill premium.
    Keywords: Skill Premium; Schooling Choice; Demographic and Technological Change; Capital-Skill Complementarity; Overlapping Generations
    JEL: E25 I21 J11 J24 J31 O33
    Date: 2009–03–01
  5. By: Diego A. Comin (Harvard Business School, Business, Government and the International Economy Unit); Norman Loayza (Economics Research, World Bank Group); Farooq Pasha (Boston College, Economics); Luis Serven (World Bank - Office of the Chief Economist)
    Abstract: We build a two country asymmetric DSGE model with two features: (i) a product cycle structure determines the range of intermediate goods used to produce new capital in each country and (ii) there are investment flow adjustment costs in the developing economy. We calibrate the model to match the Mexico-US trade and FDI flows. The model is able to explain (i) why US shocks have a larger effect on Mexico than in the US and hence why the Mexican economy is more volatile than the US; (ii) why US business cycles lead over medium term fluctuations in Mexico and (iii) why Mexican consumption is not less volatile than output.
    Keywords: Business Cycles in Developing Countries, Co-movement between Developed and Developing economies, Volatility, Extensive Margin of Trade, Product Life Cycle, FDI.
    JEL: E3 O3
    Date: 2009–10
  6. By: Luca Fanelli (Alma Mater Studiorum Università di Bologna)
    Abstract: This paper proposes the estimation of small-scale dynamic stochastic general equilibrium (DSGE) monetary models under the quasi-rational expectations (QRE) hypothesis. The QRE-DSGE model is based on the idea that the determinate reduced form solution associated with the structural model, if it exists, must have the same lag structure as the ‘best fitting’ vector autoregressive (VAR) model for the observed time series. After discussing solution properties and the local identifiability of the model, a likelihood-based iterative algorithm for estimating the structural parameters and testing the data adequacy of the system is proposed. A Monte Carlo experiment shows that, even controlling for the omitted dynamics bias, the over-rejection of the nonlinear cross-equation restrictions when asymptotic critical values are used and variables are highly persistent is a relevant issue in finite samples. An application based on euro area data illustrates the advantages of using error-correcting formulations of the QRE-DSGE model when the inflation rate and the short-term interest rate are approximated as difference stationary processes. A parametric bootstrap version of the likelihood-ratio test for the implied cross-equation restrictions does not reject the estimated QRE-DSGE model.
    Keywords: Dynamic stochastic general equilibrium model, Maximum Likelihood estimation, Quasi-Rational Expectations, VAR. Modelli DSGE, Stima di massima verosimiglianza, Aspettative Quasi-Razionali, Modelli VAR.
    Date: 2009
  7. By: Fève,P.; Materon,J.; Sahuc, J-G.
    Abstract: The Euro area as a whole has experienced a marked downward trend in inflation over the past decades and, concomitantly, a protracted period of depressed activity. Can permanent and gradual shifts in monetary policy be held responsible for these dynamics? To answer this question, we embed serially correlated changes in the inflation target into a DSGE model with real and nominal frictions. The formal Bayesian estimation of the model suggests that gradual changes in the inflation target have played a major role in the Euro area business cycle. Following an inflation target shock, the real interest rate increases sharply and persistently, leading to a protracted decline in economic activity. Counter--factual exercises show that, had monetary policy implemented its new inflation objective at a faster rate, the Euro zone would have experienced more sustained growth than it actually did.
    Keywords: Inflation target shocks , Gradualism , DSGE models , Bayesian econometrics.
    JEL: E31 E32 E52
    Date: 2009
  8. By: Verbic, Miroslav; Majcen, Boris; Cok, Mitja
    Abstract: In the article, we model R&D as a major endogenous growth element in a small open economy general equilibrium framework and consider several R&D policy scenarios for Slovenia. Increase of the share of sectoral investment in R&D that is deductible from the CIT and increase of government spending on R&D turned out to be the most effective policy measures. While the former policy measure is still in part followed by an undesired dividend increase, the increase of government spending on R&D boosts long-run productivity in the economy, thus increasing the future value of firms, which is reflected in a desire dividend increase. The households that would gain more utility from such policy scenarios are those with more skilled and highly skilled labour, but not the very top earners in the economy.
    Keywords: endogenous growth; general equilibrium modelling; R&D; Slovenia
    JEL: O38 C68 D58 O40
    Date: 2009
  9. By: Robert Amano; Malik Shukayev
    Abstract: There appears to be a disconnect between the importance of the zero bound on nominal interest rates in the real-world and predictions from quantitative DSGE models. Recent economic events have reinforced the relevance of the zero bound for monetary policy whereas quantitative models suggest that the zero bound does not constrain (optimal) monetary policy. This paper attempts to shed some light on this disconnect by studying a broader range of shocks within a standard DSGE model. Without denying the possibility of other factors, we find that risk premium shocks are key to building quantitative models where the zero bound is relevant for monetary policy design. The risk premium mechanism operates by increasing the spread between the rates of return on private capital and risk-free government bonds. Other common shocks, such as aggregate productivity, investment-specific productivity, government spending and money demand shocks, are unable to push nominal bond rates close to zero as the same risk premium spread mechanism is not at play.
    Keywords: Monetary policy framework
    JEL: E32 E52
    Date: 2009
  10. By: Andrés Erosa (IMDEA Ciencias Sociales); Luisa Fuster (IMDEA Ciencias Sociales); Diego Restuccia (University of Toronto)
    Abstract: Despite mandatory parental-leave policies being a prevalent feature of labor markets in developed countries, the aggregate effects of leave policies are not well understood. In order to assess the quantitative impact of mandated leave policies in the economy, we develop ageneral-equilibrium model of fertility and labor-market decisions that builds on the labormarket framework of Mortensen and Pissarides (1994). We find that females gain substantially with generous policies, but this benefit occurs at the expense of a reduction in the welfare of males. Mandated leave policies have important effects on fertility, leave taking decisions, and employment rate of mothers with infants. These effects are driven by how policy affects bargaining in job matches: Young females anticipate that there are some states in the future in which their threat point in bargaining will be higher. Because the realization of these states depend on the decisions of females to give birth and take a leave, the change in the threat point induced by the policy subsidizes fertility and leave taking. Unpaid parental leaves have a small impact on the time that mothers spend with their children but paid parental leaves can be an effective tool to encourage mothers to spend time with theirchildren after giving birth.
    Keywords: human capital; labor-market equilibrium; parental-leave policies; fertility; temporary separations
    JEL: E24 E60 J2 J3
    Date: 2009–09–30
  11. By: Xavier Pautrel (LEMNA - Laboratoire d'économie et de management de Nantes Atlantique - Université de Nantes : EA4272)
    Abstract: This article demonstrates that when finite lifetime is introduced in a Lucas (1988) growth model where the source of pollution is physical capital, the environmental policy may enhance the growth rate of a market economy, while pollution does not influence educational activities, labor supply is not elastic and human capital does not enter the utility function. The result arises from the “generational turnover effect” due to finite lifetime. It remains valid under conditions when the education sector uses final output besides time to accumulate human capital. Nevertheless, it does no longer hold when the source of pollution is output. Furthermore, this article demonstrates that ageing reduces the positive influence of the environmental policy when growth is driven by human capital accumulation à la Lucas (1988) and lifetime is finite. It also confirms for finite lifetime the result found by Vellinga (1999) with a single representative agent: environmental care does not influence optimal growth when utility is additive and pollution does not influence the ability of agents to be educated.
    Date: 2009
  12. By: Peter N. Ireland (Boston College)
    Abstract: This paper constructs a two-country stochastic growth model in which neutral and investment-specific technology shocks are nonstationary but cointegrated across economies. It uses this model to interpret data showing that while real investment has grown faster than real consumption in the United States since 1970, the opposite has been true in the Euro Area. The model, when estimated with these data, reveals that the EA missed out on the rapid investment-specific technological change enjoyed in the US during the 1990s; the EA, however, experienced more rapid neutral technological progress while the US economy stagnated during the 1970s.
    Keywords: growth, shocks, Euro area, technological change
    JEL: E32 F41 F43 O41 O47
    Date: 2009–09–30
  13. By: Christopher D. Carroll (Johns Hopkins University); Olivier Jeanne (Peterson Institute for International Economics)
    Abstract: We model the motives for residents of a country to hold foreign assets, including the precautionary motive that has been omitted from much previous literature as intractable. Our model captures many of the principal insights from the existing specialized literature on the precautionary motive, deriving a convenient formula for the economy's target value of assets. The target is the level of assets that balances impatience, prudence, risk, intertemporal substitution, and the rate of return. We use the model to shed light on two topical questions: The "upstream" flows of capital from developing countries to advanced countries, and the long-run impact of resorbing global financial imbalances.
    Keywords: Buffer Stock Saving, Net Foreign Assets, Sovereign Wealth Funds, Foreign Exchange Reserves, Small Open Economy
    JEL: C61
    Date: 2009–10
  14. By: Ricardo Lagos; Guillaume Rocheteau; Pierre-Olivier Weill
    Abstract: We study the efficiency of dealers’ liquidity provision and the desirability of policy intervention in over-the-counter (OTC) markets during crises. Our theory emphasizes two key frictions in OTC markets: finding counterparties takes time, and trade is bilateral, with quantities and prices determined by bargaining. We model a crisis as a negative shock to investors’ asset demands that lasts until a random recovery time. In this context, dealers can provide liquidity to outside investors by acting as counterparties in trades and by accumulating asset inventories. We find that, when frictions are severe, even well capitalized dealers may not find it optimal to accumulate inventories, given that investors choose asset positions that require small reallocations. In such circumstances, the market allocative efficiency can increase if the government steps in, purchases private assets on its own account, and resells them when the economy recovers.
    JEL: C78 D83 E44
    Date: 2009–10
  15. By: Verbic, Miroslav; Majcen, Boris; Cok, Mitja
    Abstract: In the article we model education and human capital as major endogenous growth elements in a small open economy general equilibrium framework and consider several policy scenarios for Slovenia. Decrease of the PIT rate and increase of government spending on education turned out to be the most effective policy measures. It is important, though, to understand its transitory dynamic. Namely, as education expenditure is increased, certain amount of labour is temporarily withdrawn from its productive use and put into the educational system. Higher skill upgrade of labour requires longer and higher short-term labour force decrease, but also provides us with higher long-term growth. The households that would gain more utility from such policy scenarios are those with more skilled labour and thus higher income level.
    Keywords: education; endogenous growth; general equilibrium modelling; Slovenia
    JEL: C68 E24 D58 H52
    Date: 2009
  16. By: Timothy J. Halliday (Department of Economics, University of Hawaii at Manoa; Institute for the Study of Labor (IZA)); Hui He (Department of Economics, University of Hawaii at Manoa); Hao Zhang (Department of Economics, University of Hawaii at Manoa)
    Abstract: We study the evolution of health investment over the life-cycle by calibrating a model of endogenous health accumulation. The model is able to produce the decline in labor supply with age as well as the hump-shaped consumption profile. In both cases, health and health investment play a crucial role as the former encroaches upon healthy time and the latter crowds out non-medical expenditures as people age. Finally, we quantify the value of health as both an investment and a consumption good. We show that the investment motive is about three times higher than the consumption motive during the early 20s, but decreases over the life-cycle until it disappears at retirement. In contrast, the consumption motive increases with age and surpasses the investment motive during the mid 40s.
    Keywords: Health Investment, Consumption motive, investment motive, life-cycle
    JEL: E21 I12
    Date: 2009–10–07
  17. By: Fève, P.; Matheron, J.; Sahuc, J-G.
    Abstract: The aim of this paper is to complement the MDE--SVAR approach when the weighting matrix is not optimal. In empirical studies, this choice is motivated by stochastic singularity or collinearity problems associated with the covariance matrix of Impulse Response Functions. Consequently, the asymptotic distribution cannot be used to test the economic model's fit. To circumvent this difficulty, we propose a simple simulation method to construct critical values for the test statistics. An empirical application with US data illustrates the proposed method.
    Keywords: MDE, SVAR, DSGE models.
    JEL: C15 C32 E32
    Date: 2009
  18. By: Karen Kopecky (University of Western Ontario); Tatyana Koreshkova (Concordia University)
    Abstract: We consider a life-cycle model with idiosyncratic risk in labor earnings, out-of-pocket medical and nursing home expenses, and survival. Partial insurance is available through welfare, Medicaid, and social security. Calibrating the model to the U.S., we find that nursing home expenses play an important role in the savings of the wealthy. In our policy analysis, we find that elimination of out-of-pocket expenses through public health care would reduce the capital stock by 12 percent, Medicaid and old-age welfare programs crowd out 44 percent of savings and greatly increase wealth inequality, and social security effects are influenced by out-of-pocket health expenses.
    Keywords: health expenses, nursing home, idiosyncratic risk, savings, wealth inequality, old-age social insurance
    JEL: E21 I18 I38
    Date: 2009–06–20
  19. By: Alain Gabler; Omar Licandro
    Abstract: This paper contributes to the literature on both embodied technical progress and firm dynamics, by formulating an endogenous growth model where selection and imitation play a fundamental role in helping capital good producers to learn about the productivity of technologies embodied in new plants. By calibrating the model to some key aggregates particularly relevant for the embodied capital literature, among them the growth rate of the relative investment price, the model quantitatively replicates the main facts associated to firm dynamics, such as the entry rate and the tail index of the establishment size distribution. In line with the previous literature, it also predicts a contribution to productivity growth of embodied technical progress and selection of around 60%
    Keywords: endogenous growth; investment- specific technological change; selection and imitation; firm entry and exit.
    JEL: B52 O3 O41
    Date: 2009–09–30
  20. By: Andrés Erosa (IMDEA Ciencias Sociales); Tatyana Koreshkova (Concordia University and CIREQ); Diego Restuccia (University of Toronto)
    Abstract: We develop a quantitative theory of human capital investments in order to evaluate the magnitude of cross-country differences in total factor productivity (TFP) that explains the variation in per-capita incomes across countries. We build a heterogeneous-agent economy with cross-sectional variation in ability, schooling, and expenditures on schooling quality. By embedding our analysis in a growth model with tradable and non-tradable sectors, we model sectorial productivity differences across countries, as documented in Hsieh and Klenow (2007). The parameters governing human capital production and random ability and taste processes are restricted by a set of cross-sectional data moments such as variances and intergenerational correlations of earnings and schooling, as well as slope coefficient and R2 in a Mincer regression. Our main finding is that human capital accumulation strongly amplifies TFP differences across countries: To explain a 20-fold difference in the output per worker the model requires a 5-fold difference in the TFP of the tradable sector, versus an 18-fold difference if human capital is fixed across countries. Moreover, we find that sectorial productivity differences play a prominent role in quantitative implications of the theory.
    Date: 2009–09–30
  21. By: Hui He (Department of Economics, University of Hawaii at Manoa)
    Abstract: This paper documents a dramatic increase in the college enrollment rate of women from 1955 to 1980 and asks a quantitative question: to what extent can such change be accounted for by the change in the female cohort-specific college wage premium? I develop and calibrate an overlapping generations model with discrete schooling choice. I find that changes in the life-cycle earnings differential can explain the increase in female college enrollment rate very well. Young women's changing expectations of future employment opportunity also played an important role in driving their college attendance decision from the mid 1950s to the early 1970s.
    Keywords: female college enrollment rate, college wage premium, life-cycle
    JEL: J24 J31 I21 E24
    Date: 2009–10–01

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