nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2009‒11‒21
sixteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Portfolio inertia and the equity premium By Christopher Gust; David López-Salido
  2. Indeterminacy and business-cycle fluctuations in a two-sector monetary economy with externalities By Stefano Bosi; Kazuo Nishimura; Alain Venditti
  3. Credit Crunch in a Small Open Economy By Brzoza-Brzezina, Michal; Makarski, Krzysztof
  4. Business cycle fluctuations and learning-by-doing externalities in a one-sector model By Hippolyte D'Albis; Emmanuelle Augeraud-Véron; Alain Venditti
  5. A Banking Explanation of the US Velocity of Money: 1919-2004 By Benk, Szilárd; Gillman, Max; Kejak, Michal
  6. Credit Spreads and Monetary Policy By Vasco Cúrdia; Michael Woodford
  7. The effects of foreign shocks when interest rates are at zero By Martin Bodenstein; Christopher J. Erceg; Luca Guerrieri
  8. A Bayesian approach to estimating tax and spending multipliers By Matthew Denes; Gauti B. Eggertsson
  9. Nominal Wage Adjustment, Demand Shortage and Economic Policy By Yoshiyasu Ono; Junichiro Ishida
  10. Sustainability of social security in a model of endogenous fertility By Oshio, Takashi; Yasuoka, Masaya
  11. Managing expectations and fiscal policy By Anastasios G. Karantounias with Lars Peter Hansen; Thomas J. Sargent
  12. Public and private sector wages interactions in a general equilibrium model By Gonzalo Fernández-de-Córdoba; Javier J. Pérez; José L. Torres
  13. Multiple equilibria in two-sector monetary economies: an interplay between preferences and the timing for money By Stefano Bosi; Kazuo Nishimura; Alain Venditti
  14. Risk Price Dynamics By Jaroslav Borovička; Lars Peter Hansen; Mark Hendricks; José A. Scheinkman
  15. The Credit Spread Cycle with Matching Friction By Kevin E. Beaubrun-Diant; Fabien Tripier
  16. Decentralized Trading with Private Information By Mikhail Golosov; Guido Lorenzoni; Aleh Tsyvinski

  1. By: Christopher Gust; David López-Salido
    Abstract: We develop a DSGE model in which aggregate shocks induce endogenous movements in risk. The key feature of our model is that households rebalance their financial portfolio allocations infrequently, as they face a fixed cost of transferring cash across accounts. We show that the model can account for the mean returns on equity and the risk-free rate, and generates countercyclical movements in the equity premium that help explain the response of stock prices to monetary shocks. The model is consistent with empirical evidence documenting that unanticipated changes in monetary policy have important effects on equity prices through changes in risk.
    Date: 2009
  2. By: Stefano Bosi (EQUIPPE - Université de Lille I); Kazuo Nishimura (Kyoto University - Kyoto University); 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 (EHESS) - CNRS : UMR6579)
    Abstract: We consider a two-sector economy with money-in-the-utility-function and sector-specific externalities. We provide conditions on technologies leading to the existence of local indeterminacy for any value of the interest rate elasticity of money demand, provided the elasticity of intertemporal substitution in consumption is large enough. Moreover, we show that the occurrence of multiple equilibria is intimately linked with the existence of a flip bifurcation and period-two cycles.
    Keywords: Money-in-the-utility-function ; two-sector economy ; sector-specific externalities ; indeterminacy ; period-two cycles ; sunspot equilibria
    Date: 2009–11–15
  3. By: Brzoza-Brzezina, Michal; Makarski, Krzysztof
    Abstract: We construct an open-economy DSGE model with a banking sector to analyse the impact of the recent credit crunch on a small open economy. In our model the banking sector operates under monopolistic competition, collects deposits and grants collateralized loans. Collateral effects amplify monetary policy actions, interest rate stickiness dampens the transmission of interest rates, and financial shocks generate non-negligible real and nominal effects. As an application we estimate the model for Poland - a typical small open economy. According to the results, financial shocks had a substantial, though not overwhelming, impact on the Polish economy during the 2008/09 crisis, lowering GDP by a little over one percent.
    Keywords: credit crunch; monetary policy; DSGE with banking sector
    JEL: E32 E52 E44
    Date: 2009–11
  4. By: Hippolyte D'Albis (LERNA - Economie des Ressources Naturelles - INRA : UR1081 - CEA : DPG - Université des Sciences Sociales - Toulouse I); Emmanuelle Augeraud-Véron (MIA - Mathématiques, Image et Applications - Université de La Rochelle : EA3165); 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 (EHESS) - CNRS : UMR6579)
    Abstract: We consider a one-sector Ramsey-type growth model with inelastic labor and learning-by-doing externalities based on cumulative gross investment (cumulative production of capital goods), which is assumed, in accordance with Arrow [5], to be a good index of experience. We prove that a slight memory effect characterizing the learning-by-doing process is enough to generate business cycle fluctuations through a Hopf bifurcation. This is obtained for reasonable parameter values, notably for both the elasticity of output with respect to the externality and the elasticity of intertemporal substitution. Hence, contrary to all the results available in the literature on aggregate models, we show that endogenous fluctuations are compatible with a low (in actual fact, zero) wage elasticity of the labor supply.
    Keywords: One-sector infinite-horizon model, learning-by-doing externalities, inelastic labor, business cycle fluctuations, Hopf bifurcation
    Date: 2009–11–15
  5. By: Benk, Szilárd; Gillman, Max (Cardiff Business School); Kejak, Michal
    Abstract: The paper shows that US GDP velocity of M1 money has exhibited long cycles around a 1.25% per year upward trend, during the 1919-2004 period. It explains the velocity cycles through shocks constructed from a DSGE model and annual time series data (Ingram et al., 1994). Model velocity is stable along the balanced growth path, which features endogenous growth and decentralized banking that produces exchange credit. Positive shocks to credit productivity and money supply increase velocity, as money demand falls, while a positive goods productivity shock raises temporary output and velocity. The paper explains such velocity volatility at both business cycle and long run frequencies. With filtered velocity turning negative, starting during the 1930s and the 1987 crashes, and again around 2003, results suggest that the money and credit shocks appear to be more important for velocity during less stable times and the goods productivity shock more important during stable times.
    Keywords: Volatility; business cycle; credit shocks; velocity
    JEL: E13 E32 E44
    Date: 2009–11
  6. By: Vasco Cúrdia (Federal Reserve Bank of New York); Michael Woodford (Columbia University - Department of Economics)
    Abstract: We consider the desirability of modifying a standard Taylor rule for a cen- tral bank's interest-rate policy to incorporate either an adjustment for changes in interest-rate spreads (as proposed by Taylor, 2008, and by McCulley and Toloui, 2008) or a response to variations in the aggregate volume of credit (as proposed by Christiano et al., 2007). We consider the consequences of such adjustments for the way in which policy would respond to a variety of types of possible economic disturbances, including (but not limited to) disturbances originating in the financial sector that increase equilibrium spreads and contract the supply of credit. We conduct our analysis using the simple DSGE model with credit frictions developed in C¶urdia and Woodford (2009), and compare the equilibrium responses to a variety of disturbances under the modified Tay- lor rules to those under a policy that would maximize average expected utility. According to our model, a spread adjustment can improve upon the standard Taylor rule, but the optimal size is unlikely to be as large as the one proposed, and the same type of adjustment is not desirable regardless of the source of the variation in credit spreads. A response to credit is less likely to be helpful, and the desirable size (and even sign) of response to credit is less robust to alternative assumptions about the nature and persistence of the disturbances to the economy.
    Date: 2009
  7. By: Martin Bodenstein; Christopher J. Erceg; Luca Guerrieri
    Abstract: In a two-country DSGE model, the effects of foreign demand shocks on the home country are greatly amplified if the home economy is constrained by the zero lower bound for policy interest rates. This result applies even to countries that are relatively closed to trade such as the United States. The duration of the liquidity trap is determined endogenously. Adverse foreign shocks can extend the duration of the liquidity trap, implying more contractionary effects for the home country; conversely, large positive shocks can prompt an early exit, implying effects that are closer to those when the zero bound constraint is not binding.
    Date: 2009
  8. By: Matthew Denes; Gauti B. Eggertsson
    Abstract: This paper outlines a simple Bayesian methodology for estimating tax and spending multipliers in a dynamic stochastic general equilibrium (DSGE) model. After forming priors about the parameters of the model and the relevant shock, we used the model to exactly match only one data point: the trough of the Great Depression, that is, an output collapse of 30 percent, deflation of 10 percent, and a zero short-term nominal interest rate. Because we form our priors as distributions, the key economic inference of our analysis--the multipliers of tax and spending--are well-defined probability distributions derived from the posterior of the model. While the Bayesian methods used are standard, the application is slightly unusual. We conjecture that this methodology can be applied in several different settings with severe data limitations and where more informal calibrations have been the norm. The main advantage over usual calibration exercises is that the posterior of the model offers an interesting way to think about sensitivity analysis and gives researchers a useful way to describe model-based inference. We apply our simple estimation method to the American Recovery and Reinvestment Act (ARRA), passed by Congress as part of the 2009 stimulus plan. The mean of our estimate indicates that ARRA increased output by 3.6 percent in 2009 and 2010. The standard deviation of this estimate is 1 percent.
    Keywords: Depressions ; Econometric models ; Taxation ; Government spending policy
    Date: 2009
  9. By: Yoshiyasu Ono; Junichiro Ishida
    Abstract: We formulate nominal wage adjustment by incorporating various concepts of fairness. By applying it into a continuous-time money-in-utility model we examine macroeconomic dynamics with and without a liquidity trap and obtain the condition for persistent unemployment, and that for temporary unemployment, to occur. These conditions turn out to be critical, since policy implications significantly differ between the two cases. A monetary expansion raises private consumption under temporary unemployment but does not under persistent unemployment. A fiscal expansion may or may not increase short-run private consumption but crowds out long-run consumption under temporary unemployment. Under persistent unemployment, however, it always increases private consumption.
    Date: 2009–11
  10. By: Oshio, Takashi; Yasuoka, Masaya
    Abstract: Social security tends to be unsustainable in nature in that it reduces individuals' demand for children as a measure to support their old age, which in turn undermines the financial base of social security. Using a simple overlapping-generations model with endogenous fertility and income transfer from children to parents, we discuss the maximum size of a pay-as-you-go social security program that can prevent a cumulative reduction of fertility and make the program sustainable. We also show that childcare allowance raises the maximum size of the program and raises an individual's lifetime utility.
    Keywords: social security, fertility, intergenerational income transfer
    JEL: H31 H55
    Date: 2009–08
  11. By: Anastasios G. Karantounias with Lars Peter Hansen; Thomas J. Sargent
    Abstract: This paper studies an optimal fiscal policy problem of Lucas and Stokey (1983) but in a situation in which the representative agent's distrust of the probability model for government expenditures puts model uncertainty premia into history-contingent prices. This situation gives rise to a motive for expectation management that is absent within rational expectations and a novel incentive for the planner to smooth the shadow value of the agent's subjective beliefs to manipulate the equilibrium price of government debt. Unlike the Lucas and Stokey (1983) model, the optimal allocation, tax rate, and debt become history dependent despite complete markets and Markov government expenditures.
    Date: 2009
  12. By: Gonzalo Fernández-de-Córdoba (Universidad de Salamanca); Javier J. Pérez (Banco de España); José L. Torres (Universidad de Málaga)
    Abstract: This paper develops a dynamic general equilibrium model in which the public and the private sector interact in the labor market. Previous studies that analyze the labor market effects of public sector employment and wages have mostly assumed exogenous rules for public wage and public employment. We show that theories that equalize wages with marginal products in the private sector can rationalize the interaction of public and private sector wages when extended to accommodate a non-trivial government sector/public sector union that endogenously determines public employment and wages. Our model suggests a positive correlation between public and private sector wages. Any increase in tax revenues, coupled with the existence of a positive public-private sector wage gap, makes working in the public sector an attractive option. Thus, a positive neutral productivity shock increases public and private sector wages. More interestingly, even a private-sector specific productivity shock spills-over to the public sector, increasing public wages. These facts lend some support to the wage leading role of the private sector. Nevertheless, at the same time, a positive shock to public sector wages would lead to an increase in private sector wages, via the flow of workers from the private to the public sector.
    Keywords: Public wages, public employment, labor market, trade unions
    JEL: C32 J30 J51 J52 E62 E63 H50
    Date: 2009–10
  13. By: Stefano Bosi (EQUIPPE - Université de Lille I); Kazuo Nishimura (Kyoto University - Kyoto University); 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 (EHESS) - CNRS : UMR6579)
    Abstract: In this paper, we study the occurrence of local indeterminacy in two-sector monetary economies. In order to capture the credit market imperfections and the liquidity services of money, we consider a general MIUF model with two alternative timings in monetary payments: the Cash-In-Advance timing, in which the cash available to buy goods is money in the consumers' hands after they leave the bond market but before they enter the goods market, and the Cash-After-the-Market timing, in which agents hold money for transactions after leaving the goods market. We consider three standard specifications of preferences: the additively separable formulation, the Greenwood-Hercovitz-Huffman (GHH) [18] formulation and the King-Plosser-Rebelo (KPR) [21] formulation. First, we show that for all the three types of preferences, local indeterminacy easily arises under the CIA timing with a low enough interest rate elasticity of money demand. Second, we show that with the CAM timing, determinacy always holds under separable preferences, but local indeterminacy can arise in the case of GHH and KPR preferences. We thus prove that compared to aggregate models, two-sector models provide new rooms for local indeterminacy when non-separable standard preferences are considered.
    Keywords: Money-in-the-utility-function, Indeterminacy, Sunspot equilibria
    Date: 2009–11–15
  14. By: Jaroslav Borovička; Lars Peter Hansen; Mark Hendricks; José A. Scheinkman
    Abstract: We present a novel approach to depicting asset pricing dynamics by characterizing shock exposures and prices for alternative investment horizons. We quantify the shock exposures in terms of elasticities that measure the impact of a current shock on future cash-flow growth. The elasticities are designed to accommodate nonlinearities in the stochastic evolution modeled as a Markov process. Stochastic growth in the underlying macroeconomy and stochastic discounting in the representation of asset values are central ingredients in our investigation. We provide elasticity calculations in a series of examples featuring consumption externalities, recursive utility, and jump risk.
    JEL: C52 E44 G12
    Date: 2009–11
  15. By: Kevin E. Beaubrun-Diant (LEDA-SDFi - LEDA-SDFi - Université Paris Dauphine - Paris IX); Fabien Tripier (LEMNA - Laboratoire d'économie et de management de Nantes Atlantique - Université de Nantes : EA4272)
    Abstract: We herein advance a contribution to the theoretical literature on financial frictions and show the significance of the matching mechanism in explaining the countercyclical behavior of interest rate spreads. We demonstrate that when matching friction is associated with a Nash bargaining solution, it provides a satisfactory explanation of the credit spread cycle in response to shocks in production technology or in the cost of banks' resources. During periods of expansion, the credit spread experiences a tightening for two reasons. Firstly, as a result of easier access to loans, entrepreneurs have better opportunities outside a given lending relationship and can negotiate lower interest rates. Secondly, the less selective behavior of entrepreneurs and banks results in the occurrence of fewer productive matches, a fall in the average productivity of matches, and a tightening of the credit spread. Our results also underline the amplification and propagation properties of matching friction, which represent a powerful financial accelerator mechanism.
    Date: 2009–11–10
  16. By: Mikhail Golosov; Guido Lorenzoni; Aleh Tsyvinski
    Abstract: The paper studies asset pricing in informationally decentralized markets. These markets have two key frictions: trading is decentralized (bilateral), and some agents have private information. We analyze how uninformed agents acquire information over time from their bilateral trades. In particular, we show that uninformed agents can learn all the useful information in the long run and that the long-run allocation is Pareto efficient. We then explore how informed agents can exploit their informational advantage in the short run and provide sufficient conditions for the value of information to be positive. Finally, we provide a numerical analysis of the equilibrium trading dynamics and prices.
    JEL: D82 D84 G12 G14
    Date: 2009–11

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