nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2009‒11‒27
29 papers chosen by
Christian Zimmermann
University of Connecticut

  1. A Three State Model of Worker Flows in General Equilibrium By Krusell, Per; Mukoyama, Toshihiko; Rogerson, Richard; Sahin, Aysegul
  2. Methods versus Substance: Measuring the Effects of Technology Shocks on Hours By Fuentes-Albero, Cristina; Kryshko, Maxym; Ríos-Rull, José-Víctor; Santaeulàlia-Llopis, Raül; Schorfheide, Frank
  3. DSGE-CH: A dynamic stochastic general equilibrium model for Switzerland By Cuche-Curti, Nicolas A.; Dellas, Harris; Natal, Jean-Marc
  4. Labor-Market Matching with Precautionary Savings and Aggregate Fluctuations By Krusell, Per; Mukoyama, Toshihiko; Sahin, Aysegul
  5. Monetary Policy, Velocity, and the Equity Premium By Gust, Christopher; López-Salido, J David
  6. Aggregate Labor Market Outcomes: The Role of Choice and Chance By Krusell, Per; Mukoyama, Toshihiko; Rogerson, Richard; Sahin, Aysegul
  7. Understanding the Aggregate Effects of Anticipated and Unanticipated Tax Policy Shocks By Mertens, Karel; Ravn, Morten O.
  8. A Banking Explanation of the US Velocity of Money: 1919-2004 By Benk, Szilárd; Gillman, Max; Kejak, Michal
  9. The 'Puzzles' Methodology: en route to Indirect Inference? By Le, Vo Phuong Mai; Minford, Patrick; Wickens, Michael R.
  10. Inflation and Welfare in Long-Run Equilibrium with Firm Dynamics By Janiak, Alexandre; Monteiro, Paulo Santos
  11. Macroeconomic Effects of Financial Shocks By Jermann, Urban; Quadrini, Vincenzo
  12. Life Expectancy and the Environment By Mariani, Fabio; Pérez-Barahona, Agustín; Raffin, Natacha
  13. A Tractable Model of Precautionary Reserves, Net Foreign Assets, or Sovereign Wealth Funds By Carroll, Christopher D; Jeanne, Olivier
  14. Accounting for Japanese Business Cycles: a Quest for Labor Wedges By Keisuke Otsu
  15. Firm Dynamics Support the Importance of the Embodied Question By Gabler, Alain; Licandro, Omar
  16. "Optimal monetary policy when asset markets are incomplete" By Richard Anton Braun; Tomoyuki Nakajima
  17. Frequentist Inference in Weakly Identified DSGE Models By Guerron-Quintana, Pablo A.; Inoue, Atsushi; Kilian, Lutz
  18. Learning and the Great Moderation By Bullard, James B.; Singh, Aarti
  19. Empirical evidence on the aggregate effects of anticipated and unanticipated US tax policy shocks By Karel Mertens; Morten O. Ravn
  20. Financial Structure, Informality and Development By Hernan J Moscoso Boedo; Pablo N D’Erasmo
  21. Changing Workerfs States and Inefficient Decisions on Turnover By Keisuke Kawata
  22. Financial Innovation and Endogenous Growth By Laeven, Luc; Levine, Ross; Michalopoulos, Stelios
  23. Production Structure, Household Time Allocation, and Fertility By Masako Kimura; Daishin Yasui
  24. Limited Asset Market Participation and the Consumption-Real Exchange Rate Anomaly By Kollmann, Robert
  25. International Business Cycle Accounting By Keisuke Otsu
  26. Two Orthogonal Continents? Testing a Two-country DSGE Model of the US and EU Using Indirect Inference By Le, Vo Phuong Mai; Meenagh, David; Minford, Patrick; Wickens, Michael R.
  27. How much nominal rigidity is there in the US Economy? Testing a New Keynesian DSGE model using indirect inference By Le, Vo Phuong Mai; Minford, Patrick; Wickens, Michael R.
  28. Macro-Hedging for Commodity Exporters By Borensztein, Eduardo; Jeanne, Olivier; Sandri, Damiano
  29. Foreign Demand for Domestic Currency and the Optimal Rate of Inflation By Schmitt-Grohé, Stephanie; Uribe, Martín

  1. By: Krusell, Per; Mukoyama, Toshihiko; Rogerson, Richard; Sahin, Aysegul
    Abstract: We develop a simple model featuring search frictions and a nondegenerate labor supply decision along the extensive margin. The model is a standard version of the neoclassical growth model with indivisible labor with idiosyncratic shocks and frictions characterized by employment loss and employment opportunity arrival shocks. We argue that it is able to account for the key features of observed labor market flows for reasonable parameter values. Persistent idiosyncratic productivity shocks play a key role in allowing the model to match the persistence of the employment and out of the labor force states found in individual labor market histories.
    Keywords: Labor Market Frictions; Labor Supply; Taxes
    JEL: E24 J22 J64
    Date: 2009–08
  2. By: Fuentes-Albero, Cristina; Kryshko, Maxym; Ríos-Rull, José-Víctor; Santaeulàlia-Llopis, Raül; Schorfheide, Frank
    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.
    Keywords: Business Cycle Fluctuations; Calibration; DSGE Model Estimation; Technology Shocks
    JEL: C1 C8 E3
    Date: 2009–09
  3. By: Cuche-Curti, Nicolas A. (Swiss National Bank); Dellas, Harris (University of Bern); Natal, Jean-Marc (Swiss National Bank)
    Abstract: This paper presents a DSGE (dynamic stochastic general equilibrium) model of the Swiss economy used since 2007 in the monetary policy decision process at the Swiss National Bank. In addition to forecasting the likely course of main macro variables under various scenarios for the Swiss economy, the model DSGE-CH serves as a laboratory for studying business cycles and examining the effects of actual and hypothetical monetary policies. The microfounded model DSGE-CH represents Switzerland as a small open economy with optimizing economic agents facing several real and nominal rigidities and exogenous foreign and domestic shocks. The comparison of the model’s implications with the real world indicates that DSGE-CH performs well along standard dimensions. It captures the overall stochastic structure of the Swiss economy as represented by the moments of its key macroeconomic variables; furthermore, it has appropriate dynamic properties, as judged by its impulse response functions. Finally, it quite accurately replicates the historical path of major Swiss variables.
    Keywords: DSGE; forecasting; small open economy; Switzerland
    JEL: E27 E52 E58
    Date: 2009–10–01
  4. By: Krusell, Per; Mukoyama, Toshihiko; Sahin, Aysegul
    Abstract: We analyze a Bewley-Huggett-Aiyagari incomplete-markets model with labor-market frictions. Consumers are subject to idiosyncratic employment shocks against which they cannot insure directly. The labor market has a Diamond-Mortensen-Pissarides structure: firms enter by posting vacancies and match with workers bilaterally, with match probabilities given by an aggregate matching function. Wages are determined through Nash bargaining. We also consider aggregate productivity shocks, and a complete set of contingent claims conditional on this risk. We use the model to evaluate a tax-financed unemployment insurance scheme. Higher insurance is beneficial for consumption smoothing, but because it raises workers’ outside option value, it discourages firm entry. We find that the latter effect is more potent for welfare outcomes; we tabulate the effects quantitatively for different kinds of consumers. We also demonstrate that productivity changes in the model - in steady state as well as stochastic ones - generate rather limited unemployment effects, unless workers are close to indifferent between working and not working; thus, recent findings are corroborated in our more general setting.
    Keywords: heterogenous agents; incomplete markets; matching
    JEL: D52 J63 J64
    Date: 2009–08
  5. By: Gust, Christopher; López-Salido, J David
    Abstract: We develop a DSGE model in which monetary policy generates 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. While stimulative monetary policy can lower risk in equity markets, it is also associated with higher inflation expectations and inflation risk premia. The model gives rise to periods in which the zero lower bound constraint on the nominal interest rate binds and demand for liquidity jumps, leading to procyclical movements in velocity.
    Keywords: equity premium; monetary policy; velocity
    JEL: E44 E52
    Date: 2009–08
  6. By: Krusell, Per; Mukoyama, Toshihiko; Rogerson, Richard; Sahin, Aysegul
    Abstract: Commonly used frictional models of the labor market imply that changes in frictions have large effects on steady state employment and unemployment. We use a model that features both frictions and an operative labor supply margin to examine the robustness of this feature to the inclusion of a empirically reasonable labor supply channel. The response of unemployment to changes in frictions is similar in both models. But the labor supply response present in our model greatly attenuates the effects of frictions on steady state employment relative to the simplest matching model, and two common extensions. We also find that the presence of empirically plausible frictions has virtually no impact on the response of aggregate employment to taxes.
    Keywords: labour market frictions; labour Supply; taxes
    JEL: E24 J22 J64
    Date: 2009–08
  7. By: Mertens, Karel; Ravn, Morten O.
    Abstract: We evaluate the extent to which a dynamic stochastic general equilibrium model can account for the impact of "surprise" and "anticipated" tax shocks estimated from U.S. time-series data. In U.S. data, surprise tax cuts have expansionary and persistent effects on output, consumption, investment and hours worked. Anticipated tax liability tax cuts give rise to contractions in output, investment and hours worked before their implementation while thereafter giving rise to an economic expansion. A DSGE model with changes in tax rates that may be anticipated or not, is shown to be able to account for the empirically estimated impact of tax shocks. The important features of the model include adjustment costs, variable capacity utilization and consumption habits. We derive Hicksian decompositions of the consumption and labor supply responses and show that substitution effects are key for understanding the impact of tax shocks. When allowing for rule-of-thumb consumers, we find that the estimate of their share of the population is only around 10-11 percent.
    Keywords: anticipation effects; fiscal policy; structural estimation; tax liabilities
    JEL: E20 E32 E62 H30
    Date: 2009–10
  8. By: Benk, Szilárd; Gillman, Max; 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: business cycle; credit shocks; velocity; Volatility
    JEL: E13 E32 E44
    Date: 2009–11
  9. By: Le, Vo Phuong Mai; Minford, Patrick; Wickens, Michael R.
    Abstract: We review the methods used in many papers to evaluate DSGE models by comparing their simulated moments with data moments. We compare these with the method of Indirect Inference to which they are closely related. We illustrate the comparison with contrasting assessments of a two-country model in two recent papers. We conclude that Indirect Inference is the proper end point of the puzzles methodology.
    Keywords: anomaly; Bootstrap; DSGE; indirect inference; puzzle; US-EU Model; VAR; Wald statistic
    JEL: C12 C32 C52 E1
    Date: 2009–11
  10. By: Janiak, Alexandre (University of Chile); Monteiro, Paulo Santos (University of Warwick)
    Abstract: We analyze the welfare cost of inflation in a model with cash-in-advance constraints and an endogenous distribution of establishments' productivities. Inflation distorts aggregate productivity through firm entry dynamics. The model is calibrated to the United States economy and the long-run equilibrium properties are compared at low and high inflation. We find that, when the period over which the cash-in-advance constraint is binding is one quarter, an annual inflation rate of 10 percent leads to a decrease in the steady-state average productivity of roughly 0.5 percent compared to the optimum's steady-state. This decrease in productivity is not innocuous: it leads to a doubling of the welfare cost of inflation.
    Keywords: firm dynamics, productivity, inflation, welfare
    JEL: E40 E50 L16 O40
    Date: 2009–11
  11. By: Jermann, Urban; Quadrini, Vincenzo
    Abstract: In this paper we document the cyclical properties of U.S. firms' financial flows. Equity payouts are procyclical and debt payouts are countercyclical. We develop a model with explicit roles for debt and equity financing and explore how the observed dynamics of real and financial variables are affected by `financial shocks', that is, shocks that affect the firms' capacity to borrow. Standard productivity shocks can only partially explain the movements in real and financial variables. The addition of financial shocks brings the model much closer to the data. The recent events in the financial sector show up clearly in our model as a tightening of firms' financing conditions causing the GDP decline in 2008-09. Our analysis also suggests that the downturns in 1990-91 and 2001 were strongly influenced by changes in credit conditions.
    Keywords: business cycle; debt and equity; Financial frictions
    JEL: E32 G10
    Date: 2009–09
  12. By: Mariani, Fabio (Université Catholique de Louvain); Pérez-Barahona, Agustín (Ecole Polytechnique, Paris); Raffin, Natacha (University of Paris 1)
    Abstract: We present an OLG model in which life expectancy and environmental quality dynamics are jointly determined. Agents may invest in environmental care, depending on how much they expect to live. In turn, environmental conditions affect life expectancy. As a result, our model produces a positive correlation between longevity and environmental quality, both in the long-run and along the transition path. Eventually, multiple equilibria may also arise: some countries might be caught in a low-life-expectancy / low-environmental-quality trap. This outcome is consistent with stylized facts relating life expectancy and environmental performance measures. We also discuss the welfare and policy implications of the intergenerational externalities generated by individual choices. Finally, we show that our results are robust to the introduction of growth dynamics based on physical or human capital accumulation.
    Keywords: environmental quality, life expectancy, poverty traps, human capital
    JEL: J24 O11 O40 Q56
    Date: 2009–11
  13. By: Carroll, Christopher D; Jeanne, Olivier
    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; Capital Flows; Foreign Exchange Reserves; Net Foreign Assets; Small Open Economy; Sovereign Wealth Funds
    JEL: C61 F3
    Date: 2009–09
  14. By: Keisuke Otsu (Faculty of Liberal Arts, Sophia University (E-mail:
    Abstract: A key feature of the Japanese business cycles over the 1980- 2007 period is that the fluctuation of total hours worked leads the fluctuation of output. A canonical real business cycle model cannot account for this fact. This paper uses the business cycle accounting method introduced by Chari, Kehoe and McGrattan (2007) and shows that labor market distortions are important in accounting for the this feature of the Japanese labor supply fluctuation. I further discuss fundamental economic shocks that manifest themselves as labor wedges and assess their impacts on labor fluctuation.
    Keywords: Business Cycle Accounting, Japanese Labor Market
    JEL: E13 E32
    Date: 2009–11
  15. By: Gabler, Alain; Licandro, Omar
    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; firm entry and exit; investment-specific technological change; selection and imitation
    JEL: B52 O3 O41
    Date: 2009–10
  16. By: Richard Anton Braun (Faculty of Economics, University of Tokyo); Tomoyuki Nakajima (Institute of Economic Research, Kyoto University)
    Abstract: This paper considers the properties of an optimal monetary policy when households are subject to countercyclical uninsured income shocks. We develop a tractable incompletemarkets model with Calvo price setting. Incomplete markets creates a new distortion and that distortion is large in the sense that the welfare cost of business cycles is large in our model. Nevertheless, the optimal monetary policy is very similar to the optimal policy that emerges in the representative agent framework and calls for nearly complete stabilization of the price-level.
    Date: 2009–10
  17. By: Guerron-Quintana, Pablo A.; Inoue, Atsushi; Kilian, Lutz
    Abstract: We show that in weakly identified models (1) the posterior mode will not be a consistent estimator of the true parameter vector, (2) the posterior distribution will not be Gaussian even asymptotically, and (3) Bayesian credible sets and frequentist confidence sets will not coincide asymptotically. This means that Bayesian DSGE estimation should not be interpreted merely as a convenient device for obtaining asymptotically valid point estimates and confidence sets from the posterior distribution. As an alternative, we develop new frequentist confidence sets for structural DSGE model parameters that remain asymptotically valid regardless of the strength of the identification.
    Keywords: Bayes factor; Bayesian estimation; Confidence set; DSGE models; Identification; Inference; Likelihood ratio
    JEL: C32 C52 E30 E50
    Date: 2009–09
  18. By: Bullard, James B.; Singh, Aarti
    Abstract: We study a stylized theory of the volatility reduction in the U.S. after 1984 - the Great Moderation - which attributes part of the stabilization to less volatile shocks and another part to more difficult inference on the part of Bayesian households attempting to learn the latent state of the economy. We use a standard equilibrium business cycle model with technology following an unobserved regime-switching process. After 1984, according to Kim and Nelson (1999a), the variance of U.S. macroeconomic aggregates declined because boom and recession regimes moved closer together, keeping conditional variance unchanged. In our model this makes the signal extraction problem more difficult for Bayesian households, and in response they moderate their behavior, reinforcing the effect of the less volatile stochastic technology and contributing an extra measure of moderation to the economy. We construct example economies in which this learning effect accounts for about 30 percent of a volatility reduction of the magnitude observed in the postwar U.S. data.
    Keywords: Bayesian learning; business cycles; information; regime-switching
    JEL: D8 E3
    Date: 2009–08
  19. By: Karel Mertens (Cornell University); Morten O. Ravn (University College London; University of Southampton; CEPR)
    Abstract: The authors provide empirical evidence on the dynamic effects of tax liability changes in the United States. We distinguish between surprise and anticipated tax changes using a timing convention. We document that pre-announced but not yet implemented tax cuts give rise to contractions in output, investment and hours worked, while real wages increase. In contrast, there are no significant anticipation effects on aggregate consumption. Implemented tax cuts, regardless of their timing, have expansionary and persistent effects on output, consumption, investment, hours worked and real wages. The findings are shown to be very robust. We argue that tax shocks are empirically important impulses to the US business cycle and that anticipation effects have been significant over several business cycle episodes
    Keywords: fiscal policy shocks, tax liabilities, anticipation effects, business cycles
    JEL: E20 E32 E62 H30
    Date: 2009–11
  20. By: Hernan J Moscoso Boedo; Pablo N D’Erasmo
    Abstract: This is a theory of total factor productivity based on measured capital market im- perfections and costs of creating and operating formal sector firms. We develop a firm dynamics model with endogenous formal and informal sectors where firms face a technol- ogy adoption opportunity. The model predicts that countries with a low degree of debt enforcement and high costs of formality are characterized by low allocative efficiency and a large share output produced by low productivity firms in the informal sector. We find that this mechanism is quantitatively important. When frictions are parameterized using the World Bank Doing Business database, the model explains up to 60% of total factor productivity differences between the US and developing economies.
    Keywords: Financial Structure, Informal Sector, Productivity, Policy Distortions
    JEL: D24 E26 L11 O16 O17
    Date: 2009–11
  21. By: Keisuke Kawata (Graduate School of Economics, Osaka University)
    Abstract: This paper considers an on-the-job search model that includes wage bargaining and employer-employee mismatch. There are two states of workers in relationship to their fit for a particular job, good match versus bad match (mismatch). These states change in accordance with a stochastic process. There are two main results; the first is that the turnover level that workers find optimal is lower than the socially optimal level. The second is that the level of the firmfs entry is not optimal even though the Hosios condition is hold. The first result is clearly distinct from previous studies.
    Keywords: on-the-job search, wage bargaining, mismatch, turnover
    JEL: J63 J81
    Date: 2009–11
  22. By: Laeven, Luc; Levine, Ross; Michalopoulos, Stelios
    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.
    Keywords: Corporate Finance; Economic Growth; Entrepreneurship; Financial Institutions; Invention; Technological change
    JEL: G0 O31 O4
    Date: 2009–09
  23. By: Masako Kimura (Institute of Economic Research, Kyoto University); Daishin Yasui (Graduate School of Economics, Kyoto University)
    Abstract: This paper develops an overlapping generations model that incorporates two-sector (market and non-market) production, sexual difference, and fertility choice. Our model could explain the joint evolution of production structure, household time allocation, and fertility broadly observed in the 19th and 20th centuries in the Western world as part of a single process of economic development: (i) production has shifted out of households and into the market, (ii) males first increased their labor supply to the market, and then females increased it; married-female participation in wage work outside the home dramatically increased in the latter half of the 20th century, and (iii) there has been the secular decline in fertility over the last 200 years, but there was the temporary rise in the middle of the 20th century (inverted N-shaped fertility dynamics). We also provide the quantitative analysis and examine how well our model replicates the patterns observed in U.S. data.
    Keywords: Fertility, Overlapping generations model, Structural change, Gender gap
    JEL: J13 J16 O11 O41
    Date: 2009–11
  24. By: Kollmann, Robert
    Abstract: Under efficient consumption risk sharing, as assumed in standard international business cycle models, a country’s aggregate consumption rises relative to foreign consumption, when the country’s real exchange rate depreciates. Yet, empirically, relative consumption and the real exchange rate are essentially uncorrelated. I show that this ‘consumption-real exchange rate anomaly’ can be explained by a simple model in which a subset of households trade in complete financial markets, while the remaining households lead hand-to-mouth (HTM) lives. HTM behavior also generates greater volatility of the real exchange rate and of net exports, which likewise brings the model closer to the data.
    Keywords: consumption; hand to mouth consumers; limited asset market participation; real exchange rate
    JEL: F36 F41
    Date: 2009–09
  25. By: Keisuke Otsu (Faculty of Liberal Arts, Sophia University (E-mail:
    Abstract: In this paper, I extend the business cycle accounting method a la Chari, Kehoe and McGrattan (2007) to a two-country international business cycle model and quantify the effect of the disturbances in relevant markets on the business cycle correlation between Japan and the US over the 1980-2008 period. This paper finds that disturbances in the labor market and production efficiency are important in accounting for the recent increase in the cross-country output correlation. If international financial market integration is important for considering the recent increase in cross-country output correlation, it must operate through an increase in the cross-country correlation of disturbances in the labor market and production efficiency, and not in the domestic investment market.
    Keywords: Business Cycle Accounting, International Business Cycles
    JEL: E32 F41
    Date: 2009–11
  26. By: Le, Vo Phuong Mai; Meenagh, David; Minford, Patrick; Wickens, Michael R.
    Abstract: We examine a two country model of the EU and the US. Each has a small sector of the labour and product markets in which there is wage/price rigidity, but otherwise enjoys flexible wages and prices with a one quarter information lag. Using a VAR to represent the data, we find the model as a whole is rejected. However it is accepted for real variables, output and the real exchange rate, suggesting mis-specification lies in monetary relationships. The model highlights a lack of spillovers between the US and the EU.
    Keywords: Bootstrap; DSGE; indirect inference; New Classical; New Keynesian; Open economy model; VAR; Wald statistic
    JEL: C12 C32 C52 E1
    Date: 2009–07
  27. By: Le, Vo Phuong Mai; Minford, Patrick; Wickens, Michael R.
    Abstract: We evaluate the Smets-Wouters model of the US using indirect inference with a VAR representation of the main US data series. We find that the original New Keynesian SW model is on the margin of acceptance when SW's own estimates of the variances and time-series behaviour of the structural errors are used. However when the structural errors implied jointly by the data and the structural model are used the model is rejected. We also construct an alternative (New Classical) version of the model with flexible wages and prices and a one-period information lag. This too is rejected. But when small proportions of both the labour and product markets are assumed to be imperfectly competitive within otherwise flexible markets the resulting `weighted' model is accepted.
    Keywords: Bootstrap; DSGE; grea moderation; indirect inference; New Classical; New Keynesian; regime change; structural break; US Model; VAR; Wald statistic
    JEL: C12 C32 C52 E1
    Date: 2009–11
  28. By: Borensztein, Eduardo; Jeanne, Olivier; Sandri, Damiano
    Abstract: This paper uses a dynamic optimization model to estimate the welfare gains of hedging against commodity price risk for commodity-exporting countries. We show that the introduction of hedging instruments such as futures and options enhances domestic welfare through two channels. First, by reducing export income volatility and allowing for a smoother consumption path. Second, by reducing the country's need to hold foreign assets as precautionary savings (or by improving the country's ability to borrow against future export income). Under plausibly calibrated parameters, the second channel may lead to much larger welfare gains, amounting to several percentage points of annual consumption.
    Keywords: commodity exports; default; futures; hedging; international reserves; options; precautionary savings
    JEL: C61 E21 F30 F40 G13
    Date: 2009–10
  29. By: Schmitt-Grohé, Stephanie; Uribe, Martín
    Abstract: More than half of U.S. currency circulates abroad. As a result, much of the seignorage income of the United States is generated outside of its borders. In this paper we characterize the Ramsey-optimal rate of inflation in an economy with a foreign demand for its currency. In the absence of such demand, the model implies that the Friedman rule---deflation at the real rate of interest---maximizes the utility of the representative domestic consumer. We show analytically that once a foreign demand for domestic currency is taken into account, the Friedman rule ceases to be Ramsey optimal. Calibrated versions of the model that match the range of empirical estimates of the size of foreign demand for U.S. currency deliver Ramsey optimal rates of inflation between 2 and 10 percent per year. The domestically benevolent government finds it optimal to impose an inflation tax as a way to extract resources from the rest of the world in the form of seignorage revenue.
    Keywords: Foreign demand for Currency; Friedman Rule; Optimal Inflation Rate
    JEL: E41
    Date: 2009–11

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