nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2010‒01‒10
twenty-six papers chosen by
Christian Zimmermann
University of Connecticut

  1. Worker flows and job flows: a quantitative investigation By Shigeru Fujita; Makoto Nakajima
  2. Establishments dynamics, vacancies and unemployment: a neoclassical synthesis By Marcelo Veracierto
  3. Efficient Subsidization of Human Capital Accumulation with Overlapping Generations and Endogenous Growth By Richter, Wolfram F.; Braun, Christoph
  5. The taxation of savings in overlapping generations economies with unbacked risky assets. By Julio Davila
  6. Housing and debt over the life cycle and over the business cycle By Matteo Iacoviello; Marina Pavan
  7. Produce or Speculate? Asset Bubbles, Occupational Choice and Efficiency By Cahuc, Pierre; Challe, Edouard
  8. Optimal Monetary Policy and Asset Prices: the case of Colombia By Martha R. López; Juan David Prada
  9. The Behavior of the Saving Rate in the Neoclassical Optimal Growth Model By Anastasia Litina; Theodore Palivos
  10. Stationary equilibrium distributions in economies with limited commitment By Tobias Broer
  11. Migration and human capital in an endogenous fertility model By Luca Marchiori; Patrice Pieretti; Benteng Zou
  12. Pre-announcement and Timing - The Effects of a Government Expenditure Shock By Alexander Kriwoluzky
  13. Advertising, Labor Supply and the Aggregate Economy. A long run Analysis By Benedetto Molinari; Francesco Turino
  14. Collusion at the Non-Binding Minimum Wage: An Automatic Stabilizer? By Natalya Y. Shelkova
  15. Inflation dynamics under optimal discretionary fiscal and monetary policies By Stefan Niemann; Paul Pichler; Gerhard Sorger
  16. A Multiple Equilibria Model with Intrafirm Bargaining and Matching Frictions By Julie Beugnot; Mabel Tidball
  17. On the Persistence of Income Shocks over the Life Cycle: Evidence and Implications By Fatih Karahan; Serdar Ozkan
  18. How Powerful is Demography? The Serendipity Theorem Revisited By David de la Croix; Pierre Pestieau; Grégory Ponthière
  19. Liquidity Constrained Competing Auctions By Richard Dutu; Benoit Julien; Ian King
  20. The Minimum Wage Spike in the Search Economy with Wage-Posting By Natalya Y. Shelkova
  21. Public versus Private Education with Risky Human Capital By Fabian Kindermann
  22. Desk rejection in an academic publication market model with matching frictions By Besancenot, Damien; Huynh, Kim; Vranceanu, Radu
  23. How important is the currency denomination of exports in open-economy models? By Michael Dotsey; Margarida Duarte
  24. The Economic and Policy Consequences of Catastrophes By Robert S. Pindyck
  25. The Composition of Government Expenditure in an Overlapping Generations Model By John Creedy; Shuyun May Li; Solmaz Moslehi
  26. Taxation of human capital and wage inequality: a cross-country analysis By Fatih Guvenen; Burhanettin Kuruscu; Serdar Ozkan

  1. By: Shigeru Fujita; Makoto Nakajima
    Abstract: Worker flows and job flows behave differently over the business cycle. The authors investigate the sources of the differences by studying quantitative properties of a multiple-worker version of the search/matching model that features endogenous job separation and intra-firm wage bargaining. Their calibration incorporates micro- and macro-level evidence on worker and job flows. The authors show that the dynamic stochastic equilibrium of the model replicates important cyclical features of worker flows and job flow simultaneously. In particular, the model correctly predicts that hires from unemployment move countercyclically while the job creation rate moves procyclically. The key to this result is to allow for a large hiring flow that does not go through unemployment but is part of job creation, for which procyclicality of the job finding rate dominates its cyclicality. The authors also show that the model generates large volatilities of unemployment and vacancies when a worker's outside option is at 83 percent of aggregate labor productivity.
    Keywords: Employment ; Business cycles
    Date: 2009
  2. By: Marcelo Veracierto
    Abstract: This paper develops a Walrasian equilibrium theory of establishment dynamics and matching frictions and uses it to analyze business cycle fluctuations. Two scenarios are considered: one in which the matching process is subject to congestion externalities and another in which it is not. The paper finds that the scenario with congestion externalities replicates U.S. business cycle dynamics much better than the scenario with efficient matching. Reallocation shocks improve the empirical behavior of the model in terms of microeconomic adjustments but have little consequences for aggregate dynamics.
    Date: 2009
  3. By: Richter, Wolfram F. (University of Dortmund); Braun, Christoph (Ruhr Graduate School in Economics)
    Abstract: This paper studies second-best policies in an OLG model in which endogenous growth results from human capital accumulation. When young, individuals decide on education, saving, and nonqualified labour. When old, individuals supply qualified labour. Growth equilibria are inefficient in laissez-faire because of distortionary taxation. The inefficiency is exacerbated if selfish individuals externalize the positive effect of education on descendents' productivity. It is shown to be second best not to distort education if the human capital investment function is isoelastic. If the function is not isoelastic, a case is made for subsidizing education even relative to the first best.
    Keywords: OLG model, endogenous growth, endogenous labour, education and saving, intergenerational externalities, optimal taxation
    JEL: H21 I28 J24
    Date: 2009–12
  4. By: Zheng Liu; Pengfei Wang; Tao Zha
    Abstract: Previous studies on financial frictions have been unable to establish the empirical significance of credit constraints in macroeconomic fluctuations. This paper argues that the muted impact of credit constraints stems from the absence of a mechanism to explain the observed persistent comovements between housing prices and business investment. We develop such a mechanism by incorporating two key features into a DSGE model: we identify shocks that shift the demand for collateral assets and we allow productive agents to be credit-constrained. A combination of these two features enables our model to successfully generate an empirically important mechanism that amplifies and propagates macroeconomic fluctuations through credit constraints.
    Date: 2009–12
  5. By: Julio Davila (Centre d'Economie de la Sorbonne - Paris School of Economics and CORE)
    Abstract: This paper establishes, in the context of the Diamond (1965) overlapping generations economy with production, that the risk that savings in unbacked assets (like fiat money or public debt) become worthless implies that, not only the first-best steady state, but even the best steady state attainable with those saving instruments fails to be a competitive equilibrium outcome under laissez-faire. It is nonetheless shown as well that this best monetary steady state can be implemented as a competitive equilibrium with the adequate policy of taxes on returns to capital, subsidies to returns to monetary savings, and lump-sum transfers. Interestingly enough, this policy requires non redistribution of income among agents, unlike the implementation of the first-best steady state. The policy is balanced every period at the steady state and, since no public spending exists in the model, it serves the only purpose of implementing a steady state that provides all agents with a higher utility than the laissez-faire competitive equilibrium steady state. The results thus provide a rationale for an active fiscal policy that has nothing to do with redistributive goals or the need to fund any kind of public sending.
    Keywords: Taxation of savings, overlapping generations, asset bubble.
    JEL: E62 E21 E22 H21
    Date: 2009–12
  6. By: Matteo Iacoviello; Marina Pavan
    Abstract: This paper describes an equilibrium life-cycle model of housing where nonconvex adjustment costs lead households to adjust their housing choice infrequently and by large amounts when they do so. In the cross-sectional dimension, the model matches the wealth distribution; the age profiles of consumption, homeownership, and mortgage debt; and data on the frequency of housing adjustment. In the time-series dimension, the model accounts for the procyclicality and volatility of housing investment, and for the procyclical behavior of household debt.
    Keywords: Housing ; Mortgage loans
    Date: 2009
  7. By: Cahuc, Pierre (Ecole Polytechnique, Paris); Challe, Edouard (Ecole Polytechnique, Paris)
    Abstract: We study the macroeconomic effects of rational asset bubbles in an overlapping-generations economy where asset trading requires specialized intermediaries and where agents freely choose between working in the production or in the financial sector. Frictions in the market for deposits create rents in the financial sector that affect workers' choice of occupation. When rents are large, the private gains associated with trading asset bubbles may lead too many workers to become speculators, thereby causing rational bubbles to lose their efficiency properties. Moreover, if speculation can be carried out by skilled labor only, then asset bubbles displace skilled workers away from the productive sector and raise income and consumption inequalities.
    Keywords: rational bubbles, occupational choice, dynamic efficiency
    JEL: E22 E44 G21
    Date: 2009–12
  8. By: Martha R. López; Juan David Prada
    Abstract: The unfolding of the 2007 world financial and economic crisis has highlighted the vulnerability of real economic activity to strong fluctuations in asset prices. Which is the optimal monetary policy in an economy like the Colombian that is exposed to swings in asset prices? What is the implication in terms of Central Bank losses when it follows a standard simple rule instead of the optimal monetary policy? To answer these questions we use a Dynamic Stochastic General Equilibrium (DSGE) model with physical capital and sticky wages for the Colombian economy and derive the optimal monetary policy. Then, we explore the dynamic effects of news about a future technology improvement which turns out ex post to be overoptimistic under the optimal policy rule and alternative specifications of simple rules and definitions of output gap.
    Date: 2009–12–14
  9. By: Anastasia Litina (Department of Economics, University of Macedonia); Theodore Palivos (Department of Economics, University of Macedonia)
    Abstract: This paper characterizes analytically the saving rate in the Ramsey-Cass-Koopmans model with a general production function when there exists both exogenous and endoge- nous growth. It points out conditions involving the share of capital and the elasticities of factor and intertemporal substitution under which the saving rate path to its steady-state value exhibits overshooting, undershooting, or is monotonic. Simulations illustrate these interesting dynamics. The paper also identi?es the general class of production functions that render the saving rate constant along the entire transition path and hence make the Ramsey-Cass-Koopmans model isomorphic to that of Solow-Swan.
    Keywords: Ramsey-Cass-Koopmans Model, Saving Rate, Elasticities of Substitution.
    JEL: E20 O41 O10
    Date: 2009–12
  10. By: Tobias Broer
    Abstract: Limited commitment to contracts can explain imperfect risk sharing even when individuals have access to complete insurance markets. Past contributions have focused on the resulting cross-sectional distribution of consumption (Cordoba 2008, Krueger and Perri 2006). In contrast, this paper looks at the joint dynamics of income, consumption and wealth implied by the asymmetric nature of partial insurance under limited commitment, where negative income shocks are largely insured but positive shocks can lead to large rises in consumption. A theoretical section proves the existence and uniqueness of equilibrium in a limited commitment continuum economy where incomes follow a standard markov process, and solves analytically for the joint equilibrium distribution of consumption, income and wealth. I show that individual consumption follows, at least locally, a left-skewed geometric distribution. Also, the conditional distributions of consumption and wealth are highly non-linear and have a characteristic form of heteroscedasticity, with declining conditional variances as income increases. In a quantitative part, the paper compares the exact distributions in the Krueger and Perri (2006) model to non-parametric estimates of their counterparts in US micro-data, and in a simple Ayagari economy.
    Keywords: Risk Sharing, Limited Commitment, Inequality, Wealth and Consumption Distribution, Participation Constraints, Default
    JEL: D52 D31 E21 E44
    Date: 2009
  11. By: Luca Marchiori; Patrice Pieretti; Benteng Zou (CREA, University of Luxembourg)
    Abstract: What is the impact of high-skilled emigration on fertility and human capital in migrants’ origin countries? This question is analyzed within an overlapping generations model where parents choose to finance higher education to a certain number of their children. It follows that families are composed of high- and low-skilled children who may both emigrate with a certain probability when they reach adulthood. It is found that a brain drain leads to a change in children’s skill composition, with parents choosing to provide higher education to a larger number of their children. A calibration of the model suggests that, following a brain drain, the additional children benefiting from higher education might in the long run compensate for the loss of high-educated workers and lead to a brain gain.
    JEL: F22 J13 J24
    Date: 2009
  12. By: Alexander Kriwoluzky
    Abstract: This paper investigates the effect of a government expenditure shock on consumption and real wages. I identify the shock by exploiting its pre-announced nature, i.e. different signs of the responses in investment, hours worked and output during the announcement and after the realization of the shock. Since pre-announcement leads to a non-stationary moving average representation, I estimate and identify a VMA model. The identifying restrictions are derived from a DSGE model, which is estimated by matching the impulse response functions of the VMA model. Private consumption is found to respond negatively during the announcement period and positively after the realization. The reaction of real wages is significantly positive on impact, decreases during the announcement horizon, and is again significantly positive for two quarters after the realization.
    Keywords: Fiscal Policy shock, Bayesian Estimation, DSGE model, Vector Autoregression
    JEL: C32 E62 H0
    Date: 2009
  13. By: Benedetto Molinari (Department of Economics, Universidad Pablo de Olavide); Francesco Turino (Universitat d'Alacant and Università di Bologna)
    Abstract: This paper studies the influence of persuasive advertising in a neoclassical growth model with monopolistically competitive firms. Our findings show that advertising can significantly affect the stationary equilibrium of a model economy in which the labor supply is endogenous. In this case, for empirically plausible calibrations, we find that the equilibrium level of hours worked, GDP, and consumption increase with the amount of resources invested in advertising. These findings are consistent with a new stylized fact provided in this paper: over the past decade, per-capita advertising expenditures have been positively correlated with per-capita output, consumption and hours worked across OECD countries. Because of the connection between advertising and labor supply, we show that our model improves on its neoclassical counterpart in explaining both within-country and cross-country variability of hours worked per capita.
    Keywords: Advertising, Labor Wedge, Labor supply, Economic Growth, Hours Worked.
    JEL: E20 E32 J22
    Date: 2009–12
  14. By: Natalya Y. Shelkova (Guilford College and University of Connecticut)
    Abstract: This paper examines unemployment dynamics through the lens of a wage-posting model with two sectors and two types of workers. The model assumptions include collusion at a non-binding minimum wage, costly entry and intersectoral labor mobility. Model simulations demonstrate that collusion at a non-binding minimum wage induces entry into the low-wage sector. This dampens the overall negative employment impact of economic downturns. The excess of low-wage vacancies has shown not only to secure low unemployment rates for the low-skilled workers, but also to provide employment opportunities for the high-skilled when their industries substantially decline.
    Keywords: unemployment, search, minimum wage, collusion
    JEL: J30
    Date: 2009–12
  15. By: Stefan Niemann; Paul Pichler; Gerhard Sorger
    Abstract: We examine the dynamic properties of inflation in a model of optimal discretionary fiscal and monetary policies. The lack of commitment and the presence of nominally risk-free debt provide the government with an incentive to implement policies which induce positive and persistent inflation rates. We show that this property obtains already in an environment with flexible prices and perfectly competitive product markets. Introducing nominal rigidities and imperfect competition has no qualitative but important quantitative implications. In particular, with a modest degree of price stickiness our model generates inflation dynamics very similar to those experienced in the U.S. since the Volcker disinflation of the early 1980s.
    Date: 2009–12–17
  16. By: Julie Beugnot; Mabel Tidball
    Abstract: In this paper, we combine a matching model derived from Pissarides (2000) in the case of large .rms with monopolistic competition on the product market and the model of intra.rm bargaining à la Stole and Zwiebel (1996). Moreover, we allow for increasing returns to scale in the aggregate production function leading to multiple equilibria. Then, we study the dynamics of such a framework for various size of returns to scale and propose numerical simulations. Finally, we show how the dynamical properties are altered in the case of multiple equilibria compared to that of a unique equilibrium and illustrate the issues of economic policy design in presence of multiple equilibria.
    Date: 2009–10
  17. By: Fatih Karahan (Department of Economics, University of Pennsylvania); Serdar Ozkan (Department of Economics, University of Pennsylvania)
    Abstract: This paper proposes a novel specification for residual earnings that allows for a lifetime profile in the persistence and variance of labor income shocks. We show theoretically that the statistical model is identified and estimate it using data from the PSID. We strongly reject the hypothesis of a at life-cycle profile for persistence and variance of persistent shocks, but not for the variance of transitory shocks. Shocks to earnings are only moderately persistent (around 0.75) for young individuals. Persistence rises with age up to unity until midway in life and decreases to around 0.95 toward the end of the life cycle. On the other hand, the variance of persistent shocks exhibits a U-shaped profile over the life cycle (with a minimum of 0.01 and a maximum of 0.045). Our estimate of persistence, for most of the working life, is substantially lower than typical estimates in the literature. We investigate the implications of these profiles for consumption-savings behavior with a standard life-cycle model. Under natural borrowing limits, the welfare cost of idiosyncratic risk implied by the age dependent income process is 32% lower compared to an AR(1) process without age profiles. This is mostly due to a higher degree of consumption insurance for young workers, for whom persistence is moderate. The results hold qualitatively for an economy with no borrowing, although the difference between specifications is smaller (23%). We conclude that the welfare cost of idiosyncratic risk is overstated.
    Keywords: Idiosyncratic income risk, Incomplete markets models, Earnings persistence, Consumption insurance
    JEL: C33 D31 D91 E21 J31
    Date: 2009–12–09
  18. By: David de la Croix; Pierre Pestieau; Grégory Ponthière
    Abstract: Introduced by Samuelson (1975), the Serendipity Theorem states that the competitive economy will converge towards the optimum steady-state provided the optimum population growth rate is imposed. This paper aims at exploring whether the Serendipity Theorem still holds in an economy with risky lifetime. We show that, under general conditions, including a perfect annuity market with actuarially fair return, imposing the optimum fertility rate and the optimum survival rate leads the competitive economy to the optimum steady-state. That Extended Serendipity Theorem is also shown to hold in economies where old adults work some fraction of the old-age, whatever the retirement age is fixed or chosen by the agents.
    Date: 2009
  19. By: Richard Dutu; Benoit Julien; Ian King
    Abstract: When goods are sold through competing auctions, what e¤ect does monetary policy have on the equilibrium allocation? To answer, we extend the competing auctions framework in several ways: buyers choose how much money they bring to an auction, the quantities traded at the auctions are endogenous, and sellers can charge a fee (either positive or negative) to buyers participating in their auction. We present two di¤erent speci?cations of the model. In the ?rst model, sellers post a quantity they wish to sell and a fee, and allow the price to be determined by an auction. In the second model, sellers post a price and a fee and allow the quantity sold to be determined by an auction. When sellers post a quantity and buyers bid prices, the Friedman rule implements the ?rst best and, in this case, no fee is charged by sellers. Sellers charge buyers a participation fee as soon as the nominal interest rate is positive, and marginal increments in money growth decrease both the posted quantity and buyers?entry. The use of auction fees reduces welfare in this environment. When sellers post a price and buyers bid quantities, the Friedman rule is optimal but does not yield the ?rst best as agents trade an ine¢ ciently low quantity in multilateral matches and an ine¢ ciently high quantity in pairwise matches. Marginal increments in money growth decrease the posted real price and the quantities traded. When the interest rate is low, sellers pay buyers who participate in their auction, which increases welfare. When the interest rate is high, sellers charge buyers who participate in their auction, which reduces welfare.
    Keywords: Competing auctions; money; search; in?ation; auction fees
    JEL: C78 D44 E40
    Date: 2009
  20. By: Natalya Y. Shelkova (Guilford College and University of Connecticut)
    Abstract: Empirical wage and wage offer distributions exhibit substantial clustering in economies with a mandated minimum wage, the phenomenon knows as the minimum wage spike, as well as wage dispersion. Existing search-theoretic literature does not replicate both of the empirical phenomena simultaneously. This paper attempts to reconcile the two under assumptions of wage-posting, urn-ball matching and firm productive heterogeneity. A non-degenerate minimum wage spike and wage dispersion are obtained when firm wage determination embodies both incentives for collusion at the minimum wage and competition at the same time, making the spike and the dispersion the outcomes of partially collusive equilibrium. Besides this main result, the paper also shows that a higher minimum wage may reduce unemployment.
    Keywords: wage-posting, minimum wage, minimum wage spike, wage dispersion, unemployment
    JEL: J30 J64
    Date: 2009–12
  21. By: Fabian Kindermann
    Abstract: This paper studies the long-run macroeconomic, distributional and welfare effects of tuition policy and student loans. We therefore form a rich model of risky human capital investment based on the seminal work of Heckman, Lochner and Taber (1998). We extend their original model by variable labor supply, borrowing constraints, idiosyncratic wage risk, uncertain life-span, and multiple schooling decisions. This allows us to build a direct link between students and their parents and make the initial distribution of people over different socio-economic backgrounds endogenous. Our simulation indicate that privatization of tertiary education comes with a vast reduction in the number of students, an increase in the college wage premium and longrun welfare losses of around 5 percent. Surprisingly, we find that from privatization of tertiary education, students are better off compared to workers from other educational classes, since the college wage premium nearly doubles. In addition, our model predicts that income contingent loans on which students don’t have to pay interest, improve the college enrolment situation for agents from all kinds of backgrounds.
    Keywords: public vs. private education, schooling choice, human capital investment, idiosyncratic uncertainty
    JEL: I22 J24 H52
    Date: 2009
  22. By: Besancenot, Damien (CEPN, Centre d'Economie de Paris Nord and University Paris 13); Huynh, Kim (LEM, Laboratoire d'économie moderne and University Paris 2); Vranceanu, Radu (ESSEC Business School)
    Abstract: Subject to a huge and growing number of journal titles in business and economics, scholars sometimes target the wrong journal. Editors resort more and more to paper pre-screening, and desk reject those that do not fit well to the editorial line. This paper provides a dynamic analysis of the market for academic publications that brings into the picture these matching frictions. The key modelling device is a paper-journal matching function, similar to the matching function traditional in labor economics. Our main endogenous variables are the submission fee and the tension in the publication market, itself directly related to the number of journal titles.
    Keywords: Academic Journals; Desk Rejection; Editors; Imperfect Information; Matching
    JEL: A14 C78
    Date: 2009–11
  23. By: Michael Dotsey; Margarida Duarte
    Abstract: The authors show that standard alternative assumptions about the currency in which firms price export goods are virtually inconsequential for the properties of aggregate variables, other than the terms of trade, in a quantitative open-economy model. This result is in contrast to a large literature that emphasizes the importance of the currency denomination of exports for the properties of open-economy models.
    Keywords: Exports ; Pricing
    Date: 2009
  24. By: Robert S. Pindyck
    Abstract: What is the likelihood that the U.S. will experience a devastating catastrophic event over the next few decades – something that would substantially reduce the capital stock, GDP and wealth? What does the possibility of such an event imply for the behavior of economic variables such as investment, interest rates, and equity prices? And how much should society be willing to pay to reduce the probability or likely impact of such an event? We address these questions using a general equilibrium model that describes production, capital accumulation, and household preferences, and includes as an integral part the possible arrival of catastrophic shocks. Calibrating the model to average values of economic and financial variables yields estimates of the implied expected mean arrival rate and impact distribution of catastrophic shocks. We also use the model to calculate the tax on consumption society would accept to reduce the probability or impact of a shock.
    Date: 2009–09
  25. By: John Creedy; Shuyun May Li; Solmaz Moslehi
    Abstract: This paper examines the choice of government expenditure on public goods and transfer payments (in the form of pension) under majority voting in an overlapping generations model, in which government expenditure is tax-?nanced on a pay-as-you-go (PAYG) basis. The condition required for majority support of the social contract involved in the PAYG scheme is established and shown to be independent of gov- ernment expenditure, so that the choice of expenditure composition can be made conditional on acceptance of this social contract. The model yields a closed-form solu-tion for the majority choice of the ratio of transfer payment to public goods, which depends negatively on the ratio of median to mean income, given parameters regarding preferences, tax, growth and interest rates. Informed by this result, a dataset for demo-cratic countries is examined, suggesting that income inequalities play a minor role in accounting for the substantial variations in the compostion of government expenditure across democratic countries, while di¤erent preferences for public goods resulting from cultural di¤erences may be an important determinant. Finally an alternative decision mechanism is also considered, in which a utilitarian government chooses expenditures to maximize a social welfare function. The solution is found to take a similar form to that of the majority voting context, except that a welfare-weighted average income replaces the median income.
    Keywords: Overlapping Generations; Majority Voting; Balanced Growth; Public Goods; Transfer Payments; Utilitarian Government
    JEL: D72 H41 H53 H11
    Date: 2009
  26. By: Fatih Guvenen; Burhanettin Kuruscu; Serdar Ozkan
    Abstract: Wage inequality has been significantly higher in the United States than in continental European countries (CEU) since the 1970s. Moreover, this inequality gap has further widened during this period as the US has experienced a large increase in wage inequality, whereas the CEU has seen only modest changes. This paper studies the role of labor income tax policies for understanding these facts. We begin by documenting two new empirical facts that link these inequality differences to tax policies. First, we show that countries with more progressive labor income tax schedules have significantly lower before-tax wage inequality at different points in time. Second, progressivity is also negatively correlated with the rise in wage inequality during this period. We then construct a life cycle model in which individuals decide each period whether to go to school, work, or be unemployed. Individuals can accumulate skills either in school or while working. Wage inequality arises from differences across individuals in their ability to learn new skills as well as from idiosyncratic shocks. Progressive taxation compresses the (after-tax) wage structure, thereby distorting the incentives to accumulate human capital, in turn reducing the cross-sectional dispersion of (before-tax) wages. We find that these policies can account for half of the difference between the US and the CEU in overall wage inequality and 76% of the difference in inequality at the upper end (log 90-50 differential). When this economy experiences skill-biased technological change, progressivity also dampens the rise in wage dispersion over time. The model explains 41% of the difference in the total rise in inequality and 58% of the difference at the upper end.
    Keywords: Wages ; Human capital ; Taxation
    Date: 2009

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