nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2010‒03‒06
fourteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. The Great Increase in Relative Volatility of Real Wages in the United States By Julien Champagne; André Kurmann
  2. Steady-State Growth and the Elasticity of Substitution By Irmen, Andreas
  3. Stochastic Search Equilibrium By Giuseppe Moscarini; Fabien Postel-Vinay
  4. Housing Markets and Current Account Dynamics By Gete, Pedro
  5. Fiscal Policy Reforms and Dynamic Laffer Effects By Oudheusden, P. van
  6. Optimal Target Criteria for Stabilization Policy By Marc P. Giannoni; Michael Woodford
  7. Default Risk and Risk Averse International Investors By Lizarazo, Sandra
  8. Intermediated Trade By Pol Antràs; Arnaud Costinot
  9. Expectations-Driven Cycles in the Housing Market By Mendicino, Caterina; Lambertini, Luisa; Punzi , Maria Teresa
  10. Consumption and Saving: Models of Intertemporal Allocation and Their Implications for Public Policy By Orazio P. Attanasio; Guglielmo Weber
  11. Optimal Use of Labor Market Policies: The Role of Job Search Assistance By Wunsch, Conny
  12. Unemployment and Portfolio Choice: Does Persistence Matter? By Vladimir Kuzin; Franziska M. Bremus
  13. Labour Market, Obesity and Public Policy Considerations By Eleftheriou, Konstantinos; Athanasiou, George
  14. On Endogenous Compactness of the Individual State Space in the Huggett Model By Timothy Kam

  1. By: Julien Champagne; André Kurmann
    Abstract: This paper documents that over the past 25 years, aggregate hourly real wages in the United States have become substantially more volatile relative to output. We use micro-data from the Current Population Survey (CPS) to show that this increase in relative volatility is predominantly due to increases in the relative volatility of hourly wages across different groups of workers. Compositional changes, by contrast, account for at most 12% of the increase in relative wage volatility. Using a Dynamic Stochastic General Equilibrium (DSGE) model, we show that the observed increase in relative wage volatility is unlikely to come from changes outside of the labor market (e.g. smaller exogenous shocks or more aggressive monetary policy). By contrast, increased flexibility in wage setting is capable of accounting for a large fraction of the observed increase in relative wage volatility. At the same time, increased wage flexibility generates a substantial decrease in the magnitude of business cycle fluctuations, which suggests a promising new explanation for the Great Moderation.
    Keywords: Wage volatility, business cycles, great moderation, current population survey, dynamic stochastic general equilibrium models
    JEL: E24 E32
    Date: 2010
  2. By: Irmen, Andreas
    Abstract: In a neoclassical economy with endogenous capital- and labor-augmenting technical change the steady-state growth rate of output per worker is shown to increase in the elasticity of substitution between capital and labor. This confirms the assessment of Klump and de La Grandville (2000) that the elasticity of substitution is a powerful engine of economic growth. However, unlike their findings my result applies to the steady-state growth rate. Moreover, it does not hinge on particular assumptions on how aggregate savings come about. It holds for any household sector allowing savings to grow at the same rate as aggregate output.
    Keywords: Capital Accumulation; Elasticity of Substitution; Direction of Technical Change; Neoclassical Growth Model
    Date: 2010–02–10
  3. By: Giuseppe Moscarini (Cowles Foundation, Yale University); Fabien Postel-Vinay (University of Bristol and Paris School of Economics)
    Abstract: We analyze a stochastic equilibrium contract-posting model. Firms post employment contracts, wages contingent on all payoff-relevant states. Aggregate productivity is subject to persistent shocks. Both employed and unemployed workers search randomly for these contracts, and are free to quit at any time. An equilibrium of this contract-posting game is Rank-Preserving [RP] if larger firms offer a larger value to their workers in all states of the world. We show that every equilibrium is RP, and equilibrium is unique, if firms differ either only in their initial size, or also in their fixed idiosyncratic productivity but more productive firms are initially larger, in which case turnover is always efficient, as workers always move from less to more productive firms. The RP equilibrium stochastic dynamics of firm size provide an explanation for the empirical finding that large employers are more cyclically sensitive (Moscarini and Postel-Vinay, 2009). RP equilibrium computation is tractable, and we simulate calibrated examples.
    Keywords: Equilibrium job search, Dynamic contracts, Stochastic dynamics
    JEL: J64 J31 D86
    Date: 2010–02
  4. By: Gete, Pedro
    Abstract: This paper makes a theoretical and an empirical contribution to the debate on what caused the "global imbalances". On the empirical side, I provide different types of evidence to support that housing demand shocks (shocks to the aggregate marginal rate of substitution between housing and tradables) help to explain the global imbalances. On the theory side, I show that shocks to the demand for housing generate trade deficits without need for the standard ingredients used by others to model housing (wealth effects or trade in capital goods). I model housing as a durable and nontradable good. Countries import tradable goods during periods when more domestic labor is devoted to produce nontradables to smooth consumption between tradables and nontradables. Housing booms are larger if the country can run a trade deficit because the deficit lowers the opportunity cost of building, which is the foregone consumption of tradable goods due to reallocation of labor to the construction sector. Concerning the empirical evidence, I first document that over the last decade there has been a strong cross-country correlation between housing variables and current account dynamics. Second, I show that using the cross-country dynamics of employment in construction as the explanatory variable, the model generates current account dynamics matching recent global imbalances. Finally, I use sign restrictions implied by the model to estimate a vector autoregression and identify the effects of housing demand shocks on the U.S. trade deficit. The results suggest that housing shocks matter for current account dynamics.
    Keywords: Housing; Current Account; Global Imbalances; Sign Restrictions; Two Country Models; Two Sector Models
    JEL: F4 E2 F3 E4
    Date: 2009–06
  5. By: Oudheusden, P. van (Tilburg University, Center for Economic Research)
    Abstract: We examine the impact of fiscal policy reforms on the long-run government budget balance in a one-sector model of endogenous growth with factor income taxes, a tax on consumption, non-productive public goods expenditures, and a labour-leisure trade-off. In addition, we allow for different structures of government expenditures and public debt. We analytically show that, when performing a dynamic Laffer effect analysis, there exists a set of conditions that hold for a number of endogenous growth models. We find that for the euro area an improvement in the long-run government budget balance is always obtained for a lower tax rate on capital income but is only obtained for a substantial lower tax rate on labour income. Moreover, we show that when lower taxes on factor income are financed by higher taxes on consumption, there exists a wide array of combinations for which there is an improvement in both the long-run government budget balance and lifetime welfare. These combinations, however, differ in their implications for labour supply and immediate welfare effects.
    Keywords: Dynamic Scoring;Laffer Effect;Factor Income Taxation;Endogenous Growth
    JEL: E62 H30 J22 O41
    Date: 2010
  6. By: Marc P. Giannoni; Michael Woodford
    Abstract: This paper considers a general class of nonlinear rational-expectations models in which policymakers seek to maximize an objective function that may be household expected utility. We show how to derive a target criterion that is: (i) consistent with the model's structural equations, (ii) strong enough to imply a unique equilibrium, and (iii) optimal, in the sense that a commitment to adjust the policy instrument at all dates so as to satisfy the target criterion maximizes the objective function. The proposed optimal target criterion is a linear equation that must be satisfied by the projected paths of certain economically relevant "target variables". It takes the same form at all times and generally involves only a small number of target variables, regardless of the size and complexity of the model. While the projected path of the economy requires information about the current state, the target criterion itself can be stated without reference to a complete description of the state of the world. We illustrate the application of the method to a nonlinear DSGE model with staggered price-setting, in which the objective of policy is to maximize household expected utility.
    JEL: E52 E61
    Date: 2010–02
  7. By: Lizarazo, Sandra
    Abstract: This paper develops a model of debt and default for small open economies that interact with risk averse international investors. The model developed here extends the recent work on the analysis of endogenous default risk to the case in which international investors are risk averse agents with decreasing absolute risk aversion (DARA). By incorporating risk averse investors who trade with a single emerging economy, the present model offers two main improvements over the standard case of risk neutral investors: i.) the model exhibits a better fit of debt-to-output ratio and ii.) the model explains a larger proportion and volatility of the spread between sovereign bonds and riskless assets. The paper shows that if investors have DARA preferences, then the emerging economy's default risk, capital flows, bond prices and consumption are a function not only of the fundamentals of the economy---as in the case of risk neutral investors---but also of the level of financial wealth and risk aversion of the international investors. In particular, as investors become wealthier or less risk averse, the emerging economy becomes less credit constrained. As a result, the emerging economy's default risk is lower, and its bond prices and capital inflows are higher. Additionally, with risk averse investors, the risk premium in the asset prices of the sovereign countries can be decomposed into two components: a base premium that compensates the investors for the probability of default (as in the risk neutral base) and an ``excess'' premium that compensates them for taking the risk of default.
    Keywords: default; sovereign debt; international investors; risk premium; sovereign spreads
    JEL: F34 E44 F41
    Date: 2010–01–24
  8. By: Pol Antràs; Arnaud Costinot
    Abstract: This paper develops a simple model of international trade with intermediation. We consider an economy with two islands and two types of agents, farmers and traders. Farmers can produce two goods, but in order to sell these goods in centralized (Walrasian) markets, they need to be matched with a trader, and this entails costly search. In the absence of search frictions, our model reduces to a standard Ricardian model of trade. We use this simple model to contrast the implications of changes in the integration of Walrasian markets, which allow traders from different islands to exchange their goods, and changes in the access to these Walrasian markets, which allow farmers to trade with traders from different islands. We find that intermediation always magnifies the gains from trade under the former type of integration, but leads to more nuanced welfare results under the latter, including the possibility of aggregate losses. These welfare losses may be circumvented, however, through policies that discriminate against foreign traders in a way that minimizes the margins charged by domestic traders.
    JEL: D3 D4 F10 F15 O1
    Date: 2010–02
  9. By: Mendicino, Caterina; Lambertini, Luisa; Punzi , Maria Teresa
    Abstract: This paper analyzes housing market boom-bust cycles driven by changes in households'expectations. We explore the role of expectations not only on productivity but on several other shocks that originate in the housing market, the credit market and the conduct of monetary policy. We find that, in the presence of nominal rigidities, expectations on both the conduct of monetary policy and future productivity can generate housing market boom-bust cycles in accordance with the empirical findings. Moreover, expectations of either a future reduction in the policy rate or a temporary increase in the central bank's inflation target that are not fulfilled generate a macroeconomic recession. Increased access to credit generates a boom-bust cycle in most variables only if it is expected to be reversed in the near future.
    Keywords: Credit Frictions; Boom-Bust Cycles; News Shocks; Housing Prices.
    JEL: E32 E52 E44
    Date: 2010
  10. By: Orazio P. Attanasio; Guglielmo Weber
    Abstract: This paper provides a critical survey of the large literature on the life cycle model of consumption, both from an empirical and a theoretical point of view. It discusses several approaches that have been taken in the literature to bring the model to the data, their empirical successes and failures. Finally, the paper reviews a number of changes to the standard life cycle model that could help solve the remaining empirical puzzles.
    JEL: D11 D12 E21
    Date: 2010–02
  11. By: Wunsch, Conny (University of St. Gallen)
    Abstract: This paper studies the role of job search assistance programs in optimal welfare-to-work programs. The analysis is based on a framework, that allows for endogenous choice of benefit types and levels, wage taxes or subsidies, and activation measures such as monitoring and job search assistance for each period of unemployment in a dynamic environment with negative duration dependence in the exit rates to employment and potential depreciation in reemployment wages. We show that the main role of job search assistance is to delay or prevent situations in which it is no longer optimal to incentivize the worker to provide positive search effort. It is used to restore or maintain some minimum exit rate to employment which increases with the cost-effectiveness of job search assistance. We also find that in line with existing policies, these programs should mainly be used at the beginning of unemployment and for short durations. However, contrary to existing schemes, they should be exclusively targeted at unemployed workers with low initial exit rates to employment. For all other workers, they should only be used if they fail to find a job within reasonable time despite high expected initial exit rates.
    Keywords: job search, optimal unemployment insurance, welfare-to-work policies, recursive contracts
    JEL: J64 J65 J68 D82 D86
    Date: 2010–02
  12. By: Vladimir Kuzin; Franziska M. Bremus
    Abstract: We use a life cycle model of consumption and portfolio choice to study the effects of social security on the investment decisions of households for the European case. Our model is mainly based on the one developed by Cocco, Gomes, and Maenhout (2005). We extend it by unemployment risk using Markov chains to model the transition between different employment states. In contrast to most models in the life cycle literature, our model allows for three different states, namely employment, short-term as well as long-term unemployment. This allows us to examine the effects of persistence in the unemployment process on portfolio choice. Our main findings are, first, that in case of short-term unemployment only, social security systems as those established in the EU are able to offset the negative impact of unemployment risk on the portfolio-share invested in risky assets. Second, the simulation results reveal that when allowing for long-term unemployment the equity-share is suppressed, especially for young investors. We show that this negative effect of unemployment is mainly driven by its persistence.
    Keywords: Precautionary savings, unemployment insurance, long-term unemployment, income uncertainty
    JEL: D91 E21 H31
    Date: 2010
  13. By: Eleftheriou, Konstantinos; Athanasiou, George
    Abstract: This paper attempts to investigate the relation among wages, unemployment and obesity and to identify public policies to address the problem of over-weightness. To this purpose, a simple search and matching model of labour market is developed. Our framework tries to capture the relationship between obesity and employment/unemployment by assuming that the fraction of obese workers is a function of the ratio of vacant jobs to unemployment (labour market tightness). We argue that if obesity is positively related with employment, then social optimality dictates the imposition of a lump-sum tax on all individuals. In the opposite case a subsidy should be given.
    Keywords: Obesity; Taxation; Unemployment; Wages
    JEL: I18 J64 I10
    Date: 2010–02–23
  14. By: Timothy Kam
    Abstract: One of the sufficient conditions for existence and uniqueness of a stationary distribution of agents in the Huggett [1993] model is the requirement that the space of individual states be a compact metric space. In this note, we reinforce the proof of Lemma 3 in Huggett [1993] by showing that two additional contrary hypotheses must first be ruled out, toward the construction of the proof that the individual state space is endogenously compact.
    JEL: C62 D31 D52
    Date: 2010–02

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