nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2010‒03‒20
nineteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Evaluating and estimating a DSGE model for the United Kingdom By Harrison, Richard; Oomen, Özlem
  2. Labor-dependent capital income taxation that encourages work and saving By Sagiri Kitao
  3. Technology shocks: novel implications for international business cycles By Andrea Raffo
  4. Heterogeneous Households in a Sticky Price Model By Jae Won Lee
  5. Firm-specific capital, nominal rigidities and the business cycle By David Altig; Lawrence J. Christiano; Martin Eichenbaum; Jesper Linde
  6. The Role of Construction in the Housing Boom and Bust in Spain By Carlos Garriga
  7. The Optimum Quantity of Money Revisited: Distortionary Taxation in a Search Model of Money By Moritz Ritter
  8. The Design of Unemployment Transfers: Evidence from a Dynamic Structural Life-Cycle Model By Haan, Peter; Prowse, Victoria L.
  9. An adaptation of Pissarides (1990) by using random job destruction rate By Wang, Huiming
  10. Confidence of Agents and Market Frictions By Dmitriev, Mikhail
  11. Household debt, house prices and consumption in the United Kingdom: a quantitative theoretical analysis By Waldron, Matt; Zampolli, Fabrizio
  12. Increasing Income Inequality: Productivity, Bargaining and Skill-Upgrading By Frederiksen, Anders; Poulsen, Odile
  13. Education and the Welfare Gains from Employment Protection By Olivier Charlot; Franck Malherbert
  14. Should the central bank be concerned about housing prices? By Karsten Jeske; Zheng Liu
  15. Sticky Information vs Sticky Prices: An Empirical comparison within a D S G E framework for the Euro Area By Haider, Adnan; Ramzi, Drissi
  16. The Timing of Asset Trade and Optimal Policy in Dynamic Open Economies By Ozge Senay; Alan Sutherland
  17. New Monetarist Economics: Models By Williamson, Stephen D.; Wright, Randall
  18. The Spanish Crisis from a Global Perspective By Jesús Fernández-Villaverde; Lee Ohanian
  19. Trade Liberalization, Competition and Growth By Omar Licandro; Antonio Navas Ruiz

  1. By: Harrison, Richard (Bank of England); Oomen, Özlem (Bank of England)
    Abstract: We build a small open economy dynamic stochastic general equilibrium model, featuring many types of nominal and real frictions that have become standard in the literature. In recent years it has become possible to estimate such models using Bayesian methods. These exercises typically involve augmenting a stochastically singular model with a number of shocks to structural equations to make estimation feasible, even though the motivation for the choice of these shocks is often unspecified. In an attempt to put this approach on a more formal basis, we estimate the model in two stages. First, we evaluate a calibrated version of the stochastically singular model. Then, we augment the model with structural shocks motivated by the results of the evaluation stage and estimate the resulting model using UK data using a Bayesian approach. Finally, we reassess the adequacy of this augmented and estimated model in reconciling the dynamics of the model with the data. Our findings suggest that the shock processes play a crucial role in helping to match the data.
    Keywords: DSGE models; model evaluation; Bayesian estimation; monetary policy
    JEL: E40 E50
    Date: 2010–03–10
  2. By: Sagiri Kitao
    Abstract: This paper proposes a simple mechanism of capital taxation that is negatively correlated with labor supply. Using a life-cycle model of heterogeneous agents, I show that this tax scheme provides a strong work incentive when households possess large assets and high productivity later in the life cycle, when they would otherwise work less. This reformed system also adds to the saving motive and raises aggregate capital. Moreover, the increased economic activities expand the tax base, and the revenue-neutral reform results in a lower average tax rate. My findings show that this tax scheme improves long-run welfare and that the majority of current generations would experience a welfare gain from a transition to the reformed system.
    Keywords: Labor supply ; Taxation ; Labor productivity ; Saving and investment ; Income tax
    Date: 2010
  3. By: Andrea Raffo
    Abstract: Understanding the joint dynamics of international prices and quantities remains a central issue in international business cycles. International relative prices appreciate when domestic consumption and output increase more than their foreign counterparts. In addition, both trade flows and trade prices display sizable volatility. This paper incorporates Hicks-neutral and investment-specific technology shocks into a standard two-country general equilibrium model with variable capacity utilization and weak wealth effects on labor supply. Investment-specific technology shocks introduce a source of fluctuations in absorption similar to taste shocks, thus reconciling theory and data. The paper also presents implications for the transmission mechanism of technology shocks across countries and for the Barro and King (1984) critique of investment shocks.
    Date: 2010
  4. By: Jae Won Lee (Rutgers University, Department of Economics)
    Abstract: This paper introduces heterogeneous households into an otherwise standard sticky-price model with industry-specific labor markets. Households differ in labor incomes and asset markets are incomplete. I show that household heterogeneity affects equilibrium dynamics nontrivially by amplifying price stickiness endogenously through wealth effects on labor supply. To quantify the importance of household heterogeneity in amplifying stickiness, I estimate and compare representative and heterogeneous household models. The quantitative exercise shows the heterogenous household model performs better than its representative counterpart in accounting for aggregate and sectoral dynamics in the U.S., while being more consistent with empirical evidence on nominal rigidity at the aggregate and sectoral levels, thanks to the stickiness endoge
    Keywords: DSGE model, heterogeneity, multiple sectors, real rigidities, price stickiness
    JEL: E
    Date: 2010–02–12
  5. By: David Altig; Lawrence J. Christiano; Martin Eichenbaum; Jesper Linde
    Abstract: This paper formulates and estimates a three-shock US business cycle model. The estimated model accounts for a substantial fraction of the cyclical variation in output and is consistent with the observed inertia in inflation. This is true even though firms in the model reoptimize prices on average once every 1.8 quarters. The key feature of our model underlying this result is that capital is firm-specific. If we adopt the standard assumption that capital is homogeneous and traded in economy-wide rental markets, we find that firms reoptimize their prices on average once every 9 quarters. We argue that the micro implications of the model strongly favor the firm-specific capital specification.
    Date: 2010
  6. By: Carlos Garriga
    Abstract: This paper describes a quantitative model developed to account for the change in the level of house prices (boom-and-bust cycle) in Spain. The driving forces behind the housing boom are residential investment, immigration, current account deficits, and the elimination of land regulation. The model emphasizes the interaction of housing supply (determined by the existing stock of residential investment and new construction) with market demand. A calibrated version of the model for the Spanish economy replicates the key aggregate of the economy in 1995. The model predicts that a change in observed fundamentals can rationalize at least 84 percent of the recent boom in the value of housing capital. The model suggests that without large current account deficits and demographic changes the housing boom could have been much smaller. With respect to the housing bust, the model suggests that the combination of increasing mortgage rates, unemployment, and low productivity can have large effects in the value of housing capital. Some conservative predictions quantify adjustments that range between 24 and 29 percent.
    Date: 2010–02
  7. By: Moritz Ritter (Department of Economics, Temple University)
    Abstract: This paper incorporates a distortionary tax into a microfoundations of money framework and revisits the optimum quantity of money. The money constraint in the decentralized market plays a key role in the optimal policy. Only if the constraint is binding can fiscal policy alter the agents’ surplus shares; monetary, but not fiscal, policy affects the agents’ bargaining position, leaving a special role for monetary policy. If the buyers surplus share is inefficiently small, the intensive margin is distorted and the constrained optimal policy includes a money growth rate above that prescribed by the Friedman rule, even in the presence of fiscal policy instruments.
    Keywords: Money, Search, Friedman Rule, Sales Tax
    JEL: E62 E63 H21
    Date: 2010–03
  8. By: Haan, Peter (DIW Berlin); Prowse, Victoria L. (University of Oxford)
    Abstract: In this paper we use a dynamic structural life-cycle model to analyze the employment, fiscal and welfare effects induced by unemployment insurance. The model features a detailed specification of the tax and transfer system, including unemployment insurance benefits which depend on an individual's employment and earnings history. The model also captures the endogenous accumulation of experience which impacts on future wages, job arrivals and job separations. For better identification of the structural parameters we exploit a quasi-natural experiment, namely reductions over time in the entitlement period for unemployment insurance benefits which varied by age and experience. The results show that a policy cut in the generosity of unemployment insurance operationalized as a reduction in the entitlement period generates a larger increase in employment and yields a bigger fiscal saving than a cut operationalized as a reduction in the replacement ratio. Welfare analysis of revenue neutral tax and transfer reforms also favors a reduction in the entitlement period.
    Keywords: unemployment insurance, replacement ratio, entitlement period, life-cycle labor supply, tax reform, method of simulated moments
    JEL: C23 C25 J22 J64
    Date: 2010–02
  9. By: Wang, Huiming
    Abstract: This paper works on an adaptation of the standard Pissarides model to incorporate-rate an exponentially distributed match specific…c job destruction rate. We discuss the characterization of equilibrium, equilibrium wage, number of equilibria, stead state unemployment, welfare and comparative statics problems in this adapted model.
    Keywords: Pissardies model; random job destruction rate
    JEL: J41
    Date: 2009–12
  10. By: Dmitriev, Mikhail
    Abstract: In this paper financial frictions are represented by agents heterogeneity. Presence of savers and borrowers permits to analyse financial frictions in a simple and tractable framework. Different types of borrowers create an effect of costly state verification models. Comparatively to these standard CSV framework different types of shocks are modelled, such as expected increase in the income of borrowers or change in the distribution of borrowers quality. Modellin these effects is hard in representative agent framework and such shocks were not analysed in CSV framework before.
    Keywords: Financial Frictions; DSGE; Business Cycles
    JEL: E2 E21
    Date: 2009–12
  11. By: Waldron, Matt (Bank of England); Zampolli, Fabrizio (Bank of England)
    Abstract: Household debt and house prices in the United Kingdom rose substantially between 1987 and 2006. In this paper we use a calibrated overlapping generations model of the household sector to examine the extent to which changes in demographics, lower inflation, and a lower long-run real interest rate may explain the build-up of debt and the rise in house prices over that period. Our model suggests that lower real interest rates were particularly important. If households expected lower real interest rates to persist, then the model can more than explain the rise in debt and can explain most of the rise in house prices. However, the model leaves a puzzle because it predicts that an unanticipated fall in real interest rates should lead to a consumption boom that did not materialise in the data.
    Keywords: Consumption; housing market; collateral constraints; life cycle; OLG
    JEL: E21 R31
    Date: 2010–03–10
  12. By: Frederiksen, Anders (Aarhus School of Business); Poulsen, Odile (University of East Anglia)
    Abstract: In recent decades most developed countries have experienced an increase in income inequality. In this paper, we use an equilibrium search framework to shed additional light on what is causing an income distribution to change. The major benefit of the model is that it can accommodate shocks to the skill composition in the market, employee bargaining power and productivity. Further, when our model is subjected to skill-upgrading and changes in employee bargaining power, it is capable of predicting the recent changes observed in the Danish income distribution. In addition, the model emphasizes that shocks to the employees’ relative productivity, i.e., skill-biased technological change, are unlikely to have caused the increase in income inequality.
    Keywords: income inequality, two-sector search model, bargaining power, skill-biased technological change
    JEL: J3 J6 M5
    Date: 2010–02
  13. By: Olivier Charlot; Franck Malherbert
    Abstract: This paper studies the impact of an European-like labor market regulation on the return to schooling, equilibrium unemployment and welfare. We show that firing costs and temporary employment have opposite effects on educational choices. We furthermore demonstrate that a laissez faire economy with no regulation is inefficient as it is characterized by insufficient educational investments leading to excess job destruction and inadequate job creation. By stabilizing employment relationships, firing costs may spur educational investments and therefore lead to welfare and productivity gains, though a first-best policy would be to subsidize education. However, there is little chance for a dual labor market, as is common in many European countries, with heavily regulated long-term contracts and more flexible short-term contracts to raise the incentives to schooling and aggregate welfare.
    Keywords: Human capital, job destruction, matching frictions, efficiency
    JEL: I20 J20 J60
    Date: 2010
  14. By: Karsten Jeske; Zheng Liu
    Abstract: Housing is an important component of the consumption basket. Since both rental prices and goods prices are sticky, the literature suggests that optimal monetary policy should stabilize both types of prices, with the optimal weight on rental inflation proportional to the housing expenditure share. In a two-sector DSGE model with sticky rental prices and goods prices, however, we find that the optimal weight on rental inflation in the Taylor rule is small—much smaller than that implied by the housing expenditure share. Since production of housing services uses the stocks of housing intensively, large fluctuations in the price of housing stocks lead to large adjustments in reset rental prices. This weak strategic complementarity in rental price setting calls for a small optimal weight on rental price inflation.
    Keywords: Housing - Prices ; Monetary policy ; Inflation targeting
    Date: 2010
  15. By: Haider, Adnan; Ramzi, Drissi
    Abstract: In this paper we estimate four competing closed economy DSGE models: a standard Calvo (1983) type pricing model; Hernandez’s (2004) state-dependent pricing model; Mankiw and Reis (2002) standard sticky information model; and a mixed version of sticky price-information model. Each model incorporates various other standard New-Keynesian features such as habit formation, costs of adjustment in capital accumulation and variable capacity utilization. Using Bayesian Simulation techniques, we estimate each DSGE model for the Euro Area. While estimation, we also studies the welfare properties of various monetary policies. In particular, the Ramsey allocation has been computed, giving a natural benchmark for welfare comparisons. Our interesting results show that despite the apparent similarities of all models, their responses to shocks and fit to data are quite different and there is no agreement on their relative performance. As a result, Monetary Authorities cannot afford to rely on a single reference model of the economy but need a large number of alternative modeling tools available when they take their decision of optimal monetary policy.
    Keywords: new Keynesian economics; DSGE models; nominal rigidities; monetary policy; Bayesian Approach
    JEL: E32 E31 E37
    Date: 2010–03–03
  16. By: Ozge Senay; Alan Sutherland
    Abstract: Using a standard open economy DSGE model, it is shown that the timing of asset trade relative to policy decisions has a potentially important impact on the welfare evaluation of monetary policy at the individual country level. If asset trade in the initial period takes place before the announcement of policy, a national pol?icymaker can choose a policy rule which reduces the work effort of households in the policymaker¡¯s country in the knowledge that consumption is fully insured by optimally chosen international portfolio positions. But if asset trade takes place after the policy announcement, this insurance is absent and households in the poli?cymaker¡¯s country bear the full consumption consequences of the chosen policy rule. The welfare incentives faced by national policymakers are very different between the two cases. Numerical examples confirm that asset market timing has a significant impact on the optimal policy rule.
    Keywords: Optimal Policy, Timing of Asset Trade, Monetary Policy in Open Economies.
    JEL: E52 F41 G15
    Date: 2010–01
  17. By: Williamson, Stephen D.; Wright, Randall
    Abstract: he purpose of this paper is to discuss some of the models used in New Monetarist Economics, which is our label for a body of recent work on money, banking, payments systems, asset markets, and related topics. A key principle in New Monetarism is that solid microfoundations are critical for understanding monetary issues. We survey recent papers on monetary theory, showing how they build on common foundations. We then lay out a tractable benchmark version of the model that allows us to address a variety of issues. We use it to analyze some classic economic topics, like the welfare effects of inflation, the relationship between money and capital accumulation, and the Phillips curve. We also extend the benchmark model in new ways, and show how it can be used to generate new insights in the study of payments, banking, and asset markets.
    Keywords: monetarism; monetary theory; monetary policy; banking; financial intermediation
    JEL: E5 E4 E3
    Date: 2010–02–28
  18. By: Jesús Fernández-Villaverde; Lee Ohanian
    Abstract: This paper studies the recent evolution of the Spanish economy in the context of the developments of the world economy and presents a benchmark model with …nancial frictions to assess the sources of these ‡uctuations. We pay particular attention to the comparison with the United States and some of Spain’s European peers in the 1994-2009 period. First, we document the long expansion between 1994 and early 2008 in terms of the main economic aggregates and the boom in the real estate market. Second, we also report on the fast downturn of these economies in the second half of 2008. Third, we use our benchmark model with …nancial frictions to evaluate how much we understand of the mechanism behind these large changes in aggregate behavior. We conclude with some policy remarks.
    Date: 2010–02
  19. By: Omar Licandro; Antonio Navas Ruiz
    Abstract: Increasing evidence support the claim that international trade enhances innovation and productivity growth through an increase in competition. This paper develops a two-country endogenous growth model, with firm specific R&D and a continuum of oligopolistic sectors under Cournot competition to provide a theoretical support to this claim. Since countries are assumed to produce the same set of varieties, trade openness makes markets more competitive, reducing prices and increasing quantities. Under Cournot competition, trade is pro-competitive. Since firms undertake cost reducing innovations, the increase in production induced by a more competitive market push firms to innovate more. Consequently, a reduction on trade barriers enhances growth by reducing domestic firm's market power.
    Keywords: Trade Openness, Growth, Competition
    JEL: F13 F43 O3
    Date: 2010–03–04

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