nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2010‒06‒04
fourteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Financial Shocks, Financial Frictions and Financial Intermediaries in DSGE Models: Comments on the Recent Literature By Arend, Mario
  2. Debt Policy and Economic Growth in a Small Open Economy Model with Productive Government Spending By Koichi Futagami; Ryoji Ohdoi; Takeo Hori
  3. Liquidity Shocks and the Business Cycle By Bigio, Saki
  4. Documentation of the Estimated, Dynamic, Optimization-based (EDO) model of the U.S. economy: 2010 version By Hess T. Chung; Michael T. Kiley; Jean-Philippe Laforte
  5. Estimating Incentive and Welfare Effects of Non-Stationary Unemployment Benefits By Andrey Launov; Klaus Wälde
  6. Trading Off Generations: Infinitely-Lived Agent Versus OLG By Maik T. Schneider; Christian Traeger; Ralph Winkler
  7. Conditional forecasts in DSGE models By Junior Maih
  8. Intergenerational interactions in human capital accumulation By Jakub Growiec; Lukasz Wozny
  9. Euler-Equation Estimation for Discrete Choice Models: A Capital Accumulation Application By Russell Cooper; John Haltiwanger; Jonathan L. Willis
  10. Shifts in Portfolio Preferences of International Investors: An Application to Sovereign Wealth Funds By Sá, F.; Viani, F.
  11. The great trade collapse of 2008-2009: an inventory adjustment? By George Alessandria; Joseph P. Kaboski; Virgiliu Midrigan
  12. What Really Matters: Discounting, Technological Change and Sustainable Climate By Georg Müller-Fürstenberger; Gunter Stephan
  13. For Rich or for Poor: When does Uncovered Interest Parity Hold? By Maurice J. Roche; Michael J. Moore
  14. Costly Portfolio Adjustment By Yosef Bonaparte; Russell Cooper

  1. By: Arend, Mario
    Abstract: The aim of this work is to compare and contrast different ways of modeling financial shocks and financial intermediaries in the Dynamic Stochastic General Equilibrium models (DSGE models) and to discuss the empirical evidence on the importance of modeling financial sector and financial shocks in the economy. The analysis is based on four papers on the matter Jerman and Quiadrini (2009),Christiano, Motto and Rostagno (2006), Goodfriend and McCallum (2007), and Gertler and Kiyotaki (2009)
    Keywords: Financial frictions; Financial Intermediaries; Financial shocks; DSGE models.
    JEL: E5 E44 E4 E3
    Date: 2010–05–27
  2. By: Koichi Futagami; Ryoji Ohdoi; Takeo Hori
    Abstract: In this paper, the effects of introducing constraints on government borrowing have been examined by using a continuous-time overlapping generations model of a small open economy. Government placing constraints on the amount of government bonds have been considered outstanding by establishing an upper limit, or target level, for the ratio of government bonds to gross domestic product. First it is shown that there exist multiple steady states in the model small open economy. Next the target level for bonds affecting economic growth rates at the steady states is examined.
    Keywords: government, borrowing, overlapping, generations, model, positive, amount, asset, holdings, economy
    Date: 2010
  3. By: Bigio, Saki (Department of Economics, New York University)
    Abstract: This paper studies the properties of an economy subject to random liquidity shocks. As in Kiyotaki and Moore [2008], liquidity shocks affect the ease with which equity can be used as to finance the down-payment for new investment projects. We obtain a liquidity frontier which separates the state-space into two regions (liquidity constrained and unconstrained). In the unconstrained region, the economy behaves according to the dynamics of the standard real business cycle model. Below the frontier, liquidity shocks have the effects of investment shocks. In this region, investment is under-efficient and there is a wedge between the price of equity and the real cost of capital. As with investment shocks, we argue that liquidity shocks are not an important source of business cycle fluctuations in absence of other frictions affecting the labor market.
    Keywords: Business Cycle, Asset Pricing, Liquidity
    JEL: E32 E44 D82
    Date: 2010–05
  4. By: Hess T. Chung; Michael T. Kiley; Jean-Philippe Laforte
    Abstract: This paper provides documentation for a large-scale estimated DSGE model of the U.S. economy--the Federal Reserve Board's Estimated, Dynamic, Optimization-based (FRB/EDO) model project. The model can be used to address a wide range of practical policy questions on a routine basis. The paper discusses the model's specification, estimated parameters, and key properties.
    Date: 2010
  5. By: Andrey Launov (Chair in Macroeconomics, Johannes Gutenberg-Universität Mainz, Germany); Klaus Wälde (Chair in Macroeconomics, Johannes Gutenberg-Universität Mainz, Germany)
    Abstract: The distribution of unemployment duration in our equilibrium matching model with spell-dependent unemployment bene?ts displays a time-varying exit rate. Building on Semi-Markov processes, we translate these exit rates into an expres- sion for the aggregate unemployment rate. Structural estimation using a German micro-data set (SOEP) allows us to discuss the effects of a recent unemployment bene?t reform (Hartz IV). The reform reduced unemployment by only 0.3%. Contrary to general beliefs, we ?nd that both employed and unemployed workers gain (the latter from an intertemporal perspective). The reason is the rise in the net wage caused by more vacancies per unemployed worker.
    Keywords: Non-stationary unemployment bene?ts, endogenous effort, matching model, structural estimation, Semi-Markov process
    JEL: E24 J64 J68 C13
    Date: 2010–05–21
  6. By: Maik T. Schneider; Christian Traeger; Ralph Winkler
    Abstract: The prevailing literature discusses intergenerational trade-offs predominantly in infinitely-lived agent models despite the finite lifetime of individuals. We discuss these trade-offs in a continuous time OLG framework and relate the results to the infinitely-lived agent setting. We identify three shortcomings of the latter: First, underlying normative assumptions about social preferences cannot be deduced unambiguously. Second, the distribution among generations living at the same time cannot be captured. Third, the optimal solution may not be implementable in overlapping generations market economies. Regarding the recent debate on climate change, we conclude that it is indispensable to explicitly consider the generations' life cycles.
    Keywords: climate change; discounting; infinitely-lived agents; intergenerational equity; overlapping generations; time preference
    JEL: D63 H23 Q54
    Date: 2010–03
  7. By: Junior Maih (Norges Bank (Central Bank of Norway))
    Abstract: New-generation DSGE models are sometimes misspecified in dimensions that matter for their forecasting performance. The paper suggests one way to improve the forecasts of a DSGE model using a conditioning information that need not be accurate. The technique presented allows for agents to anticipate the information on the conditioning variables several periods ahead. It also allows the forecaster to apply a continuum of degrees of uncertainty around the mean of the conditioning information, making hard-conditional and unconditional forecasts special cases. An application to a small open-economy DSGE model shows that the benefits of conditioning depend crucially on the ability of the model to capture the correlation between the conditioning information and the variables of interest.
    Keywords: DSGE model, conditional forecast
    JEL: C53 F47
    Date: 2010–04–27
  8. By: Jakub Growiec (National Bank of Poland, Economic Institute); Lukasz Wozny (Warsaw School of Economics)
    Abstract: We analyze an economy populated by a sequence of generations who decide over their consumption and investment in human capital of their immediate descendants. The objective of the paper is twofold: firstly, to identify the impact of strategic interactions between consecutive generations on the time path of human capital accumulation. To this end, we characterize the Markov perfect equilibrium (MPE) in such an economy and derive the sufficient conditions for its existence and uniqueness. We then benchmark our results against an optimal but time-inconsistent policy which abstracts from strategic interactions between generations. We prove analytically that human capital accumulation is unambiguously lower in the “strategic” case than in the optimal, “non-strategic” case. The second objective of the current paper is to work out a functional parametrization of the model, suitable for obtaining clear-cut results on the monotonicity of the (unique) Markov perfect equilibrium policy and the optimal policy. We then carry out a sensitivity analysis under this parametrization, thereby assessing quantitatively the magnitude of discrepancies between human capital accumulation paths whether strategic interactions between consecutive generations are taken into account or not.
    Keywords: human capital, intergenerational interactions, Markov perfect equilibrium, stochastic transition, constructive approach
    JEL: C73 I20 J22
    Date: 2010
  9. By: Russell Cooper; John Haltiwanger; Jonathan L. Willis
    Abstract: This paper studies capital adjustment at the establishment level. Our goal is to characterize capital adjustment costs, which are important for understanding both the dynamics of aggregate investment and the impact of various policies on capital accumulation. Our estimation strategy searches for parameters that minimize ex post errors in an Euler equation. This strategy is quite common in models for which adjustment occurs in each period. Here, we extend that logic to the estimation of parameters of dynamic optimization problems in which non-convexities lead to extended periods of investment inactivity. In doing so, we create a method to take into account censored observations stemming from intermittent investment. This methodology allows us to take the structural model directly to the data, avoiding time-consuming simulationbased methods. To study the effectiveness of this methodology, we first undertake several Monte Carlo exercises using data generated by the structural model. We then estimate capital adjustment costs for U.S. manufacturing establishments in two sectors.
    Date: 2010
  10. By: Sá, F.; Viani, F.
    Abstract: Reversals in capital inflows can have severe economic consequences. This paper develops a dynamic general equilibrium model to analyse the effect on interest rates, asset prices, investment, consumption, output, the exchange rate and the current account of a shift in portfolio preferences of foreign investors. The model has two countries and two asset classes (equities and bonds). It is characterized by imperfect substitutability between assets and allows for endogenous adjustment in interest rates and asset prices. Therefore, it accounts for capital gains arising from equity price movements, in addition to valuation effects caused by changes in the exchange rate. To illustrate the mechanics of the model, we calibrate it to analyse the conse- quences of an increase in the importance of Sovereign Wealth Funds (SWFs). Specifically, we ask what would happen if 'excess' reserves held by Emerging Markets were transferred from central banks to SWFs. We look separately at two diversification paths: one in which SWFs keep the same allocation across bonds and equities as central banks, but move away from dollar assets (path 1); and another in which they choose the same currency composition as central banks, but shift from US bonds to US equities (path 2). In path 1, the dollar depreciates and US net debt falls on impact and increases in the long run. In path 2, the dollar depreciates and US net debt increases in the long run. In both cases, there is a reduction in the 'exorbitant privilege', i.e., the excess return the US receives on its assets over what it pays on its liabilities. The model is applicable to other episodes in which foreign investors change the composition of their portfolios.
    Keywords: portfolio preferences, sudden stops, imperfect substitutability, global imbalances, sovereign wealth funds
    JEL: F32
    Date: 2010–05–29
  11. By: George Alessandria; Joseph P. Kaboski; Virgiliu Midrigan
    Abstract: This paper examines the role of inventories in the decline of production, trade, and expenditures in the US in the economic crisis of late 2008 and 2009. Empirically, the authors show that international trade declined more drastically than trade-weighted production or absorption and there was a sizeable inventory adjustment. This is most clearly evident for autos, the industry with the largest drop in trade. However, relative to the magnitude of the US downturn, these movements in trade are quite typical. The authors develop a two-country general equilibrium model with endogenous inventory holdings in response to frictions in domestic and foreign transactions costs. With more severe frictions on international transactions, in a downturn, the calibrated model shows a larger decline in output and an even larger decline in international trade, relative to a more standard model without inventories. The magnitudes of production, trade, and inventory responses are quantitatively similar to those observed in the current and previous US recessions.
    Keywords: Inventories ; Global financial crisis ; International trade
    Date: 2010
  12. By: Georg Müller-Fürstenberger; Gunter Stephan
    Abstract: This paper discusses the interplay between the choice of the discount rate, greenhouse gas mitigation and endogenous technological change. Neglecting the issue of uncertainty it is shown that the green golden rule stock of atmospheric carbon is uniquely determined, but is not affected by technological change. More general it is shown analytically within the framework of a reduced model of integrated assessment that optimal stationary stocks of atmospheric carbon depend on the choice of the discount rate, but are independent of the stock of technological knowledge. These results are then reinforced numerically in a fully specified integrated assessment analysis.
    Keywords: Integrated Assessment; discount rate; endogenous technological change; climate change
    JEL: Q40 O13
    Date: 2010–05
  13. By: Maurice J. Roche (Department of Economics, Ryerson University, Toronto, Canada); Michael J. Moore (School of Management and Economics, The Queen's University of Belfast, Belfast, Northern Ireland)
    Abstract: We present a model that simultaneously explains why uncovered interest parity holds for some pairs of countries and not for others. The flexible-price two-country monetary model is extended to include a consumption externality with habit persistence. Habit persistence is modeled using Campbell Cochrane preferences with ‘deep’ habits along the lines of the work of Ravn, Schmitt-Grohe and Uribe. By deep habits, we mean habits defined over goods rather than countries. The negative slope in the Fama regression arises when monetary instability is low and the precautionary savings motive dominates the intertemporal substitution motive. When monetary instability is high, the Fama slope is positive in line with uncovered interest parity. The model is simulated using the artificial economy methodology for 34 currencies against the US dollar. We conclude that, given the predominance of precautionary savings, the degree of monetary instability explains whether or not uncovered interest parity holds.
    Keywords: Monetary instability; Uncovered interest parity; Forward biasedness puzzle; Carry trade; Habit persistence
    JEL: F31 F41 G12
    Date: 2010–05
  14. By: Yosef Bonaparte; Russell Cooper
    Abstract: This paper studies the dynamic optimization problem of a household when portfolio adjustment is costly. The analysis is motivated by the observation that on a monthly basis, less than 10% of stockholders typically adjust their portfolio of common stocks. We use this, and related observations, to estimate the parameters of household preferences and portfolio adjustment costs. We find significant adjustment costs, beyond the direct costs of buying and selling assets. These adjustment costs imply that inferences drawn about household risk aversion and the elasticity of intertemporal substitution are biased: household risk aversion is lower compared to other estimates and it is not equal to the inverse of the elasticity of intertemporal substitution.
    Date: 2010

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