nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2010‒07‒10
seventeen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Search-Theoretic Money, Capital and International Exchange Rate Fluctuations By Gomis-Porqueras, Pere; Kam, Timothy; Lee, Junsang
  2. Selective Reductions in Labor Taxation Labour Market Adjustments and Macroeconomic Performance By Anna BATYRA; Henri SNEESSENS
  3. Equilibrium asset prices and the wealth distribution with inattentive consumers By Finocchiaro, Daria
  4. Micro-based estimates of heterogeneous pricing rules: the united states vs. The euro area By Luis J. Álvarez; Pablo Burriel
  5. Transitional Dynamics of Dividend and Capital Gains Tax Cuts By François Gourio; Jianjun Miao
  6. Public investment in basic education and economic growth By Kuhl Teles, Vladimir; Andrade, Joaquim
  7. Expectations-driven cycles in the housing market By Luisa Lambertini; Caterina Mendicino; Maria Teresa Punzi
  8. Monetary equilibrium with decentralized trade and learning By Araujo, Luis; Camargo, Braz
  9. Optimal Monetary Policy with Non-Zero Net Foreign Wealth By Mykhaylova, Olena
  10. The Macroeconomics of Health Savings Accounts By Juergen Jung; Chung Tran
  11. Business Cycles, Consumption and Risk-Sharing: How Different Is China? By Chadwick C. Curtis; Nelson Mark
  12. On a Unique Nondegenerate Distribution of Agents in the Huggett Model By Kam, Timothy
  13. A Dynamic General Equilibrium Approach to Asset Pricing Experiments By John Duffy; Sean Crockett
  14. Dynamic Income Taxation without Commitment: Comparing Alternative Tax Systems By J-T Guo; A Krause
  15. On the Growth-Maximizing Allocation of Public Investment By Pantelis Kalaitzidakis; Vangelis Tzouvelekas
  16. Limited memory and the essentiality of money By Araujo, Luis; Camargo, Braz
  17. Money versus memory By Araujo, Luis; Camargo, Braz

  1. By: Gomis-Porqueras, Pere; Kam, Timothy; Lee, Junsang
    Abstract: In this paper we develop a two-country global monetary economy where a monetary equilibrium exists because of fundamentaldecentralized trade frictions ? a Lagos-Wright search and matching friction. In the decentralized markets (DM), the terms of trade can be determined either by bargaining or by competitive price taking (baseline model). We show that the baseline model is capable of generating quite realistic real and nominal exchange rate volatility observed in the data, without relying on more ad-hoc sticky price assumptions commonly used in the international macroeconomics literature. The key mechanism lies in the role of search and matching frictions and a primitive technological assumption ? that capital is also a complementary input to production in the DM. This creates an internal propagation mechanism by modifying asset-pricing relations and relative price dynamics in the model.
    Keywords: Search-theoretic Money, Open Economy, Real Exchange Rate Puzzle
    JEL: E31 E32 E43 E44
    Date: 2010–06
  2. By: Anna BATYRA (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES)); Henri SNEESSENS (CREA, UniversitŽ du Luxembourg, IRES, UniversitŽ catholique de Louvain, and IZA, Bonn)
    Abstract: We use a calibrated general equilibrium model with heterogeneous labor and search to evaluate the quantitative effects of various labor tax cut scenarios. The focus is on skill heterogeneity combined with downward wage rigidities at the low end of the skill ladder. Workers can take jobs for which they are overeducated. We compare targeted and non-targeted tax cuts, both with or without over-education effects. Introducing over-education changes substantially the employment, productivity and welfare effects of a tax cut, although tax cuts targeted on the least skilled workers always have larger effects.
    Keywords: Minimum Wage, Job Creation, Job Destruction, Job Competition, Search Unemployment, Taxation, Computable General Equilibrium Models
    JEL: C68 E24 J64
    Date: 2010–01–31
  3. By: Finocchiaro, Daria (Research Department, Central Bank of Sweden)
    Abstract: This paper studies the effects of heterogeneity in planning propensity on wealth inequality and asset prices. I consider an economy populated by "attentive" and "inattentive" agents. Attentive agents plan their consumption period by period, while inattentive agents plan every other period. Infrequent planning increases uncertainty concerning future income or future asset returns. In general equilibrium, inattentive consumers trade at unfavorable prices. If the only source of uncertainty is future income, inattentive consumers will still accumulate more wealth. In contrast, in a version of the model driven by uncertain asset returns, infrequent planning produces the opposite result: inattentive investors accumulate less wealth, in line with empirical evidence. Moreover, asset prices are much more volatile than in a representative agent model with full attention, because changes in asset prices must induce attentive consumers to voluntarily bear the burden of adjusting to aggregate shocks.
    Keywords: Inattentiveness; Infrequent Planning; Heterogeneous Agents
    JEL: D52 D80 D91 E21
    Date: 2010–05–01
  4. By: Luis J. Álvarez (Banco de España); Pablo Burriel (Banco de España)
    Abstract: This paper presents US and euro area estimates for a fully heterogeneous model, in which there is a continuum of f rms setting prices with a constant probability of adjustment, which may differ from f rm to f rm. The estimated model accurately matches the empirical distribution function of individual price durations for the US and the euro area. Incorporating these micro based pricing rules into a DSGE model, we f nd that nominal shocks have a greater real impact in the fully heterogeneous economy than in the standard Calvo model. We also f nd that nominal and real shocks bring about a reallocation of resources among sectors. Monetary policy is found to have a greater real impact in the euro area than in the United States.
    Keywords: price setting, heterogeneity, DSGE, Calvo model
    JEL: C40 D40 E30
    Date: 2010–06
  5. By: François Gourio; Jianjun Miao
    Abstract: We develop a dynamic general equilibrium model to study the impact of the 2003 dividend and capital gains tax cuts. In the model, firms are heterogeneous in productivity and make investment and financing decisions subject to capital adjustment costs, equity issuance costs, and collateral constraints. We show that when the dividend and capital gains tax cuts are unexpected and permanent, dividend payments, equity issuance, and aggregate investment rise immediately. By contrast, when these tax cuts are unexpected and temporary, aggregate investment falls in the short run. This fall allows firms to distribute large dividends initially in response to the temporary dividend tax cut. We also find that the effects of a temporary dividend tax cut are very different from those of a temporary capital gains tax cut.
    JEL: D92 E22 E62 G31 H32
    Date: 2010–07
  6. By: Kuhl Teles, Vladimir; Andrade, Joaquim
    Abstract: The main objective of this paper was to visualize the relation between governmentspending on basic education and the human capital accumulation process, observingthe impacts of this spending on individual investments in higher education, and oneconomic growth. It is used an overlapping-generations model where the governmenttax the adult generation and spent it in basic education of the next generations. Itwas demonstrated that the magnitude of the marginal effect of government spendingin basic education on growth crucially depends on public budget constrains. The paperexplains why some countries with a lot of public investment in basic education growthat low rates. In that sense if a country has only a lot of public investment in basiceducation without investment in higher education it may growth at low rates becausethe taxation can cause distortions in the agents incentives to invest in higher education.
    Date: 2010–06–29
  7. By: Luisa Lambertini (College of Management); Caterina Mendicino (Banco de Portugal); Maria Teresa Punzi (Banco de Portugal)
    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 f nd 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 f ndings. Moreover, expectations of either a future reduction in the policy rate or a temporary increase in the central bank’s inf ation target that are not fulf lled 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: boom-bust cycles, credit frictions, housing market
    JEL: E32 E44 E52
    Date: 2010–07
  8. By: Araujo, Luis; Camargo, Braz
    Abstract: This paper analyzes the stability of monetary regimes in an economy where fiat money isendogenously created by the government, information about its value is imperfect, and learningis decentralized. We show that monetary stability depends crucially on the speed of informationtransmission in the economy. Our model generates a dynamic on the acceptability of fiat moneythat resembles historical accounts of the rise and eventual collapse of overissued paper money.It also provides an explanation of the fact that, despite its obvious advantages, the widespreaduse of fiat money is only a recent development.
    Date: 2010–06–25
  9. By: Mykhaylova, Olena
    Abstract: I study the impact of net foreign wealth on the optimal monetary policy of an open economy in a two-country DSGE model with incomplete markets, sticky prices and deviations from the Law of One Price. I find that by optimally manipulating monetary policy, central banks can affect the timing of interest receipts (or payments) and therefore increase the risk-sharing role of the internationally traded asset. In particular, debtor nations find it optimal to allow their currency to float relatively more freely than do creditor nations. In order to maximize consumer welfare, in most specifications of the model central bank should target a weighted average of CPI inflation and changes in the nominal exchange rate.
    Keywords: Optimal monetary policy; welfare; open economy; net foreign wealth.
    JEL: F34 F32 E52 E44
    Date: 2010–07–01
  10. By: Juergen Jung (Department of Economics, Towson University); Chung Tran (Department of Economics, University of New South Wales)
    Abstract: We analyze whether the introduction of Health Savings Accounts (HSAs), which is a health insurance reform coupled with a capital tax reform, can reduce health care expenditures in the United States and increase the fraction of the population with health insurance. Unlike previous studies on HSAs, our analysis relies on a general equilibrium framework and therefore fully accounts for feedback effects from general equilibrium price changes. Our results from numerical simulations indicate that the introduction of HSAs increases the percentage of the working age population with health insurance in the long run but fails to control spending on health care. The outcome of a HSAs reform depends critically on the annual contribution limits to HSAs and the interplay of general equilibrium effects. Finally, the long-run tax revenue loss due to the introduction of HSAs is large and can amount to up to 5 percent of GDP.
    Keywords: Health saving accounts, health care reform, privatization of health care systems, health insurance, stochastic dynamic general equilibrium model with health.
    JEL: H51 I18 I38
    Date: 2010–06
  11. By: Chadwick C. Curtis; Nelson Mark
    Abstract: Can standard business-cycle methodology be applied to China? In this chapter, we address this question by examining the macroeconomic time series and identifying dimensions in which China differs from economies (such as Canada and the U.S.) that are typically the subject of business-cycle research. We show that naively applying the standard business-cycle tools to China is no more ridiculous than applying it to Canada, although the dimensions along which the model struggles is different. For China, the model cannot account for the low level of consumption (or high saving) as a proportion of income observed in the data. An examination of provincial level consumption data suggests that the absence of channels for intranational consumption risk sharing may be an important reason why the business-cycle model has trouble accounting for Chinese consumption and saving behavior.
    JEL: E21 E32 F41
    Date: 2010–07
  12. By: Kam, Timothy
    Abstract: A theoretical curiosity remains in the Huggett [1993] model as to the possible existence of a unique and degenerate stationary distribution of agent types. This coincides with the possibility that an equilibrium individual state space may turn out to be trivial in the sense that every agent never escapes the binding common borrowing constraint. In this note, we extend and reinforce the proof of Lemma 3 in Huggett [1993]. By invoking a simple comparative-static argument, we establish that Huggett's result of a unique stationary equilibrium distribution of agents must be one that is nontrivial or nondegenerate.
    Keywords: Compactness, Individual state space, Stationary distribution
    JEL: C62 D31 D52
    Date: 2010–06
  13. By: John Duffy; Sean Crockett
    Abstract: We report results from a laboratory experiment that implements a consumption-based dynamic general equilibrium model of asset pricing. This work-horse model of the macrofinance literature posits that agents buy and sell assets for the purpose of intertemporally smoothing consumption, and that asset prices are determined by individual risk and time preferences as well as the distribution of income and dividends. The experimental findings are largely supportive of the model’s theoretical predictions. Notably we observe that asset price bubbles, defined as sustained departures of prices from those implied by fundamentals, are infrequent and short-lived. This finding is a stark departure from many recent multi-period asset pricing experiments that lack a consumption-smoothing objective. Indeed, we find that when subjects are induced to adjust shareholdings to smooth consumption, assets typically trade at a discount relative to their expected value and market participation is broad; when the consumption smoothing motivation to trade assets is removed in an otherwise identical economy, assets frequently trade at a premium relative to fundamentals and shareholdings become highly concentrated.
    JEL: C90 D51 D91 G12
    Date: 2010–06
  14. By: J-T Guo; A Krause
    Abstract: This paper addresses the question as to whether it is optimal to use separating or pooling nonlinear income taxation, or to use linear income taxation, when the government cannot commit to its future tax policy. We consider both two-period and infinite-horizon settings. Under empirically plausible parameter values, separating income taxation is optimal in the two-period model, whereas linear income taxation is optimal when the time horizon is infinite. The welfare effects of varying the discount rate, the degree of wage inequality, and the population of high-skill workers are also explored. For realistic changes in these parameters, separating income taxation remains optimal in the two-period formulation, and linear income taxation remains optimal in the infinite-horizon model.
    Keywords: Dynamic Income Taxation; Commitment.
    JEL: H21 H24
    Date: 2010–06
  15. By: Pantelis Kalaitzidakis (Dept of Economics, University of Crete, Greece); Vangelis Tzouvelekas (Department of Economics, University of Crete, Greece)
    Abstract: In this paper we present an endogenous growth model to analyze the growth maximizing allocation of public investment among N different types of public capital. Using this general model of public capital formation, we analyze the stability of the long-run equilibrium and we derive the growth-maximizing values of the shares of public investment allocated to the different types of public capital, as well as the growth-maximizing tax rate (amount of total public investment as a share of GDP). The empirical implication of the modelis that both the effects of the shares of public investment and the tax rate on the long-run growth rate are non-linear, following an inverse U-shaped pattern.
    Date: 2010–07–01
  16. By: Araujo, Luis; Camargo, Braz
    Abstract: This paper investigates the relationship between memory and the essentiality ofmoney. We consider a random matching economy with a large finite population inwhich commitment is not possible and memory is limited in the sense that only afraction m E(0; 1) of the population has publicly observable histories. We show thatno matter how limited memory is, there exists a social norm that achieves the firstbest regardless of the population size. In other words, money can fail to be essentialirrespective of the amount of memory in the economy. This suggests that the emphasison limited memory as a fundamental friction for money to be essential deserves a deeperexamination.
    Date: 2010–06–25
  17. By: Araujo, Luis; Camargo, Braz
    Abstract: A well–established fact in monetary theory is that a key ingredient for the essentialityof money is its role as a form of memory. In this paper we study a notion ofmemory that includes information about an agent’s past actions and trading opportunitiesbut, in contrast to Kocherlakota (1998), does not include information aboutthe past actions and trading opportunities of an agent’s past partners. We first showthat the first–best can be achieved with memory even if it only includes informationabout an agent’s very recent past. Thus, money can fail to be essential even if memoryis minimal. We then establish, more interestingly, that if information about tradingopportunities is not part of an agent’s record, then money can be better than memory.This shows that the societal benefit of money lies not only on being a record of pastactions, but also on being a record of past trading opportunities, a fact that has beenoverlooked by the monetary literature.
    Date: 2010–06–25

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