New Economics Papers
on Dynamic General Equilibrium
Issue of 2010‒10‒09
sixteen papers chosen by

  1. Macroeconomic propagation under different regulatory regimes: Evidence from an estimated DSGE model for the euro area By Matthieu Darracq Pariès; Christoffer Kok Sørensen; Diego Rodriguez Palenzuela
  2. Debt Policy in a Competitive Two-Sector Overlapping Generations Model By Partha Sen
  3. A Dynamic Politico-Economic Model of Intergenerational Contracts By Francesco Lancia; Alessia Russo
  4. Business Cycle Dependent Unemployment Insurance By Andersen, Torben; Svarer, Michael
  5. Endogenous Credit Constraints, Human Capital Investment and Optimal Tax Policy By Hongyan Yang
  6. Private Pensions, Retirement Wealth and Lifetime Earnings By James MacGee; Jie Zhou
  7. Growth and Welfare under Endogenous Lifetime By Maik T. Schneider; Ralph Winkler
  8. Fear of model misspecification and the robustness premium By Konstantinos Angelopoulos; James Malley
  9. How Non-Gaussian Shocks Affect Risk Premia in Non-Linear DSGE Models By Martin M. Andreasen
  10. Social Security as Markov Equilibrium in OLG Models: A Note By Martín Gonzalez Eiras
  11. Catalyzers for Social Insurance: Education Subsidies vs. Real Capital Taxation By Dirk Schindler; Hongyan Yang
  12. Uncertainty in the Public Debt Market and Stochastic Long-Run Growth By Panagiotis Tsintzos; Theologos Dergiades
  13. The quantitative role of child care for female labor force participation and fertility By Bick, Alexander
  14. A Study on Dynamic General Equilibrium under the Classical Growth Framework By Li, Wu
  15. Intergenerational Conflict and International Risk Sharing By Martín Gonzalez Eiras
  16. Leverage Constraints and the International Transmission of Shocks By Michael B. Devereux; James Yetman

  1. By: Matthieu Darracq Pariès (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Christoffer Kok Sørensen (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Diego Rodriguez Palenzuela (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: The financial crisis clearly illuminated the potential amplifying role of financial factors on macroeconomic developments. Indeed, the heavy impairments of banks’ balance sheets brought to the fore the banking sector’s ability to provide a smooth flow of credit to the real economy. However, most existing structural macroeconomic models fail to take into account the crucial role of banks’ balance sheet adjustment in the propagation of shocks to the economy. This paper contributes to fill this gap, analyzing the role of credit market frictions in business cycle fluctuations and in the transmission of monetary policy. We estimate a closed-economy dynamic stochastic general equilibrium (DSGE) model for the euro area with financially-constrained households and firms and embedding an oligopolistic banking sector facing capital constraints. Using this setup we examine the macroeconomic implications of various financial frictions on the supply and demand of credit, and in particular we assess the effects of introducing risk-sensitive and more stringent capital requirements. Finally, we explore the scope for counter-cyclical bank capital rules and the strategic complementarities between macro-prudential tools and monetary policy. JEL Classification: E4, E5, F4.
    Keywords: DSGE models, Bayesian estimation, Banking, Financial regulation.
    Date: 2010–10
  2. By: Partha Sen
    Abstract: In this paper debt policy in a two-period, two-sector overlapping generations model with Leontief technologies has been analysed. It has been found that debt, issued to transfer resources to the initially old, could be welfare improving in the new steady state for an economy which satisfies the usual conditions for dynamic efficiency viz. the rate of interest is at least as great as the population growth rate. [Working paper No. 137]
    Keywords: Government Debt, Overlapping Generations, Two-Sector Models, Dynamic Efficiency
    Date: 2010
  3. By: Francesco Lancia; Alessia Russo
    Abstract: This paper investigates the conditions for the emergence of implicit intergenerational contracts without assuming reputation mechanisms, commitment technology and altruism. We present a tractable dynamic politico-economic model in OLG environment where politicians play Markovian strategies in a probabilistic voting environment, setting multidimensional political agenda. Both backward and forward intergenerational transfers, respectively in the form of pension benefits and higher education investments, are simultaneously considered in an endogenous human capital setting with labor income taxation. On one hand, social security sustains investment in public education; on the other hand investment in education creates a dynamic linkage across periods through both human and physical capital driving the economy toward di¤erent Welfare State Regimes. Embedding a repeated-voting setup of electoral competition, we find that in a dynamic efficient economy both forward and backward intergenerational transfers simultaneously arise. The equilibrium allocation is education efficient, but, due to political overrepresentation of elderly agents, the electoral competition process induces overtaxation compared with a Benevolent Government solution with balanced welfare weights.
    Keywords: aging, Benevolent Government allocation, intergenerational redistribution, Markovian equilibria, repeated voting;
    JEL: C61 D71 E62 H11
    Date: 2010–09
  4. By: Andersen, Torben (University of Aarhus); Svarer, Michael (University of Aarhus)
    Abstract: The consequences of business cycle contingencies in unemployment insurance systems are considered in a search-matching model allowing for shifts between “good” and “bad” states of nature. We show that not only is there an insurance argument for such contingencies, but there may also be an incentive argument. Since benefits may be less distortionary in a recession than a boom, it follows that counter-cyclical benefits reduce average distortions compared to state independent benefits. We show that optimal (utilitarian) benefits are counter-cyclical and may reduce the structural (average) unemployment rate, although the variability of unemployment may increase.
    Keywords: unemployment benefits, business cycle, insurance, incentives
    JEL: J6 H3
    Date: 2010–09
  5. By: Hongyan Yang (Department of Economics, University of Konstanz, Germany)
    Abstract: This paper employs a two-period life-cycle model to derive the optimal tax policy when educational investments are subject to credit constraints. Credit constraints arise from the limited commitment of debitors to repay loans and are endogenously determined by private banks under the non-default condition that individuals can-not be better off by defaulting. We show that the optimal redistributive taxation trades the welfare gain of reducing borrowing demand and of changing the credit constraints against the efficiency costs of distorting education and labor supply. In addition, we compare the optimal taxation with that when credit constraints are taken as given. If income taxation decreases (increases) the borrowing limit, taking credit constraints as given leads to a too high (low) labor tax rate. Thus, ignoring the effects of tax policy on credit constraints overestimates (underestimates) the welfare effects of income taxation. Numerical examples show that income taxation tightens the credit constraints and the optimal tax rates are lower when credit constrains are endogenized. The intuition is that redistributive taxation reduces the incentive to invest in education and to work, thus exaggerating the moral hazard problems associated with credit constraints.
    Keywords: labor taxation, human capital investment, credit constraints
    JEL: H21 I2 J2
    Date: 2010–09–30
  6. By: James MacGee (University of Western Ontario); Jie Zhou (Nanyang Technological University)
    Abstract: This paper investigates the effect of private pensions on the retirement wealth distribution. The model incorporates stochastic private pension coverage into a life- cycle model with stochastic earnings. The predictions of the calibrated model are compared to the distribution of retirement net worth and private pension wealth in the PSID. While private pensions lead to higher wealth inequality and reduces the lifetime earnings - retirement wealth correlation, the model still generates too little wealth inequality. However, when we extend the model to include heterogeneous life-cycle earnings profiles and permanent return differences across households, we find that the model largely accounts for the sizeable variation in retirement wealth.
    Keywords: private pensions; Wealth inequality; retirement
    JEL: D31 E21 J32
    Date: 2010
  7. By: Maik T. Schneider (CER-ETH - Center of Economic Research at ETH Zurich, Switzerland); Ralph Winkler (Department of Economics and Oeschger Centre for Climate Change Research, University of Bern)
    Abstract: We develop a perpetual youth model to investigate how longevity affects economic growth and welfare. Life expectancy is determined by individuals’ investments in healthcare. We find that improvements in the healthcare technology always increase the steady state growth rate. Although the effect is small, even for large increases in longevity, welfare gains may be substantial depending on the type of the technological improvement. We identify two externalities associated with healthcare investments and provide a condition when healthcare expenditures are inefficiently low in the market equilibrium. Finally, we discuss our results with respect to alternative spillover specifications in the production sector.
    Keywords: economic growth, endogenous longevity, healthcare expenditures, healthcare technology, quality-quantity trade-off
    JEL: O40 I10 J10
    Date: 2010–09
  8. By: Konstantinos Angelopoulos; James Malley
    Abstract: Robust decision making implies welfare costs or robustness premia when the approximating model is the true data generating process. To examine the importance of these premia at the aggregate level we employ a simple two-sector dynamic general equilibrium model with human capital and introduce an additional form of precautionary be- havior. The latter arises from the robust decision maker's ability to reduce the effects of model misspecification through allocating time and existing human capital to this end. We find that the extent of the robustness premia critically depends on the productivity of time rela- tive to that of human capital. When the relative efficiency of time is low, despite transitory welfare costs, there are gains from following ro- bust policies in the long-run. In contrast, high relative productivity of time implies misallocation costs that remain even in the long-run. Fi- nally, depending on the technology used to reduce model uncertainty, we find that while increasing the fear of model misspecification leads to a net increase in precautionary behavior, investment and output can fall.
    Date: 2010–09
  9. By: Martin M. Andreasen (Bank of England and CREATES)
    Abstract: This paper studies how non-Gaussian shocks affect risk premia in DSGE models approximated to second and third order. Based on an extension of the results in Schmitt-Grohé & Uribe (2004) to third order, we derive propositions for how rare disasters, stochastic volatility, and GARCH affect any risk premia in a wide class of DSGE models. To quantify these effects, we then set up a standard New Keynesian DSGE model where total factor productivity includes rare disasters, stochastic volatility, and GARCH. We ?find that rare disasters increase the mean level of the 10-year nominal term premium, whereas a key effect of stochastic volatility and GARCH is an increase in the variability of this premium.
    Keywords: Epstain-Zin-Weil preferences, GARCH, rare disasters, risk premia, stochastic volatility.
    JEL: C68 E30 E43 E44
    Date: 2010–09–10
  10. By: Martín Gonzalez Eiras (Department of Economics, Universidad de San Andres & CONICET)
    Abstract: I refine and extend the Markov perfect equilibrium of the social security policy game in Forni (2005) for the special case of logarithmic utility. Under the restriction that the policy function be continuous, instead of differentiable, the equilibrium is globally well defined and its dynamics always stable.
    Keywords: social security, overlapping generations models, Markov equilibria
    Date: 2010–09
  11. By: Dirk Schindler (Department of Economics, University of Konstanz, Germany); Hongyan Yang (Department of Economics, University of Konstanz, Germany)
    Abstract: To analyze the optimal social insurance package, we set up a two-period life-cycle model with risky human capital investment, where the government has access to labor taxation, education subsidies and capital taxation. Social insurance is provided by redistributive labor taxation. Moreover, both education subsidies and capital taxation are used as catalyzers to facilitate social insurance by mitigating distortions from labor taxation. We derive a Ramsey-rule for the optimal combination of these two instruments. Relative to capital taxation, optimal education subsidies increase in their relative effectiveness to boost labor supply and in households' underinvestment into education, but they decrease in their relative net distortions. For their absolute levels, indirect complementarity effects, i.e., influencing the effectiveness of the other instrument, do matter. Generally, a decrease in capital taxes should go along with an increase in education subsidies.
    Keywords: Human Capital Investment, Education Subsidies, Capital Taxation, Risk, Social Insurance
    JEL: H21 I2 J2 D80
    Date: 2010–09–30
  12. By: Panagiotis Tsintzos (Department of Economics, University of Macedonia); Theologos Dergiades (Department of Economics, University of Macedonia)
    Abstract: In a continuous time model, a representative household has to allocate its investment and consumption in an optimal manner under conditions of uncertainty. In the present study it is hypothesized that there are two types of assets: a risk-free and a risky asset. The risk-free asset is assumed to be the physical capital, while at the same time uncertainty is allowed to result from the exogenous random variations in the public debt market, rendering in this way government bonds to act as the risky-asset. In the endogenous growth framework with productive public investment, the expected long-run growth rate, the dynamic path of consumption as well as the optimal allocation of investment between a risky and a riskless asset, are analytically derived. This kind of treatment allows us to create a locus for the long-run growth over the various levels of uncertainty. The outcome of the analysis is that a rise in uncertainty impacts negatively upon the long-run growth rate. In order to empirically assess the relationship between growth and uncertainty, we lay our emphasis on the US economy for the period 1957:1 to 2008:4. Within the framework of a bivariate BEKK-GARCH(1,1)-M model a significant negative relationship between uncertainty and economic growth has been established.
    Keywords: public debt management; stochastic optimal control; endogenous growth; BEKK GARCH-M model.
    JEL: C32 C51 H50 H63 O40
    Date: 2010–10
  13. By: Bick, Alexander
    Abstract: Consistent with facts for a cross-section of OECD countries, I document that the labor force participation rate of West German mothers with children aged zero to two exceeds the corresponding child care enrollment rate whereas the opposite is true for mothers with children aged three to mandatory school age. I develop a life-cycle model that explicitly accounts for this age-dependent relationship through various types of non-paid and paid child care. The calibrated version of the model is used to evaluate two recently passed policy reforms concerning the supply of subsidized child care for children aged zero to two in Germany. These counterfactual policy experiments suggest that the lack of subsidized child care constitutes indeed for some females a barrier to participate in the labor market and depresses fertility.
    Keywords: Child Care; Fertility; Life-cycle Female Labor Supply
    JEL: J13 J22 D10
    Date: 2010–08–09
  14. By: Li, Wu
    Abstract: The equilibrium analyses under the classical growth framework mainly concern production processes so far and the utility-maximization of consumers is not considered sufficiently. Treating a consumer as a producer of labor or land-use right etc. with a utility parameter, this paper presents equilibrium formulas taking account of the utility-maximization of consumers, which may facilitate the analysis of dynamic general equilibrium involving both profit-maximizing firms and utility-maximizing consumers under the classical growth framework. For concreteness, some numerical examples with Cobb-Douglas production and utility functions are utilized to illustrate the method of the equilibrium analysis involving utility-maximizing consumers.
    Keywords: dynamic general equilibrium; utility; Sraffian system; von Neumann growth model; land rent
    JEL: B51 Q24 D58 C67
    Date: 2010–09–29
  15. By: Martín Gonzalez Eiras (Department of Economics, Universidad de San Andres & CONICETAuthor-Name: Leandro Arozamena)
    Abstract: Existing models of foreign debt and insurance capacity assume that the costs and benefits of default are evenlydistributed across agents in the defaulting country. To study how tensions among different groups inside a country affect its sovereign risk management I consider an economy whose agents differ in their life spans. This makes the cost and benefits of default to be different across generations. The country is able to come up with a positive level of insurance by linking intergenerational transfers to the default decision of its citizens. This results is found both for the case of a Ramsey planner who cares for all present and future generations, and when decisions are taken by majority vote among living generations.
    Keywords: intergenerational, conflict, risk sharing
    JEL: F34 H55 D61 D72
    Date: 2010–09
  16. By: Michael B. Devereux (University of British Columbia and National Bureau of Economic Research and Centre for Economic Policy Research and Hong Kong Institute for Monetary Research); James Yetman (Bank for International Settlements and Hong Kong Institute for Monetary Research)
    Abstract: Recent macroeconomic experience has drawn attention to the importance of interdependence among countries through financial markets and institutions, independently of traditional trade linkages. This paper develops a model of the international transmission of shocks due to interdependent portfolio holdings among leverage-constrained investors. In our model, without leverage constraints on investment, financial integration itself has no implication for international macro co-movements. When leverage constraints bind however, the presence of these constraints in combination with diversified portfolios introduces a powerful financial transmission channel which results in a positive co-movement of production, independently of the size of international trade linkages. In addition, the paper shows that, with binding leverage constraints, the type of financial integration is critical for international co-movement. If international financial markets allow for trade only in non-contingent bonds, but not equities, then the international co-movement of shocks is negative. Thus, with leverage constraints, moving from bond trade to equity trade reverses the sign of the international transmission of shocks.
    Keywords: Leverage, International Transmission, Portfolios
    JEL: F3 F32 F34
    Date: 2010–05

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