nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2010‒11‒06
eighteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Capital Requirement and Financial Frictions in Banking: Macroeconomic Implications By Ali Dib
  2. The Role of Interest Rates in the Brazilian Business Cycle By Nelson F. Souza Sobrinho
  3. Aging and Pensions in General Equilibrium: Labor Market Imperfections Matter By David de la Croix; Olivier Pierrard; Henri Sneessens
  4. Endogenous fertility, endogenous lifetime and economic growth: the role of child policies By Fanti, Luciano; Gori, Luca
  5. Optimal Monetary and Fiscal Policies In a Search-theoretic Model of Money and Unemployment By Pedro, Gomis-Porqueras; Benoit, Julien; Chengsi, Wang
  6. Produce or speculate? Asset bubbles, occupational choice and efficiency By Cahuc, P.; Challe, E.
  7. Expectations-Driven Cycles in the Housing Market By Lambertini, Luisa; Mendicino, Caterina; Punzi, Maria Teresa
  8. Are Microloans Bad for Growth? By Emerson, Patrick M.; McGough, Bruce
  9. Endogenous fertility and development traps with endogenous lifetime By Fanti, Luciano; Gori, Luca
  10. How Optimism Leads to Price Discovery and Efficiency in a Dynamic Matching Market By Majumdar, Dipjyoti; Shneyerov, Art; Xie, Huan
  11. Global policy at the Zero Lower Bound in a large-scale DSGE model By Sandra Gomes; P. Jacquinot; Ricardo Mestre; João Sousa
  12. DSGE model restrictions for structural VAR identification By Liu, Philip; Theodoridis, Konstantinos
  13. Balanced Budget Government Spending in a Small Open Regional Economy By Patrizio Lecca; Peter McGregor; Kim Swales
  14. Quantitative Analysis of Health Insurance Reform: Separating Community Rating from Income Redistribution By Pashchenko, Svetlana; Porapakkarm, Ponpoje
  15. Entry, Exit, Firm Dynamics, and Aggregate Fluctuations By Gian Luca Clementi; Dino Palazzo
  16. Optimal Taxation of Education with an Initial Endowment of Human Capital By Christoph Braun
  17. The Case for a Financial Approach to Money Demand By Ragot, X.
  18. Informal sector, productivity, and tax collection By Leal Ordóñez, Julio C.

  1. By: Ali Dib
    Abstract: The author develops a dynamic stochastic general-equilibrium model with an active banking sector, a financial accelerator, and financial frictions in the interbank and bank capital markets. He investigates the importance of banking sector frictions on business cycle fluctuations and assesses the role of a regulatory capital requirement in propagating the effects of shocks in the real economy. Bank capital is introduced to satisfy the regulatory capital requirement, and serves as collateral for borrowing in the interbank market. Financial frictions are introduced by assuming asymmetric information between lenders and borrowers that creates moral hazard and adverse selection problems in the interbank and bank capital markets, respectively. Highly leveraged banks are vulnerable and therefore pay higher costs when raising funds. The author finds that financial frictions in the interbank and bank capital markets amplify and propagate the effects of shocks; however, the capital requirement attenuates the real impacts of aggregate shocks (including financial shocks), reduces macroeconomic volatilities, and stabilizes the economy.
    Keywords: Economic models; Business fluctuations and cycles; Financial markets; Financial stability
    JEL: E32 E44 G1
    Date: 2010
  2. By: Nelson F. Souza Sobrinho
    Abstract: This paper offers additional insights on the relationship between interest rates and business cycles in Brazil. First, I document that Brazilian interest rates are very volatile, counter-cyclical and positively correlated with net exports, as observed in other emerging economies. Next, I present a dynamic general equilibrium model in which firms face working capital constraints and labor supply is independent of consumption. This parsimonious model, appropriately calibrated to the Brazilian economy, predicts that interest rate shocks can explain about one third of output fluctuations and generates business cycle regularities consistent with the Brazilian data.
    Date: 2010–10
  3. By: David de la Croix (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES) and CORE); Olivier Pierrard (Banque centrale du Luxembourg and IRES, UCL); Henri Sneessens (Université du Luxembourg, CREA and IRES (UCL))
    Abstract: This paper re-examines the effects of population aging and pension reforms in an OLG model with labor market frictions. The most important feature brought about by labor market frictions is the connection between the interest rate and the unemployment rate. Exogenous shocks (such as aging) leading to lower interest rates also imply lower equilibrium unemployment rates, because lower capital costs stimulate labor demand and induce firms to advertize more vacancies. These effects may be reinforced by increases in the participation rate of older workers, induced by the higher wage rates and the larger probability of finding a job. These results imply that neglecting labor market frictions and employment rate changes may seriously bias the evaluation of pension reforms when they have an impact on the equilibrium interest rate.
    Keywords: Overlapping Generations, Search Unemployment, Labor Force Participation, aging, Pensions, Labor Market
    JEL: E24 H55 J26 J64
    Date: 2010–09–31
  4. By: Fanti, Luciano; Gori, Luca
    Abstract: We examine the effects of child policies on both the transitional dynamics and long-run demo-economic outcomes in the conventional overlapping generations model of neoclassical growth extended with endogenous longevity and endogenous fertility. The government invests in public health (Chakraborty, 2004) and the individual survival probability at the end of youth depends on health expenditure through an S-shaped longevity function. This may give rise to four steady states and, hence, development traps are possible. However, poverty or prosperity may not depend on initial conditions, while being the result of a child policy design. In particular, a child tax can be used to effectively allow those economies that were entrapped into poverty to prosper irrespective of where they start from.
    Keywords: Child policy; Endogenous fertility; Health; Life expectancy; OLG model
    JEL: J13 O40 I10
    Date: 2010–10–23
  5. By: Pedro, Gomis-Porqueras; Benoit, Julien; Chengsi, Wang
    Abstract: In this paper we study the optimal monetary and fiscal policies of a general equilibrium model of unemployment and money with search frictions both in labor and goods markets as in Berentsen, Menzio and Wright (2010). We abstract from revenue-raising motives to focus on the welfare-enhancing properties of optimal policies. We show that some of the inefficiencies in the Berentsen, Menzio and Wright (2010) framework can be restored with appropriate fiscal policies. In particular, when lump sum monetary transfers are possible, a production subsidy financed by money printing can increase output in the decentralized market and a vacancy subsidy financed by a dividend tax even when the Hosios’ rule does not hold.
    Keywords: Search and matching; Fiscal polices;Money; Unemployment; Efficiency
    JEL: E52 E63
    Date: 2010–10–28
  6. By: Cahuc, P.; Challe, E.
    Abstract: We study the macroeconomic effects of rational asset bubbles in an overlapping-generations economy where asset trading requires specialized intermediaries and where agents freely choose between working in the production or in the financial sector. Frictions in the market for deposits create rents in the financial sector that affect workers' choice of occupation. When rents are large, the private gains associated with trading asset bubbles may lead too many workers to become speculators, thereby causing rational bubbles to lose their efficiency properties. Moreover, if speculation can be carried out by skilled labor only, then asset bubbles displace skilled workers away from the productive sector and raise income and consumption inequalities. Classification-JEL: E22; E44; G21.
    Keywords: Rational bubbles; occupational choice; dynamic efficiency.
    Date: 2010
  7. By: Lambertini, Luisa; Mendicino, Caterina; 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 originated in the housing market, the credit market, the production sector and the conduct of monetary policy. We find that expectations related to different sectors of the economy can generate booms in the housing market in accordance with the empirical findings. However, only expectations of future expansionary monetary policy that are not fulfilled can also generate a macroeconomic recession. Regarding the credit market, increased access to credit generates boom-bust cycles only if it is expected to be reversed in the near future. Moreover, economies with higher access to credit are characterized by higher volatility of consumption and indebtedness but, not necessarily, of real GDP.
    Keywords: Boom-Bust Cycles, Credit Frictions, Housing Market
    JEL: E32 E52 E44
    Date: 2010–10–22
  8. By: Emerson, Patrick M. (Oregon State University); McGough, Bruce (Oregon State University)
    Abstract: This paper constructs a two-period overlapping generations model of human capital investment decisions where a microloan program designed to finance entrepreneurial activities is active. It is shown that, in the presence of human capital externalities (social returns to education) there exists a range of microloan amounts that are growth depressing and welfare decreasing through their affect on the opportunity cost of schooling. By increasing the opportunity cost of schooling, microloans divert investment away from human capital: by failing to internalize the social returns to education, households’ individually optimal investment decisions in the face of microcredit availability act to depress the growth of the economy and result in sub-optimal welfare outcomes.
    Keywords: microloans, growth, human capital
    JEL: E24 O10 O40
    Date: 2010–10
  9. By: Fanti, Luciano; Gori, Luca
    Abstract: We extend the literature on endogenous lifetime and economic growth by Chakraborty (2004) and Bunzel and Qiao (2005) to endogenous fertility. It is shown that development traps due to under investments in health can never appear when fertility is an economic decision variable.
    Keywords: Endogenous fertility; Health; Life expectancy; OLG model
    JEL: J13 O40 I10
    Date: 2010–10–23
  10. By: Majumdar, Dipjyoti; Shneyerov, Art; Xie, Huan
    Abstract: Abstract We study a market search equilibrium with aggregate uncertainty, private information and heterogeneus beiefs. Traders initially start out optimistic and then update their beliefs based on their matching experience in the market, using the Bayes rule. It is shown that all separating equilibria converge to perfect competition in the limit as the time between matches tends to 0. We also establish existence of a separating equilibrium.
    Keywords: Markets with search frictions, aggregate uncertainty, heterogeneous beliefs, optimism, bargaining, foundations of Walrasian equilibrium
    JEL: C73 C78 D83
    Date: 2010–10–23
  11. By: Sandra Gomes; P. Jacquinot; Ricardo Mestre; João Sousa
    Abstract: The purpose of this paper is to analyse whether fiscal policies can alleviate the effects of the zero lower bound (ZLB) on interest rates and if they should be coordinated internationally. The analysis is carried out using EAGLE, a DSGE model of the global economy. We consider that the fiscal shocks are temporary and that fscal policy retains full credibility at all times. In this setup we find significant non-linearities in a ZLB situation that amplify the<br>effects of fiscal shocks compared to the non-ZLB case. International coordination is helpful but does not play a major role in the results.
    JEL: E52 E62 E63 F42
    Date: 2010
  12. By: Liu, Philip (International Monetary Fund); Theodoridis, Konstantinos (Bank of England)
    Abstract: The identification of reduced-form VAR model had been the subject of numerous debates in the literature. Different sets of identifying assumptions can lead to very different conclusions in the policy debate. This paper proposes a theoretically consistent identification strategy using restrictions implied by a DSGE model. Monte Carlo simulations suggest the proposed identification strategy is successful in recovering the true structural shocks from the data. In the face of misspecified model restrictions, the data tend to push the identified VAR responses away from the misspecified model and closer to the true data generating process.
    Keywords: VAR identification; model misspecification; DSGE model
    JEL: E52 F41
    Date: 2010–10–28
  13. By: Patrizio Lecca (Department of Economics, Strathclyde University); Peter McGregor (Fraser of Allander Institute, Strathclyde University); Kim Swales (Department of Economics, Strathclyde University)
    Abstract: This paper investigates the impact of a balanced budget fiscal policy expansion in a regional context within a numerical dynamic general equilibrium model. We take Scotland as an example where, recently, there has been extensive debate on greater fiscal autonomy. In response to a balanced budget fiscal expansion the model suggests that: an increase in current government purchase in goods and services has negative multiplier effects only if the elasticity of substitution between private and public consumption is high enough to move downward the marginal utility of private consumers; public capital expenditure crowds in consumption and investment even with a high level of congestion; but crowding out effects might arise in the short-run if agents are myopic.
    Keywords: regional computable general equilibrium analysis, fiscal federalism, fiscal policy.
    JEL: H72 R13 R50
    Date: 2010–10
  14. By: Pashchenko, Svetlana; Porapakkarm, Ponpoje
    Abstract: Two key components of the upcoming health reform are a reorganization of the individual health insurance market and an increase in income redistribution in the economy. Which component contributes more to the welfare outcome of the reform? We address this question by constructing a general equilibrium life cycle model that incorporates both medical expenses and labor income risks. We replicate the key features of the current health insurance system in the U.S. and calibrate the model using the Medical Expenditures Panel Survey dataset. We find that the reform decreases the number of uninsured more than four times. It also brings significant welfare gains equivalent to almost one percent of the annual consumption. However, these welfare gains mostly come from the redistributive measures embedded in the reform. If the reform only reorganizes the individual market, introduces individual mandates but does not include any income-based transfers, the welfare gains are much smaller. This result is mostly driven by the fact that most uninsured people have low income. High burdens of health insurance premiums for this group are relieved disproportionately more by income-based measures than by the new rules in the individual market.
    Keywords: health insurance; health reform; risk sharing; general equilibrium
    JEL: E65 D91 D52 E21 I10
    Date: 2010–10–23
  15. By: Gian Luca Clementi (Department of Economics, Stern School of Business, New York University and RCEA); Dino Palazzo (Department of Finance and Economics, Boston University School of Management)
    Abstract: How important are firm entry and exit in shaping aggregate dynamics? We address this question by characterizing the equilibrium allocation in Hopenhayn (1992)’s model of equilibrium industry dynamics, amended to allow for investment in physical capital and aggregate fluctuations. We find that entry and exit propagate the effects of aggregate shocks. In turn, this results in greater persistence and unconditional variation of aggregate time-series. In the aftermath of a positive productivity shock, the number of entrants increases. The new firms are smaller and less productive than the incumbents, as in the data. As the common productivity component reverts to its unconditional mean, the new entrants that survive become progressively more productive, keeping aggregate efficiency higher than in a scenario without entry or exit. We also find that both the mean and variance of the cross-sectional distribution of firm–level productivity are counter–cyclical, in spite of the assumption that innovations to firm–level productivity are i.i.d. and orthogonal to aggregate shocks. This happens because of selection: the idiosyncratic productivity of the marginal entrant is lower in expansion than during recessions. Since idiosyncratic productivity is mean–reverting, mean and variance of the distribution of productivity growth are pro–cyclical.
    Keywords: Selection, Propagation, Persistence, Survival, Reallocation
    JEL: D21 D92 E32 L11
    Date: 2010–01
  16. By: Christoph Braun
    Abstract: Bovenberg and Jacobs (2005) and Richter (2009) derive the education efficiency theorem: In a second-best optimum, the education decision is undistorted if the function expressing the stock of human capital features a constant elasticity with respect to education. I drop this assumption. The household inherits an initial stock of human capital, implying that the aforementioned elasticity is increasing. In a two-period Ramsey model of optimal taxation, I show that the education efficiency theorem does not hold. In a second-best optimum, the discounted marginal social return to education is smaller than the marginal social cost. The household overinvests in human capital relative to the first best. The government effectively subsidizes the return to education.
    Keywords: Optimal taxation, human capital
    JEL: H21 I28 J24
    Date: 2010–10
  17. By: Ragot, X.
    Abstract: The distribution of money across households is much more similar to the distribution of financial assets than to that of consumption levels. This is a puzzle for theories which directly link money demand to consumption. This paper shows that the joint distribution of money and financial assets can be explained in an heterogeneous agent model where both a cash-in-advance constraint and financial adjustment costs, as in the Baumol-Tobin literature, are introduced. Studying each friction in turn, I find that the financial friction explains 85% of total money demand. Classification-JEL: E40, E50.
    Keywords: Money Demand, Money Distribution, Heterogeneous Agents.
    Date: 2010
  18. By: Leal Ordóñez, Julio C.
    Abstract: The informal sector is a prominent characteristic of many developing countries. Most of the literature has focused on understanding the determinants of informality. The connection between the informal sector and economic development is, nonetheless, relatively less understood. One of the most important determinants of informality is the tax enforcement quality of a country which, some authors argue, additionally distorts firms' decisions and creates inefficiency. In this paper, I assess the quantitative importance of the effects of incomplete tax enforcement on aggregate output and productivity. I use a dynamic general equilibrium framework to study effects that have received little attention in the literature. I calibrate the model using data for Mexico, an economy where 31% of the employees work in informal establishments. I then investigate the effects of improving enforcement. My main finding is that under complete enforcement, Mexico's labor productivity and output would be 17% higher.
    Keywords: Informal Sector; Productivity; tax enforcement; TFP; Heterogeneous plants
    JEL: O47 O17 E26
    Date: 2010–02

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