nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2010‒11‒13
nineteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Aging and Pensions in General Equilibrium: Labor Market Imperfections Matter By de la Croix, David; Pierrard, Olivier; Sneessens, Henri R.
  2. New Keynesian DSGE Models and the IS-LM Paradigm By Ulrich Frische; Ingrid Größl
  3. A Macroeconomic Analysis of the Fiscal System in Egypt By Gerhard Glomm; Juergen Jung
  4. Revisiting Overborrowing and Its Policy Implications By Gianluca Benigno; Huigang Chen; Chris Otrok; Alessandro Rebucci; Eric Young
  5. Does Cointegration Matter? An Analysis in a RBC Perspective. By Laura Bisio; Andrea Faccini
  6. On inflation, wealth inequality and welfare in emerging economies By Sunel, Enes
  7. Relative-preference shifts and the business cycle. By William Addessi; Francesco Busato
  8. Public Debt Places No Burden on Future Generations under Demand Shortage By Takayuki Ogawa; Yoshiyasu Ono
  9. Trends in U.S. Hours and the Labor Wedge By Simona E. Cociuba; Alexander Ueberfeldt
  10. How Should Financial Intermediation Services be Taxed? By Lockwood, Ben
  11. On approximating DSGE models by series expansions By Giovanni Lombardo
  12. Contractionary Effects of Supply Shocks: Evidence and Theoretical Interpretation. By Francesco Giuli; Massimiliano Tancioni
  13. Stability versus Flexibility: The Role of Temporary Employment in Labour Adjustment By Shutao Cao; Danny Leung
  14. Complete closed-form solution to a stochastic growth model and corresponding speed of economic recovery By Feicht, Robert; Stummer, Wolfgang
  15. Skill Investment, Farm Size Distribution and Agricultural Productivity By Cai, Wenbiao
  16. Maximizing Human Development By Merwan Engineer; Ian King
  17. There Will Be Money By Luis Araujo; Bernardo Guimaraes
  18. The History Augmented Solow model By Dalgaard, Carl-Johan; Strulik, Holger
  19. Adjusting to Capital Account Liberalization By Kosuke Aoki; Gianluca Benigno; Nobuhiro Kiyotaki

  1. By: de la Croix, David (Université catholique de Louvain); Pierrard, Olivier (Université catholique de Louvain); Sneessens, Henri R. (University of Luxembourg)
    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: 2010–10
  2. By: Ulrich Frische (University of Hamburg); Ingrid Größl (University of Hamburg)
    Abstract: New Keynesian DSGE models propose a dynamic and expectational version of the old IS-LM paradigm. Acknowledging that the Taylor rule as a substitute for the LM-curve has its merits we show that standard DSGE models do not model how the central bank achieves its targets. In filling this gap we make evident that models neglecting a store-of-value function of money but still assuming a Taylor rule are inconsistent. Our major point concerns the-so called new Keynesian IS-curve. We prove that DSGE models which typically rest on the assumption of representative agents are unable to derive the IS-curve. This implies that these models lack the capability to analyse the role of savings as a a gap in aggregate demand. By assuming overlapping generations we make evident how this shortcoming can be avoided. We also show how OLG models add a richer dynamics to the standard DSGE approach.
    Date: 2010
  3. By: Gerhard Glomm (Department of Economics, Indiana University - Bloomington); Juergen Jung (Department of Economics, Towson University)
    Abstract: We construct a dynamic general equilibrium model to analyze the fiscal situation of Egypt. We model Egypt as a small open economy that takes real interest rates and world prices of fuel as given. Since a large component of the government budget consists of pensions payments, we use an overlapping generations structure. The model contains descriptions of the public and private sector, as well as descriptions of the production sectors for a public good such as infrastructure, energy, and a final aggregate consumption good. The model pays special attention to the energy sector. We then calibrate the model to data from Egypt. The following policy reforms are considered: (i) reductions in pensions to public sector workers, (ii) reductions in pensions to private sector workers, (iii) reductions in the public sector pay premiums, (iv) decreases of the energy subsidies, and (v) a decrease of the public sector workforce. In each case we reduce the "expenditure" by 15 percent. For each of the reforms we adjust consumption taxes, labor taxes, "capital taxes", or public investments in infrastructure to satisfy the government budget constraint. We calculate the new steady states, the transition paths to the new steady states, and the size of the welfare gains or losses for all reforms. We find that due to the modest nature of the reforms, the effect of the policy reforms on GDP and consumption are modest. Often these gains are in the neighborhood of 1 percent. We find that welfare gains or losses can be sizable and that the largest gains from the reforms are attained when the freed up resources are used for infrastructure investments or for lowering the tax on company profits.
    Keywords: Fiscal policy reform, public sector reform, energy subsidies, growth.
    JEL: E21 E63 H55 J26 J45
    Date: 2010–10
  4. By: Gianluca Benigno; Huigang Chen; Chris Otrok; Alessandro Rebucci; Eric Young
    Abstract: This paper analyzes quantitatively the extent to which there is overborrowing (i.e., inefficientborrowing) in a business cycle model for emerging market economies with production and anoccasionally binding credit constraint. The main finding of the analysis is that overborrowing is not arobust feature of this class of model economies: it depends on the structure of the economy and itsparametrization. Specifically, we find underborrowing in a production economy with our baselinecalibration, but overborrowing with more impatient agents and more volatile shocks. Endowmenteconomies display overborrowing regardless of parameter values, but they do not allow for policyintervention when the constraint binds (in crisis times). Quantitatively, the welfare gains fromimplementing the constrained-efficient allocation are always larger near crisis times than in normalones. In production economies, they are one order of magnitude larger than in endowment economiesboth i n crisis and normal times. This suggests that the scope for economy-wide macro-prudentialpolicy interventions (e.g. prudential taxation of capital flows and capital controls) is weak in this classof models.
    Keywords: Bailouts, financial frictions, macro prudential policies, overborrowing
    JEL: E52 F37 F41
    Date: 2010–10
  5. By: Laura Bisio; Andrea Faccini
    Abstract: The aim of this paper is to verify if a proper SVEC representation of a standard Real Business Cycle model exists even when the capital stock series is omitted. The argument is relevant as the common unavailability of su¢ ciently long medium-frequency capital series prevent researchers from including capital in the widespread structural VAR (SVAR) repre- sentations of DSGE models - which is supposed to be the cause of the SVAR biased estimates. Indeed, a large debate about the truncation and small sample bias affecting the SVAR performance in approximat- ing DSGE models has been recently rising. In our view, it might be the case of a smaller degree of estimates distorsions when the RBC dynamics is approximated through a SVEC model as the information provided by the cointegrating relations among some variables might compensate the exclusion of the capital stock series from the empirical representation of the model.
    Keywords: RBC, SVAR, SVEC model, cointegration.
    JEL: E27 E32 C32 C52
    Date: 2010–05
  6. By: Sunel, Enes
    Abstract: Evidence shows that globally observed disinflation in the last two decades has been more predominant in emerging economies. This paper undertakes a quantitative investigation of the distributional and welfare consequences of a sharp reduction in inflation in a monetary model of a small open economy with uninsured idiosyncratic earnings risk. Consumers hold non-interest bearing real balances (demand deposits) that economize transactions costs of consumption and internationally-traded risk-free bonds (term deposits) that are useful for consumption smoothing. Bonds are modeled as inflation-indexed to incorporate financial dollarization. Analytical results for deterministic economies show that alternative fiscal responses to inflationary finance create various redistributive wealth effects in addition to wealth-eroding and consumption-distorting effects of inflation. The stochastic model is calibrated to Turkish data and is used to compare stationary equilibria with quarterly inflation rates of 15% (for 1987:1-2003:4) and 2% (for 2004:1-2009:4) under alternative fiscal arrangements. I find that (i) when uniform transfers are endogenous, reducing inflation lowers aggregate welfare by 2.65% in terms of compensating consumption variation. This is because the reduction in the costs of inflation for the poor is less than the decrease in transfers. This also tightens natural debt limits, increases precautionary savings motive and causes the distribution of bonds to be more equitable. When endogenous transfers are proportional to individual-specific inflation tax payments, aggregate welfare increases by 0.5%. This is because proportional transfers do not drive redistributive effects. Welfare gains increase further (1.67%) if wasteful spending is endogenous. The model also generates a cross sectional portfolio consistent with the disaggregated deposits data and the literature.
    Keywords: Small open economy; incomplete markets; welfare effects of inflation
    JEL: D31 E52 F41
    Date: 2010–11–04
  7. By: William Addessi; Francesco Busato
    Abstract: This paper develops a two-sector dynamic general equilibrium model in which intertemporal fluctuations (and sectoral comovement) are driven by idiosyncratic shocks to relative preferences between consumption goods. This class of shocks may be interpreted as shifts in consumer tastes. When shifts in preferences occur, consumers associate a new and different level of satisfaction to the same basket of consumption goods according to the modified preferences. The paper shows that, if the initial composition of the consumption basket is sufficiently asymmetric, a shift in relative preferences produces a so strong "perception effect" capable of inducing inter and intra sectoral positive comovement of the main macroeconomic variables (i.e., output, consumption, investment, and employment). Furthermore, extending the theoretical framework to a multi-sector model and introducing a more flexible structure of the relative preference shock, we show that the parameter restrictions, necessary in order to observe sectoral comovement after a relative preference shock, are much less severe. In particular, the comovement between the most of the sectors emerges under general conditions, without requiring high asymmetry in the composition of the consumption basket and/or high aversion to risk. It is a welcome result that these findings are reached without introducing either aggregate technology shocks or input-output linkages, or shocks perturbing the relative preference between aggregate consumption and leisure.
    Keywords: Demand Shocks, Two-sector Dynamic General Equilibrium Models.
    JEL: F11 E32
    Date: 2010–05
  8. By: Takayuki Ogawa; Yoshiyasu Ono
    Abstract: In a Diamond-type overlapping-generations setting public debt issuanceplaces no burden on future generations including those who repay the debt if prices and wages are fixed and unemployment occurs in the periods in which public bonds are issued and repaid. Whether the collected fund is spent on government purchases or transfers to the present generation, public bond issuance stimulates aggregate demand and creates additional employment of future generations, which yields additional income that is large enough to cover their tax burden. This property is true whether the debt is repaid by children or grandchildren.
    Date: 2010–09
  9. By: Simona E. Cociuba; Alexander Ueberfeldt
    Abstract: From 1980 until 2007, U.S. average hours worked increased by thirteen percent, due to a large increase in female hours. At the same time, the U.S. labor wedge, measured as the discrepancy between a representative household’s marginal rate of substitution between consumption and leisure and the marginal product of labor, declined substantially. We examine these trends in a model with heterogeneous households: married couples, single males and single females. Our quantitative analysis shows that the shrinking gender wage gaps and increasing labor income taxes observed in U.S. data are key determinants of hours and the labor wedge. Changes in our model’s labor wedge are driven by distortionary taxes and non-distortionary factors, such as cross-sectional differences in households’ labor supply and productivity. We conclude that the labor wedge measured from a representative household model partly reflects imperfect household aggregation.
    Keywords: Labour markets; Economic models; Potential output
    JEL: E24 H20 H31 J22
    Date: 2010
  10. By: Lockwood, Ben (CBT, CEPR and Department of Economics, University of Warwick)
    Abstract: This paper considers the optimal taxation of savings intermediation and payment services in a dynamic general equilibrium setting, when the government can also use consumption and income taxes. When payment services are used in strict proportion to final consumption, and the cost of intermediation services is fixed and the same across firms, the optimal taxes are generally indeterminate. But, when firms differ exogenously in the cost of intermediation services, the tax on savings intermediation should be zero. Also, when household time and payment services are substitutes in transactions, the optimal tax rate on payment services is determined by the returns to scale in the conditional demand for payment services, and is generally different to the optimal rate on consumption goods. In particular, with constant returns to scale, payment services should be untaxed. These results can be understood as applications of the Diamond-Mirrlees production efficiency theorem. Finally, as an extension, we endogenize intermediation, in the form of monitoring, and show that it may be oversupplied in equilibrium when banks have monopoly power, justifying a Pigouvian tax in this caseKeywords:
    Keywords: financial intermediation services ; tax design ; banks ; monitoring ;payment services JEL Classification: G21 ; H21 ; H25
    Date: 2010
  11. By: Giovanni Lombardo (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: We show how to use a simple perturbation method to solve non-linear rational expectation models. Drawing from the applied mathematics literature we propose a method consisting of series expansions of the non-linear system around a known solution. The variables are represented in terms of their orders of approximation with respect to a perturbation parameter. The final solution, therefore, is the sum of the different orders. This approach links to formal arguments the idea that each order of approximation is solved recursively taking as given the lower order of approximation. Therefore, this method is not subject to the ambiguity concerning the order of the variables in the resulting state-space representation as, for example, has been discussed by Kim et al. (2008). Provided that the model is locally stable, the approximation technique discussed in this paper delivers stable solutions at any order of approximation. JEL Classification: C63, E0.
    Keywords: Solving dynamic stochastic general equilibrium models, Perturbation methods, Series expansions, Non-linear difference equations.
    Date: 2010–11
  12. By: Francesco Giuli; Massimiliano Tancioni
    Abstract: The debate on the response of hours worked after productivity improvements is still an open issue in the theoretical and empirical literature. In this work we show that, once conditional correlations are taken into account, both hours and investment decline temporarily following a positive technology shock. We first provide evidence about this apparent puzzle employing weakly identified SVECs. We then set-up and estimate a sticky price/wage DSGE model in which the presence of strategic complementarities in price setting lowers the slope of the New Keynesian Phillips curve, and show that the posterior impulse responses are consistent with the SVEC-based evidence.
    Keywords: technology shocks, investment dynamics, vector error correction model, Bayesian inference.
    JEL: E32 E22 C11
    Date: 2010–03
  13. By: Shutao Cao; Danny Leung
    Abstract: In Canada, temporary workers account for 14 per cent of jobs in the non-farm business sector, are present in a range of industries, and account for 40 per cent of the total job reallocation. Yet most models of job reallocation abstract from temporary workers. This paper evaluates the importance of temporary workers in job reallocation in a multi-sector model with costly labour adjustment and temporary workers. The calibrated model captures some features of job reallocation in Canada. The paper shows that the adjustment cost parameters for permanent workers are underestimated if temporary workers are ignored. It also shows that when a shock occurs where permanent workers bear the brunt of reallocation (e.g. the 2005-2008 commodity price boom and the appreciation of the Canadian dollar), aggregate adjustment costs are underestimated if temporary workers are not accounted for.
    Keywords: Labour markets; Productivity
    JEL: D24 J32
    Date: 2010
  14. By: Feicht, Robert; Stummer, Wolfgang
    Abstract: We consider a continuous-time neoclassical one-sector stochastic growth model of Ramsey-type with CRRA utility and Cobb-Douglas technology, where each of the following components are exposed to exogeneous uncertainties (shocks): capital stock K, effectiveness of labor A, and labor force L; the corresponding dynamics is modelled by a system of three interrelated stochastic differential equations. For this framework, we solve completely explicitly the problem of a social planner who seeks to maximize expected lifetime utility of consumption. In particular, for any (e.g. short-term) time-horizon t > 0 we obtain in closed form the sample paths of the economy values Kt,At, Lt and the optimal consumption copt(Kt,At, Lt) as well as the non-equilibrium sample paths of the per capita effective capital stock kt = Kt / At Lt . Moreover, we also deduce explicitly the limiting long-term behaviour of kt expressed by the corresponding steady-state equilibrium distribution. As illustration, we present some Monte Carlo simulations where the abovementioned economy is considerably disturbed (out of equilibrium) by a sudden crash but recovers well within a realistic-size time-period. --
    Keywords: stochastic Ramsey-type growth,utility maximization,stochastic differential equations,explicit closed-form sample path dynamics,economic recovery,Monte Carlo simulations,steady-state
    Date: 2010
  15. By: Cai, Wenbiao
    Abstract: This paper develops a general equilibrium model to quantitatively explain high labor share, low productivity and small farm size in agriculture in low income countries. The model features individual heterogeneity in skill that is augmentable over time and endogenous occupation choice. Calibrated to the U.S, the model can reproduce bulk of the observed variations in agriculture employment, agriculture output per worker and mean farm size across countries in the sample. In addition, the model generates endogenous farm size distributions that closely resemble the empirical counterpart for a large set of countries. Counterfactual exercises show TFP to be the main source of productivity differences.
    Keywords: Income differences; agricultural productivity; Skill investment; farm size distribution
    JEL: O11 O15 O13 O14
    Date: 2010–10–21
  16. By: Merwan Engineer; Ian King
    Abstract: The Human Development Index (HDI) is widely used as an aggregate measure of overall human well being. We examine the allocations implied by the maximization of this index, using a standard growth model — an extended version of Mankiw, Romer, andWeil’s (1992) model — and compare these with the allocations implied by the golden rule in that model. We find that maximization of the HDI leads to the overaccumulation of both physical and human capital, relative to the golden rule, and consumption is pushed to minimal levels. We then propose an alternative specification of the HDI, which replaces its income component with a consumption component. Maximization of this modified HDI yields a “human development golden rule” which balances consumption, education and health expenditures, and avoids the more extreme implications of the existing HDI.
    Keywords: Economic growth, Human Development Index, Planning
    Date: 2010
  17. By: Luis Araujo; Bernardo Guimaraes
    Abstract: A common belief among monetary theorists is that monetary equilibria are tenuous due to theintrinsic uselessness of fiat money (Wallace (1978)). In this article we argue that thetenuousness of monetary equilibria vanishes as soon as one introduces a small perturbation inan otherwise standard random matching model of money. Precisely, we show that the sheerbelief that fiat money may become intrinsically useful, even if only in an almost unreachablestate, might be enough to rule out nonmonetary equilibria. In a large region of parameters,agents' beliefs and behavior are completely determined by fundamentals.
    Keywords: Fiat money, autarky, equilibrium selection
    JEL: E40 D83
    Date: 2010–09
  18. By: Dalgaard, Carl-Johan; Strulik, Holger
    Abstract: Unified growth theory predicts that the timing of the fertility transition is a key determinant of contemporary comparative development, as it marks the onset of the take-off to sustained growth. Neoclassical growth theory presupposes a take-off, and explains comparative development by variations in (subsequent) investment rates. The present analysis integrates these two perspectives empirically, and shows that they together constitute a powerful predictive tool vis-a-vis contemporary income differences.
    Keywords: Comparative Development; Unified Growth Theory; Neoclassical Growth Theory
    JEL: O11 O57
    Date: 2010–11
  19. By: Kosuke Aoki; Gianluca Benigno; Nobuhiro Kiyotaki
    Abstract: We study theoretically how the adjustment to liberalization of international financialtransaction depends upon the degree of domestic financial development. Using a model withdomestic and international borrowing constraints, we show that, when the domestic financialsystem is underdeveloped, capital account liberalization is not necessarily beneficial becauseTFP stagnates in the long-run or employment decreases in the short-run. Government policy,including allowing foreign direct investment, can mitigate the possible loss of employment,but cannot eliminate it unless the domestic financial system is improved.
    Keywords: credit frictions, capital account liberalization
    JEL: F32
    Date: 2010–10

This nep-dge issue is ©2010 by Christian Zimmermann. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.