nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2010‒11‒20
fifteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Optimal Unemployment Insurance over the Business Cycle By Camille Landais; Pascal Michaillat; Emmanuel Saez
  2. Fertility, Female Labor Supply, and Family Policy By Hans Fehr; Daniela Ujhelyiova
  3. Estimating Incentive and Welfare Effects of Non-Stationary Unemployment Benefits By Andrey Launov; Klaus Wälde
  4. Increasing Returns and Unsynchronized Wage Adjustment in Sunspot Models of the Business Cycle By Kevin X.D. Huang; Qinglai Meng
  5. How Optimism Leads to Price Discovery and Efficiency in a Dynamic Matching Market By Dipjyoti Majumdar; Artyom Shneyerov; Huan Xie
  6. Firm leverage, household leverage and the business cycle By Solomon, Bernard Daniel
  7. International Capital Flows and Credit Market Imperfections: a Tale of Two Frictions By Alberto Martin; Filippo Taddei
  8. Reform and backlash to reform : economic effects of ageing and retirement policy By Jensen, Svend E. Hougaard; Jorgensen, Ole Hagen
  9. Search, Wage Posting, and Urban Spatial Structure By Zenou, Yves
  10. Model Nash Bargaining, Credible Bargaining and Efficiency Wages in a Matching Model for the US By James M. Malcomson; Sophocles Mavroeidis
  11. The Price of Egalitarianism By Yongsung Chang; Sun-Bin Kim
  12. Prices and volumes of options: A simple theory of risk sharing when markets are incomplete By Le Grand, F.; Ragot, X.
  13. A Defense of the Current US Tax Treatment of Employer-Provided Medical Insurance By Kevin X. D. Huang; Gregory W. Huffman
  14. Incomplete markets, liquidation risk, and the term structure of interest rates By Challe, E.; Le Grand, F.; Ragot, X.
  15. A Comparison of Parametric Approximation Techniques to Continuous-Time Stochastic Dynamic Programming Problems By Tom Kompas; Long Chu

  1. By: Camille Landais; Pascal Michaillat; Emmanuel Saez
    Abstract: This paper analyzes optimal unemployment insurance over the business cycle in a search model in which unemployment stems from matching frictions (in booms) and job rationing (in recessions). Job rationing during recessions introduces two novel effects ignored in previous studies of optimal unemployment insurance. First, job-search efforts have little effect on aggregate unemployment because the number of jobs available is limited, independently of matching frictions. Second, while job-search efforts increase the individual probability of finding a job, they create a negative externality by reducing other jobseekers’ probability of finding one of the few available jobs. Both effects are captured by the positive and countercyclical wedge between micro-elasticity and macro-elasticity of unemployment with respect to net rewards from work. We derive a simple optimal unemployment insurance formula expressed in terms of those two elasticities and risk aversion. The formula coincides with the classical Baily-Chetty formula only when unemployment is low, and macro- and micro-elasticity are (almost) equal. The formula implies that the generosity of unemployment insurance should be countercyclical. We illustrate this result by simulating the optimal unemployment insurance over the business cycle in a dynamic stochastic general equilibrium model calibrated with US data.
    JEL: E24 E32 H21 H23
    Date: 2010–11
  2. By: Hans Fehr; Daniela Ujhelyiova
    Abstract: The present paper develops a general equilibrium model with overlapping generations and endogenous fertility in order to analyze the interaction between public policy and household labor supply and fertility decisions. The model's benchmark equilibrium reflects the current family policy as well as the differential fertility pattern of educational groups in Germany. Then we simulate alternative reforms of child benefits and family taxation that increase the long-run fertility and growth rate of the economy. Our simulations indicate two central results: First, although households are typically hurt by the first-order effects of family policy, it is possible to generate long-run welfare gains due to positive second-order effects from induced changes in the population structure. Second, specific family policies could be designed that yield a joint increase of the fertility rate and female employment rate as observed in cross-country studies.
    Keywords: stochastic fertility, general equilibrium life cycle model
    JEL: J12 J22
    Date: 2010
  3. By: Andrey Launov; Klaus Wälde
    Abstract: The distribution of unemployment duration in our equilibrium matching model with spell-dependent unemployment benefits displays a time-varying exit rate. Building on Semi-Markov processes, we translate these exit rates into an expression for the aggregate unemployment rate. Structural estimation using a German micro-data set (SOEP) allows us to discuss the effects of a recent unemployment benefit reform (Hartz IV). The reform reduced unemployment by only 0:3%. Contrary to general beliefs, we find 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 benefits, endogenous effort, matching model, structural estimation, Semi-Markov process
    JEL: E24 J64 J68 C13
    Date: 2010
  4. By: Kevin X.D. Huang (Department of Economics, Vanderbilt University); Qinglai Meng (Department of Economics, Oregon State University, Department of Economics, Chinese University of Hong Kong)
    Abstract: A challenge facing the literature of equilibrium indeterminacy and sunspot-driven business cycle fluctuations based on increasing returns to scale in production is that the required degree of increasing returns for generating indeterminacy can be implausibly large and rise quickly with the relative risk aversion in labor. We show that unsynchronized wage adjustment via a relative wage effect can both lower the required degree of increasing returns for indeterminacy to an empirically plausible level and make it invariant to the relative risk aversion in labor. As a result, indeterminacy and sunspot-driven business cycle fluctuations may emerge for empirically plausible increasing returns regardless of the value of the relative risk aversion in labor. The impulse responses of our model to demand shocks under indeterminacy are reasonable in terms of matching the business cycle, and sunspot shocks become more important due to the presence of labor market frictions.
    Keywords: Increasing returns, Unsynchronized wage adjustment, Relative wages, Relative risk aversion in labor, Indeterminacy, Sunspot
    JEL: E12 E31 E52
    Date: 2010–03
  5. By: Dipjyoti Majumdar (Concordia University); Artyom Shneyerov (Concordia University); Huan Xie (Concordia University)
    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: 2010–10–22
  6. By: Solomon, Bernard Daniel
    Abstract: This paper develops a macroeconomic model of the interaction between consumer debt and firm debt over the business cycle. I incorporate interest rate spreads generated by firm and household loan default risk into a real business cycle model. I estimate the model on US aggregate data. This allows me to analyse the quantitative importance of possible feedback effects between the debt levels of firms and households, and the relative contributions of financial and supply shocks to economic fluctuations. While firm level credit market frictions significantly amplify the response of investment to shocks, they do not amplify output responses. In general equilibrium, higher external financing spreads for households contribute to lower external financing spreads for firms, contrary to traditional Keynesian predictions. Furthermore, total factor productivity shocks remain an important source of business cycles in my model. They are responsible for 71 - 74% of the variance of output and 56 - 69% of the variance of consumption in the model. Financial shocks are important in explaining interest rate spreads and leverage ratios, but they account for less than 11% of the fluctuations in output. My results suggest that other factors, beyond credit market frictions on their own, are necessary to justify an important role for financial shocks in aggregate output fluctuations.
    Keywords: Financial frictions; external finance premium; DSGE models; Bayesian estimation; business cycles
    JEL: E43 E32 E44 E21 C11
    Date: 2010–10–30
  7. By: Alberto Martin; Filippo Taddei
    Abstract: The financial crisis of 2007-08 has underscored the importance of adverse selection in financial markets. This friction has been mostly neglected by macroeconomic models of financial frictions, however, which have focused almost exclusively on the effects of limited pledgeability. In this paper, we fill this gap by developing a standard growth model with adverse selection. Our main results are that, by fostering unproductive investment, adverse selection: (i) leads to an increase in the economy's equilibrium interest rate, and (ii) it generates a negative wedge between the marginal return to investment and the equilibrium interest rate. Under financial integration, we show how this translates into excessive capital inflows and endogenous cycles. We also explore how these results change when limited pledgeability is added to the model. We conclude that both frictions complement one another and argue that limited pledgeability exacerbates the effects of adverse selection.
    Keywords: Limited Pledgeability; Asymmetric Information; International Capital Flows; Credit Market Imperfections
    JEL: D53 D82 E22 F34
    Date: 2010
  8. By: Jensen, Svend E. Hougaard; Jorgensen, Ole Hagen
    Abstract: Using a stochastic general equilibrium model with overlapping generations, this paper studies (i) the effects on both extensive and intensive labor supply responses to changes in fertility rates, and (ii) the potential of a retirement reform to mitigate the effects of fertility changes on labor supply. In order to neutralize the effects on effective labor supply of a fertility decline, a retirement reform, designed to increase labor supply at the extensive margin, is found to simultaneously reduce labor supply at the intensive margin. This backlash to retirement reform requires the statutory retirement age to increase more than proportionally to fertility changes in order to compensate for endogenous responses of the intensity of labor supply. The robustness of this result is checked against alternative model specifications and calibrations relevant to an economic region such as Europe.
    Keywords: Labor Policies,Labor Markets,Pensions&Retirement Systems,Economic Theory&Research,Population Policies
    Date: 2010–11–01
  9. By: Zenou, Yves (Dept. of Economics, Stockholm University)
    Abstract: We develop an urban-search model in which firms post wages. When all workers are identical, there is a unique wage in equilibrium even in the presence of search and spatial frictions. This wage is affected by spatial and labor costs. When workers differ according to the value imputed to leisure, we show that, under some conditions, two wages emerge in equilibrium. The commuting cost affects the land market but also the labor market through wages. Workers’ productivity also affects housing prices and this impact can be positive or negative depending on the location in the city. We then run some numerical simulations to reproduce some stylized facts about the labor-market outcomes of black and white workers. We find that a reduction in commuting costs for all workers reduces the unemployment rate of white workers and the profit of all firms but increases the wage of all workers (black and white) and raises the fraction of firms posting the high wage.
    Keywords: Diamond paradox; urban land-use; spatial compensation; search frictions; wage dispersion
    JEL: D83 J64 R14
    Date: 2010–11–08
  10. By: James M. Malcomson; Sophocles Mavroeidis
    Abstract: This paper incorporates Nash bargaining, credible bargaining and efficiency wages as special cases of an over-arching model of wage determination in a matching model that is used to assess econometrically how well each fits US data. With Nash bargaining, estimates for worker bargaining power and the value of non-work activity are almost identical to those calibrated by Hagedorn and Manovskii (2008). However, the over-identifying restrictions are overwhelmingly rejected statistically, as they are for credible bargaining. Efficiency wages fit the data better, with the over-identifying restrictions not rejected statistically, and result in a lower, more plausible estimated value of non-work activity.
    Keywords: Matching frictions, wage bargaining, efficiency wages, unemployment, shirking
    JEL: E2 J3 J6
    Date: 2010
  11. By: Yongsung Chang (University of Rochester); Sun-Bin Kim (Department of Economics, Korea University)
    Abstract: We compute the welfare cost of egalitarianism—a tax policy that equalizes wages for all. The benchmark “laissez-faire†economy has features a la Aiyagari (1994) with endogenous labor supply. A progressive income tax provides insurance against income risks but at the cost of efficiency: it undermines highly productive workers’ incentives to work. We find that in an economy with the labor-supply elasticity of 1, the welfare cost of egalitarianism, measured in consumption-equivalence units, is only 1% as the welfare gain from insurance against income risks nearly offsets the efficiency loss from distorting labor effort. However, with an elastic labor supply, the welfare cost of egalitarianism is as large as 7.5% of steady state consumption.
    Keywords: Egalitarianism; Welfare Cost; Equal-Wage Policy; Income Risks.
    JEL: E2 E6 J3
    Date: 2010–10
  12. By: Le Grand, F.; Ragot, X.
    Abstract: We present a simple theory of business-cycle movements of option prices and volumes. This theory relies on time-varying heterogeneity between agents in their demand for insurance against aggregate risk. Formally, we build an infinite-horizon model where agents face an aggregate risk, but also different levels of idiosyncratic risk. We manage to characterize analytically a general equilibrium in which positive quantities of derivatives are traded. This allows us to explain the informational content of derivative volumes over the business cycle. We also carry out welfare analysis with respect to the introduction of options, which appears not to be Pareto-improving.
    Keywords: Option Pricing, Open Interest, Incomplete Markets.
    JEL: G1 G10 E44
    Date: 2010
  13. By: Kevin X. D. Huang (Department of Economics, Vanderbilt University); Gregory W. Huffman (Department of Economics, Vanderbilt University)
    Abstract: The US tax system currently provides an incentive for individuals to obtain medical insurance through their employers. This feature introduces a distortion which encourages households consume more medical services than they otherwise would, and likely results in the medical consumption taking up 17 percent total consumption, which is much higher than in other advanced economies. This unusual and unique tax treatment is widely excoriated as resulting in high costs and distorting consumption decisions. This paper presents a simple general equilibrium model to compare the outcomes for different systems for the provision of medical services. It is shown that the current tax system may be superior to an identical system in which the tax subsidy is absent. It also is shown that eliminating the tax subsidy for employer-provided medical insurance results in higher unemployment, lower output, and lower welfare. Furthermore, having the government raise taxes to finance the provision of medical care results in substantial decreases in employment, output and welfare.
    Keywords: Tax, employment, medical benefit, welfare
    JEL: E2 E6 H2 H3 I1
    Date: 2010–02
  14. By: Challe, E.; Le Grand, F.; Ragot, X.
    Abstract: We analyze the term structure of real interest rates in a general equilibrium model with incomplete markets and borrowing constraints. Agents are subject to both aggregate and idiosyncratic income shocks, which latter may force them into early portfolio liquidation in a bad aggregate state. We derive a closed-form equilibrium with limited agent heterogeneity (despite market incompleteness), which allows us to produce analytical expressions for bond prices and returns at any maturity. The attractiveness of bonds as liquidity makes aggregate bond demand downward-sloping, so that greater bond supply raises both the level and the slope of the yield curve. Moreover, time-variations in liquidation risk are shown to help explain the rejection of the Expectations Hypothesis.
    Keywords: Incomplete markets; yield curve; borrowing constraints.
    JEL: E21 E43 G12
    Date: 2010
  15. By: Tom Kompas (Crawford School of Economics and Government, and The Australian Centre for Biosecurity and Environmental Economics, Australian National University); Long Chu (Crawford School of Economics and Government, Australian National University)
    Abstract: We compare three parametric techniques to approximate Hamilton-Jacobi-Bellman equations via unidimensional and multidimensional problems. The linear programming technique is very efficient for unidimensional problems and offers a balance of speed and accuracy for multidimensional problems. A comparable projection technique is shown to be slow, but has stable accuracy, whereas a perturbation technique has the least accuracy although its speed suffers least from the curse of dimensionality. The linear programming technique is also shown to be suitable for problems in resource management, including applications to biosecurity and marine reserve design.
    Date: 2010–09

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