nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2010‒11‒27
twenty-six papers chosen by
Christian Zimmermann
University of Connecticut

  1. Products, patents and productivity persistence: A DSGE model of endogenous growth By Tom Holden
  2. How does multinational production change international comovement? By Silvio Contessi
  3. A Forecasting Metric for Evaluating DSGE Models for Policy Analysis By Gupta, Abhishek
  4. "Hysteresis in Dynamic General Equilibrium Models with Cash-in-Advance Constraints" By Kazuya Kamiya; Takashi Shimizu
  5. Endogenous Separation, Wage Rigidity and theDynamics of Unemployment By Daniel Tortorice
  6. Interpreting life-cycle inequality patterns as an efficient allocation: mission impossible? By Alejandro Badel; Mark Huggett
  7. Posterior Predictive Analysis for Evaluating DSGE Models By Faust, Jon; Gupta, Abhishek
  8. International Capital Flows and Aggregate Output By Juergen von Hagen; Haiping zhang
  9. A Search Model in a Segmented Labour Market: the Odd Role of Unions By Chiara BROCCOLINI; Marco LILLA; Stefano STAFFOLANI
  10. Crime, Immigration and the Labor Market: A General Equilibrium Model By Thomas Bassetti, Luca Corazzini, Darwin Cortes
  11. Is History a Blessing or a Curse? International Borrowing without Commitment, Leapfrogging and Growth Reversals By Raouf Boucekkine; Patrick-Antoine Pintus
  12. Channel systems: Why is there a positive spread? By Aleksander Berentsen; Alessandro Marchesiani; Christopher J. Waller
  13. Numerical Explorations of the Ngai-Pissarides Model of Growth and Structural Change By Dietrich, Andreas; Krüger, Jens
  14. Life span and the problem of optimal population size By Raouf Boucekkine; Giorgio Fabbri; Fausto Gozzi
  15. Channel systems: why is there a positive spread? By Aleksander Berentsen; Alessandro Marchesiani; Christopher J. Waller
  16. Understanding permanent black-white earnings inequality By Alejandro Badel
  17. Home Equity, Mobility, and Macroeconomic Fluctuations By Vincent Sterk
  18. Consumption Smoothing and the Equity Premium By Benjamin Eden
  19. Search, Migration, and Urban Land Use: The Case of Transportation Policies By Zenou, Yves
  20. The distributional consequences of supply-side reforms in general equilibrium By Konstantinos Angelopoulos; Bernardo X. Fernandez; James Malley
  21. Social Security and the job search behavior of workers approaching retirement By Jose Ignacio García Pérez; Alfonso R. Sánchez Martín
  22. Industrialization and the role of government By Takeuchi, Nobuyuki
  23. Pricing-to-market and business cycle synchronization By Luciana Juvenal; Paulo Santos Monteiro
  24. Fiscal stimulus in model with endogenous firm entry By Totzek, Alexander; Winkler, Roland C.
  25. Real Estate, the External Finance Premium and Business Investment: A Quantitative Dynamic General Equilibrium Analysis By Jin, Yi; Leung, Charles Ka Yui; Zeng, Zhixiong
  26. Entry dynamics and the decline in exchange-rate pass-through By Christopher Gust; Sylvain Leduc; Robert Vigfusson

  1. By: Tom Holden
    Abstract: This paper builds a dynamic stochastic general equilibrium (DSGE) model of endogenous growth that is capable of generating substantial degrees of endogenous persistence in productivity. When products go out of patent protection, the rush of entry into their production destroys incentives for process improvements. Consequently, old production processes are enshrined in industries producing non-protected products, resulting in aggregate productivity persistence. Our model also generates sizeable delayed movements in productivity in response to preference shocks, providing a form of endogenous news shock. Finally, if we calibrate our model to match a high aggregate mark-up then we can replicate the negative response of hours to a positive technology shock, even without the inclusion of any frictions.
    Keywords: Productivity persistence, patent protection, oligopoly, research and development
    JEL: E32 E37 L16 O31 O33 O34
    Date: 2010
  2. By: Silvio Contessi
    Abstract: I study the aggregate implications of the entry of Multinational Firms (MNFs) in a two country Dynamic Stochastic General Equilibrium model in which firms have heterogeneous productivity in the sense of Ghironi and Melitz (2005). Unlike the extant open economy macroeconomics literature, this model endogenizes both multinational production and exports as possible strategies of internationalization of production, a feature that substantially improves the match between model-simulated moments and business cycle data along two dimensions. First, once I allow for concurrent entry (and exit) of MNFs and exporters over the business cycle, the consumption output anomaly disappears and I can successfully replicate the ranking of cross-country correlations of output and consumption found in the data. Second, I show that the model with heterogeneous MNFs is capable of bringing the simulated volatility of the Real Exchange Rate much closer to the data than previous models with either representative or heterogeneous exporters.>
    Keywords: Business cycles ; International business enterprises
    Date: 2010
  3. By: Gupta, Abhishek
    Abstract: This paper evaluates the strengths and weaknesses of dynamic stochastic general equilibrium (DSGE) models from the standpoint of their usefulness in doing monetary policy analysis. The paper isolates features most relevant for monetary policymaking and uses the diagnostic tools of posterior predictive analysis to evaluate these features. The paper provides a diagnosis of the observed flaws in the model with regards to these features that helps in identifying the structural flaws in the model. The paper finds that model misspecification causes certain pairs of structural shocks in the model to be correlated in order to fit the observed data.
    Keywords: Posterior predictive analysis; DSGE; Monetary Policy; Forecast Errors; Model Evaluation.
    JEL: E58 C52 E1 C11
    Date: 2010–10–30
  4. By: Kazuya Kamiya (Faculty of Economics, University of Tokyo); Takashi Shimizu (Faculty of Economics, Kansai University)
    Abstract: In this paper, we investigate equilibrium cycles in dynamic general equilibrium models with cash-in-advance constraints. Our findings are two-fold. First, in such models, if an equilibrium cycle exists, then there also exists a continuum of equilibrium cycles in its neighborhood. Second, the limit cycle, to which a dynamic path converges, varies continuously according to the initial distribution of the money holdings. Thus, temporary shocks that affect the initial distribution have permanent effects in such models; that is, such models exhibit hysteresis. Furthermore, we also explore the logic behind the results.
    Date: 2010–10
  5. By: Daniel Tortorice (Department of Economics, Brandeis University)
    Abstract: This paper shows that the Mortensen-Pissarides (MP) model requires endogenous separation to explain the volatility of unemployment. I estimate a version of the MP model with wage rigidity and permanent shocks to match productivity. The model generates sufficient volatility in unemployment, vacancies, job-finding and job-separation despite relatively low worker outside options. I then re-estimate the model while restricting the separation rate to be constant and show that, even though the estimation procedure finds the best fitting model, the model predicts too little variance in unemployment and too much variance in the job-finding rate. Based on this result I conclude that models of unemployment fluctuations need endogenous separation rates to explain unemployment fluctuations.
    Keywords: Unemployment, Search Models, Business Cycles
    JEL: J64 E24 E32
    Date: 2010–09
  6. By: Alejandro Badel; Mark Huggett
    Abstract: Data on consumption, earnings, wages and hours dispersion over the life cycle is commonly viewed as incompatible with a Pareto efficient allocation. We show that a model with preference and wage shocks and full insurance produces the rise in consumption, wages and hours dispersion over the life cycle found in U.S. data. The efficient allocation model requires an increasing preference shifter dispersion profile to account for an increasing consumption dispersion profile. We examine U.S. data and find support for the view that the dispersion in preference shifters increases with age.>
    Keywords: Consumption (Economics) ; Econometric models
    Date: 2010
  7. By: Faust, Jon; Gupta, Abhishek
    Abstract: In this paper, we develop and apply certain tools to evaluate the strengths and weaknesses of dynamic stochastic general equilibrium (DSGE) models. In particular, this paper makes three contributions: One, it argues the need for such tools to evaluate the usefulness of the these models; two, it defines these tools which take the form of prior and particularly posterior predictive analysis and provides illustrations; and three, it provides a justification for the use of these tools in the DSGE context in defense against the standard criticisms for the use of these tools.
    Keywords: Prior and posterior predictive analysis; DSGE Model Evaluation; Monetary Policy.
    JEL: C52 E1 C11
    Date: 2010–10–30
  8. By: Juergen von Hagen (University of Bonn); Haiping zhang (School of Economics, Singapore Management University)
    Abstract: We develop a tractable multi-country overlapping-generations model and show that cross-country differences in financial development explain three recent empirical patterns of international capital flows. Domestic financial frictions in our model distort interest rates and aggregate output in the less financially developed countries. International capital flows help ameliorate the two distortions.International flows of financial capital and foreign direct investment a ect aggregate output in each country directly through affecting the size of aggregate investment. In addition, they affect aggregate output indirectly through affecting the composition of aggregate investment and the size of aggregate savings. Under certain conditions, the indirect effects may dominate the direct effects so that, despite "uphill" net capital flows, full capital mobility may raise the steady-state aggregate output in the poor country as well as raise world output. However, if foreign direct investment is restricted, "uphill" financial capital flows strictly reduce the steady-state aggregate output in the poor countries and it is more likely that the steady-state world output is lower than under international financial autarky.
    Keywords: Capital account liberalization, financial frictions, financial development, foreign direct investment, world output gains
    JEL: E44 F41
    Date: 2010–05
  9. By: Chiara BROCCOLINI (Universita' Politecnica delle Marche, Dipartimento di Economia); Marco LILLA (Universita' Politecnica delle Marche, Dipartimento di Economia); Stefano STAFFOLANI (Universita' Politecnica delle Marche, Dipartimento di Economia)
    Abstract: Assuming random matching productivity, we present a search equilibrium model where each match ends in a vacancy, in a temporary job or in a permanent job. Centralized bargaining sets the wage rate of permanent workers whereas rms decide unilaterally the wage rate of temporary workers. In this segmented labour market: a) the wage setting function can be downward sloping; b) higher union bargaining power leads to higher wage and higher unemployment; c) average worker productivity shows a maximum with respect to union bargaining power.
    Keywords: Productivity, Search Model, Temporary contract, Unemployment, Unions
    JEL: J31 J51 J64
    Date: 2010–10
  10. By: Thomas Bassetti, Luca Corazzini, Darwin Cortes
    Abstract: Does immigration cause crime? To answer this question, we build a two-country general equilibrium model with search costs in which the migration (in/out-)flows, the crime rates and the equilibrium wages in the two countries are determined by the interaction between the labor market, the crime market and the decision to migrate. The main result of our model is that, in equilibrium, the relationship between immigration and crime depends on the conditions of both the labor and crime markets of the two countries. In particular, when the tightness of the labor market is sufficiently elastic relative to that of the crime market, immigration causes a reduction in the domestic crime rate of the host country. An implication of this result is that migration flows from countries with strong work rigidities to societies characterized by more elastic labor markets are mutually benefic in terms of reducing the corresponding crime rates.
    Keywords: Crime Rate, Labor Market, Immigration.
    JEL: J61 J64 K42
    Date: 2010–11
  11. By: Raouf Boucekkine (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille II - Université Paul Cézanne - Aix-Marseille III - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - CNRS : UMR6579); Patrick-Antoine Pintus (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille II - Université Paul Cézanne - Aix-Marseille III - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - CNRS : UMR6579)
    Abstract: We develop a simple open-economy AK model with collateral constraints that accounts for growth-reversal episodes, during which countries face abrupt changes in their growth rate that lead to either growth miracles or growth disasters. Absent commitment to investment by the borrowing country, imperfect contract enforcement leads to an informational lag such that the debt contracted upon today depends upon the past stock of capital. The no-commitment delay originates a history effect by which the richer a country has been in the past, the more it can borrow today. For (arbitrarily) small deviations from perfect contract enforcement, the history effect offsets the growth benefits from international borrowing and dampens growth, and it leads to leapfrogging in long-run levels. When large enough, the history effect originates growth reversals and we connect the latter to leapfrogging. Finally, we argue that the model accords with the reported evidence on growth disasters and growth accelerations. We also provide examples showing that leapfrogging and growth reversals may coexist, so that currently poor but fast-growing countries experiencing sharp growth reversals may end up, in the long-run, significantly richer than currently rich but declining countries.
    Keywords: Growth Reversals; Leapfrogging; International Borrowing; Open Economies
    Date: 2010
  12. By: Aleksander Berentsen; Alessandro Marchesiani; Christopher J. Waller
    Abstract: An increasing number of central banks implement monetary policy via two standing facilities: a lending facility and a deposit facility. In this paper we show that it is socially optimal to implement a non-zero interest rate spread. We prove this result in a dynamic general equilibrium model where market participants have heterogeneous liquidity needs and where the central bank requires government bonds as collateral. We also calibrate the model and discuss the behavior of the money market rate and the volumes traded at the ECB’s deposit and lending facilities in response to the recent financial crisis.
    Date: 2010
  13. By: Dietrich, Andreas; Krüger, Jens
    Abstract: In this paper we specialize the Ngai-Pissarides model of growth and structural change [American Economic Review 97 (2007), 429-443] to the case of three sectors, representing the primary (agriculture, mining), secondary (construction, manufacturing) and tertiary (services) sectors. On that basis we explore the dynamic properties of the model along the transition path to the steady-state equilibrium by numerical methods. Our explorations show that the model misses several stylized facts of structural change among these sectors. We propose several extensions of the model to align the model more closely with the facts.
    Keywords: economic growth, structural change, transition path
    Date: 2010–10
  14. By: Raouf Boucekkine (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille II - Université Paul Cézanne - Aix-Marseille III - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - CNRS : UMR6579); Giorgio Fabbri (Dipartimento Matematica e statistica - Université de Naples); Fausto Gozzi (Dipartimento di Scienze Economiche e Aziendali - Libera Università INTERNAZIONALE DEGLI STUDI SOCIALI G. CARLI)
    Abstract: We reconsider the optimal population size problem in a continuous time economy populated by homogenous cohorts with a fixed life span. This assumption is combined with a linear production function in the labor input and standard rearing costs. A general social welfare function is specified, admitting the Millian and Benthamite cases as polar parameterizations. It is shown that if the lifetime is low enough, population is asymptotically driven to extinction whatever the utility function and the level of inter-generational altruism. Moreover, population is driven to extinction at finite time whatever the values of lifetime and altruism provided the utility function is negative. When the utility function is positive, it is shown that the Millian welfare function leads to optimal extinction at finite time whatever the lifetime. In contrast, the Benthamite case is much more involved: for isoelastic positive utility functions, it gives rise to two threshold lifetime values, say T_0 < T_1: below T_0, finite time extinction is optimal; above T_1, balanced growth paths are optimal. In between, asymptotic extinction is optimal. Last, intermediate welfare functions are studied, resulting in more complex optimal consumption and fertility dynamics compared to the two polar cases but delivering similar optimal extinction features.
    Keywords: Optimal population size; Benthamite Vs Millian criterion; finite lives; optimal extinction; optimal control of infinite dimensioned problems
    Date: 2010
  15. By: Aleksander Berentsen; Alessandro Marchesiani; Christopher J. Waller
    Abstract: An increasing number of central banks implement monetary policy via two standing facilities: a lending facility and a deposit facility. In this paper we show that it is socially optimal to implement a non-zero interest rate spread. We prove this result in a dynamic general equilibrium model where market participants have heterogeneous liquidity needs and where the central bank requires government bonds as collateral. We also calibrate the model and discuss the behavior of the money market rate and the volumes traded at the ECB’s deposit and lending facilities in response to the recent financial crisis.
    Keywords: Monetary policy, open market operations, standing facilities
    JEL: E52 E58 E59
    Date: 2010–11
  16. By: Alejandro Badel
    Abstract: Average annual earnings of black US households have remained at around half the average earnings of white households for more than 30 years. Why are the earnings of black households so low compared to those of white households? Why can blackwhite earnings inequality of such magnitude be permanent? This paper provides a quantitative answer based on neighborhood effects. The economic and demographic characteristics of neighborhoods and the distribution of earnings are determined endogenously from the location and investment decisions of altruistic parents. Permanent racial inequality arises from residential segregation by race and earnings coupled with neighborhood effects that impact the productivity of parental investments. The model is calibrated by targeting observed segregation by race, segregation by earnings, housing price differences across neighborhoods, intergenerational earnings mobility, and the magnitude of parental investments in children. The benchmark steady state earnings distribution accounts for .72 of the observed black-white percent difference in household earnings. The paper argues that local housing markets, local human capital externalities and racial neighborhood preferences are necessary ingredients in explaining permanent black white inequality.>
    Keywords: Income distribution ; Wages -- Social aspects -- United States
    Date: 2010
  17. By: Vincent Sterk
    Abstract: How does a fall in house prices affect real activity? This paper presents a business cycle model in which a decline in house prices reduces geographical mobility, creating distortions in the labor market. This happens because homeowners face declines in their home equity levels, after which it becomes more difficult to provide the down-payment required for a new mortgage loan. Unemployed homeowners therefore turn down job offers that would require them to move. The model explains joint cyclical patterns in housing and labor market aggregates, as well as the puzzling breakdown of the U.S. Beveridge curve that occurred during 2009.
    Keywords: Housing Markets; Labor Markets; Refinancing Constraints
    JEL: E24 E44 R21
    Date: 2010–10
  18. By: Benjamin Eden (Department of Economics, Vanderbilt University)
    Abstract: The paper investigates the role of the Intertemporal Elasticity of Substitution () in determining the equity premium. This is done in an overlapping generations economy populated by agents that live for 2 periods and maximize a Kihlstrom-Mirman expected utility function. The equity premium depends both on the demand for smoothing as measured by the inverse of and on risk aversion but the first seems to play a more important role. The paper also attempts to understand the difference between the predictions of a 2 periods Kihlstrom-Mirman expected utility and the predictions of a 2 periods Epstein-Zin-Weil utility.
    Keywords: Fluctuations Aversion, Risk Aversion, Asset Prices, Equity Premium Puzzle, Risk Free Rate Puzzle
    JEL: D11 D81 D91 G12
    Date: 2010–11
  19. By: Zenou, Yves (Stockholm University)
    Abstract: We develop a search-matching model with rural-urban migration and an explicit land market. Wages, job creation, urban housing prices are endogenous and we characterize the steady-state equilibrium. We then consider three different policies: a transportation policy that improves the public transport system in the city, an entry-cost policy that encourages investment in the city and a restricting-migration policy that imposes some costs on migrants. We show that all these policies can increase urban employment but the transportation policy has much more drastic effects. This is because a decrease in commuting costs has both a direct positive effect on land rents, which discourages migrants to move to the city, and a direct negative effect on urban wages, which reduces job creation and thus migration. When these two effects are combined with search frictions, the interactions between the land and the labor markets have amplifying positive effects on urban employment. Thus, improving the transport infrastructure in cities can increase urban employment despite the induced migration from rural areas.
    Keywords: rural-urban migration, transportation policies, entry costs, restricting migration
    JEL: D83 J61 O18 R14
    Date: 2010–11
  20. By: Konstantinos Angelopoulos; Bernardo X. Fernandez; James Malley
    Abstract: This paper addresses the issue on whether tax reforms consistent with lower public debt-to-GDP in the long-run can lead to a more efficient and equitable economy. To this end we solve a heterogeneous agent model comprised of a government, a representative capitalist and representative skilled and unskilled workers, under both rational expectations and adaptive learning. Our main findings are that (i) reductions in capital taxation, while beneficial at the aggregate level, lead to increased inequality mainly due to the substitutability of un- skilled labour and capital; (ii) a fall in taxation for skilled labour is Pareto improving, which is largely explained by its complementarity with the other factor inputs; (iii) all agents would prefer increasing the tax rate on capital to increasing the tax rate on skilled and un- skilled labour since it leads to relatively lower welfare losses; and (iv) heterogeneity in initial beliefs under adaptive learning quantitatively matters for welfare.
    Keywords: tax reform, structural heterogeneity, inequality, adaptive learning
    JEL: E25 E62
    Date: 2010–11
  21. By: Jose Ignacio García Pérez; Alfonso R. Sánchez Martín
    Abstract: This paper explores the links between unemployment, retirement and their associated public insurance programs. The analysis combines the development of a life-cycle model of search and retirement with a detailed exploration of the empirical regularities using a Spanish administrative data-set based on employment histories. Our ultimate goal is to uncover the relative contribution of bad institutional incentives versus poor labor demand to the observed low reemployment rates of Spanish workers aged 55 or over. We find that the low labor supply of the unemployed younger than 60 (the minimum retirement age) is, according to our model, largely the product of the poor conditions in the Spanish labor market. The disincentives in the regulations would not stop these workers from searching if presented with higher job offer rates. In sharp contrast, improvements in incentives will make a real difference for workers over 60. In particular, we explore the effects of changing the pension rules to link early retirement penalties to the age when the individual stops paying contributions. This reform removes the incentive to stay unemployed without searching, encouraging individuals to either retire or actively engage in a search process. As a result, the implicit fnancial liabilities of the pension system are reduced, to the extent that it would be possible to compensate all the workers that suffer direct welfare losses through the reform.
    Date: 2010–10
  22. By: Takeuchi, Nobuyuki
    Abstract: We construct a two-sector endogenous growth model to examine the role of government in industrialization. Three main features of this model are (a) household preference is non-homothetic; (b) government’s sector-specific spending is introduced as a production factor and (c) technological progress occurs only in the manufacturing sector through learning-by-doing. By using the model with these features, we derive the optimal policy for government resource allocation, optimal tax rate and share of government spending for each sector, to maximize the household’s utility. In addition, we examine the dynamics of the model. The model reveals that (a) increments in both agricultural productivity and manufacturing productivity cause labour to move from the agricultural sector to the manufacturing sector; (b) depending on the relative elasticity of production with respect to government’s spending between the two sectors, the optimal tax rate will shrink or expand with the passage of time and will stay at a level of balanced growth path in the long run and (c) as the industrialization progresses, the optimal share of government spending for the agricultural sector will decline.
    Keywords: industrialization; productive government spending; learning-by-doing; economic growth
    JEL: O11 O41
    Date: 2010–11
  23. By: Luciana Juvenal; Paulo Santos Monteiro
    Abstract: There is substantial evidence that countries or regions with stronger trade linkages tend to have business cycles which are more synchronized. However, the standard international business cycle framework cannot replicate this finding. In this paper we study a multiple- country model of international trade with imperfect competition and variable markups and embed it into a real business cycle framework by including aggregate technology shocks and allowing for variable labor supply. The model is successful at replicating the empirical relation between trade and business cycle synchronization. High trade costs increase the real exchange rate volatility because firms choose to price-to-market and this volatility decouples countries' business cycle fluctuations. We find empirical evidence supporting this mechanism.>
    Keywords: International trade ; Business cycles
    Date: 2010
  24. By: Totzek, Alexander; Winkler, Roland C.
    Abstract: This paper explores different fiscal stimuli within a business cycle model with an endogenous mass of firms which we estimate for the U.S. economy using Bayesian techniques. We demonstrate that a changing mass of firms is a crucial dimension for evaluating fiscal policy since it can both accelerate and decelerate the impacts of fiscal stimuli. When fiscal interventions cause the mass of firms to decline, an additional crowding-out effect of investment in new firms results in a multiplier below that of the standard RBC model. In the presence of demand stimuli, fiscal multipliers are small and the mass of firms may decline. This holds in particular under distortionary tax financing. By contrast, policies that disburden private agents from income taxes are effective in boosting economic activity and product creation.
    Keywords: Fiscal Multipliers; Firm Entry; Product Variety
    JEL: E62 E32 E22
    Date: 2010–04–07
  25. By: Jin, Yi; Leung, Charles Ka Yui; Zeng, Zhixiong
    Abstract: This paper studies the connection between the capital market and the real estate market. Empirically, we find that positive real house price shocks lower the external finance premium and stimulate nonresidential investment and real GDP. Our theoretical framework is able to mimic the volatility of the external finance premium, the relative price of real estate and capital, and the investment in real estate and capital. It also captures the cyclicality of the external finance premium and of real estate prices. The contribution of real estate price fluctuations to the variability of the external finance premium and the GDP is confirmed to be significant.
    Keywords: External Finance Premium; Residential and Corporate Real Estate; Capital Market Imperfections; Equilibrium Default; Real Estate Price Volatility.
    JEL: E44 D82 R21 R31
    Date: 2010–11
  26. By: Christopher Gust; Sylvain Leduc; Robert Vigfusson
    Abstract: The degree of exchange-rate pass-through to import prices is low. An average pass-through estimate for the 1980s would be roughly 50 percent for the United States implying that, following a 10 percent depreciation of the dollar, a foreign exporter selling to the U.S. market would raise its price in the United States by 5 percent. Moreover, substantial evidence indicates that the degree of pass-through has since declined to about 30 percent. ; Gust, Leduc, and Vigfusson (2010) demonstrate that, in the presence of pricing complementarity, trade integration spurred by lower costs for importers can account for a significant portion of the decline in pass-through. In our framework, pass-through declines solely because of markup adjustments along the intensive margin. ; In this paper, we model how the entry and exit decisions of exporting firms affect pass-through. This is particularly important since the decline in pass-through has occurred as a greater concentration of foreign firms are exporting to the United States. ; We find that the effect of entry on pass-through is quantitatively small and is more than offset by the adjustment of markups that arise only along the intensive margin. Even though entry has a relatively small impact on pass-through, it nevertheless plays an important role in accounting for the secular rise in imports relative to GDP. In particular, our model suggests that over 3/4 of the rise in the U.S. import share since the early 1980s is due to trade in new goods. Thus, a key insight of this paper is that adjustment of markups that occur along the intensive margin are quantitatively more important in accounting for secular changes in pass-through than adjustments that occur along the extensive margin.
    Date: 2010

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