nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2011‒01‒03
35 papers chosen by
Christian Zimmermann
University of Connecticut

  1. Consumption and time use over the life cycle By Michael Dotsey; Wenli Li; Fang Yang
  2. Competitive equilibrium with search frictions: Arrow-Debreu meets Diamond-Mortensen-Pisarides By Belén Jerez
  3. Numerical Simulation of the Overlapping Generations Models with Indeterminacy By Zhigang Feng
  4. Capital taxation with entrepreneurial risk By Vasia Panousi
  5. House Prices and Consumption By Song, In Ho
  6. The Domestic and International Effects of Interstate U.S. Banking By Fabio Ghironi; Viktors Stebunovs
  7. Optimal taxation and monitoring in an economy with matching frictions and underground activities By Lisi, Gaetano
  8. Financial intermediaries, leverage ratios, and business cycles By Mimir, Yasin
  9. Steady-State Growth and the Elasticity of Substitution By Andreas Irmen
  10. Asset Prices and Financial Frictions in Monetary Transmission: The Case of Latvia By Kristine Vitola; Ludmila Fadejeva
  11. Asymmetric demographic shocks and institutions: The impact on international capital flows and welfare By Arezki, Rabah
  12. The Propagation of U.S. Shocks to Canada: Understanding the Role of Real-Financial Linkages By Kimberly Beaton; René Lalonde; Stephen Snudden
  13. The role of housing in labor reallocation By Morris A. Davis; Jonas D. M. Fisher; Marcelo Veracierto
  14. Net Foreign Assets, Productivity and Real Exchange Rates in Constrained Economies By Dimitris K. Christopoulos; Karine Gente; Miguel A. Leon-Ledesma
  15. Trend shocks and business cycles in Sub Saharan Africa By Claude Francis Naoussi; Fabien Tripier
  16. Existence of competitive equilibrium in an optimal growth model with heterogeneous agents and endogenous leisure By Goenka, Aditya; Le Van, Cuong; Nguyen, Manh-Hung
  17. Commodity money with frequent search By Ezra Oberfield; Nicholas Trachter
  18. Endogenous growth in a model with heterogeneous agents and voting on public goods By Borissov, Kirill; Surkov, Alexander
  19. Fitting observed inflation expectations By Marco Del Negro; Stefano Eusepi
  20. The effect of openness in a small open monetary union By Orjasniemi, Seppo
  21. International real business cycles : a re-visit By Nguyen, Quoc Hung
  22. The Financial Crisis: What have macroeconomists learnt? By Jagjit S. Chadha
  23. Optimal monetary policy in a model of money and credit By Pedro Gomis-Porqueras; Daniel R. Sanches
  24. International Business Cycle Accounting By Keisuke Otsu
  25. Introduction to the macroeconomic dynamics: special issues on money, credit, and liquidity By Ed Nosal; Christopher Waller; Randall Wright
  26. Growth and Crisis, Unavoidable Connection? By Roberto Piazza
  27. Eductive stability in real business cycle models By Georges W. Evans; Roger Guesnerie; Bruce McGough
  28. Tariff, Growth, and Welfare By Lee, Shun-Fa
  29. Discrimination in the Equilibrium Search Model with Wage-Tenure Contracts By Fang, Zheng; Sakellariou, Chris
  30. Can we prevent boom-bust cycles during euro area accession? By Michał Brzoza-Brzezina; Pascal Jacquinot; Marcin Kolasa
  31. Rationality of expectations: another OCA criterion? A DSGE analysis By Andrzej Torój
  32. On the optimality of Ramsey taxes in Mirless economies By Borys Grochulski
  33. A dynamic model of unsecured credit By Daniel R. Sanches
  34. Summer workshop on money, banking, payments and finance: an overview By Ed Nosal; Randall Wright
  35. Recursive Contracts, Lotteries and Weakly Concave Pareto Sets By Harold Cole; Felix Kubler

  1. By: Michael Dotsey; Wenli Li; Fang Yang
    Abstract: The authors incorporate home production in a dynamic general equilibrium model of consumption and saving with illiquid housing and a collateralized borrowing constraint. They show that the model is capable of explaining life-cycle patterns of households' time use and consumption of different categories. Specifically, households' market hours and home hours are fairly stable early in the life cycle. Market hours start to decline sharply at age 50, while home hours begin to increase at age 55. Households' consumption of the market good, home input, and housing services all exhibit hump shapes over the life cycle, with the market good having the most pronounced hump, followed by the home input, and then housing services. A plausibly parameterized version of the authors' model predicts that the interaction of the labor efficiency profile and the availability of home production technology explain households' time use over the life cycle. The resulting income profiles, the endogenous borrowing constraint and the presence of home production account for the initial hump in all three consumption goods. The consumption profiles in the second half of the life cycle are mostly driven by the complementarity of home hours, home input, and housing in home production.
    Keywords: Consumption (Economics) ; Production (Economic theory)
    Date: 2010
  2. By: Belén Jerez
    Abstract: When the trading process is characterized by search frictions, traders may be rationed so markets need not clear. We argue that rationing can be part of general equilibrium, even if it is outside its normal interpretation. We build a general equilibrium model where the uncertainty arising from rationing is incorporated in the definition of a commodity, in the spirit of the Arrow- Debreu theory. Prices of commodities then depend not only on their physical characteristics, but also on the probability that their trade is rationed. The standard definition of a competitive equilibrium is extended by replacing market clearing with a matching condition. This condition relates the traders' rationing probabilities to the measures of buyers and sellers in the market via an exogenous matching function, as in the search models of Diamond (1982a, 1982b), Mortensen (1982a, 1982b) and Pissarides (1984, 1985). When search frictions vanish (so matching is frictionless) our model is equivalent to the competitive assignment model of Gretsky, Ostroy and Zame (1992, 1999). We adopt their linear programming approach to derive the welfare and existence theorems in our environment.
    Keywords: Search frictions, Competitive (price-taking) equilibrium, Matching function, Linear programming, Duality
    JEL: D50 D61 D80
    Date: 2010–12
  3. By: Zhigang Feng
    Date: 2010–12–14
  4. By: Vasia Panousi
    Abstract: This paper studies the effects of capital taxation in a dynamic heterogeneous-agent economy with uninsurable entrepreneurial risk. Although it allows for rich general-equilibrium effects and a stationary distribution of wealth, the model is highly tractable. This permits a clear analysis, not only of the steady state, but also of the entire transitional dynamics following any change in tax policies. Unlike either the complete-markets paradigm or Bewley-type models where idiosyncratic risk impacts only labor income, here it is shown that capital taxation may actually stimulate capital accumulation. This possibility emerges because of the general-equilibrium effects of the insurance aspect of capital taxation. In particular, for the preferred calibrated version of the model, when the tax on capital is 25 percent, output per work-hour is 2.2 percent higher than it would have been had the tax rate been zero. Turning to the welfare effects of a reform in capital taxation, it is examined how these effects depend on whether one focuses on the steady state or also takes into account transitional dynamics, as well as how they vary in the cross-section of the population (rich versus poor, entrepreneurs versus non-entrepreneurs).
    Date: 2010
  5. By: Song, In Ho
    Abstract: I study the consumption responses of heterogeneous households following changes in both house prices and interest rates. I show the common assumption that household period utility is separable in housing and consumption can be consistent with the observed co-movement between these two series only in the absence of housing transaction costs. When these costs are introduced into dynamic stochastic general equilibrium (DSGE) models characterized by separable preferences, consumption no longer increases after a rise in house prices. As it is well known, transaction costs are an important ingredient in house sales. I address this issue by developing a model that allows for non-separable preferences in housing and consumption alongside housing transaction costs. The results of my model closely match the aggregate data. Furthermore, it predicts that credit-constrained households will be substantially more responsive to changes in both house prices and interest rates than unconstrained households. Following a rise in house prices, consumption among constrained households increases by far more than the consumption of unconstrained households. Following a rise in interest rates, constrained households' consumption falls by more than that of unconstrained households. I trace this differing responsiveness in consumption to the house loan-to-value ratio of credit-constrained households. Higher loan-to-value ratios imply larger differences in their elasticity of response relative to unconstrained households. I also find that these differences widen with the degree of complementarity between housing and consumption. These predictions of my model are confirmed by household data from the Consumer Expenditure Surveys.
    Keywords: DSGE; House Prices; Heterogeneous Households; Elasticity of Intra-Temporal Substitution (EIS); Complementarity; Credit
    JEL: D50 E44 C10 G12 E30 E52 R21 G10
    Date: 2010–11–28
  6. By: Fabio Ghironi (Boston College); Viktors Stebunovs (Board of Governors of the Federal Reserve System)
    Abstract: This paper studies the domestic and international effects of the transition to an interstate banking system implemented by the U.S. since the late 1970s in a dynamic, stochastic, general equilibrium model with endogenous producer entry. Interstate banking reduces the degree of local monopoly power of financial intermediaries. We show that the an economy that implements this form of deregulation experiences increased producer entry, real exchange rate appreciation, and a current account deficit. The rest of the world experiences a long-run increase in GDP and consumption. Less monopoly power in financial intermediation results in less volatile business creation, reduced markup countercyclicality, and weaker substitution effects in labor supply in response to productivity shocks. Bank market integration thus contributes to a moderation of firm-level and aggregate output volatility. In turn, trade and financial ties between the two countries in our model allow also the foreign economy to enjoy lower GDP volatility in most scenarios we consider. The results of the model are consistent with features of the U.S. and international business cycle after the U.S. began its transition to interstate banking.
    Keywords: Business cycle volatility; Current account; Deregulation; Interstate banking; Producer entry; Real exchange rate
    JEL: E32 F32 F41 G21
    Date: 2010–12–17
  7. By: Lisi, Gaetano
    Abstract: This short paper shows the interdependence of taxation and monitoring policy in a search and matching model of equilibrium unemployment with an underground sector. More precisely, from a social welfare standpoint, two options are available to the policy maker: s/he may either substitute a tighter monitoring with a higher penalty or enforce both a higher taxation and an increased monitoring.
    Keywords: optimal taxation; tax evasion; underground economy; job search theory
    JEL: H21 J64 E26 H26
    Date: 2010–11–27
  8. By: Mimir, Yasin
    Abstract: I document cyclical properties of aggregate measures of liabilities, equity, and leverage ratio in the U.S. financial sector and those of credit spread. I find that (i) liabilities and equity are procyclical, leverage ratio is acyclical, and credit spread is countercyclical, (ii) financial variables are three to ten times more volatile than output, and (iii) financial variables lead the business cycle. I present a dynamic stochastic general equilibrium model with profit maximizing banks where bank equity mitigates a moral hazard problem between banks and their depositors. The driving sources of business cycles are shocks to bank equity as well as standard productivity shocks. The model generates real and financial fluctuations consistent with the U.S. data. The model also delivers some policy prescriptions about capital adequacy requirements of banks.
    Keywords: Banks; Financial Fluctuations; Credit Frictions; Bank Equity; Real Fluctuations
    JEL: E32 E44 E10 E20
    Date: 2010–09–01
  9. By: Andreas Irmen (University of Luxembourg and CESifo, Munich)
    Abstract: In a neoclassical economy with endogenous capital- and labor-augmenting technical change the steady-state growth rate of output per worker is shown to increase in the elasticity of substitution between capital and labor. This confirms the assessment of Klump and de La Grandville (2000) that a greater elasticity of substitution allows for faster economic growth. However, unlike their findings my result applies to the steady-state growth rate. Moreover, it does not hinge on particular assumptions on how aggregate savings come about. It holds for any household sector allowing savings to grow at the same rate as aggregate output.
    Keywords: Capital Accumulation, Elasticity of Substitution, Direction of Technical Change, Neoclassical Growth Model.
    JEL: E22 O11 O33 O41
    Date: 2010
  10. By: Kristine Vitola; Ludmila Fadejeva
    Abstract: The purpose of this paper is to quantify the role of financial frictions in Latvia's monetary transmission. Our model extends M. Iacoviello (9) framework along three dimensions. First, we introduce open-economy features by allowing imports of foreign consumer goods and borrowing from abroad. Second, we relax the assumption of fixed housing stock, allowing for investment. Finally, we assume a risk premium on foreign borrowing, which depends on net foreign asset position. We estimate the model by Bayesian approach and compare impulse responses to shocks under various scenarios. In addition to the baseline scenario, we explore the importance of tighter borrowing constraints and higher foreign risk premium elasticity in the model dynamics. Our findings show that tighter credit constraints weaken the transmission of shocks to housing demand and consumption. In the case of foreign interest rate and risk premium shocks, higher risk premium elasticity lessens the effect of monetary transmission on the domestic economy through higher cost of external funds.
    Keywords: financial frictions, monetary transmission, asset prices, DSGE model, Bayesian approach
    JEL: C11 E32 E44 E52 R21
    Date: 2010–12–23
  11. By: Arezki, Rabah
    Abstract: This paper examines the consequences of an asymmetric negative fertility shock on capital formation, saving/investment imbalance, and welfare. The framework of analysis is a Diamond-type overlapping-generations small open economy with capital market imperfection. The capital market imperfection is modelled through a symmetric wedge between foreign investor and domestic investor return on capital. The shock is transmitted to the small open economy depending on whether the wedge is below a given threshold. If the wedge is not too high, capital first flows in the small open economy to exploit the di¤erence in returns on capital. After the shock has occurred, capital is repatriated in order to …nance the old age consumption of rest of the world investors. If capital flows internationally, lifetime utility in the small open economy decreases unambiguously for individuals born one period before the shock occurs. Provided that the small open economy is initially below its golden rule, individuals born after the time the shock has occurred experience an increase in their lifetime utility.
    Keywords: population aging; capital market imperfection; open economy; capital flows; welfare
    JEL: H55 F32 J10 F21
    Date: 2010–12–25
  12. By: Kimberly Beaton; René Lalonde; Stephen Snudden
    Abstract: This paper examines the transmission of U.S. real and financial shocks to Canada and, in particular, the role of financial frictions in affecting the transmission of these shocks. These questions are addressed within the Bank of Canada's Global Economy Model (de Resende et al. forthcoming), a dynamic stochastic general-equilibrium model with an active banking sector and a detailed role for financial frictions. We find that U.S. financial shocks, as well as real shocks, have important effects on the Canadian economy. Moreover, financial frictions on both the demand and supply sides of credit amplify the first round impact of all types of U.S. shocks on the U.S. economy, as well as the second round impact on Canada. Real-financial linkages also increase the persistence of the Canadian response to U.S. shocks. We find that the interaction between the endogenous response of commodity prices and U.S. financial frictions plays an important role in the propagation of U.S. shocks to the Canadian economy. Finally, real-financial linkages also help to generate the positive cross correlation between domestic demand in the United States and Canada observed in the data, which is difficult to explain with a model where the transmission of shocks between countries is only based only on trade.
    Keywords: Business fluctuations and cycles; Economic models; International topics
    JEL: E21 E27 E32 F36 F40
    Date: 2010
  13. By: Morris A. Davis; Jonas D. M. Fisher; Marcelo Veracierto
    Abstract: This paper builds a dynamic general equilibrium model of cities and uses it to analyze the role of local housing markets and moving costs in determining the character and extent of labor reallocation in the US economy. Labor reallocation in the model is driven by idiosyncratic city-specific productivity shocks, which we measure using a dataset that we compile using more than 350 U.S. cities for the years 1984 to 2008. Based on this measurement, we find that our model is broadly consistent with the city-level evidence on net and gross population flows, employment, wages and residential investment. We also find that the location-specific nature of housing is more important than moving costs in determining labor reallocation. Absent this quasi-fixity of housing, and under various assumptions governing population flows, population and employment would be much more volatile than observed.
    Keywords: Housing - Econometric models ; Labor market
    Date: 2010
  14. By: Dimitris K. Christopoulos; Karine Gente; Miguel A. Leon-Ledesma
    Abstract: Empirical evidence suggests that real exchange rates (RER) behave differently in developed and developing countries. We develop an overlapping generations two-sector exogenous growth model in which RER determination may depend on the country's capacity to borrow from international capital markets. The country faces a constraint on capital inflows. With high demestic savings, the RER only depends on productivity spread between two sectors (Balassa-Samuelson effect). If the constraint is too tight and/or domestic savings too low, the RER depends on both net foreign assets (transfer effect) and productivity. We then analyze the empirical implications of the model and find that, in accordance with the theory, the RER is mainly driven by productivity and net foreign assets in constrained countries and by productivity in unconstrained countries.
    Keywords: Real Exchange Rate; Capital Inflows Constraint; Overlapping Generations
    JEL: E39 F32 F41
    Date: 2010–12
  15. By: Claude Francis Naoussi (LEMNA - Laboratoire d'économie et de management de Nantes Atlantique - Université de Nantes : EA4272); Fabien Tripier (LEMNA - Laboratoire d'économie et de management de Nantes Atlantique - Université de Nantes : EA4272)
    Abstract: This article explores the role of trend shocks in explaining the specificities of business cycles in Sub-Saharan African (SSA) countries using the methodology introduced by Aguiar and Gopinath (2007) [Emerging Market Business Cycles: The Cycle Is the Trend Journal of Political Economy 115(1)]. We specify a small open economy model with transitory and trend shocks on productivity to replicate the differences in the business cycle behavior of output and consumption across countries, especially the excess volatility of consumption in SSA countries. Our results suggest a strong relationship between the weight of trend shocks in the source of fluctuations and economic development. The weight of trend shocks is (i) higher in SSA countries than in emerging and developed countries; (ii) negatively correlated with the level of income, the quality of institutions, and the size of the credit market; and (iii) uncorrelated with the aid received by countries, the ratio of trade-openness, the inflation rate, and government spending.
    Keywords: Business cycle; Permanent shocks; Growth; Africa; Small open economy
    Date: 2010–12–14
  16. By: Goenka, Aditya; Le Van, Cuong; Nguyen, Manh-Hung
    Date: 2010–12
  17. By: Ezra Oberfield; Nicholas Trachter
    Abstract: A prominent feature of the Kiyotaki and Wright (1989) model of commodity money is the multiplicity of dynamic equilibria. We show that the frequency of search is strongly related to the extent of multiplicity. To isolate the role of frequency of search in generating multiplicity, we (i) vary the frequency of search without changing the frequency of finding a trading partner and (ii) focus on symmetric dynamic equilibria, a class for which we can sharply characterize several features of the set of equilibria. For any finite frequency of search this class retains much of the multiplicity. For each frequency we characterize the full set of equilibrium payoffs, strategies played and dynamic paths of the state variables. Indexed by any of these features, the set of equilibria converges uniformly to a unique equilibrium in the continuous search limit. We conclude that when search is frequent, the seemingly exotic dynamics are irrelevant.
    Keywords: Money ; Markov processes
    Date: 2010
  18. By: Borissov, Kirill; Surkov, Alexander
    Abstract: We consider a Barro-type endogenous growth model in which the government’s purchases of goods and services enter into the production function. The provision of government services is financed by flat-rate (linear) income or lump-sum taxes. It is assumed that individuals differing in their discount factors vote on the tax rates. We propose a concept of voting equilibrium leading to some versions of the median voter theorem for steady-state equilibria, fully characterize steady-state equilibria and show that if the median voter discount factor is sufficiently low, the long-run rate of growth in the case of flat-rate income taxation is higher than that in the case of lump-sum taxation.
    Keywords: economic growth; voting; proportional; flat-rate; linear tax; lump-sum tax; heterogeneous agents; endogenous growth
    JEL: E62 H21 H31 H41 D91 D72 O4
    Date: 2010
  19. By: Marco Del Negro; Stefano Eusepi
    Abstract: This paper provides evidence on the extent to which inflation expectations generated by a standard Christiano et al. (2005)/Smets and Wouters (2003)–type DSGE model are in line with what is observed in the data. We consider three variants of this model that differ in terms of the behavior of, and the public’s information on, the central banks’ inflation target, allegedly a key determinant of inflation expectations. We find that: 1) time-variation in the inflation target is needed to capture the evolution of expectations during the post-Volcker period; 2) the variant where agents have imperfect information is strongly rejected by the data; 3) inflation expectations appear to contain information that is not present in the other series used in estimation; and 4) none of the models fully captures the dynamics of this variable.
    Keywords: Banks and banking, Central ; Inflation (Finance) ; Inflation targeting ; Bayesian statistical decision theory
    Date: 2010
  20. By: Orjasniemi, Seppo (Bank of Finland Research)
    Abstract: In this paper we build a dynamic stochastic general equilibrium model of a small open monetary union with optimal monetary and fiscal policy, to study the transmission of country specific shocks and associated exchange rate fluctuations. We show that movements of the monetary union’s exchange rate stabilize the output fluctuations inside the monetary union, reducing the need for fiscal stabilization. We also show that, under the optimal policy, fluctuations in the exchange rate and the union-wide aggregates are affected by the differences in the degree of nominal rigidities among the monetary union member countries.
    Keywords: monetary union; monetary policy; fiscal policy; exchange rate
    JEL: E52 E62 F41
    Date: 2010–12–02
  21. By: Nguyen, Quoc Hung
    Abstract: It is well known that several quantitative properties of international real business cycle models with are at odds with the data. First, the cross-country correlations are much higher for consumption than for output, while in the data the opposite is true (the BKK puzzle). Second, cross-country correlations of employment and investment are negative, while in the data they are positive. This paper quantitatively shows that preferences with a zero income effect on labor supply help generate a correct cross-country correlation in employment even without any restrictions on financial markets. In a bond economy, a zero income effect in labor supply, combined with time-to-build investment, can generate a positive cross-country correlation in investment, and the BKK puzzle is also resolved when the inter-temporal elasticity of substitution in labor supply is low.
    Keywords: International real business cycles, Income effects, GHH preferences, Business cycles, International economic relations, Consumption, Investments, Employment
    JEL: E21 E22 E24 E32 F41
    Date: 2010–12
  22. By: Jagjit S. Chadha
    Abstract: I outline a simple roadmap for work in micro-founded models. Rather than abandoning the route to further micro-foundations and returning to ad hoc economics, the techniques we have used over the past two decades to develop micro-founded business cycle models will allow us to develop models with meaningful financial frictions and thus address once again the question of monetary and fiscal policies with active rather than passive financial sectors. Macroeconomics and finance are likely to remain bound together.
    Keywords: Future of Macroeconomics; DSGE Models; Crisis
    JEL: E42 E52 E58
    Date: 2010–12
  23. By: Pedro Gomis-Porqueras; Daniel R. Sanches
    Abstract: The authors study optimal monetary policy in a model in which fiat money and private debt coexist as a means of payment. The credit system is endogenous and allows buyers to relax their cash constraints. However, it is costly for agents to publicly report their trades, which is necessary for the enforcement of private liabilities. If it is too costly for the government to obtain information regarding private transactions, then it relies on the public information generated by the private credit system. If not all private transactions are publicly reported, the government has imperfect public information to implement monetary policy. In this case, the authors show that there is no incentive-feasible policy that can implement the socially efficient allocation. Finally, they characterize the optimal policy for an economy with a low record-keeping cost and a large number of public transactions, which results in a positive long-run inflation rate.
    Keywords: Monetary policy ; Disclosure of information
    Date: 2010
  24. By: Keisuke Otsu
    Abstract: In this paper, I extend the business cycle accounting method a la Chari, Kehoe and McGrattan (2007) to a two-country international business cycle model and quantify the effect of the disturbances in relevant markets on the business cycle correlation between Japan and the US over the 1980-2008 period. I find that disturbances in the labor market and production efficiency are important in accounting for the recent increase in the cross-country output correlation. Financial globalization can be the cause of the recent increase in cross-country output correlation if it operated through an increase in the cross- country correlation of disturbances in the labour market and production efficiency, not in the domestic or international capital markets.
    Keywords: Business Cycle Accounting; International Business Cycles; Financial Globalization
    JEL: E32 F41
    Date: 2010–12
  25. By: Ed Nosal; Christopher Waller; Randall Wright
    Abstract: We motivate and provide an overview to New Monetarist Economics. We then briefly describe the individual contributions to the Macroeconomics Dynamics special issues on money, credit and liquidity.
    Keywords: Macroeconomics - Econometric models
    Date: 2010
  26. By: Roberto Piazza
    Abstract: In emerging economies periods of rapid growth and large capital inflows can be followed by sudden stops and financial crises. I show that, in the presence of financial markets imperfections, a simple modification of a neoclassical growth model can account for these facts. I study a growth model for a small open economy where decreasing marginal returns to capital appear only after the country has reached a threshold level of development, which is uncertain. Limited enforceability of contracts allows default on international debt. International investors optimally choose to suddenly restrict lending when the appearance of decreasing marginal returns slows down growth. The economy defaults and enters a financial crisis.
    Keywords: Capital inflows , Capital markets , Credit restraint , Debt sustainability , Economic growth , Economic models , Emerging markets , External borrowing , Financial crisis ,
    Date: 2010–11–22
  27. By: Georges W. Evans; Roger Guesnerie; Bruce McGough
    Abstract: We re-examine issues of coordination in the standard RBC model. Can the unique rational expectations equilibrium be "educed" by rational agents who contemplate the possibility of small deviations from equilibrium? Surprisingly, we find that coordination along this line cannot be expected. Rational agents anticipating small but possibly persistent deviations have to face the existence of retroactions that necessarily invalidate any initial tentative "common knowledge" of the future. This "impossibility" theorem for eductive learning is not fully overcome when adaptive learning is incorporated into the framework.
    Date: 2010
  28. By: Lee, Shun-Fa
    Abstract: We develop a two-country (Home and Foreign) by two-good (consumption good and investment good) by one factor (capital) endogenous growth model with international knowledge spillover to study the relationship between an import tariff and economic growth and welfare. First, unlike the past literature, we do not need to make an assumption such that the growth rates between countries are identical in a balanced growth path (BGP). Second, we show that there exists a unique and saddle-point BGP with both countries being incompletely specialized. Third, a higher import tariff on the consumption good in the domestic country may boost (reduce) the rate of economic growth when the foreign (domestic) country has an absolute advantage in the investment good. Finally, a rise in the tariff rate by one country may improve world welfare under some parameter spaces.
    Keywords: two-country endogenous growth model; international knowledge spillover; import tariff; economic growth; welfare
    JEL: F13 O41 F43
    Date: 2010–11–04
  29. By: Fang, Zheng; Sakellariou, Chris
    Abstract: We extend the Burdett and Coles (2003) search model with wage-tenure contracts to two types of workers and firms and derive the equilibrium earnings distributions for both types of workers, by means of which we succeed in predicting many stylized facts found in empirics. For example, we find that at the same wage level, majority workers almost always experience a faster wage increase than the minority workers; minority workers have a higher unemployment rate; discriminating firms make lower profit than non-discriminating firms and offers to minority workers by non-discriminating firms are consistently superior to those provided by discriminating firms etc. Besides, we find a similar result to the classical discrimination theory that the average wage of the majority workers, though higher in most cases, can be smaller than their counterpart’s wage when the fraction of discriminating firms is small and the degree of recruiting discrimination and disutility are mild. We also show that in a special case of CRRA utility function with the coefficient of relative risk aversion approaching infinity, our model degenerates to Bowlus and Eckstein (2002).
    Keywords: discrimination; wage gap; equilibrium search; wage-tenure
    JEL: J41 J31 J71
    Date: 2010–02
  30. By: Michał Brzoza-Brzezina (National Bank of Poland.); Pascal Jacquinot (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Marcin Kolasa (National Bank of Poland.)
    Abstract: Euro-area accession caused boom-bust cycles in several catching-up economies. Declining interest rates and easier financing conditions fuelled spending and worsened the current account balance. Over time inflation deteriorated external competitiveness and lowered domestic demand, turning the boom into a bust. We ask whether such a scenario can be avoided using macroeconomic tools that are available in the period of joining a monetary union: central parity revaluation, fiscal tightening or increased taxation. While all these policies can be used to cool down the output boom, exchange rate revaluation seems the most attractive option. It simultaneously trims the expansion of output and domestic demand, reduces the cost pressure and ranks first in terms of welfare. JEL Classification: E52, E58, E63.
    Keywords: boom-bust cycles, euro area accession, dynamic general equilibrium models
    Date: 2010–12
  31. By: Andrzej Torój (Ministry of Finance, Poland)
    Abstract: The Walters critique of EMU presumed that pro-cyclical country-specific real interest rates would incorporate significant macroeconomic instability in an environment of asymmetric shocks. The literature on optimum currency areas suggests a number of criteria to minimize this risk, such as market flexibility, high degrees of openness, financial integration or similarity in inflation rates. In this paper, we argue that an essential part of macroeconomic volatility in a monetary union's member country also depends on the mechanism of forming expectations. This is mainly due to (i) the construction of ex ante country-specific real interest rate, implying a strong or weak negative correlation with current inflation rate and (ii) anticipated (and hence smoothed) loss in competitiveness and boom-bust cycle. In a 2-region 2-sector New Keynesian DSGE model, we apply 5 different specifications of ex ante real interest rates, based on commonly considered types of expectations: rational, adaptive, static, extrapolative and regressive, as well as their hybrids. Our simulations show that rational expectations dominate the other specifications in terms of minimizing the volatility of the most macroeconomic variables. This conclusion is generally insensitive to which group of agents (producers or consumers) and which region (home or foreign) forms the expectations. It also turns out that for some types of expectations the Walters critique indeed applies, i.e. the system does not fulfil the Blanchard-Kahn conditions or the system's companion matrix has explosive eigenvalues.
    Keywords: optimum currency areas, rational expectations, DSGE, EMU, inflation differentials
    JEL: C60 F15 F47
    Date: 2010–12–22
  32. By: Borys Grochulski
    Abstract: In this paper, we show that a simple, linear capital tax— the kind used in the Ramsey analysis— can be optimal in a Mirrlees economy with private information. We extend the Mirrlees approach to optimal taxation by studying taxes side-by-side with another institution, rather than in isolation. We consider an implementation in which agents use unsecured credit and personal bankruptcy to obtain insurance. Taxes are levied to fund government expenditures. An optimal tax system consists of lump-sum taxes and a simple Ramsey tax on wealth. In Mirrlees private information environments, optimal capital taxes do not have to be complicated.
    Keywords: Financial markets ; Financial institutions ; Bankruptcy
    Date: 2010
  33. By: Daniel R. Sanches
    Abstract: The author studies the terms of credit in a competitive market in which sellers (lenders) are willing to repeatedly finance the purchases of buyers (borrowers) by engaging in a credit relationship. The key frictions are: (i) the lender is unable to observe the borrower's ability to repay a loan; (ii) the borrower cannot commit to any long-term contract; (iii) it is costly for the lender to contact a borrower and to walk away from a contract; and (iv) transactions within each credit relationship are not publicly observable. The lender's optimal contract has two key properties: delayed settlement and debt forgiveness. Asymmetric information gives rise to the property of delayed settlement, which is a contingency in which the lender allows the borrower to defer the repayment of his loan in exchange for more favorable terms of credit within the relationship. This property, together with the borrowers' lack of commitment, gives rise to debt forgiveness. When the borrower's participation constraint binds, the lender needs to "forgive" part of the borrower's debt to keep him in the relationship. Finally, the author studies the impact of the changes in the initial cost of lending on the terms of credit.
    Keywords: Credit ; Contracts
    Date: 2010
  34. By: Ed Nosal; Randall Wright
    Abstract: The 2010 Summer Workshop on Money, Banking, Payments and Finance met at the Federal Reserve Bank of Chicago this summer, for the second year. The following document summarizes and ties together the papers presented.
    Keywords: Payment systems
    Date: 2010
  35. By: Harold Cole (Department of Economics, University of Pennsylvania); Felix Kubler (University of Zurich and Swiss Finance Institute)
    Abstract: Marcet and Marimon (1994, revised 1998) developed a recursive saddle point method which can be used to solve dynamic contracting problems that include participation, enforcement and incentive constraints. Their method uses a recursive multiplier to capture implicit prior promises to the agent(s) that were made in order to satisfy ear- lier instances of these constraints. As a result, their method relies on the invertibility of the derivative of the Pareto frontier and cannot be applied to problems for which this frontier is not strictly concave. In this paper we show how one can extend their method to a weakly concave Pareto frontier by expanding the state space to include the realizations of an end of period lottery over the extreme points of a .at region of the Pareto frontier. With this expansion the basic insight of Marcet and Marimon goes through .one can make the problem recursive in the Lagrangian multiplier which yields significant computational advantages over the conventional approach of using utility as the state variable. The case of a weakly concave Pareto frontier arises naturally in applications where the principal’s choice set is not convex but where randomization is possible.
    Keywords: Recursive Contracting, Recursive Multipliers, Lotteries
    JEL: C61 C63
    Date: 2010–12–10

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