nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2011‒01‒16
twenty-two papers chosen by
Christian Zimmermann
University of Connecticut

  1. Confronting model misspecification in macroeconomics By Daniel F. Waggoner; Tao Zha
  2. Investment-specific technology shocks and consumption By Francesco Furlanetto; Martin Seneca
  3. Robust control, informational frictions, and international consumption correlations By Yulei Luo; Jun Nie; Eric R. Young
  4. Aggregate Implications of Employer Search and Recruiting Selection By Benjamín Villena Roldán
  5. Capital taxation during the U.S. Great Depression By Ellen R. McGrattan
  6. Robustness, information-processing constraints, and the current account in small open economies By Yulei Luo; Jun Nie; Eric R. Young
  7. Applications and Interviews: A Structural Analysis of Two-Sided Simultaneous Search By Ronald P. Wolthoff
  8. Balanced Budget Government Spending in a Small Open Regional Economy By Patrizio Lecca; Peter McGregor; Kim Swales
  9. Structural unemployment and the regulation of product market By Alexandre Janiak
  10. The effects of unionization in an R&D growth model with (In)determinate equilibrium By Lai, Chung-Hui; Wang, Vey
  11. The Demand for Liquid Assets, Corporate Saving, and Global Imbalances By Bacchetta Philippe; Benhima Kenza
  12. Evaluating the strength of identification in DSGE models. An a priori approach By Nikolay Iskrev
  13. Franchise Fee, Tax/Subsidy Policies and Economic Growth By Wang, Vey; Lai, Chung-Hui
  14. Learning about monetary policy rules when labor market search and matching frictions matter By Takushi Kurozumi; Willem Van Zandweghe
  15. Labor force heterogeneity: implications for the relation between aggregate volatility and government size By Alexandre Janiak; Paulo Santos Monteiro
  16. The impact of medical and nursing home expenses and social insurance By Karen A. Kopecky; Tatyana Koreshkova
  17. Trade and Labor Market Outcomes By Elhanan Helpman; Oleg Itskhoki; Stephen Redding
  18. Change-over within little scope: On the decision neutrality of recent tax reform proposals By Siemers, Lars-H. R.; Zöller, Daniel
  19. Eductive Stability in Real Business Cycle Models By George W. Evans; Roger Guesnerie; Bruce McGough
  20. Learning about one’s own type in two-sided search By Akiko Maruyama
  21. Total factor productivity and signal noise volatility in an incomplete information setting By Vega, Hugo
  22. Real Business Cycle Models of the Great Depression. By Luca Pensieroso

  1. By: Daniel F. Waggoner; Tao Zha
    Abstract: We confront model misspecifications in macroeconomics by proposing an analytic framework for merging multiple models. This framework allows us to address uncertainty about models and parameters simultaneously and trace out the historical periods in which one model dominates other models. We apply the framework to a richly parameterized dynamic stochastic general equilibrium (DSGE) model and a corresponding Bayesian vector autoregressive model. The merged model, fitting the data better than both individual models, substantially alters economic inferences about the DSGE parameters and the implied impulse responses.
    Date: 2010
  2. By: Francesco Furlanetto (Norges Bank (Central Bank of Norway)); Martin Seneca (Norges Bank (Central Bank of Norway))
    Abstract: Current business cycle models systematically underestimate the correlation between consumption and investment. One reason for this failure is that a positive investment-specific technology shock generally induces a negative consumption response. The objective of this paper is to investigate whether positive consumption responses to investment-specific technology shocks can be obtained in a modern business cycle model. We find that the answer to this question is yes. With a combination of nominal rigidities and non-separable preferences, the consumption response is positive for general parameterisations of the model.
    Keywords: Investment-specific technology shocks, Consumption, GHH preferences, Nominal rigidities, Comovement.
    JEL: E32
    Date: 2010–12–29
  3. By: Yulei Luo; Jun Nie; Eric R. Young
    Abstract: In this paper we examine the effects of two types of information imperfections, robustness (RB) and nite information-processing capacity (called rational inattention or RI), on international consumption correlations in an otherwise standard small open economy model. We show that in the presence of capital mobility in nancial markets, RB lowers the international consumption correlations by generating heterogeneous responses of consumption to income shocks across countries facing different macroeconomic uncertainty. However, the calibrated RB model cannot explain the observed consumption correlations quantitatively. We then show that introducing RI is capable of matching the behavior of international consumption quantitatively via two channels: (1) the gradual response to income shocks that increases the correlations and (2) the presence of the common noise shocks that reduce the correlations.
    Date: 2010
  4. By: Benjamín Villena Roldán
    Abstract: This paper develops a general equilibrium model of nonsequential employer search with recruiting selection and heterogeneous workers, and characterizes its equilibrium. I depart from the standard search model by allowing firms to simultaneously meet several applicants and choose the best candidate. Recruiting selection is important: firms interview a median of 5 applicants per vacancy and spend 2.5% of their total labor cost-about US$4200 per recruit - in these activities. The model provides an endogenous matching process with heterogeneous workers in which the hazard rate out of unemployment increases in productivity. The model also accounts for the empirical evidence of negative duration dependence of both hazard rates and re-employment wages. Under recruiting selection, lifetime inequality increases relative to the sequential search benchmark because low wage workers go through longer and more volatile unemployment spells, and have less valuable outside options to bargain with firms. I also show that stronger recruiting selection worsens the productivity of the unemployed and may not generate a more efficient job assignment at the aggregate level. Search frictions coupled with recruiting selection generate new kinds of externalities that affect not only transition probabilities, but also the expected productivity of recruited workers. The calibrated model can replicate moments of the distribution of wages and unemployment durations in CPS data. Using this parametrization, I also show that an increase of screening costs reduces inequality and productive efficiency, and decreases negative externalities on other employers.
    Date: 2010
  5. By: Ellen R. McGrattan
    Abstract: Previous studies of the U.S. Great Depression find that increased taxation contributed little to either the dramatic downturn or the slow recovery. These studies include only one type of capital taxation: a business profits tax. The contribution is much greater when the analysis includes other types of capital taxes. A general equilibrium model extended to include taxes on dividends, property, capital stock, and excess and undistributed profits predicts patterns of output, investment, and hours worked more like those in the 1930s than found in earlier studies. The greatest effects come from the increased tax on corporate dividends.
    Date: 2010
  6. By: Yulei Luo; Jun Nie; Eric R. Young
    Abstract: We examine the effects of two types of informational frictions, robustness (RB) and nite information-processing capacity (called rational inattention or RI) on the current account, in an otherwise standard intertemporal current account (ICA) model. We show that the interaction of RB and RI has the potential to improve the model’s predictions on the joint dynamics of the current account and income: (i) the contemporaneous correlation between the current account and income, (ii) the volatility and persistence of the current account in small open emerging and developed economies. In addition, we show that the two informational frictions could also better explain consumption dynamics in small open economies: the impulse responses of consumption to income shocks and the relative volatility of consumption growth to income growth. Calibrated versions using detection probabilities t the data better along these dimensions than the standard model does.
    Date: 2010
  7. By: Ronald P. Wolthoff
    Abstract: A large part of the literature on frictional matching in the labor market assumes bilateral meetings between workers and firms. This ignores the frictions that arise when workers and firms meet in a multilateral way and cannot coordinate their application and hiring decisions. I analyze the magnitude of these frictions. For this purpose, I present an equilibrium search model of the labor market with an endogenous number of contacts between workers and firms. Workers contact firms by applying to vacancies, whereas firms contact applicants by interviewing them. Sending more applications and interviewing more applicants are both costly activities but increase the probability to match. In equilibrium, contract dispersion arises endogenously and workers spread their applications over the different types of contracts. Estimation of the model on the Employment Opportunities Pilot Projects data set provides values for the fundamental parameters of the model, including the cost of an application, the cost of an interview, and the value of non-market time. These estimates are used to determine the loss in social surplus compared to a Walrasian world. Frictions on the worker and the firm side each cause approximately half of the 4.7% loss. There is a potential role for activating labor market policies, because I show that for the estimated parameter values welfare is improved if unemployed workers increase their search intensity.
    Keywords: labor, search, recruitment, frictions, efficiency
    JEL: J64 J31 E24 D83
    Date: 2010–12–30
  8. By: Patrizio Lecca (Department of Economics, Strathclyde University); Peter McGregor (Fraser of Allander Institute, Strathclyde University); Kim Swales (Department of Economics, Strathclyde University)
    Abstract: This paper investigates the impact of a balanced budget fiscal policy expansion in a regional context within a numerical dynamic general equilibrium model. We take Scotland as an example where, recently, there has been extensive debate on greater fiscal autonomy. In response to a balanced budget fiscal expansion the model suggests that: an increase in current government purchase in goods and services has negative multiplier effects only if the elasticity of substitution between private and public consumption is high enough to move downward the marginal utility of private consumers; public capital expenditure crowds in consumption and investment even with a high level of congestion; but crowding out effects might arise in the short-run if agents are myopic.
    Keywords: regional computable general equilibrium analysis, fiscal federalism, fiscal policy.
    JEL: H72 R13 R50
    Date: 2010–10
  9. By: Alexandre Janiak
    Abstract: I assess the impact of product market regulation on unemployment in a large-firm model of the labor market with search frictions and firm entry and exit. Two regulatory frictions are considered: administrative costs of establishing a new firm and the share of capital entrepreneurs recover when exiting. Product market regulation explains half the unemployment gap between Continental Europe and the United States in the calibrated model. More precisely, exit regulation is responsible for the entire explained gap, entry regulation playing no role. The degree of returns to scale and the presence of fixed capital in the model are important assumptions behind those results.
    Date: 2010
  10. By: Lai, Chung-Hui; Wang, Vey
    Abstract: This paper extends an R&D-based growth model of the Rivera-Batiz and Romer-type [Quarterly Journal of Economics 106 (1991) 531] endogenous growth model by embodying a union with elastic labor to investigate the effects of unionization on employment and growth by highlighting the essence of internal conflict within the union. It is shown that an increase in the union’s bargaining power or a union which is more employment-oriented boosts employment and economic growth when the balanced growth equilibrium is determinate. On the other hand, if the union is more wage-oriented, employment and economic growth are enhanced when the balanced growth equilibrium is indeterminate.
    Keywords: Union; Collective bargaining; R&D; Indeterminacy; Economic growth
    JEL: O30 O40 J50
    Date: 2010–11–07
  11. By: Bacchetta Philippe; Benhima Kenza
    Abstract: In the recent decade, capital outflows from emerging economies, in the form of a demand for liquid assets, have played a key role in the context of global imbalances. In this paper, we model the demand for liquid assets by firms in a dynamic open-economy macroeconomic model. We find that the implications of this model are very different from standard models, because the demand for foreign bonds is a complement to domestic investment rather than a substitute. We show that this complementarity is at work when an emerging economy is on its convergence path or when it has a higher TFP growth rate. This framework is consistent with global imbalances and with a number of stylized facts such as high corporate saving rates in high-growth, high-investment, emerging countries.
    Keywords: capital flows; global imbalances; working capital; credit constraints
    JEL: E22 F21 F41 F43
    Date: 2010–12
  12. By: Nikolay Iskrev
    Abstract: This paper presents a new approach to parameter identification analysis in DSGE models wherein the strength of identification is treated as property of the underlying model and studied prior to estimation. The strength of identification reflects the empirical importance of the economic features represented by the parameters. Identification problems arise when some parameters are either nearly irrelevant or nearly redundant with respect to the aspects of reality the model is designed to explain. The strength of identification therefore is not only crucial for the estimation of models, but also has important implications for model development. The proposed measure of identification strength is based on the Fisher information matrix of DSGE models and depends on three factors: the parameter values, the set of observed variables and the sample size. By applying the proposed methodology, researchers can determine the effect of each factor on the strength of identification of individual parameters, and study how it is related to structural and statistical characteristics of the economic model. The methodology is illustrated using the medium-scale DSGE model estimated in Smets and Wouters (2007).
    JEL: C32 C51 C52 E32
    Date: 2010
  13. By: Wang, Vey; Lai, Chung-Hui
    Abstract: In this paper, we take a new look at the effects of the subsidy policy and the government’s R&D activities in an R&D-based growth model. The government not only subsidizes the R&D cost of the firms but also engages in R&D activities and, in addition, levies a specific tax on the firms producing the final and the intermediate goods, respectively, in order to finance the expenditure. We find that in the economy there exist two balanced equilibrium growth paths. In an economy with a high growth path, the government’s subsidy policy and its R&D activities will crowd out the private R&D activities, and hence the fiscal policies are of no help to the economic growth. In other words, the intermediate goods firms play an important role in driving the economic growth. By contrast, in an economy with a low growth path, the government that directly engages in R&D activities plays an important role in economic growth. The fiscal policies of the government have a positive effect on the economic growth.
    Keywords: Government’s R&D activities; Specific tax; Subsidy policy; Endogenous growth; R&D
    JEL: O30 O40 L00
    Date: 2010–06–27
  14. By: Takushi Kurozumi; Willem Van Zandweghe
    Abstract: This paper examines implications of incorporating labor market search and matching frictions into a sticky price model for determinacy and E-stability of rational expectations equilibrium (REE) under interest rate policy. When labor adjustment takes place solely at the extensive margin, forecast-based policy that meets the Taylor principle is likely to induce indeterminacy and E-instability, regardless of whether it is strictly or flexibly inflation targeting. When labor adjustment takes place at both the extensive and intensive margins, the strictly inflation-forecast targeting policy remains likely to induce indeterminacy, but it generates a unique E-stable fundamental REE as long as the Taylor principle is satisfied. These results suggest that introducing the search and matching frictions alter determinacy properties of the strictly inflation-forecast targeting policy, but not its E-stability properties in the presence of the intensive margin of labor.
    Date: 2010
  15. By: Alexandre Janiak; Paulo Santos Monteiro
    Abstract: There is substantial evidence of a negative correlation between government size and output volatility. We put forward the hypothesis that large governments stabilize output fluctuations because in economies with high tax rates the share of total market hours supplied by demographic groups exhibiting a more volatile labor supply is lower. This hypothesis is motivated by the observation that employment volatility is larger for young workers than for prime aged workers, and that the share of hours worked by the young workers is lower in countries with high tax rates. This paper illustrates these empirical facts and assesses in a calibrated model their quantitative importance for the relation between government size and macroeconomic stability.
    Date: 2010
  16. By: Karen A. Kopecky; Tatyana Koreshkova
    Abstract: We consider a life-cycle model with idiosyncratic risk in labor earnings, out-of-pocket medical and nursing home expenses, and survival. Partial insurance is available through welfare, Medicaid, and social security. Calibrating the model to the United States, we find that 12 percent of aggregate savings is accumulated to finance and self-insure against old-age health expenses given the absence of complete public health care for the elderly and that nursing home expenses play an important role in the savings of the wealthy and on aggregate. Moreover, we find that the aggregate and distributional effects of public health care provision are highly dependent on the availability of other programs making up the social insurance system.
    Date: 2010
  17. By: Elhanan Helpman; Oleg Itskhoki; Stephen Redding
    Abstract: This paper reviews a new framework for analyzing the interrelationship between inequality, unemployment, labor market frictions, and foreign trade. This framework emphasizes firm heterogeneity and search and matching frictions in labor markets. It implies that the opening of trade may raise inequality and unemployment, but always raises welfare. Unilateral reductions in labor market frictions increase a country's welfare, can raise or reduce its unemployment rate, yet always hurt the country's trade partner. Unemployment benefits can alleviate the distortions in a country's labor market in some cases but not in others, but they can never implement the constrained Pareto optimal allocation. We characterize the set of optimal policies, which require interventions in product and labor markets.
    JEL: F12 F16 J64
    Date: 2011–01
  18. By: Siemers, Lars-H. R.; Zöller, Daniel
    Abstract: Political economy aspects make progressive income taxation and taxation of capital income imperative in practise. International tax competition and profit shifting, in turn, put pressure on corporate and capital taxes. Hence, the scope for a politically feasible change-over to a status of improved taxation is little. We provide an extended dynamic general equilibrium model and analyze politically feasible recent reform proposals referring neutrality. We then propose an alternative tax reform that, in contrast to these proposals, guarantees even growth neutrality, without necessarily jeopardizing political feasibility.
    Keywords: Dynamic general equilibrium models; taxation; tax reform; decision neutrality; ACE; dual income tax
    JEL: H21 H25 H24 D58
    Date: 2011–01–06
  19. By: George W. Evans (University of Oregon Economics Department and University of St. Andrews); Roger Guesnerie (Paris School of Economics and Collège de France); Bruce McGough (Oregon State University)
    Abstract: We reexamine issues of coordination in the standard RBC model. Is the unique rational expectations equilibrium attainable by rational agents who contemplate the possibility of small deviations from equilibrium? Surprisingly, we find that coordination cannot be expected. Even with strong common knowledge assumptions, rational agents anticipating small but persistent deviations are led to take actions that eventually contradict the common knowledge assumption. This “impossibility†theorem for eductive learning is not fully overcome when adaptive learning is incorporated into the framework.
    Keywords: Eductive Learning, Instability, Fluctuations
    JEL: D84 E32 C62
    Date: 2010–11–13
  20. By: Akiko Maruyama (National Graduate Institute for Policy Studies)
    Abstract: This paper is an analysis of a two-sided search model in which agents are vertically heterogeneous and some agents do not know their own types. Agents who do not know their own types update their beliefs about their own types through the offers or rejections that they receive from others. In the belief-updating process, an agent who is unsure of his or her own type frequently behaves as an over- or underconfident agent. In this paper, we show that this apparent over- or underconfidence influences both on the individual’s and other agents’ matching behaviors. We show, especially, that the apparent overconfidence of some agents prevents the lowest-type agents from matching in an equilibrium.
    Keywords: two-sided search; imperfect self-knowledge; overconfidence; looking-glass self
    JEL: D82 D83 J12
    Date: 2010–12
  21. By: Vega, Hugo (Banco Central de Reserva del Perú)
    Abstract: Imperfection information models where agents solve some kind of signal extraction problem are multiplying and developing fast. They have commonly been used to study the impact of imperfect information on the business cycle and the importance of news versus noise shocks. This paper attempts to apply the framework to a di¤erent, albeit related, question: that of the e¤ect of volatility (both in news and noise) on the economy, from a long and short run perspective. An RBC model where the agent faces imperfect information regarding productivity is developed and calibrated in order to address the question, coming to the conclusion that the long run e¤ect is insigni…cant while further development is required to address the short run conclusively.
    Date: 2010–12
  22. By: Luca Pensieroso (FNRS, IRES, Université catholique de Louvain (Belgique).)
    Abstract: This paper presents and assesses the recent application of models in the Real Business Cycle (RBC) tradition to the analysis of the Great Depression of the 1930s. The main conclusion is that the breaking of the depression taboo has been a desirable completion of the cliometric revolution: no historic event should be exempt from a dispassionate quantitative analysis. On the other hand, the substantive contribution of RBC models is not yet sufficient to establish a new historiography of the Great Depression.
    Date: 2010

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