nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2011‒02‒26
23 papers chosen by
Christian Zimmermann
University of Connecticut

  1. Optimal Monetary and Fiscal Policies in a Search-Theoretic Model of Money and Unemployment By Pedro Gomis-Porqueras; Benoit Julien; Chengsi Wang
  2. Bayesian Estimation of Dynamic Stochastic General Equilibrium Model Using UK Data By Kamal, Mona
  3. Human Capital Formation on Skill-Specific Labor Markets By Runli Xie
  4. Sorting and the Output Loss due to Search Frictions By Pieter A. Gautier; Coen N. Teulings
  5. An Estimated Dynamic Stochastic General Equilibrium Model of the Jordanian Economy By Tigran Poghosyan; Samya Beidas-Strom
  6. Sectoral Effects of Tax Reforms in an Open Economy By Olivier CARDI; Romain RESTOUT
  7. Anticipated Alternative Policy-Rate Paths in Policy Simulations By Laséen, Stefan; Svensson, Lars E.O.
  8. Governmental debt, interest policy, and tax stabilization in a stochastic OLG economy By Hillebrand, Marten
  9. Macroeconomic Aspects of Italian Pension Reforms of 1990s By Tetyana Dubovyk
  10. Pricing, Advertising, and Market Structure with Frictions By Pedro Gomis-Porqueras; Benoit Julien; Chengsi Wang
  11. Learning About Inflation Measures for Interest Rate Rules By Luis-Felipe Zanna; Marco Airaudo
  12. Worthy Transfers? A Dynamic Analysis of Turkey's Accession to the European Union By Gul Ertan Ozguzer; Luca Pensieroso
  13. Search Frictions and the Liquidity of Large Blocks of Shares By Rui Albuquerque; Enrique Schroth
  14. Labor Market Matching under Imperfect Information By Tim Willems
  15. Evidence on a Real Business Cycle Model with Neutral and Investment-Specific Technology Shocks using Bayesian Model Averaging By Rodney W. Strachan; Herman K. van Dijk
  16. An Experimental Test of a Collective Search Model By Yoichi Hizen; Keisuke Kawata; Masaru Sasaki
  17. Population Aging, the Composition of Government Spending,and Endogenous Economic Growth in Politico-Economic Equilibrium By Kuehnel, Johanna
  18. Global Stochastic Properties of Dynamic Models and their Linear Approximations By Ana Babus; Casper G. de Vries
  19. Trade and the Skill Premium Puzzle with Capital Market Imperfections By Roberto Bonfatti; Maitreesh Ghatak
  20. Overborrowing, Financial Crises and ‘Macro-prudential’ Policy? By Javier Bianchi; Enrique G. Mendoza
  21. The Relationship Between Financial Risk Premia and Macroeconomic Volatility: Issues and Perspectives on the Run-Up to the Turmoil By M. Marzo; L. Zhoushi; P. Zagaglia
  22. The Costs and Benefits of Informality By Nicoletta Batini; Paul Levine; Emanuela Lotti
  23. The Effects of Housing Prices and Monetary Policy in a Currency Union By Pau Rabanal; Oriol Aspachs-Bracons

  1. By: Pedro Gomis-Porqueras (School of Economics, Australian National University); Benoit Julien (School of Economics, University of New South Wales); Chengsi Wang (School of Economics, University of New South Wales)
    Abstract: In this paper we study the optimal monetary and fiscal policies of a general equilibrium model of unemployment and money with search frictions both in labor and goods markets as in Berentsen, Menzio and Wright (2010). We abstract from revenue-raising motives to focus on the welfare-enhancing properties of optimal policies. We show that some of the inefficiencies in the Berentsen, Menzio and Wright (2010) framework can be restored with appropriate fiscal policies. In particular, when lump sum monetary transfers are possible, a production subsidy financed by money printing can increase output in the decentralized market and a vacancy subsidy financed by a dividend tax even when the Hosios’ rule does not hold.
    Keywords: Search and matching; Fiscal polices; Money; Unemployment; Efficiency
    JEL: E52 E63
    Date: 2010–11
  2. By: Kamal, Mona
    Abstract: This paper applies the Bayesian method to estimate a Dynamic Stochastic General Equilibrium (DSGE) model using quarterly data for the UK over the period from 1971:Q1 through 2009:Q2. The contribution of the paper is two-fold. First, we estimate a model characterised by nominal and real frictions. This estimation allows us to recover the structural parameters of the economy and study the transmission mechanism of a government spending shock. Second, we investigate how the inclusion of fiscal policy rules affect the propagation of shocks and the ability of the model to fit the data. We establish that this inclusion enable the model to fit the data more closely. In addition, it has an impact on the qualitative responses of macroeconomic variables to the government spending shock.
    Keywords: The transmission mechanism of a government spending shock; Bayesian analysis;(DSGE)model.
    JEL: C01 E60
    Date: 2011–02–17
  3. By: Runli Xie
    Abstract: This paper focuses on the dynamic link between skill-specific labor markets with search frictions. Human capital investment is formed through households' endogenous decision, and competes with physical capital investment. Idiosyncratic shock shifts the skilled labor share and changes tightness in both skilled and unskilled markets. Given inelastic labor participation, the model can generate downward-sloping Beveridge curves in aggregate, skilled and unskilled labor markets. Upon a neutral shock, total unemployment decrease is two-staged: firstly with a reduction in unskilled unemployment, and then due to a sharp decline of skilled unemployment when skill substitution dominates. A higher elasticity of substitution between two types of labor leads to higher volatility of the model variables and higher u - v correlation.
    Keywords: skill-specific unemployment, human capital investment, idiosyncratic shock, skill substitution, search and matching
    JEL: E24 E32 J24 J63
    Date: 2011–02
  4. By: Pieter A. Gautier (VU University Amsterdam); Coen N. Teulings (Netherlands Bureau of Policy Analysis CPB, The Hague, and University of Amsterdam)
    Abstract: We analyze a general search model with on-the-job search and sorting of heterogeneous workers into heterogeneous jobs. This model yields a simple relationship between (i) the unemployment rate, (ii) the value of non-market time, and (iii) the max-mean wage differential. The latter measure of wage dispersion is more robust than measures based on the reservation wage, due to the long left tail of the wage distribution. We estimate this wage differential using data on match quality and allow for measurement error. The estimated wage dispersion for the US is consistent with an unemployment rate of 4-6%. We find that without search frictions, output would be between 7.5% and 18.5% higher, depending on whether or not firms can ex ante commit to wage payments.
    Keywords: Sorting; search frictions; wage dispersion; unemployment; mismatch; on-the-job search; output loss; business stealing
    JEL: E24 J62 J63 J64
    Date: 2011–01–14
  5. By: Tigran Poghosyan; Samya Beidas-Strom
    Abstract: This paper presents and estimates a small open economy dynamic stochastic general-equilibrium model (DSGE) for the Jordanian economy. The model features nominal and real rigidities, imperfect competition and habit formation in the consumer’s utility function. Oil imports are explicitly modeled in the consumption basket and domestic production. Bayesian estimation methods are employed on quarterly Jordanian data. The model’s properties are described by impulse response analysis of identified structural shocks pertinent to the economy. These properties assess the effectiveness of the pegged exchange rate regime in minimizing inflation and output trade-offs. The estimates of the structural parameters fall within plausible ranges, and simulation results suggest that while the peg amplifies output, consumption and (price and wage) inflation volatility, it offers a relatively low risk premium.
    Keywords: Income , Monetary policy , Exchange rate depreciation , Exchange rate appreciation , Economic models , External shocks , Demand , Oil prices , Price adjustments , Wage policy , Consumption , Exchange rate policy ,
    Date: 2011–02–02
  6. By: Olivier CARDI (Université Panthéon-Assas ERMES, Ecole Polytechnique); Romain RESTOUT (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES))
    Abstract: We use a neoclassical open economy model with traded and non traded goods to investigate the sectoral effects of three tax reforms: i) two revenue-neutral shifting the tax burden from labor to consumption taxes and ii) one labor tax restructuring keeping the marginal tax wedge constant. Regardless of its type, a tax reform crowds-in both consumption and investment and raises employment. Whereas tax reforms have a small impact on GDP, they exert substantial effects on sectoral outputs which move in opposite direction in the short-run. The sensitivity analysis reveals that raising the elasticity of labor supply or reducing the tradable content in consumption expenditure amplifies the heterogeneity in sectoral output responses. Finally, allowing for the markup to depend on the number of competitors, we find that a substantial share of sectoral output variations can be attributed to the change in the markup triggered by firm entry.
    Keywords: Non Traded Goods; Employment; Current Account; Tax Reform
    JEL: F41 E62 E22
    Date: 2010–12–21
  7. By: Laséen, Stefan (Monetary Policy Department, Central Bank of Sweden); Svensson, Lars E.O. (Sveriges Riksbank)
    Abstract: This paper specifies a new convenient algorithm to construct policy projections conditional on alternative anticipated policy-rate paths in linearized dynamic stochastic general equilibrium (DSGE) models, such as Ramses, the Riksbank's main DSGE model. Such projections with anticipated policy-rate paths correspond to situations where the central bank transparently announces that it, conditional on current information, plans to implement a particular policy-rate path and where this announced plan for the policy rate is believed and then anticipated by the private sector. The main idea of the algorithm is to include among the predetermined variables (the "state" of the economy) the vector of nonzero means of future shocks to a given policy rule that is required to satisfy the given anticipated policy-rate path.
    Keywords: Optimal monetary policy; instrument rules; policy rules; optimal policy projections
    JEL: E52 E58
    Date: 2011–01–01
  8. By: Hillebrand, Marten
    Abstract: The paper analyzes the sustainability of governmental debt and its welfare properties in an overlapping generations economy with stochastic production and capital accumulation. In the absence of taxation, equilibria with positive debt generically converge to debtless eauilibria are typically inefficient. It is shown that this may be overcome by a tax on labor income which stabilizes the level of debt against unfavorable shocks. A long-run welfare criterion is formulated which measures consumer utility at the stabilized equlibrium. Based on this criterion, the welfare effects of different interest policies and alternative stabilization objectives are investigated. The results offer a simple explanation why empirical debt levels are high and typically yield a riskless return despite both fails to be optimal in the long run. --
    Keywords: OLG,governmental debt,interest policy,risk sharing,tax stabilization,stabilized equilibrium,long-run welfare
    JEL: C62 E27 E H21 H63
    Date: 2011
  9. By: Tetyana Dubovyk (CeRP-Collegio Carlo Alberto)
    Abstract: In 1990s, several pension reforms had been adopted to insure financial sustainability of Italian Social Security system. This paper studies two main features of Amato and Dini reforms: (i) adoption of notional defined contributions formula; (ii) price indexation of benefits as compared to wage indexation prior to 1992. As the reforms envision a long phase-in period, I consider the effect of the reforms on different generations. This paper studies household decisions and welfare consequences of the reforms using general equilibrium overlapping generations framework. The major focus is on time allocation and human capital accumulation decisions of transition generations. The economic and demographic structure of the economy is calibrated to (i) Italian macroeconomic variables in 1992, (ii) observed earnings profiles in Survey of Household Income and Wealth by Banca d'Italia (SHIW). The reforms decrease financial obligations of the pension system. The paper quantifies the effect of the reforms on transition generations.
    Date: 2010–11
  10. By: Pedro Gomis-Porqueras (School of Economics, Australian National University); Benoit Julien (School of Economics, University of New South Wales); Chengsi Wang (School of Economics, University of New South Wales)
    Abstract: This paper develops a model of pricing and advertising in a matching environment with capacity constrained sellers and uncoordinated buyers. Sellers’ search intensity attracts buyers only probabilistically through costly informative advertisement. Equilibrium prices and profit maximizing advertising levels are derived and their properties analyzed. The model generates an inverted U-shape relationship between individual advertisement and market tightness which is robust to alternative advertising technologies. The well known empirical fact in the IO literature reflects the trade-off between price and market tightness matching effects. Finally, in this environment we can alleviate the discontinuity problem, allowing for unique symmetric equilibrium price to be derived.
    Keywords: Directed searching; Advertising; Pricing; Market structure
    JEL: E52 E63
    Date: 2010–11
  11. By: Luis-Felipe Zanna; Marco Airaudo
    Abstract: Empirical evidence suggests that goods are highly heterogeneous with respect to the degree of price rigidity. We develop a DSGE model featuring heterogeneous nominal rigidities across two sectors to study the equilibrium determinacy and stability under adaptive learning for interest rate rules that respond to inflation measures differing in their degree of price stickiness. We find that rules responding to headline inflation measures that assign a positive weight to the inflation of the sector with low price stickiness are more prone to generate macroeconomic instability than rules that respond exclusively to the inflation of the sector with high price stickiness. By this we mean that they are more prone to induce non-learnable fundamental-driven equilibria, learnable self-fulfilling expectations equilibria, and equilibria where fluctuations are unbounded. We discuss how our results depend on the elasticity of substitution across goods, the degree of heterogeneity in price rigidity, as well as on the timing of the rule.
    Keywords: Economic models , Inflation , Inflation rates , Price stabilization , Stabilization measures ,
    Date: 2010–12–22
  12. By: Gul Ertan Ozguzer (Department of Economics, Izmir University of Economics); Luca Pensieroso (Department of Economics, IRES - Universite catholique de Louvain)
    Abstract: We build a two-country dynamic general equilibrium model to study whether European citizens would benet from the eventual accession of Turkey to the European Union. The results of the simulations show that Turkey's accession to the European Union is welfare enhancing for Europeans, provided that Turkish total factor productivity (TFP) increases suciently after enlargement. In the model with no capital mobility, the Europeans are better o if the Turkish TFP increase bridges more than 31% of the initial TFP gap between Turkey and the European Union. That gure becomes 45% when capital mobility is introduced.
    Keywords: European Union, Turkey, Enlargement, Dynamic General Equilibrium, Open Economy Macroeconomics
    JEL: F41
    Date: 2010–10
  13. By: Rui Albuquerque (Boston University School of Management, ECGI, and CEPR); Enrique Schroth (University of Amsterdam)
    Abstract: This paper investigates empirically the illiquidity of majority blocks of shares in the context of a search model of block trades. The search model incorporates two aspects of illiquidity, or search frictions. First, upon a liquidity shock, the incumbent blockholders may be forced to sell to a less efficient buyer. Second, a block liquidity sale may occur at a fire sale price. We conduct a structural estimation of the model using data on majority block trades in the U.S. The structural estimation is particularly useful in this exercise as it allows us to evaluate the counterfactual price that would result absent liquidity shocks. Our results help shed light into the size of the marketability discount, the control discount and an illiquidity-spillover discount we identify, and on the determinants of aggregate liquidity.
    Keywords: Block pricing; marketability discount; liquidity; control transactions; search frictions; structural estimation
    JEL: G34
    Date: 2011–02–11
  14. By: Tim Willems (University of Amsterdam)
    Abstract: Recent research has shown that the standard labor market matching model fails to match the dynamics of US data. In particular, the model lacks sufficient propagation of shocks. This paper shows that refining the informational structure of the model leads to significant improvements along this dimension. In particular, when one assumes that agents cannot separately identify persistent and transitory technology shocks on impact (so that they must solve a signal extraction problem) shocks are propagated and the standard matching model performs much better.
    Keywords: imperfect information; labor market matching; option value of waiting; signal extraction
    JEL: D80 E32 J63 J64
    Date: 2010–09–30
  15. By: Rodney W. Strachan (The Australian National University); Herman K. van Dijk (Erasmus University Rotterdam)
    Abstract: The empirical support for a real business cycle model with two technology shocks is evaluated using a Bayesian model averaging procedure. This procedure makes use of a finite mixture of many models within the class of
    Keywords: Posterior probability; Real business cycle model; Cointegration; Model averaging; Stochastic trend; Impulse response; Vector autoregressive model
    JEL: C11 C32 C52
    Date: 2010–05–17
  16. By: Yoichi Hizen (Hokkaido University); Keisuke Kawata (Osaka University); Masaru Sasaki (Osaka University)
    Abstract: This paper's objectives are to design laboratory experiments of finite and infinite sequen- tial collective search models and to test some implications obtained in the model of Albrecht, Anderson and Vroman (2010) (the AAV model). We find that, compared with single-agent search, the average search duration is longer in collective search with the unanimity rule, but it is shorter in the case of collective search in which at least one vote is needed to stop searching. In addition, according to estimates from round-based search decisions, subjects are more likely to vote to stop searching in collective search than in single-agent search. This confirms that agents are less picky in the case of collective search. Overall, the experimental outcomes are consistent with the implications suggested by the AAV model. However, a different outcome is obtained from the AAV model in terms of the size order of the probabilities of voting to stop searching in collective search for the various plurality voting rules.
    Keywords: experiment, collective search, voting rule.
    JEL: C91 D83
    Date: 2011–02
  17. By: Kuehnel, Johanna
    Abstract: This paper introduces a democratic voting process into an OLG economy in order to analyze the effects of a rising old-age dependency ratio on the composition of government spending and endogenous economic growth. Forward-looking agents vote each period on the public policy mix between productive government expenditure and public consumption spending that benefits the elderly. Population aging shifts political power from the young to the old. While this does not affect public productive expenditure, it leads to an increase in public spending on the elderly and a slowdown in economic growth. However, the overall effect on long-term economic growth is positive. This is due to reduced capital dilution or increased saving.
    Keywords: Demographics; Endogenous Economic Growth; Government Spending; Markov Perfect Equilibrium; Probabilistic Voting
    JEL: D72 E62 O41
    Date: 2011–02–17
  18. By: Ana Babus (University of Cambridge); Casper G. de Vries (Erasmus University Rotterdam)
    Abstract: The dynamic properties of micro based stochastic macro models are often analyzed through a linearization around the associated deterministic steady state. Recent literature has investigated the error made by such a deterministic approximation. Complementary to this literature we investigate how the linearization affects the stochastic properties of the original model. We consider a simple real business cycle model with noisy learning by doing. The solution has a stationary distribution that exhibits moment failure and has an unbounded support. The linear approximation, however, yields a stationary distribution with possibly a bounded support and all moments
    Keywords: Linearization; ARCH process; Real business cycles model; Stochastic difference equation
    JEL: C22 C62 E32
    Date: 2010–08–26
  19. By: Roberto Bonfatti; Maitreesh Ghatak
    Abstract: An interesting puzzle is that trade liberalization in the 1980s and 1990s has been associated with a sharp increase in the skill premium in both developed and developing countries. This is in contrast with neoclassical theory, according to which trade should increase the relative return of the relatively abundant factor. We develop a simple model of trade with capital market imperfections, and show that trade can increase the skill premium in both the North and the South, and both in the short run as well as in the long run. We show that trade with a skill-intensive economy has two effects: it reduces the skilled wage, and thus discourages non talented agents out of the skilled labor force; and it reduces the cost of subsistence, thus allowing the talented offspring of unskilled workers to go to school. This compositional effect has a positive effect on the observed skill premium, possibly strong enough to counterweight the decrease in the skilled wage.
    Keywords: Trade Liberalization, Skill Premium, Credit Market Frictions, Latin America
    JEL: F16 O15 O16
    Date: 2010–11
  20. By: Javier Bianchi; Enrique G. Mendoza
    Abstract: This paper studies overborrowing, financial crises and macro-prudential policy in an equilibrium model of business cycles and asset prices with collateral constraints. Agents in a decentralized competitive equilibrium do not internalize the negative effects of asset fire-sales on the value of other agents' assets and hence they borrow too much" ex ante, compared with a constrained social planner who internalizes these effects. Average debt and leverage ratios are slightly larger in the competitive equilibrium, but the incidence and magnitude of financial crises are much larger. Excess asset returns, Sharpe ratios and the market price of risk are also much larger. State-contigent taxes on debt and dividends of about 1 and -0.5 percent on average respectively support the planner’s allocations as a competitive equilibrium and increase social welfare.
    Keywords: Borrowing , Business cycles , Credit , Economic models , Financial crisis , Global Financial Crisis 2008-2009 ,
    Date: 2011–02–01
  21. By: M. Marzo; L. Zhoushi; P. Zagaglia
    Abstract: This note sketches the issues that arise while interpreting the relation between macroeconomic volatility and financial risk premia from the perspective of the standard consumption-based asset pricingmodel. The relation arises from the fact that all assets are priced by the same "pricingkernel", given by the inter-temporal marginal rate of substitution in consumption of the representative investor. Since the pricing kernel is a function of aggregate consumption, financial risk premia are positively related to consumption growth volatility. Therefore, from the perspective of this workhorse often employed in the academic debate, the persistent reduction in macroeconomic volatility can be considered a cause for the low average risk premia prevailing during the so-called Great Moderation, namely the period preceding the recent turmoil in financial markets. We challenge this view by shedding light on the issues that generate an inconsistent interpretation of the model outcomes. In particular, since the consumption-based model is geared towards asset prices consistent with macroeconomic fundamentals, we argue that it is not suited for interpreting current developments where underestimation of risk may have subsidized asset prices. In particular, according to the evidence for the Great Moderation, the model view suffers from observational equivalence.
    JEL: E43 G12
    Date: 2011–02
  22. By: Nicoletta Batini (University of Surrey and IMF); Paul Levine (University of Surrey); Emanuela Lotti (University of Southampton and University of Surrey)
    Abstract: We explore the costs and benefits of informality associated with the informal sector lying outside the tax regime in a two-sector New Keynesian model. The informal sector is more labour intensive, has a lower labour productivity, is untaxed and has a classical labour market. The formal sector bears all the taxation costs, produces all the government services and capital goods, and wages are determined by a real wage norm. We identify two welfare costs of informalization: (1) long-term costs restricting taxes to the formal sector and (2) short-term fluctuation costs of tax changes to finance fluctuations in government spending. The benefit of informality derives from its wage flexibility. We investigate whether taxing the informal sector and thereby reducing its size sees a net welfare improvement.
    Keywords: Informal economy, labour market, tax policy, interest rate rules
    JEL: J65 E24 E26 E32
    Date: 2010–12
  23. By: Pau Rabanal; Oriol Aspachs-Bracons
    Abstract: The recent boom-and-bust cycle in housing prices has refreshed the debate on the drivers of housing cycles as well as the appropriate policy response. We analyze the case of Spain, where housing prices have soared since it joined the EMU. We present evidence based on a VAR model, and we calibrate a New Keynesian model of a currency area with durable goods to explain it. We find that labor market rigidities provide stronger amplification effects to all type of shocks than financial frictions do. Finally, we show that when the central bank reacts to house prices, the non-durable sector suffers an important contraction. As a result, the boom-and-bust cycle would not have been avoided if Spain had remained outside the EMU during the 1996-2007 period.
    Keywords: Demand , Economic models , European Economic and Monetary Union , External shocks , Housing , Housing prices , Interest rates , Labor markets , Monetary policy , Spain ,
    Date: 2011–01–07

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