nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2011‒03‒19
nineteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Optimal Simple Monetary and Fiscal Rules under Limited Asset Market Participation By Giorgio Motta; Patrizio Tirelli
  2. Optimal Unemployment Insurance: How Important is the Demand Side? By Rune Vejlin
  3. How Powerful is Demography? The Serendipity Theorem Revisited By David De La Croix; Pierre Pestieau; Grégory Ponthière
  4. Endogenous Market Structures and Labor Market Dynamics By Colciago, Andrea; Rossi, Lorenza
  5. Induced Innovation, Endogenous Growth, and Income Distribution: a Model along Classical Lines By Luca Zamparelli
  6. Existence and stability of overconsumption equilibria By Grégory Ponthière
  7. Monetary Shocks and the Cyclical Behavior of Loan Spreads By Pierre-Richard Agénor; George Bratsiotis; D. Pfajfar
  8. Motivations for Remittances: Evidence from Moldova By Keisuke Otsu; Masashi Saito
  9. Debt Stabilization in a Non-Ricardian Economy By Campbell Leith; Ioana Moldovan; Simon Wren-Lewis
  10. Myopic governments and welfare-enhancing debt limits By Malte Rieth
  11. Investments in education and welfare in a two-sector, random matching economy By Mendolicchio, Concetta; Paolini, Dimitri; Pietra, Tito
  12. Asymptotic age structures and intergenerational trade By Grégory Ponthière
  13. Did Housing Policies Cause the Post-War Boom in Homeownership? A General Equilibrium Analysis By Matthew Chambers; Carlos Garriga; Don E. Schlagenhauf
  14. How Should Environmental Policy Respond to Business Cycles? Optimal Policy under Persistent Productivity Shocks By Heutel, Garth
  15. The long-term effects of in-work benefits in a life-cycle model for policy evaluation By Richard Blundell; Monica Costa Dias; Costas Meghir; Jonathan Shaw
  16. Does a Rising Tide Lift All Boats? Welfare Consequences of Asymmetric Growth By Murphy, Daniel P
  17. Leaning Against Boom-Bust Cycles in Credit and Housing Prices By Luisa Lambertini; Caterina Mendicino; Maria Teresa Punzi
  18. Testing for Parameter Stability in DSGE Models. The Cases of France, Germany and Spain By Jerger, Jürgen; Röhe, Oke
  19. Real indeterminacy and the timing of money in open economies By Stephen McKnight

  1. By: Giorgio Motta; Patrizio Tirelli
    Abstract: When the central bank is the sole policymaker, the combination of limited asset market participation and consumption habits can have dramatic implications for the optimal monetary policy rule and for stability properties of a business cycle model characterized by price and nominal wage rigidities. In this framework, a simple countercyclical fiscal rule plays a twofold role. On the one hand it ensures uniqueness of the rational expectations equilibrium when monetary policy follows a standard Taylor rule. On the other hand it brings aggregate dynamics substantially closer to their socially efficient levels.
    Keywords: Rule of Thumb Consumers, DSGE, Determinacy, Limited Asset Market Participation, Taylor Principle, Optimal Simple Rule
    JEL: E52
    Date: 2011–03
  2. By: Rune Vejlin (School of Economics and Management, Aarhus University, Denmark)
    Abstract: I develop and simulate an equilibrium model of search with endogenous savings and search intensity. The wage offer distribution is endogenized by firms making vacancy and entry choices. This allows me to conduct a counterfactual analysis of the optimal unemployment insurance (UI) level. The provision of UI is motivated by the worker's inability to perfectly insure against income shocks, but at the same time UI introduces a distortion to the level of search intensity of the worker and vacancy intensity of firms. I find that equilibrium effects are important to take into account. Making policy from a partial model can introduce large welfare loses. It is also shown that different kinds of taxes have different implications on welfare.
    Keywords: Equilibrium Search Model, Optimal Unemployment Insurance, Endogenous Saving
    JEL: D3 D9 E2 E61 J6
    Date: 2011–03–11
  3. By: David De La Croix (CORE - Department of Economics - Université Catholique de Louvain); Pierre Pestieau (CREPP - Center of Research in Public Economics and Population Economics - Université de Liège, CORE - Center of Operation Research and Econometrics [Louvain] - Université Catholique de Louvain, CEPR - Center for Economic Policy Research - CEPR, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - Ecole des Ponts ParisTech - Ecole Normale Supérieure de Paris - ENS Paris); Grégory Ponthière (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - Ecole des Ponts ParisTech - Ecole Normale Supérieure de Paris - ENS Paris)
    Abstract: Introduced by Samuelson (1975), the Serendipity Theorem states that the competitive economy will converge towards the optimum steady-state provided the optimum population growth rate is imposed. This paper aims at exploring whether the Serendipity Theorem still holds in an economy with risky lifetime. We show that, under general conditions, including a perfect annuity market with actuarially fair return, imposing the optimum fertility rate and the optimum survival rate leads the competitive economy to the optimum steady-state. That Extended Serendipity Theorem is also shown to hold in economies where old adults work some fraction of the old-age, whatever the retirement age is fixed or chosen by the agents.
    Keywords: serendipity Theorem ; fertility ; mortality ; overlapping generations ; retirement
    Date: 2011–03–09
  4. By: Colciago, Andrea; Rossi, Lorenza
    Abstract: We propose a flexible prices model where endogenous market structures and search and matching frictions in the labor market interact endogenously. The interplay between firms endogenous entry, strategic interactions among producers and labor market frictions represents a strong amplification channel of technology shocks on labor market variables, and helps addressing the unemployment-volatility puzzle. Consistently with U.S. evidence, new firms create a large fraction of new jobs and grow faster than more mature firms, net firms' entry is procyclical and the price mark up is countercyclical.
    Keywords: Endogenous Market Structures; Firms' Entry; Search and Matching Frictions
    JEL: E32 L11 E24
    Date: 2011–02
  5. By: Luca Zamparelli (Department of Economic Theory, Sapienza University of Rome)
    Abstract: This paper presents a classical micro-founded growth model with endogenous direction and size of technical change. In a standard induced innovation model firms freely adopt productivity improvements from an innovation possibilities frontier describing the trade-off between increasing capital or labor productivity. The shape of the innovation possibility frontier uniquely determines the steady state distribution of income. The model proposed allows firms to choose not only the direction but also the size of innovation by making innovation a costly activity requiring R&D investment. Comparative dynamics analysis shows that income distribution is are sensitive to saving parameters and fiscal policy. In particular, an increase in the discount factor or in subsidy to R&D raises the labor share.
    Keywords: Induced innovation, endogenous growth, direction of technical change, classical growth.
    JEL: D33 O31 O33 O40
    Date: 2011
  6. By: Grégory Ponthière (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - Ecole des Ponts ParisTech - Ecole Normale Supérieure de Paris - ENS Paris)
    Abstract: Growth models with endogenous mortality assume generally that life expectancy is increasing with output per capita, and, thus, with individual consumption, whatever the consumption level is. However, empirical evidence on the effect of overconsumption and obesity on mortality tends to question that postulate. This paper develops a two-period OLG model where life expectancy is a non-monotonic function of consumption. The existence, uniqueness and stability of steady-state equilibria are studied. It is shown that overconsumption equilibria - i.e. equilibria at which consumption exceeds the level maximizing life expectancy - exist in highly productive economies with a low impatience. Stability analysis highlights conditions under which there exist non-converging cycles in output and longevity around overconsumption equilibria.
    Keywords: longevity ; growth ; overconsumption ; obesity ; OLG model
    Date: 2011–03–09
  7. By: Pierre-Richard Agénor; George Bratsiotis; D. Pfajfar
    Abstract: This paper examines the impact of monetary shocks on the loan spread in a DSGE model that combines the cost channel effect of monetary transmission with the role of collateral under asymmetric information. Its key feature is the endogenous derivation of the default probability that results in a lending rate being set as a countercyclical risk premium over the cost of borrowing from the central bank. The endogenous probability of default is shown to provide an accelerator effect through which monetary shocks can amplify the loan spread The behavior of the spread appears to be consistent with existing empirical evidence.
    Date: 2011
  8. By: Keisuke Otsu; Masashi Saito
    Abstract: This paper constructs a dynamic stochastic general equilibrium model in which labor reallocations between production and organizational tasks generate endogenous TFP movements and also amplify and propagate the effects of exogenous shocks on macroeconomic activity. Organizational tasks in our model enhances financial relationships between firms and lenders, which lowers the credit spread. We calibrate and estimate the model using Japanese data and conduct a quantitative analysis. Our results suggest that the labor reallocation channel considered in this paper contributes greatly to the observed movements in the measured TFP, and serves as a quantitatively important amplification and propagation mechanism in aggregate fluctuations.
    Keywords: Labor Reallocations; Financial Relationship; Organizational Capital; TFP; Aggregate Fluctuations
    JEL: E13 E32
    Date: 2011–02
  9. By: Campbell Leith; Ioana Moldovan; Simon Wren-Lewis
    Abstract: In models with a representative infinitely lived household, modern versions of tax smoothing imply that the steady-state of government debt should follow a random walk. This is unlikely to be the case in OLG economies, where the equilibrium interest rate may differ from the policy-maker’s rate of time preference such that it may be optimal to reduce debt today to reduce distortionary taxation in the future. Moreover, the level of the capital stock (and therefore output and consumption) in these economies is likely to be sub-optimally low, and reducing government debt will ‘crowd in’ additional capital. Using an elaborated version of the model of perpetual youth developed by Blanchard (1985) and Yaari (1985), we derive the optimal steady state level of government assets. We show how and why this level of government assets falls short of the level of debt that achieves the optimal capital stock and the level that eliminates income taxes.
    Keywords: Non-Ricardian consumers, macroeconomic stability, distortionary taxes
    JEL: E21 E32 E63
    Date: 2011
  10. By: Malte Rieth (University of Dortmund, Chair of Applied Economics and Ruhr Graduate School in Economics, Vogelpothsweg 87, 44227 Dortmund, Germany.)
    Abstract: This paper studies welfare consequences of a soft borrowing constraint on sovereign debt which is modeled as a proportional fine per unit of debt exceeding some reference value. Debt is the result of myopic fiscal policy where the government is assumed to have a smaller discount factor than the private sector. Due to the absence of lump-sum taxation, debt reduces welfare. The paper shows that the imposition of a soft borrowing constraint, which resembles features of the Stability and Growth Pact and which is taken into account by the policy maker when setting its instruments, prevents excessive borrowing. The constraint can be implemented such as to (i) control the long run level of debt, (ii) prevent debt accumulation, and (iii) induce debt consolidation. In all three cases the constraint enhances welfare and in a welfare ranking these gains outweigh the short run welfare losses of increasing the costs of using debt to smooth taxes over the business cycle. JEL Classification: H3, H63, E6.
    Keywords: Myopic governments, debt bias, fiscal constraints, Stability and Growth Pact, social welfare.
    Date: 2011–03
  11. By: Mendolicchio, Concetta (Institut für Arbeitsmarkt- und Berufsforschung (IAB), Nürnberg [Institute for Employment Research, Nuremberg, Germany]); Paolini, Dimitri; Pietra, Tito
    Abstract: "We consider a random matching model where heterogeneous agents choose optimally to invest time and real resources in education. Generically, there is a steady state equilibrium, where some agents, but not all of them, invest. Regular steady state equilibria are constrained inefficient in a strong sense. The Hosios (1990) condition is neither necessary, nor sucient, for constrained efficiency. We also provide restrictions on the fundamentals sufficient to guarantee that equilibria are characterized by overeducation (or undereducation), present some results on their comparative statics properties, and discuss the nature of welfare improving policies." (author's abstract, IAB-Doku) ((en))
    JEL: J24 H2
    Date: 2011–03–07
  12. By: Grégory Ponthière (PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - Ecole des Ponts ParisTech - Ecole Normale Supérieure de Paris - ENS Paris, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: While demographers Lotka (1939) and Lopez (1961) proposed conditions on (exogenous) fertility and mortality laws under which populations with distinct initial age structures exhibit the same asymptotic age structure, this paper re-examines the issues of age structure stabilization and convergence, by considering a population whose fertility and mortality are endogenously determined in the economy. For that purpose, we develop a three-period OLG model where human capital accumulation and intergenerational trade affect fertility and longevity. It is shown that the age structure must converge asymptotically towards a stable structure, whose form depends on the structural parameters of the economy. Moreover, populations with distinct initial age structures will end up with the same long-run age structure when fertility and mortality laws are converging, which requires converging terms of trade between coexisting generations in the different populations under study.
    Keywords: age structure ; OLG model ; fertility ; mortality ; demographic transition ; intergenerational trade
    Date: 2011–03–09
  13. By: Matthew Chambers (Department of Economics, Towson University); Carlos Garriga (Federal Reserve Bank of St. Louis); Don E. Schlagenhauf (Department of Economics, Florida State University)
    Abstract: The objective of this paper is to understand the sources of the boom in home ownership between 1940 and 1960. The increase over this period was five times larger than the recent episode 1996-2004. In the post-depression period the government opted to intervene and regulate housing finance, provide assistance programs (i.e. through the Veteran Administration), and change tax provision towards housing. The result was a change in the maturity structure of mortgage loans, downpayment requirements and increase of credit. In addition, the economy underwent important changes in the demographic structure, the income distribution. The relative importance of these different driving forces is analyzed using a quantitative general equilibrium overlapping generation model with housing. The parameterized model is consistent with key aggregate and distributional features in the U.S. in 1940. In contrast to the recent episode, income and demographics are the crucial variables in accounting for the increase in homeownership. Essentially, the level and shape of income over the life-cycle are a precondition for the government reforms in housing markets and housing finance to play an important role in generating an increase in the aggregate home ownership. The increase in life expectancy and the shift in the distribution of age cohort also had a significant effect in the demand for housing.
    Keywords: Housing Finance, First-time buyers, life-cycle.
    JEL: E2 E6
    Date: 2011–02
  14. By: Heutel, Garth (University of North Carolina at Greensboro, Department of Economics)
    Abstract: How should environmental policy respond to economic fluctuations caused by persistent productivity shocks? This paper answers that question using a dynamic stochastic general equilibrium real business cycle model that includes a pollution externality. I first estimate the relationship between the cyclical components of carbon dioxide emissions and US GDP and find it to be inelastic. Using this result to calibrate the model, I find that optimal policy allows carbon emissions to be procyclical: increasing during expansions and decreasing during recessions. However, optimal policy dampens the procyclicality of emissions compared to the unregulated case. A price effect from costlier abatement during booms outweighs an income effect of greater demand for clean air. I also model a decentralized economy, where government chooses an emissions tax or quantity restriction and firms and consumers respond. The optimal emissions tax rate and the optimal emissions quota are both procyclical: during recessions, the tax rate and the emissions quota both decrease.
    Keywords: Climate change; Environmental policy
    JEL: E32 Q54 Q58
    Date: 2011–03–08
  15. By: Richard Blundell (Institute for Fiscal Studies and University College London); Monica Costa Dias (Institute for Fiscal Studies and Institute for Fiscal Studies); Costas Meghir (Institute for Fiscal Studies and University College London); Jonathan Shaw (Institute for Fiscal Studies)
    Abstract: <p><p>This paper presents a life-cycle model of woman's labour supply, human capital formation and savings for the evaluation of welfare-to-work and tax policies. Women's decisions are formalised in a dynamic and uncertain environment. The model includes a detailed characterisation of the tax system and of the dynamics of family formation while explicitly considering the determinants of employment and education decisions: (i ) contemporaneous incentives to work, (ii ) future consequences for employment through human capital accumulation and (iii) anticipatory effects on the value of employment and education. The choice of parameters follows a careful calibration procedure, based of a large sample of data moments from the British population during the nineties using BHPS data. Many important features established in the empirical literature are reproduced in the simulation exercises, including the employment effects of the WFTC reform in the UK. The model is used to gain further insight into the responses to two recent policy changes, the October 1999 WFTC and the April 2003 WTC/CTC reforms. We find small but non-negligible anticipation effects on employment and education.</p></p>
    Date: 2011–02
  16. By: Murphy, Daniel P
    Abstract: A common presumption is that increased growth in the aggregate enhances the welfare of both the rich and the poor. I show that instead, as the rich get richer, the welfare of the poor may decline if the underlying growth is asymmetric. There are two distinct and complementary explanations: First, sector-biased, skill-biased technological change, and second, efficiency improvements in the government sector. In the first case, skill-biased technological change in sectors consumed by the skilled rich increases their income beyond the increase in economic wealth, causing a decline in the consumption and welfare of the low-skilled poor. This result stands in contrast to the standard model of skill-biased technological change. In the second case, growth takes the form of improved efficiency in a government sector that is financed by rich taxpayers. The welfare of the low-skilled poor will decline whenever the consumption bundle of the skilled rich embodies more skill intensity than does the production of government services. This analysis demonstrates that a rising tide need not lift all boats and that the exact nature of consumption patterns is important not only for growth and inequality, as has been emphasized in earlier literature, but also for welfare.
    Keywords: economic growth; inequality; skill-biased technological change; public economics
    JEL: O11 H50 I31 O39 J24 J30
    Date: 2011–01
  17. By: Luisa Lambertini (EPFL); Caterina Mendicino (Bank of Portugal); Maria Teresa Punzi (Central Bank of Ecuador)
    Abstract: This paper studies the potential gains of monetary and macro-prudential policies that lean against news-driven boom-bust cycles in housing prices and credit generated by expectations of future macroeconomic developments. First, we find no trade-off between the traditional goals of monetary policy and leaning against boom-bust cycles. An interest-rate rule that completely stabilizes inflation is not optimal. In contrast, an interest-rate rule that responds to financial variables mitigates macroeconomic and financial cycles and is welfare improving relative to the estimated rule. Second, counter-cyclical Loan-to-Value rules that respond to credit growth do not increase in ation volatility and are more effective in maintaining a stable provision of financial intermediation than interest-rate rules that respond to financial variables. Heterogeneity in the welfare implications for borrowers and savers make it dicult to rank the two policy frameworks.
    Date: 2011
  18. By: Jerger, Jürgen; Röhe, Oke
    Abstract: We estimate a New Keynesian DSGE model on French, German and Spanish data. The main aim of this paper is to check for the respective sets of parameters that are stable over time, making use of the ESS procedure ( â€Estimate of Set of Stable parameters“) developed by Inoue and Rossi (2011). This new econometric technique allows to address the stability properties of each single parameter in a DSGE model separately. In the case of France and Germany our results point to structural breaks after the beginning of the second stage of EMU in the mid-nineties, while the estimates for Spain show a significant break just before the start of the third stage in 1998. Specifically, there are significant changes in monetary policy behavior for France and Spain, while monetary policy in Germany seems to be stable over time.
    Keywords: DSGE; EMU; Monetary Policy; Structural Breaks
    JEL: E31 E32 E52
    Date: 2011–03–07
  19. By: Stephen McKnight (El Colegio de México)
    Abstract: Should central banks target producer price inflation or consumer price inflation in the setting of monetary policy? Previous studies suggest that in order to avoid real indeterminacy and self-fulfilling fluctuations, the interest rate rule for open economies should react to producer price inflation. However, as this paper shows, the preference towards a particular inflation index crucially depends upon the timing assumption on money employed in the determinacy analysis. This timing assumption importantly determines the transactions-facilitating services of money. It is shown that the conclusions of the existing literature, that advocate targeting producer price inflation, is a by-product of adopting end-of-period timing, i.e. what matters for transactions purposes is the money one leaves the goods market with. However, we find that the conditions for equilibrium determinacy change significantly once cash-in-advance timing is adopted, i.e. what matters for current transactions is the money one enters the goods market with. Thus in stark contrast to previous studies, we show that under cash-in-advance timing, targeting consumer price inflation is preferable to targeting producer price inflation in preventing self-fulfilling expectations.
    Keywords: real indeterminacy, open economy monetary models, trade openness, interest rate rules
    JEL: E32 E43 E53 E58 F41
    Date: 2011–03

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