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on Dynamic General Equilibrium |
| By: | Kevin J. Lansing |
| Abstract: | This paper investigates how concentrated ownership of capital influences the pricing of risky assets in a production economy. The model is designed to approximate the skewed distribution of wealth and income in U.S. data. I show that concentrated ownership significantly magnifies the equity risk premium relative to an otherwise similar representative-agent economy because the capital owners' consumption is more strongly linked to volatile dividends from equity. A temporary shock to the technology for producing new capital (an "investment shock") causes dividend growth to be much more volatile than aggregate consumption growth, as in long-run U.S. data. The investment shock can also be interpreted as a depreciation shock, or more generally, a financial friction that affects the supply of new capital. Under power utility with a risk aversion coefficient of 3.5, the model can roughly match the first and second moments of key asset pricing variables in long-run U.S. data, including the historical equity risk premium. About one-half of the model equity premium is attributable to the investment shock while the other half is attributable to a standard productivity shock. On the macro side, the model performs reasonably well in matching the business cycle moments of aggregate variables, including the pro-cyclical movement of capital's share of total income in U.S. data. |
| Keywords: | Asset pricing ; Capital |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:2011-07&r=dge |
| 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 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:29629&r=dge |
| By: | Andreasen, Martin (Bank of England) |
| Abstract: | This paper studies how non-Gaussian shocks affect risk premia in DSGE models approximated to second and third order. Based on an extension of the work by Schmitt-Grohe and Uribe to third order, we derive propositions for how rare disasters, stochastic volatility, and GARCH affect any risk premia in a wide class of DSGE models. To quantify these effects, we then set up a standard New Keynesian DSGE model where total factor productivity includes rare disasters, stochastic volatility, and GARCH. We find that rare disasters increase the mean level of the ten-year nominal term premium, whereas a key effect of stochastic volatility and GARCH is an increase in the variability of this premium. |
| Keywords: | Epstein-Zin-Weil preferences; GARCH; rare disasters; risk premia; stochastic volatility. |
| JEL: | C68 E30 E43 E44 G12 |
| Date: | 2011–03–15 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:0417&r=dge |
| By: | Andreasen , Martin (Bank of England); Zabczyk, Pawel (Bank of England) |
| Abstract: | This paper develops a fast method of computing arbitrary order perturbation approximations to bond prices in DSGE models. The procedure is implemented to third order where it can shorten the approximation process by more than 100 times. In a consumption-based endowment model with habits, it is further shown that a third-order perturbation solution is more accurate than the log-normal method and a procedure using consol bonds. |
| Keywords: | Perturbation method; DSGE models; habit model; higher-order approximation. |
| JEL: | C63 G12 |
| Date: | 2011–03–15 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:0416&r=dge |
| By: | Igor Vetlov (Bank of Lithuania); Ricardo Mourinho Félix (Banco de Portugal); Laure Frey (Banque de France); Tibor Hlédik (Czech National Bank); Zoltán Jakab (Office of the Fiscal Council, Republic of Hungary); Niki Papadopoulou (Central Bank of Cyprus); Lukas Reiss (Oesterreichische Nationalbank); Martin Schneider (Oesterreichische Nationalbank) |
| Abstract: | The new generation of dynamic stochastic general equilibrium (DSGE) models seems particularly suited for conducting scenario analysis. These models formalise the behaviour of economic agents on the basis of explicit micro-foundations. As a result, they appear less prone to the Lucas critique than more traditional macroeconometric models. DSGE models provide researchers with powerful tools, which allow for the designing of a broad range of scenarios and tackling a large range of issues, offering at the same time an appealing structural interpretation of the scenario specification and simulation results. The paper provides illustrations on some of the modelling issues that often arise when implementing scenarios using DSGE models in the context of projection exercises or policy analysis. These issues reflect the sensitivity of DSGE model-based analysis to scenario assumptions, which in more traditional models are apparently less critical, such as, for example, scenario event anticipation and duration, treatment of monetary and fiscal policy rules. |
| Keywords: | business fluctuations, monetary policy, fiscal policy, forecasting and simulation |
| JEL: | E32 E52 E62 E37 |
| Date: | 2010–08–25 |
| URL: | http://d.repec.org/n?u=RePEc:lie:wpaper:8&r=dge |
| By: | Yvonne Adema (Erasmus University Rotterdam, and Netspar); Jan Bonenkamp (CPB Netherlands Bureau for Economic Policy Analysis, and Netspar); Lex Meijdam (University of Tilburg, and Netspar) |
| Abstract: | This paper explores the interaction between retirement flexibility and portfolio choice in an overlapping-generations model of a closed economy. Retirement flexibility is often seen as a hedge against capital market risks which justifies more risky asset portfolios. We show, however, that this positive relationship between risk taking and retirement flexibility is weakened - and under some conditions even turned around - if not only capital market risks but also productivity risks are considered. Productivity risk in combination with a high elasticity of substitution between consumption and leisure creates a positive correlation between asset returns and labour income, reducing the willingness of consumers to bear risk. Moreover, it turns out that general equilibrium effects can either increase or decrease the equity exposure, depending on the degree of substitutability between consumption and leisure. |
| Keywords: | portfolio choice; retirement (in)flexibility; productivity and depreciation risk; intratemporal substitution; general equilibrium |
| JEL: | E21 G11 J26 |
| Date: | 2011–02–17 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:uvatin:20110038&r=dge |
| By: | Raouf Boucekkine (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille II - Université Paul Cézanne - Aix-Marseille III - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - CNRS : UMR6579); Giorgio Fabbri (Dipartimento Matematica e statistica - Université de Naples); Patrick-Antoine Pintus (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille II - Université Paul Cézanne - Aix-Marseille III - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - CNRS : UMR6579) |
| Abstract: | We show that leapfrogging and growth reversals entail sizeable welfare gains and losses, respectively, in an AK economy that cannot credibly commit to investment when borrowing from international financial markets. Small no-commitment delays originate a trade-off that has an ambiguous effect on welfare: they reduce the long-run consumption growth rate but increase the initial level of consumption that is optimally chosen. Essentially, the larger the delay, the tighter the borrowing constraint and the weaker the incentives to accumulate capital, so that smaller growth and larger initial consumption follow. We show under logarithmic utility and small delays that the short-run effect dominates the long-run effect and that welfare improves, provided that the economy has historically been growing fast enough, and numerical examples suggest that this benchmark result extends to CRRA utility. When relative risk aversion is larger than one, it follows that there exists a positive welfare-maximizing delay associated with slower growth relative to the no-delay case. We then apply our results to show that leapfrogging in consumption level typically imply large welfare gains. In contrast, growth reversals occur for large delays and lead to significant welfare losses. Finally, financial integration, as measured by the credit multiplier given the no-commitment delay, is welfare-improving only for economies that have historically been growing fast enough. |
| Keywords: | Growth Reversals; Leapfrogging; International Borrowing; Open Economies; Welfare |
| Date: | 2011–03–15 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-00576743&r=dge |
| By: | Misch, Florian; Gemmell, Norman; Kneller, Richard |
| Abstract: | This paper considers the implications of complementarity in private production and constraints on government for optimal fiscal policy. Using an endogenous growth model with public finance, it derives three central results which modify findings in the literature under standard assumptions. First, it shows that optimal public spending composition and taxation are interrelated so that first- and second-best fiscal policies differ. Second, it shows that the growth-maximizing fiscal policy is affected by preference parameters. Third, it shows that with budget rigidities and informational limitations, knowledge about the optimal fiscal policy parameter values is not necessary for growth-enhancing fiscal policy adjustments. -- |
| Keywords: | Imperfect Knowledge,Economic Growth,Productive Public Spending,Optimal Fiscal Policy |
| JEL: | E62 H21 H50 O40 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:zewdip:11018&r=dge |
| By: | Selim, Sheikh (Cardiff Business School) |
| Abstract: | We examine the optimal taxation problem in a two sector neoclassical economy with workers and capitalists. We show that in a steady state of this economy the optimal policy may involve a capital income tax or subsidy, differential taxation of labour income and redistribution. The level and the direction of the redistribution associated with such an optimal policy depends on the pre tax allocation of capital but not on the social weights attached to the different groups of taxpayers. Excess production of consumption goods creates a difference between the social marginal values of consumption and investment which in turns violates the production efficiency condition. Such a difference can be undone by taxing capital income from the consumption sector, and with this optimal policy the government can implement a redistribution scheme where both workers and capitalists bear the burden of distorting taxes. On the contrary, an optimal policy that involves a capital income subsidy in the production of consumption can implement allocations that minimize the relative price difference between consumption and investment that resulted from the excess production of investment goods. |
| Keywords: | Optimal taxation; Ramsey problem; Two Sector Economy; Redistribution |
| JEL: | C61 E13 E62 H21 |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:cdf:wpaper:2011/6&r=dge |
| By: | Di Bartolomeo Giovanni; Tirelli Patrizio; Acocella Nicola |
| Abstract: | We challenge the widely held belief that New Keynesian models cannot predict an optimal positive inflation rate. In fact we find that even for the US economy, characterized by relatively small government size, optimal trend inflation is justified by the Phelps argument that the inflation tax should be part of an optimal (distortionary) taxation scheme. This mainly happens because, unlike standard calibrations of public expenditures that focus on public consumption-to-GDP ratios, we also consider the diverse, highly distortionary effect of public transfers to households. Our prediction of the optimal inflation rate is broadly consistent with recent estimates of the Fed inflation target. We also contradict the view that the Ramsey-optimal policy should minimize inflation volatility over the business cycle and induce near-random walk dynamics of public debt in the long run. In fact optimal fiscal and monetary policies should stabilize long-run debt-to-GDP ratios in order to limit tax (and inflation) distortions in steady state. This latter result is strikingly similar to policy analyses in the aftermath of the 2008 financial crisis. |
| Keywords: | Trend inflation, monetary and fiscal policy, Ramsey plan |
| JEL: | E52 E58 J51 E24 |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:ter:wpaper:0069&r=dge |
| By: | Hatcher, Michael C. (Cardiff Business School) |
| Abstract: | This paper investigates the long-term impact of price-level targeting on social welfare in an overlapping generations model in which the young save for old age by investing in productive capital and indexed and nominal government bonds. A key feature of the model is that the extent of bond indexation is determined endogenously in response to monetary policy as part of an optimal commitment Ramsey policy. Due to the absence of base-level drift under price-level targeting, long-term inflation risk is reduced by an order of magnitude compared to inflation targeting. Consequently, real bond returns are stabilised somewhat, and consumption volatility for old generations is reduced by around 15 per cent. The baseline welfare gain from price- level targeting is equivalent to a permanent increase in aggregate consumption of only 0.01 per cent, but this estimate is strongly sensitive on the upside. |
| Keywords: | inflation targeting; price-level targeting; optimal indexation; government bonds |
| JEL: | E52 E58 |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:cdf:wpaper:2011/5&r=dge |
| By: | Acocella Nicola; Bisio Laura; Di Bartolomeo Giovanni; Pelloni Alessandra |
| Abstract: | By using the recent Gertler and Kiyotaki's (2010) setup, this paper explores the interaction between real distortions stemming from the labor market institutions and financial shocks. We find that neither labor market imperfections nor fiscal institutions determining tax wedges have an impact on the volatility of the real economy induced by a financial shock. By contrast, real wage rigidities matter as they amplify the financial shock effects. Thus, economies with larger imperfections will not systematically observe larger or smaller recessions, unless a causality between imperfections and real wage rigidities is introduced. |
| Keywords: | Financial accelerator, credit frictions, wage-setters, business cycle, volatility |
| JEL: | E32 E44 |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:ter:wpaper:0070&r=dge |
| By: | Christopher M. Gunn; Alok Johri |
| Abstract: | The years leading up to the "great recession" were a time of rapid innovation in the financial industry. This period also saw a fall in interest rates, and a boom in liquidity that accompanied the boom in real activity, especially investment. In this paper we argue that these were not unrelated phenomena. The adoption of new financial products and practices led to a fall in the expected costs of intermediation which in turn engendered the flood of liquidity in the financial sector, lowered interest rate spreads and facilitated the boom in economic activity. When the events of 2007-2009 led to a re-evaluation of the effectiveness of these new products, agents revised their expectations regarding the actual efficiency gains available to the financial sector and this led to a withdrawal of liquidity from the financial system, a reversal in interest rates and a bust in real activity. We treat the efficiency of the financial sector as an exogenous process and study the impact of "news shocks" regarding this process. Following the expectations driven business cycle literature, we model the boom and bust cycle in terms of an expected future efficiency gain which is eventually not realized. The build up in liquidity and economic activity in expectation of these efficiency gains is then abruptly reversed when agent's hopes are dashed. The model generates counter-cyclical movements in the spread between lending rates and the risk-free rate which are driven purely by expectations, even in the absence of any exogenous movement in intermediation costs. |
| Keywords: | externalities; expectations-driven business cycles, intermediation shocks, credit shocks, financial intermediation, financial innovation, news shocks, business cycles. |
| JEL: | E3 |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:mcm:deptwp:2011-02&r=dge |
| By: | Franklin Allen; Elena Carletti; Douglas Gale |
| Abstract: | Most analyses of banking crises assume that banks use real contracts. However, in practice contracts are nominal and this is what is assumed here. We consider a standard banking model with aggregate return risk, aggregate liquidity risk and idiosyncratic liquidity shocks. We show that, with non-contingent nominal deposit contracts, the first-best efficient allocation can be achieved in a decentralized banking system. What is required is that the central bank accommodates the demands of the private sector for fiat money. Variations in the price level allow full sharing of aggregate risks. An interbank market allows the sharing of idiosyncratic liquidity risk. In contrast, idiosyncratic (bank-specific) return risks cannot be shared using monetary policy alone; real transfers are needed. |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2011/04&r=dge |
| By: | Andrew Clausen; Carlo Strub |
| Abstract: | Classical models of money are typically based on a competitive market without capital or credit. They then impose exogenous timing structures, market participation constraints, or cash-in-advance constraints to make money essential. We present a simple model without credit where money arises from a fixed cost of production. This leads to a rich equilibrium structure. Agents avoid the fixed cost by taking vacations and the trade between workers and vacationers is supported by money. We show that agents acquire and spend money in cycles of finite length. Throughout such a “money cycle,” agents decrease their consumption which we interpret as the hot potato effect of inflation. We give an example where money holdings do not decrease monotonically throughout the money cycle. Optimal monetary policy is given by the Friedman rule, which supports efficient equilibria. Thus, monetary policy provides an alternative to lotteries for smoothing out non-convexities. |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:zur:econwp:008&r=dge |
| By: | Panetti, Ettore |
| Abstract: | In the present paper, I analyze how unobservable savings affect risk sharing and bankruptcy decisions in the financial system. I extend the Diamond and Dybvig (1983) model of financial intermediation to an environment with heterogeneous intermediaries, aggregate uncertainty and agents' hidden borrowing and lending. I demonstrate three results. First, unobservability imposes a burden on financial intermediaries, that in equilibrium are not able to offer a banking contract that balances insurance and incentive motivations. Second, unobservable markets do induce default, but only as long as insurance markets are incomplete. Therefore, their presence is not a rationale for government intervention on bankruptcy via "resolution regimes". Third, even in case of complete markets the competitive equilibrium is inefficient, and a simple tier-1 capital ratio similar to the one proposed in the Basel III Accord implements the efficient allocation. |
| Keywords: | financial intermediation; hidden savings; bankruptcy; insurance; optimal regulation |
| JEL: | E44 G28 G21 |
| Date: | 2011–02–10 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:29542&r=dge |
| By: | Panetti, Ettore |
| Abstract: | How do market-based channels for the provision of liquidity affect financial liberalization and contagion? In order to answer this question, I extend the Diamond and Dybvig (1983) model of financial intermediation to a two-country environment with unobservable markets for borrowing and lending and comparative advantages in the investment technologies. I demonstrate that the role of hidden markets crucially depends on the level of financial integration of the economy. Despite always imposing a burden on intermediaries, unobservable markets allow agents to partially enjoy gains from financial integration when interbank markets are autarkic. In fully liberalized systems such effect instead disappears. Similarly, in autarky the distortion created by hidden markets improve the resilience of the system to unexpected liquidity shocks. With fully integrated interbank markets, such effect again disappears, as unexpected liquidity shocks always lead to bankruptcy and contagion. |
| Keywords: | financial intermediation; financial liberalization; financial contagion; unobservable savings |
| JEL: | E44 G28 G21 |
| Date: | 2011–03–01 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:29540&r=dge |
| By: | Russell Cooper; Hubert Kempf |
| Abstract: | This paper studies the provision of deposit insurance without commitment in an economy with heterogenous households. When households are identical, deposit insurance will be provided ex post to reap insurance gains. But the ex post provision of deposit insurance redistributes consumption when households differ in their claims on the banking system as well as in their tax obligations to finance the deposit insurance. Deposit insurance will not be provided ex post if it requires a (socially) undesirable redistribution of consumption which outweighs insurance gains. |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2011/07&r=dge |