nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2011‒04‒02
25 papers chosen by
Christian Zimmermann
University of Connecticut

  1. Fiscal policy and the labour market: the effects of public sector employment and wages By Pedro Gomes
  2. How useful are estimated DSGE model forecasts? By Rochelle M. Edge; Refet S. Gurkaynak
  3. Investment Risk, Pareto Distribution, and the Effects of Tax By NIREI Makoto
  4. Generalized Taylor and Generalized Calvo price and wage-setting: micro evidence with macro implications By Dixon, H.; Le Bihan, H.
  5. News and policy foresight in a macro-finance model of the US By Cristian Badarinza; Emil Margaritov
  6. Input and output inventory dynamics By Yi Wen
  7. A Monetary Theory with Non-Degenerate Distributions By Guido Menzio; Shouyong Shi; Hongfei Sun
  8. Financial Crises and Macro-Prudential Policies By Gianluca Benigno; Huigang Chen; Christopher Otrok; Alessandro Rebucci; Eric Young
  9. Crime, Immigration and the Labor Market: A General Equilibrium Model By Thomas Bassetti; Luca Corazzini; Darwin Cortes
  10. New perspectives on depreciation shocks as a source of business cycle fluctuations By Francesco Furlanetto; Martin Seneca
  11. Fiscal policy in the EU in the crisis: a model-based approach By István P. Székely; Werner Roeger; Jan in 't Veld
  12. Government spending in dynamic general equilibrium models. By Kühn, Stefan
  13. Money Cycles By Clausen, Andrew; Strub, Carlo
  14. Imperfect Information and Saving in a Small Open Economy By Agustin Roitman; Christian Daude
  15. Fiscal Consolidation in a Small Euro Area Economy By Vanda Almeida; Gabriela Lopes de Castro; Ricardo Mourinho Félix; José Ramos Maria
  16. Leaning Against Boom-Bust Cycles in Credit and Housing Prices By Luisa Lambertini; Caterina Mendicino; Maria Tereza Punzi
  17. Learning-by-doing in Two Sectors, Production Structure, Leisure and Optimal Endogenous Growth By Matthias Göcke
  18. Investment and interest rate policy in the open economy By Stephen McKnight
  19. Equity Sales and Manager Efficiency Across Firms and the Business Cycle By Fabio Ghironi; Karen K. Lewis
  20. Leadership Contestability, Monopolistic Rents and Growth By Roberto Piazza
  21. Structural change in an open economy By Kei-Mu Yi; Jing Zhang
  22. Liquidity hoarding By Douglas Gale; Tanju Yorulmazer
  23. Sequential Estimation of Dynamic Programming Models with Unobserved Heterogeneity By Kasahara, Hiroyuki; Shimotsu, Katsumi
  24. An Equilibrium Model of Habitat Conservation under Uncertainty and Irreversibility By Luca Di Corato; Michele Moretto; Sergio Vergalli
  25. Recursive methods for incentive problems By Matthias Messner; Nicola Pavoni; Christopher Sleet

  1. By: Pedro Gomes
    Abstract: I build a dynamic stochastic general equilibrium model with search and matching frictions in order to study the labour market effects of public sector employment and wages. Public sector wages are important to achieve the effcient allocation. High wages induce too many unemployed to queue for public sector jobs, raising unemployment. Following technology shocks, public sector wages should be procyclical and deviations from the optimal policy increase the volatility of unemployment significantly. Another conclusion is that different types of fiscal shocks have opposite effects on labour market variables. I then estimate the parameters of the model for the United States
    JEL: E24 E62 J45
    Date: 2011–02
  2. By: Rochelle M. Edge; Refet S. Gurkaynak
    Abstract: DSGE models are a prominent tool for forecasting at central banks and the competitive forecasting performance of these models relative to alternatives--including official forecasts--has been documented. When evaluating DSGE models on an absolute basis, however, we find that the benchmark estimated medium scale DSGE model forecasts inflation and GDP growth very poorly, although statistical and judgmental forecasts forecast as poorly. Our finding is the DSGE model analogue of the literature documenting the recent poor performance of macroeconomic forecasts relative to simple naive forecasts since the onset of the Great Moderation. While this finding is broadly consistent with the DSGE model we employ--ie, the model itself implies that under strong monetary policy especially inflation deviations should be unpredictable--a "wrong" model may also have the same implication. We therefore argue that forecasting ability during the Great Moderation is not a good metric to judge the usefulness of model forecasts.
    Keywords: Economic forecasting ; Inflation (Finance) ; Econometric models
    Date: 2011
  3. By: NIREI Makoto
    Abstract: This paper investigates the effects of taxation on the distributions of income and wealth and on the welfare of heterogeneous households. I first demonstrate that the tails of income and wealth distributions converge to a Pareto distribution in a Bewley model in which households bear idiosyncratic investment shocks. This result extends the previous analysis in Nirei (2009). Thereafter, a non-distortionary tax and flat-rate taxes on capital income and consumption are introduced, and their impacts on aggregate wealth, the inequality index, households' welfare, and transition paths are quantitatively investigated. When the tax rate is set to generate the same GDP-government expenditure ratio, the model with capital tax generates smaller aggregate wealth and a smaller inequality index than the case with consumption tax or non-distortionary tax.
    Date: 2011–03
  4. By: Dixon, H.; Le Bihan, H.
    Abstract: The Generalized Calvo and the Generalized Taylor model of price and wage-setting are, unlike the standard Calvo and Taylor counterparts, exactly consistent with the distribution of durations observed in the data. Using price and wage micro-data from a major euro-area economy (France), we develop calibrated versions of these models. We assess the consequences for monetary policy transmission by embedding these calibrated models in a standard DSGE model. The Generalized Taylor model is found to help rationalizing the hump-shaped response of inflation, without resorting to the counterfactual assumption of systematic wage and price indexation.
    Keywords: Contract length, steady state, hazard rate, Calvo, Taylor, wage-setting, price-setting.
    JEL: E31 E32 E52 J30
    Date: 2011
  5. By: Cristian Badarinza (House of Finance, Goethe University, Frankfurt am Main, Germany.); Emil Margaritov (House of Finance, Goethe University, Frankfurt am Main, Germany.)
    Abstract: We study the effects of information shocks on macroeconomic and term structure dynamics in an estimated medium-scale DSGE model for the US economy. We consider news about total factor productivity and investment-specific technology, as well as foresight about monetary policy. Our empirical investigation confirms the findings of previous studies on the limited role played by productivity news in this class of models. In contrast, we uncover a non-trivial role for investment-specific news and anticipated monetary policy shocks not only in the historical and variance decomposition of real economic variables but also for the overall dynamic behavior of the term structure of interest rates. We also document substantial qualitative differences in the dynamic responses of the macroeconomy and the bond yield term structure to anticipated and surprise structural and policy innovations. JEL Classification: E32, E43, E52.
    Keywords: News, Policy Foresight, Term Structure, DSGE Model.
    Date: 2011–03
  6. By: Yi Wen
    Abstract: This paper develops an analytically tractable general-equilibrium model of inventory dynamics based on a precautionary stockout-avoidance motive. The model’s predictions are broadly consistent with the U.S. business cycle and key features of inventory behavior. It is also shown that technological improvement of inventory management can increase, rather than decrease, the volatility of aggregate output. Key to this seemingly counterintuitive result is that a stockout-avoidance motive leads to a procyclical shadow value of inventories, which acts as an automatic stabilizer that discourages sales in booms and encourages demand in recessions, thereby reducing the variability of GDP.>
    Keywords: Inventories ; Business cycles
    Date: 2011
  7. By: Guido Menzio; Shouyong Shi; Hongfei Sun
    Abstract: Dispersion of money balances among individuals is the basis for a range of policies but it has been abstracted from in monetary theory for tractability reasons. In this paper, we fill in this gap by constructing a tractable search model of money with a non-degenerate distribution of money holdings. We assume search to be directed in the sense that buyers know the terms of trade before visiting particular sellers. Directed search makes the monetary steady state block recursive in the sense that individuals\' policy functions, value functions and the market tightness function are all independent of the distribution of individuals over money balances, although the distribution affects the aggregate activity by itself. Block recursivity enables us to characterize the equilibrium analytically. By adapting lattice-theoretic techniques, we characterize individuals\' policy and value functions, and show that these functions satisfy the standard conditions of optimization. We prove that a unique monetary steady state exists. Moreover, we provide conditions under which the steady-state distribution of buyers over money balances is non-degenerate and analyze the properties of this distribution.
    Keywords: Money; Distribution; Search; Lattice-Theoretic
    JEL: E00 E4 C6
    Date: 2011–03–24
  8. By: Gianluca Benigno; Huigang Chen; Christopher Otrok; Alessandro Rebucci; Eric Young
    Abstract: Stochastic general equilibrium models of small open economies with occasionally binding financial frictions are capable of mimicking both the business cycles and the crisis events associated with the sudden stop in access to credit markets (Mendoza, 2010). This paper studies the inefficiencies associated with borrowing decisions in a two-sector small open production economy, finding that this economy is much more likely to display under-borrowing rather than over-borrowing in normal times. As a result, macro-prudential policies (e.g, Tobin taxes or economy-wide controls on capital inflows) are costly in welfare terms. Moreover, macro-prudential policies aimed at minimizing the probability of the crisis event might be welfare-reducing in production economies. The analysis shows that there is a much larger scope for welfare gains from policy interventions during financial crises. That is to say that, ex post or crisis-management policies dominate ex ante or macro-prudential ones.
    Keywords: Capital controls, Crises, Financial frictions, Macro-prudential policies, Bailouts, Overborrowing
    JEL: E52 F37 F41
    Date: 2011–02
  9. By: Thomas Bassetti (Università di Padova); Luca Corazzini (Università di Padova); Darwin Cortes (Universidad del Rosario)
    Abstract: Does immigration cause crime? To answer this question, we build a two-country general equilibrium model with search costs in which the migration (in/out-)flows, the crime rates and the equilibrium wages in the two countries are determined by the interaction between the labor market, the crime market and the decision to migrate. The main result of our model is that, in equilibrium, the relationship between immigration and crime depends on the conditions of both the labor and crime markets of the two countries. In particular, when the tightness of the labor market is sufficiently elastic relative to that of the crime market, immigration causes a reduction in the domestic crime rate of the host country. An implication of this result is that migration flows from countries with strong work rigidities to societies characterized by more elastic labor markets are mutually benefic in terms of reducing the corresponding crime rates.
    Keywords: Crime Rate, Labor Market, Immigration.
    JEL: J61 J64 K42
    Date: 2010–11
  10. By: Francesco Furlanetto (Norges Bank (Central Bank of Norway)); Martin Seneca (Norges Bank (Central Bank of Norway))
    Abstract: In this paper we study the transmission for capital depreciation shocks. The existing literature in the Real Business Cycle tradition has concluded that these shocks are irrelevant for business cycle fluctuations. We show that these shocks are potentially important drivers of aggregate fluctuations in a New Keynesian model. Nominal rigidities and some persistence in the shock process are the key ingredients to generate co-movement across real variables.
    Keywords: Keywords: depreciation shocks, investment-specific technology shocks, consumption, nominal rigidities, co-movement.
    JEL: E32
    Date: 2011–03–25
  11. By: István P. Székely; Werner Roeger; Jan in 't Veld
    Abstract: This paper uses a multi region DSGE model with collateral constrained households and residential investment to examine the effectiveness of fiscal policy stimulus measures in a credit crisis. The paper explores alternative scenarios which differ by the type of budgetary measure, its length, the degree of monetary accommodation and the level of international coordination. In particular we provide estimates for New EU Member States where we take into account two aspects. First, debt denomination in foreign currency and second, higher nominal interest rates, which makes it less likely that the Central Bank is restricted by the zero bound and will consequently not accommodate a fiscal stimulus. We also compare our results to other recent results obtained in the literature on fiscal policy which generally do not consider credit constrained households.
    Keywords: Fiscal Policy, Monetary Policy, Fiscal Multiplier, Collateral Constraint, DSGE modelling
    JEL: E21 E62 F42 H31 H63
    Date: 2011–03
  12. By: Kühn, Stefan (Maastricht University)
    Date: 2011
  13. By: Clausen, Andrew; Strub, Carlo
    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: 2011–01
  14. By: Agustin Roitman; Christian Daude
    Abstract: Emerging markets are more volatile and face different types of shocks, in size and nature, compared to their developed counterparts. Accurate identification of the stochastic properties of shocks is difficult. We show evidence suggesting that uncertainty about the underlying stochastic process is present in commodity prices. In addition, we build a dynamic stochastic general equilibrium model with informational frictions, which explicitly considers uncertainty about the nature of shocks. When formulating expectations, the economy assigns some probability to the shocks being temporary even if they are actually permanent. Parameter instability in the stochastic process implies that optimal saving levels (debt holdings) should be higher (lower) compared to a process with fixed parameters. Imperfect information about the nature of shocks matters when commodity GDP shares are high. Thus, economic policies based on misperception of the underlying regime can lead to substantial over/under saving with important associated costs.
    Keywords: Commodity prices , Economic models , Emerging markets , External shocks , Savings , Small states ,
    Date: 2011–03–18
  15. By: Vanda Almeida; Gabriela Lopes de Castro; Ricardo Mourinho Félix; José Ramos Maria
    Abstract: This article focuses on the costs and benefits of a fiscal consolidation in a small euro area economy. The macroeconomic impacts and the welfare analysis are conducted in a New-Keynesian general equilibrium model with non-Ricardian agents. We define a benchmark fiscal consolidation strategy based on a permanent reduction in Government expenditure. We find that, over the long run, fiscal consolidation leads to a considerable increase in the level of output and consumption, and is welfare improving. In addition, the gains are boosted if the fiscal strategy also involves a tax reform that shifts the tax burden away from labour income towards the final goods consumption. However, important short-run costs arise, notably output, consumption and welfare losses. Finally, we assess the effect of alternative fiscal consolidation paths in terms of the degree of front loading, the speed of its completion and the interaction with risk premium.
    JEL: E62 F41 H62
    Date: 2011
  16. By: Luisa Lambertini; Caterina Mendicino; Maria Tereza Punzi
    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 inflation 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 difficult to rank the two policy frameworks.
    JEL: E32 E44 E52
    Date: 2011
  17. By: Matthias Göcke (University of Giessen)
    Abstract: A model with two different production sectors and endogenous growth based on the accumulation of sector-specific human capital due to learning-by-doing is presented. Accumulation of experience is measured by means of sectoral production output aggregated over time. Growth is controlled by a dynamic optimisation of the use of time for working in the different sectors or for leisure. Transitional dynamics of production growth, especially of structural change towards a 'new' sector (with relatively scarce experience), of the optimal sectoral distribution of working time and of leisure as well as the corresponding steady state levels are derived and a numerical simulation is performed.
    JEL: C61 D90 J22 O41
    Date: 2011
  18. By: Stephen McKnight (El Colegio de México)
    Abstract: This paper analyses the necessary and sufficient conditions to ensure that interest rate policy does not introduce real indeterminacy and thus self-fulfilling fluctuations into open economies. A key feature of the model is the incorporation of capital and investment spending into the analysis. The conditions for real determinacy are examined for two measures of inflation that central banks' can target in open economies: domestic vs. consumer price inflation. In stark contrast to previous studies, in the presence of investment activity monetary policy that targets domestic price inflation is more susceptible to self-fulfilling fluctuations than monetary policy rules that target consumer price inflation. However, the problem of indeterminacy identified under domestic price inflation can be ameliorated provided the policy rule also responds to either the exchange rate or to output.
    Keywords: real indeterminacy, open economy monetary models, trade openness, interest rate rules
    JEL: E32 E43 E52 E58 F41
    Date: 2011–03
  19. By: Fabio Ghironi (Department of Economics, Boston College, 140 Commonwealth Avenue, Chestnut Hill, MA 02467-3859, U.S.A. (E-mail: Fabio.; Karen K. Lewis (Department of Finance, 2300 SH-DH, Wharton School, University of Pennsylvania, Philadelphia, PA 19104-6367, U.S.A. (E-mail:
    Abstract: Smaller firms sell more equity in response to expansions than do larger firms. Also, consumption is more pro-cyclical for high income groups than others. In this paper, we present a model that captures key features of both of these patterns found in recent empirical studies. Managers own firms with unique differentiated products and can sell ownership in these firms. Equity sales require paying consulting fees, but the resulting scrutiny also make firms more efficient. We find four main results: (1) Equity sales are pro-cylical since the benefits of efficient production outweigh the consulting fees during a boom. (2) Equity shares in smaller firms are more pro-cyclical because expansions make previously solely-owned firms to seek outside equity financing. (3) Households must absorb the increased equity sales by managers, thereby affecting their consumption response relative to managers. (4) Greater underlying managerial inefficiency induces more firms to seek outside advice and ownership in equilibrium. As a result, the cyclical impact on efficiency is mitigated by outside ownership.
    Keywords: Equity Sales, Managerial Efficiency, Firm Size, Business Cycles
    JEL: E25 E44 E21
    Date: 2011–03
  20. By: Roberto Piazza
    Abstract: I construct an endogenous growth model where R&D is carried out at the industry level in a game of innovation between leaders and followers. Innovation costs for followers are assumed to increase with the technological lag from leaders. We obtain three results that contrast with standard Schumpeterian models, such as Aghion and Howitt (1992). First, leaders may innovate in equilibrium, in an attempt to force followers out of the innovation game. Second, policies (such as patents) that allow for strong protections of monopolies can reduce the steady state growth rate of the economy. Third, multiple equilibria arise when monopolies' protection is large.
    Date: 2011–03–23
  21. By: Kei-Mu Yi; Jing Zhang
    Abstract: We develop a tractable, three-sector model to study structural change in a two-country world. The model features an endogenous pattern of trade dictated by comparative advantage. We derive an intuitive expression linking sectoral employment shares to sectoral expenditure shares and to sectoral net export shares of total GDP. Changes in productivity and in trade barriers affect expenditure and net export shares, and thus, employment shares, across sectors. We show how these driving forces can generate the "hump" pattern that characterizes the manufacturing employment share as a country develops, even when manufacturing is the sector with the highest productivity growth.
    Date: 2011
  22. By: Douglas Gale; Tanju Yorulmazer
    Abstract: Banks hold liquid and illiquid assets. An illiquid bank that receives a liquidity shock sells assets to liquid banks in exchange for cash. We characterize the constrained efficient allocation as the solution to a planner’s problem and show that the market equilibrium is constrained inefficient, with too little liquidity and inefficient hoarding. Our model features a precautionary as well as a speculative motive for hoarding liquidity, but the inefficiency of liquidity provision can be traced to the incompleteness of markets (due to private information) and the increased price volatility that results from trading assets for cash.
    Keywords: Bank liquidity ; Bank assets ; Interbank market
    Date: 2011
  23. By: Kasahara, Hiroyuki; Shimotsu, Katsumi
    Abstract: This paper develops a new computationally attractive procedure for estimating dynamic discrete choice models that is applicable to a wide range of dynamic programming models. The proposed procedure can accommodate unobserved state variables that (i) are neither additively separable nor follow generalized extreme value distribution, (ii) are serially correlated, and (iii) affect the choice set. Our estimation algorithm sequentially updates the parameter estimate and the value function estimate. It builds upon the idea of the iterative estimation algorithm proposed by Aguirregabiria and Mira (2002, 2007) but conducts iteration using the value function mapping rather than the policy iteration mapping. Its implementation is straightforward in terms of computer programming; unlike the Hotz-Miller type estimators, there is no need to reformulate a fixed point mapping in the value function space as that in the space of probability distributions. It is also applicable to estimate models with unobserved heterogeneity. We analyze the convergence property of our sequential algorithm and derive the conditions for its convergence. We develop an approximated procedure which reduces computational cost substantially without deteriorating the convergence rate. We further extend our sequential procedure for estimating dynamic programming models with an equilibrium constraint, which include dynamic game models and dynamic macroeconomic models.
    Keywords: dynamic discrete choice, value function mapping, nested pseudo, likelihood, unobserved, heterogeneity, equilibrium constraint
    JEL: C13 C14 C63
    Date: 2011–03
  24. By: Luca Di Corato (Swedish University of Agricultural Sciences); Michele Moretto (Università di Padova); Sergio Vergalli (Università di Brescia)
    Abstract: In this paper stochastic dynamic programming is used to investigate habitat conservation by a multitude of landholders under uncertainty about the value of environmental services and irreversible development. We study land conversion under competition on the market for agricultural products when voluntary and mandatory measures are combined by the Government to induce adequate participation in a conservation plan. We analytically determine the impact of uncertainty and optimal policy conversion dynamics and discuss different policy scenarios on the basis of the relative long-run expected rate of deforestation. Finally, some numerical simulations are provided to illustrate our findings.
    Keywords: optimal stopping, deforestation, payments for environmental services, Natural Resources Management.
    JEL: C61 D81 Q24 Q58
    Date: 2010–12
  25. By: Matthias Messner; Nicola Pavoni; Christopher Sleet
    Abstract: Many separable dynamic incentive problems have primal recursive formulations in which utility promises serve as state variables. We associate families of dual recursive problems with these by selectively dualizing constraints. We make transparent the connections between recursive primal and dual approaches, relate value iteration under each and give conditions for it to be convergent to the true value function.
    Date: 2011

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