nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2011‒04‒09
seventeen papers chosen by
Christian Zimmermann
University of Connecticut

  1. The Effects of Endogenous Firm Exit on Business Cycle Dynamics and Optimal Fiscal Policy By Vilmi, Lauri
  2. Realised and Optimal Monetary Policy Rules in an Estimated Markov-Switching DSGE Model of the United Kingdom By Xiaoshan Chen; Ronald MacDonald
  3. Real Business Cycles with a Human Capital Investment Sector and Endogenous Growth: Persistence, Volatility and Labor Puzzles By Dang, Jing; Gillman, Max; Kejak, Michal
  4. Misallocation of Capital in a Model of Endogenous Financial Intermediation and Insurance By Radim Bohacek; Hugo Rodríguez-Mendizábal
  5. Frictions, Persistence, and Central Bank Policy in an Experimental Dynamic Stochastic General Equilibrium Economy By Noussair, C.N.; Pfajfar, D.; Zsiros, J.
  6. Markets, Income and Policy By Hongfei Sun
  7. Endogenous Entry, International Business Cycles, and Welfare By Stéphane Auray; Aurélien Eyquem
  8. Solution Concept for Intergenerational Conflict: the Role of Intergenerational Bargaining By Yusuke Kinai
  9. Search Unemployment and New Economic Geography By vom Berge, Philipp
  10. Poverty Traps, Economic Inequality and Delinquent Incentives By Edgar Villa; Andres Salazar
  11. Intergenerational Risk Sharing in Time-Consistent Funded Pension Schemes By Ed Westerhout
  12. Financial Sector Shocks, External Finance Premium and Business Cycle . By Zhang, Hongru
  13. Forecasting Long-Term Interest Rates with a Dynamic General Equilibrium Model of the Euro Area: The Role of the Feedback By Paolo Zagaglia
  14. Financial globalization and the raising of public debt By Marina Azzimonti; Eva de Francisco; Vincenzo Quadrini
  15. Embodied technological change, capital sectoral allocation and export-led growth By Araujo, Ricardo Azevedo; Lima, Gilberto Tadeu
  16. Sovereign Default Risk Premia, Fiscal Limits and Fiscal Policy By Huixin Bi
  17. War signals: a theory of trade, trust and conflict By Dominic Rohner; Mathias Thoenig; Fabrizio Zilibotti

  1. By: Vilmi, Lauri (Department of Economics)
    Abstract: We explore the implications of endogenous firm entry and exit for business cycle dynamics and optimal fiscal policy. We first show that when the firm exit rate is endogenous, negative technology shocks lead to reductions in the number of firms. Technology shocks therefore have additional effects on household welfare relative to an economy with only endogenous entry. Second, endogenous firm exit creates a new channel for monetary policy when debt contracts are written in nominal terms, as monetary shocks affect the rate of firm defaults. Monetary shocks therefore have real effects also when prices and wages are flexible. Third, we show that endogenous firm exit creates a new role for fiscal policy to increase efficiency and welfare by subsidizing firms and decreasing the number of defaults. Finally, we demonstrate that endogenous firm exit implies that non-persistent shocks to technology and money supply have persistent effects on labor productivity. This has implications for the estimated persistence of technology shocks.
    Keywords: firm defaults; money supply shock; labor productivity
    JEL: E32 E52
    Date: 2011–02–01
  2. By: Xiaoshan Chen; Ronald MacDonald
    Abstract: This paper conducts a systematic investigation of parameter instability in a small open economy DSGE model of the UK economy over the past thirty-five years. Using Bayesian analysis, we find a number of Markov-switching versions of the model provide a better fit for the UK data than a model with time-invariant parameters. The Markov-switching DSGE model that has two independent Markov-chains - one governing the shifts in UK monetary policy and nominal price rigidity and one governing the standard deviations of shocks - is selected as the best fitting model. The preferred model is then used to evaluate and design monetary policy. For the latter, we use the Markov-Jump-Linear-Quadratic (MJLQ) model, as it incorporates abrupt changes in structural parameters into derivations of the optimal and arbitrary policy rules. It also reveals the entire forecasting distribution of the targeted variables. To our knowledge, this is the first paper that attempts to evaluate and design UK monetary policy based on an estimated open economy Markov-switching DSGE model.
    Keywords: DSGE models; Markov-switching; Bayesian analysis
    JEL: C11 C32 C51 C52
    Date: 2011–01
  3. By: Dang, Jing; Gillman, Max (Cardiff Business School); Kejak, Michal
    Abstract: A positive joint two-sector productivity shock causes Rybczynski (1955) and Stolper and Samuelson (1941) effects that release leisure time and initially raises the relative price of human capital investment so as to favor it over goods production. This enables a basic RBC model, modified by having the household sector produce human capital investment sector, to succeed along related major dimensions of output, consumption, investment and labor, similar to the international approach of Maodifying the dynamics relative to the important work of Jones et al. (2005), two key US facts stressed by Cogley and Nason (1995) are captured: persistent movements in the growth rates of output and hump-shaped impulse responses of output. Further, physical capital investment has data consistent persistence within a hump-shaped impulse response. And Gali's (1999) challenging empirical finding that labour supply decreases upon impact of a positive productivity shock is reproduced, while volatility in working hours is also data-consistent because of the substitution between market and nonmarket sectors.
    Keywords: Real business cycle; human capital; persistence; volatility; labor
    JEL: E24 E32 O41
    Date: 2011–03
  4. By: Radim Bohacek; Hugo Rodríguez-Mendizábal
    Abstract: In this paper we analyze productivity and welfare losses from capital misallocation in a general equilibrium model of occupational choice and endogenous financial intermediation. We study the effects of borrowing and lending, insurance, and risk sharing on the optimal allocation of resources. We find that financial markets together with general equilibrium effects have large impact on entrepreneurs' entry and firm-size decisions. Efficiency gains are increasing in the quality of financial markets, particularly in their ability to alleviate a financing constraint by providing insurance against idiosyncratic risk.
    Keywords: Financial markets and the macroeconomy; Occupational choice; Personal income and wealth and their distributions
    JEL: E44 J24 D31
    Date: 2011–03–15
  5. By: Noussair, C.N.; Pfajfar, D.; Zsiros, J. (Tilburg University, Center for Economic Research)
    Abstract: New Keynesian dynamic stochastic general equilibrium models are the principal paradigm currently employed for central bank policymaking. In this paper, we construct experimental economies, populated with human subjects, with the structure of a New Keynesian DSGE model. We give individuals monetary incentives to maximize the objective functions in the model, but allow scope for agents' boundedly rational behavior and expectations to influence outcomes. Subjects participate in the roles of consumer/workers, producers, or central bankers. Our objective is twofold. The first objective is general, and is to create an experimental environment for the analysis of macroeconomic policy questions. The second objective is more focused and is to consider several specific research questions relating to the persistence of shocks, the behavior of human central bankers, and the pricing behavior of firms, using our methodology. We find that the presence of menu costs is not necessary to generate persistence of output shocks, but rather that monopolistic competition in the output market is sufficient. Interest rate policies of human discretionary central bankers are characterized by persistence in interest rate shocks, the use of the Taylor principle, and lower output and welfare than under an automated instrumental rule. Pattens in price changes conform closely to stylized empirical facts.
    Keywords: Experimental Economics;DSGE economy;Monetary Policy;Menu costs.
    JEL: C91 C92 E31 E32
    Date: 2011
  6. By: Hongfei Sun (Queen's University)
    Abstract: I construct a unified macroeconomic framework by incorporating frictional markets in a neoclassical environment. This framework formalizes a theory that the variety and the functioning of markets reflect the status of national income. In the model, households have free access to markets with and without trading frictions. Uninsurable income risks generate money distributions and price dispersions. In equilibrium, the frictionless markets are generically used to smooth consumption and the frictional markets are only used when households have sufficiently high expected real income. Income inequality critically determines the equilibrium trading protocols across frictional markets. The optimal policy program consists of money growth, proportional income taxes and sales subsidies. Policy coordination is critical. It can be welfare-improving for the government to alleviate income taxes when the monetary authority is running deflation and to elevate income taxes under inflation.
    Keywords: markets, frictions, income, policy, competitive search
    JEL: E0 E4 E5 E6 H2 H3
    Date: 2011–03
  7. By: Stéphane Auray (CNRS – THEMA (UMR 8184), EQUIPPE (EA 4018) – Universités Lille Nord de France (ULCO), Université de Sherbrooke (GREDI) and CIRPEE, Canada); Aurélien Eyquem (GATE LSE, Université de Lyon, and Ecole Normale Supérieure de Lyon, France, and GREDI, Université de Sherbrooke, Canada)
    Abstract: This paper examines if taking into account changes in the number of producers, or equivalently changes in the product variety space over the business cycle, helps to understand and replicate international business cycle facts. To this end, we develop a two-country model in which the economy is driven by real and monetary policy shocks. It is characterized by an endogenous number of firms and varieties, sticky prices and financial markets incompleteness. We show that these features are crucial to reproduce international business cycle statistics. We also evaluate the welfare implications of various monetary policies and highlight the importance for monetary policymakers to respond moderately to output fluctuations.
    Keywords: International Business Cycles, Endogenous Entry, Financial Markets Incompleteness, Sticky Prices, Monetary Policy, Welfare
    JEL: E51 E58 F36 F41
    Date: 2011–03–31
  8. By: Yusuke Kinai (Graduate School of Economics, Osaka University)
    Abstract: This paper specifically examines intergenerational conflict and analyzes an overlapping generations model of public goods provision from the viewpoint of time-consistency. Public goods are financed through labor-income and capital-income taxation, thereby distorting savings and the labor supply. Taxes redistribute income across generations in the form of public goods. Under such a situation, there emerge dual intergenerational conflicts: the first is related to the amount of public goods and the second is the tax burden. We then contrast the politico-economic equilibrium with commitment allocation, and analyze the sources of conflict and time-inconsistency, and attempt to resolve such a conflict by introducing the concept of eintergenerational bargainingf. Our main findings are the following. First, taxation derived using Lagrange method fails to be time-consistent. Second, depending on bargainingpower, taxation based on intergenerational bargaining can be time-consistent. Third, we portray the properties of taxation and public goods provision rules based on intergenerational bargaining.
    Keywords: Dual Intergenerational Conflicts; Intergenerational Bargaining;Time-inconsistency; Modified Public Goods Provision Rule.
    JEL: E61 E62 H41
    Date: 2011–03
  9. By: vom Berge, Philipp
    Abstract: This paper develops a general equilibrium geographical economics model which uses matching frictions on the labor market to generate regional unemployment disparities alongside the usual core-periphery pattern of industrial agglomeration. In the model, regional wage differentials do not only influence migration decisions of mobile workers, but also affect the bargaining process on local labor markets, leading to differences in vacancies and unemployment as well. In a setting with two regions, both higher or lower unemployment rates in the core region are possible equilibrium outcomes, depending on transport costs and the elasticity of substitution. Stylized facts suggest that both patterns are of empirical relevance.
    Keywords: Regional labor markets; New Economic Geography; job matching; unemployment
    JEL: F12 J61 J64 R12
    Date: 2011–03–28
  10. By: Edgar Villa; Andres Salazar
    Abstract: This paper explores theoretical linkages between poverty traps, economic inequality and delinquency in a two sector overlapping generations model under perfect competition in which barriers to skilled educational attainment and delinquent incentives interact. We find that the existence of a poverty trap under high economic inequality and costly indivisible human capital investments generate persistent delinquency. We study shocks that increase skilled wages or reduce assets for the unskilled and find that these temporal shocks produce an outburst of delinquency in the short run that die out later on. If the shock is permanent then delinquency increases permanently in the long run. Furthermore, we find that when law enforcement policies increase deterrence and incapacitation permanently delinquency dimineshes en the long run but is accompanied by an increase in wealth inequality. We also find that subsidies for human capital investments can have an ambiguous effect on delinquency in the long run.
    Date: 2011–03–27
  11. By: Ed Westerhout
    Abstract: Intergenerational risk sharing by funded pension schemes may increase welfare in an ex ante sense. However, it also suffers from a time inconsistency problem. In particular, young generations may be unwilling to start participating in a pension scheme if this requires them to make huge transfers to older generations.
    JEL: H55
    Date: 2011–04
  12. By: Zhang, Hongru (Cardiff Business School)
    Abstract: This paper extends Nolan and Thoenissen (2009), hence NT, model with an explicit financial intermediary that transfer funds from households to entrepreneurs subject to a well defined loan production function. The loan productivity shock is treated as the supply side financial disturbance. Together with NT.s net worth shock that resembles the credit demand perturbation, both of the two-sided shocks are robustly extracted by combining the model with US quarterly data. The two shocks are found to be tightly linked with the post-war recessions. Each recession happens when both of the two shocks become contractionary. A few potential economic downturns seem to have been avoided because of the expansion of credit which offset the simultaneous contraction of entrepreneurial net wealth. This new introduced shock has significant explanatory power for the variance of EFP and the model simulated EFP holds high correlation with various spreads as proxies for empirical EFP.
    Keywords: DSGE modeling; corporate net wealth shock; loan productivity shock; external financing; shock construction; historical decomposition; variance decomposition
    JEL: E32 E44 G21
    Date: 2011–03
  13. By: Paolo Zagaglia (Department of Economics, University of Bologna)
    Abstract: This paper studies the forecasting performance of the general equilibrium model of bond yields of Marzo, Söderström and Zagaglia (2008), where long-term interest rates are an integral part of the monetary transmission mechanism. The model is estimated with Bayesian methods on Euro area data. I compare the out-of-sample predictive performance of the model against a variety of competing specifications, including that of De Graeve, Emiris and Wouters (2009). Forecast accuracy is evaluated through both univariate and multivariate measures. I also control the statistical significance of the forecast differences using the tests of Diebold and Mariano (1995), Hansen (2005) and White (1980). I show that taking into account the impact of the term structure of interest rates on the macroeconomy generates superior out-of-sample forecasts for both real variables, such as output, and inflation, and for bond yields.
    Keywords: Yield curve, general equilibrium models, Bayesian estimation, forecasting
    JEL: E43 E44 E52
    Date: 2011–03
  14. By: Marina Azzimonti (Federal Reserve Bank of Philadelphia); Eva de Francisco (Department of Economics, Towson University); Vincenzo Quadrini (Department of Economics, University of Southern California)
    Abstract: During the last three decades the stock of government debt has increased in most developed countries. During the same period inter- national capital markets have been liberalized. In this paper we de- velop a two-country political economy model with incomplete markets and endogenous government borrowing and show that countries choose higher levels of public debt when nancial markets are internationally integrated.
    Date: 2011–03
  15. By: Araujo, Ricardo Azevedo; Lima, Gilberto Tadeu
    Abstract: This paper contributes to the literature on economic growth by seeking to join several lines of research on structural factors in a more fully specified framework, on the one hand, and by making this more inclusive supply side to interact with demand factors in a model of export-led growth, on the other hand. Balance-of-payments constraints influence the adoption of investment-specific technological change which requires the import of capital goods, while the sectoral allocation of physical and human capital is likewise revealed to be crucial for economic growth, both results having important policy implications.
    Keywords: embodied technological change; sectoral allocation of investment; human capital accumulation; export-led growth
    JEL: O11 O41 O33
    Date: 2011–03
  16. By: Huixin Bi
    Abstract: We develop a closed economy model to study the interactions among sovereign risk premia, fiscal limits, and fiscal policy. The stochastic fiscal limits, which measure the ability and willingness of the government to service its debt, arise endogenously from a dynamic Laffer curve. The distribution of fiscal limits is country-specific, depending on the size of the government, the degree of countercyclical policy responses, economic diversity, and political uncertainty, among other characteristics. The model rationalizes different sovereign ratings across developed countries. A nonlinear relationship between sovereign risk premia and the level of government debt, which emerges in equilibrium, is consistent with the empirical evidence that once risk premia begin to rise, they do so rapidly. Movements in default risk premia for long-term bonds precede those for shortterm bonds, providing early warnings of increasing probabilities of sovereign defaults.
    Keywords: Fiscal policy; International topics
    JEL: E62 H30 H60
    Date: 2011
  17. By: Dominic Rohner; Mathias Thoenig; Fabrizio Zilibotti
    Abstract: We construct a dynamic theory of civil conflict hinging on inter-ethnic trust and trade. The model economy is inhabitated by two ethnic groups. Inter-ethnic trade requires imperfectly observed bilateral investments and one group has to form beliefs on the average propensity to trade of the other group. Since conflict disrupts trade, the onset of a conflict signals that the aggressor has a low propensity to trade. Agents observe the history of conflicts and update their beliefs over time, transmitting them to the next generation. The theory bears a set of testable predictions. First, war is a stochastic process whose frequency depends on the state of endogenous beliefs. Second, the probability of future conflicts increases after each conflict episode. Third, "accidental" conflicts that do not reflect economic fundamentals can lead to a permanent breakdown of trust, plunging a society into a vicious cycle of recurrent conflicts (a war trap). The incidence of conflict can be reduced by policies abating cultural barriers, fostering inter-ethnic trade and human capital, and shifting beliefs. Coercive peace policies such as peacekeeping forces or externally imposed regime changes have instead no persistent effects.
    Keywords: Beliefs, civil war, conict, cultural transmission, ethnic fractionalization, human capital investments, learning, matching, peacekeeping, stochastic war, strategic complementarity, trade
    JEL: D74 D83 O15 Q34
    Date: 2011–03

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