nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2011‒04‒30
38 papers chosen by
Christian Zimmermann
University of Connecticut

  1. Life Cycle Equilibrium Unemployment By Chéron, Arnaud; Hairault, Jean-Olivier; Langot, François
  2. Intergenerational redistribution in the Great Recession By Andrew Glover; Jonathan Heathcote; Dirk Krueger; José-Víctor Ríos-Rull
  3. A General Equilibrium Model of Environmental Option Values By Iain Fraser; Katsuyuki Shibayama
  4. Beyond the DSGE Straitjacket By Pesaran, Hashem; Smith, Ron P.
  5. Global rebalancing: the macroeconomic impact on the United Kingdom By Haberis, Alex; Markovic, Bojan; Mayhew, Karen; Zabczyk, Pawel
  6. A Monetary Theory with Non-Degenerate Distributions By Hongfei Sun; Shouyong Shi; Guido Menzio
  7. Life-Cycle Search, Match Quality and Japan's Labor Flow By Julen ESTEBAN-PRETEL; FUJIMOTO Junichi
  8. French and American labour markets in response to cyclical shocks between 1986 and 2007: a DSGE approach By T. LE BARBANCHON; B. OURLIAC; O. SIMON
  9. Japan's Labor Market Cyclicality and the Volatility Puzzle By Julen ESTEBAN-PRETEL; NAKAJIMA Ryo; TANAKA Ryuichi
  10. Matching Models of Equilibrium Unemployment: An Overview By Lisi, Gaetano
  11. Accounting for Japanese Business Cycles: A Quest for Labor Wedges By Keisuke Otsu
  12. SOE PL 2009 - An Estimated Dynamic Stochastic General Equilibrium Model for Policy Analysis And Forecasting By Grzegorz Grabek; Bohdan Klos; Grzegorz Koloch
  13. Emerging Market Business Cycles Revisited: Learning about the Trend By Emine Boz; Christian Daude; C. Bora Durdu
  14. Business cycle dynamics under rational inattention By Bartosz Maćkowiak; Mirko Wiederholt
  15. Understanding the macroeconomic effects of working capital in the United Kingdom By Fernandez-Corugedo, Emilio; McMahon, Michael; Millard, Stephen; Rachel, Lukasz
  16. Household Leverage and the Recession By Thomas Philippon; Virgiliu Midrigan
  17. Migration, Social Security, and Economic Growth By Chen, Hung-Ju; Fang, I-Hsiang
  18. Social Status, Human Capital Formation and the Long-run Effects of Money By Chen, Hung-Ju
  19. The impact of EPL on labour productivity in a general equilibrium matching model By Lisi, Domenico
  20. Shifts in portfolio preferences of international investors: an application to sovereign wealth funds By Sa, Filipa; Viani, Francesca
  21. Tailwinds and headwinds: how does growth in the BRICs affect inflation in the G7? By Lipinska, Anna; Millard, Stephen
  22. Distributional dynamics under smoothly state-dependent pricing By James Costain; Anton Nakov
  23. Fiscal policy, structural reforms and external imbalances: a quantitative evaluation for Spain By Ángel Gavilán; Pablo Hernández de Cos; Juan F. Jimeno; Juan A. Rojas
  24. Agent-based macroeconomics - a baseline model By Lengnick, Matthias
  25. House purchase versus rental in Spain By Eva Ortega; Margarita Rubio; Carlos Thomas
  26. Age Matching Patterns and Search By Anja Sautmann
  27. Costly financial intermediation in neoclassical growth theory By Rajnish Mehra; Facundo Piguillem; Edward C. Prescott
  28. Environmental Fiscal Reform and Fiscal Consolidation: The Quest for the Third Dividend in Portugal By Alfredo Marvão Pereira; Rui M. Pereira
  29. Price uncertainty and the existence of financial equilibrium By Lionel De Boisdeffre
  30. Bank Finance Versus Bond Finance By Fiorella De Fiore; Harald Uhlig
  31. International Propagation of Financial Shocks in a Search and Matching Environment By Marlène Isoré
  32. Equilibrium Structure of Production Economies with Uncertainty: The Natural Projection Approach By Pascal Stiefenhofer
  33. Debt Portfolios By Hintermaier, Thomas; Koeniger, Winfried
  34. On the Relationship Between Mobility, Population Growth, and Capital Spending in the United States By Marco Bassetto; Leslie McGranahan
  35. Monotonicity and Continuity of the Critical Capital Stock in the Dechert-Nishimura Model By Ken-Ichi Akao; Takashi Kamihigashi; Kazuo Nishimura
  36. Social Capital, Institutions and Growth: Further Lessons from the Italian Regional Divide By L. Mauro; Francesco Pigliaru
  37. Repeated moral hazard and recursive Lagrangeans By Mele, Antonio
  38. Economic Growth, Technical Progress, and Social Capital: the Inverted U Hypothesis By Antoci, Angelo; Sabatini, Fabio; Sodini, Mauro

  1. By: Chéron, Arnaud; Hairault, Jean-Olivier; Langot, François
    Abstract: This paper extends the job creation-job destruction approach to the labor market to take into account a deterministic finite horizon. As hirings and separations depend on the time over which to recoup investment costs, the life-cycle setting implies age-differentiated labor market flows. Whereas the search effort of unemployed workers presents an age-decreasing profile, the age-dynamics of the separation rate can be either decreasing or increasing. Worker heterogeneity in the context of the undirected search implies an intergenerational externality, which is not eliminated by the Hosios condition. We show that age-specific policies are necessary to reach the first best allocation.
    Keywords: search; matching; retirement; life cycle
    JEL: J22 J26 H55
    Date: 2011–04
  2. By: Andrew Glover; Jonathan Heathcote; Dirk Krueger; José-Víctor Ríos-Rull
    Abstract: In this paper we construct a stochastic overlapping-generations general equilibrium model in which households are subject to aggregate shocks that affect both wages and asset prices. We use a calibrated version of the model to quantify how the welfare costs of severe recessions are distributed across different household age groups. The model predicts that younger cohorts fare better than older cohorts when the equilibrium decline in asset prices is large relative to the decline in wages, as observed in the data. Asset price declines hurt the old, who rely on asset sales to finance consumption, but benefit the young, who purchase assets at depressed prices. In our preferred calibration, asset prices decline more than twice as much as wages, consistent with the experience of the US economy in the Great Recession. A model recession is approximately welfare-neutral for households in the 20–29 age group, but translates into a large welfare loss of around 10% of lifetime consumption for households aged 70 and over.
    Date: 2011
  3. By: Iain Fraser; Katsuyuki Shibayama
    Abstract: In this paper we consider the option value of the environment employing a general equilibrium growth model with a stochastic technology. In our model, as in existing studies, because of irreversibility, the environment has significant real option value. However, unlike the existing literature in which the uncertainty of the value of the environment is given exogenously, the value of the environment is endogenously determined. In our model, the elasticity of substitution eta between the environment and consumption plays a crucial role. We show that the option value, and hence, the optimal decision are both affected by eta not only quantitatively but also qualitatively.
    Keywords: real option values; environment; general equilibrium; elasticity of substitution
    JEL: G13 Q31
    Date: 2011–04
  4. By: Pesaran, Hashem (University of Cambridge); Smith, Ron P. (Birkbeck College, University of London)
    Abstract: Academic macroeconomics and the research department of central banks have come to be dominated by Dynamic, Stochastic, General Equilibrium (DSGE) models based on micro-foundations of optimising representative agents with rational expectations. We argue that the dominance of this particular sort of DSGE and the resistance of some in the profession to alternatives has become a straitjacket that restricts empirical and theoretical experimentation and inhibits innovation and that the profession should embrace a more flexible approach to macroeconometric modelling. We describe one possible approach.
    Keywords: macroeconometric models, DSGE, VARs, long run theory
    JEL: C1 E1
    Date: 2011–04
  5. By: Haberis, Alex (Bank of England); Markovic, Bojan (National Bank of Serbia); Mayhew, Karen (Bank of England); Zabczyk, Pawel (Bank of England)
    Abstract: This paper considers the implications for the United States, the United Kingdom and the rest of the world (ROW) of shocks that may contribute to a further reduction in global current account imbalances using a dynamic stochastic general equilibrium (DSGE) model. We consider a shock that increases domestic demand in the ROW; a shock that reduces domestic demand in the United States; and a supply shock that raises US productivity relative to other countries. The impact on UK output and inflation depends on the nature of the shock that drives global rebalancing. An increase in domestic demand in the ROW would raise UK exports and output, but would also contribute to increased inflationary pressure in the United Kingdom. Further weakness in US domestic demand is likely to weigh on UK output and inflation. Productivity gains in the United States relative to other countries would worsen the United Kingdom’s current account position, pushing down on output, but would lead to reduced inflationary pressure in the United Kingdom.
    Keywords: Global imbalances; Current account; DSGE models.
    JEL: D58 F41 F47
    Date: 2011–04–15
  6. By: Hongfei Sun (Queen's University); Shouyong Shi (University of Toronto); Guido Menzio (University of Pennsylvania)
    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
    Abstract: The Japanese labor market displays U-shaped unemployment and separation rates, and declining job-finding rates as workers age. Traditional infinite horizon search models of the labor market cannot account for such patterns. We develop a life-cycle search and matching model that features random match quality and incorporates elements capturing several main characteristics of the Japanese labor market. We show that the model, calibrated for Japan, replicates the life-cycle properties of the data. Our model, following an empirically plausible productivity drop, produces changes in the steady state levels of the unemployment and finding rates similar in magnitude to those observed in Japan since the 1980s.
    Date: 2011–04
  8. By: T. LE BARBANCHON (Insee); B. OURLIAC (Insee); O. SIMON (Insee)
    Abstract: Until the current economic crisis, the recovery capacity of the American and French labour markets had often been compared. The United States had been considered more "resilient", namely more affected by cyclical shocks in the short term but more quickly coming back to their initial path in the medium term. As this conclusion may be modified in the context of the current crisis, it is also relevant to study if it is actually valid on the previous period. Between 1986 and 2007, the output gap of the United States presented more pronounced fluctuations and came back to the equilibrium more rapidly. However, it does not mean that the United States were more resilient since it can also result from the fact that the American economy was affected by other kinds of shocks than the French economy. To distinguish which explanation is the most relevant, it is difficult to use an astructural approach. This study is therefore based on a structural approach directly inspired from Christoffel and Linzert (2005). We use two calibrated DSGE models, one for the French economy, the other for the United States, which include a labour market matching model à la Diamond, Mortensen and Pissarides. The comparison of the impulse response functions between the two models show that differences in resilience cannot be assessed globally: they depend on the shock which affects the economy. The differences are the most significant for shocks related to the labour market but they are less sensible for standard shocks like productivity shocks or monetary shocks. We use the same DSGE models to determine the nature of historical shocks between 1986 and 2007 and to assess the contributions of these shocks to output fluctuations. According to the models, the dynamics of the two economies on the period is thus characterized by different combinations of shocks, rather than different absorption capacity of these shocks.
    Keywords: Labour market, matching model, business fluctuations, DSGE model, resilience
    JEL: E24 E32 J64
    Date: 2011
    Abstract: The search and matching model has recently come under criticism for its inability to account for some of the cyclical properties of the U.S. labor market. Shimer (2005) has shown that the basic version of the model is incapable of reproducing the volatility of the market tightness for reasonable movements in productivity. This paper considers whether the so-called "Shimer Puzzle" also holds for the Japanese economy. We present empirical evidence on the cyclical properties of the labor market variables in Japan and compare these to their U.S. counterparts. We then build, parametrize, and simulate three different versions of the search and matching model (with exogenous job destruction, with endogenous job destruction, and embedded in a Real Business Cycle model) and compare the simulated statistics to the data. We find that the "Shimer Puzzle" does hold for Japan, since the model is unable to generate as much volatility on the market tightness as in the data.
    Date: 2011–04
  10. By: Lisi, Gaetano
    Abstract: This book aims to provide an overview of the labour market's benchmark macroeconomic models. The matching models of equilibrium unemployment are, in fact, the primary and most popular theoretical tools used by economists to evaluate various labour market policies and to study one of the key macroeconomic variables: the unemployment rate. It has been recognised that unemployment has also a structural nature which persists over the business cycle. The matching models, i.e. the models à la Mortensen-Pissarides, explain the co-existence in equilibrium of unemployment and vacancies through frictions in matching workers and firms. Furthermore, these models generate predictions that have the right direction: unemployment goes up in recession and down in boom, while job vacancies shift in the opposite direction. The central role of these models in imperfect labour markets has recently been confirmed by the 2010 Nobel Prize for economy awarded to the founders of this approach: Peter Diamond, Dale Mortensen and Christopher Pissarides.
    Keywords: Matching and Job Search Theory; Vacancies; Labour Markets with frictions
    JEL: J6
    Date: 2011–02–28
  11. By: Keisuke Otsu
    Abstract: The Japanese business cycle from 1980-2007 portrays less contemporaneous correlation of labor with output than in the U.S. and also tends to lead output by one quarter. A canonical real business cycle model cannot account for these facts. This paper uses the business cycle accounting method a la Chari, Kehoe and McGrattan (2007) and shows that efficiency and labor market distortions are important in accounting for the quarterly business cycle fluctuation patterns in Japan. Fiscal and monetary variables such as labor income tax, money growth and interest rates cannot fully account for the distortions in the Japanese labor market.
    Keywords: business cycle accounting; japanese labor market
    JEL: E13 E32
    Date: 2011–04
  12. By: Grzegorz Grabek (National Bank of Poland, Economic Institute); Bohdan Klos (National Bank of Poland, Economic Institute); Grzegorz Koloch (National Bank of Poland, Economic Institute)
    Abstract: The paper documents the effects of work on the dynamic stochastic general equilibrium (DSGE) SOEPL model that has been carried out in the recent years at the National Bank of Poland, initially at the Bureau of Macroeconomic Research and lately at the Bureau of Applied Research of the Economic Institute. In 2009, a team consisting of the authors of this paper developed a new version of the model, called SOEPL−2009 which in 2010 is to be used to obtain routine mid-term forecasts of the inflation processes and the economic trends, supporting and supplementing the traditional structural macroeconometric model and experts’ forecasts applied so far. In the recent years many researchers have engaged in the work over a class of estimated macroeconomic models (of the business cycle) integrating the effects of at least three important lines of economic and econometric research: • methods of macroeconomic modelling (gradual departure from the traditional structural models towards models resistant to Lucas’ and Sims’ critique, strongly motivated with microeconomics); • micro- and macroeconomic theories (monetary policy issues, with emphasis on the consequence of imperfect competition, the role of nominal and real rigidities, as well as anticipating and optimising behaviours of agents in an uncertain environment, with a strong shift of point of view towards general equilibrium); • estimation techniques (reduction in parameters calibration, shift from classical techniques to Bayesian techniques with Bayesian-specific risk quantification as well as systematic and controlled introduction of experts’ knowledge, improvement of projections accuracy). Merger of the three trends has brought about a class of models — DSGE models — with high analytical and developmental potential. The very potential of the models of this class seems to be the most important reason for the interest of central banks in that area, research that may be directly translated into the practice of monetary policy. Along with the development of numerical, econometric methods and the theory of economics, a number of central banks supplement or even replace the traditional structural macroeconometric models, whose forecasting applications are enhanced with experts’ knowledge, with estimated DSGE models, namely models which attempt to translate the economic processes in a more explicit and systematic manner, whereby experts’ knowledge is introduced through Bayesian methods. It happens although no formal reasons exist for which the ex post verified accuracy of forecasts within the DSGE models should be higher than that of classical models. DSGE models give, however, a chance of structural (internally consistent and microfounded) explanations of the reasons for the recently observed phenomena and their consequences for the future. DSGE models present a different image of economic processes than classical macroeconometric models — they capture the world from the perspective of structural disturbances. These disturbances set the economy in motion and economic agents respond to them in an optimal way, which eliminates the consequences of the disturbances, i.e. restores the economy to equilibrium. The analytical knowledge and experience gathered in contact with the traditional structural models rather interferes with than helps interpret the results of DSGE models. In econometric categories, the results of DSGE models are, nevertheless, at least partially compliant with that which may be achieved with VAR and SVAR models, thus, it is hard to speak about revolution here. Following the events of 2008–2009 (global financial crisis), while searching for the reasons for the problems’ occurrence, the usefulness of formalised tools constructed on a uniform, internally coherent (but also restrictive) paradigm for macroeconomic policy tends to be questioned. The reasons for the global economy problems are searched for in models oversimplifying perception of the world and burdening the decisions regarding economic policy. We have noticed that the critique refers to a larger extent to the models as such (i.e. tools) and less to the practice of applying them (i.e. the user). Therefore, we consider that conclusions from a deeper analysis of the sources of 2008–2009 crisis, verification of the directions of economic research and methods of the research, which is likely to be held, as well as the analysis of the current policy less influenced by its rationalisation shall confirm the legitimacy of building and applying models, particularly DSGE class models. The issue of applications using the strong sides of the models remains, however, open. In our opinion, the best we can do is to try to use our model, gather and exchange experience, develop new procedures and thoroughly verify the results. The model whose details we shall present further herein derives from the structure developed at Riksbank — DSGE model for the euro area see Adolfson et al. (2005b). The euro area DSGE model, know-how, methods of estimation and applications received within the technical support of Riksbank enabled us to start several experiments, build different versions of DSGE model (a family of SOEPL models) and develop our own procedures of the model application. Some of the experiments have been described in separate papers, e.g. Grabek et al. (2007), Grabek and Kłos (2009), Grabek and Utzig-Lenarczyk (2009). The alternative we present in this paper summarizes some of the gathered experience. We pass the DSGE SOEPL−2009 model for use, with a view to considering and analysing other interpretation and understanding of economic processes than that proposed by the traditional models. Additionally, systematic work with the model (preparing forecasts and analyses of their accuracy, simulation experiments and analytical works) may reveal issues and problems that will have to be solved. Resulting knowledge shall enable the preparation of a more thorough future modification of the model, taking into account the effects of the parallel research and the conclusions arrived at during use. This paper consists of three basic parts. In the first part — relatively independent of the other parts — we have made an attempt to outline the development of the methods of macroeconomic (macroeconometric) modelling and the economic thought related to monetary policy, which brought about the creation of dynamic stochastic general equilibrium models, pushing aside other classes of models — at least in the academic world. The considerations are illustrated with simple models of real business cycles (RBC) and DSGE model based on new Keynesian paradigm. The second chapter of the first part focuses on the technical aspects of construction, estimation and application of DSGE models, drawing attention to mathematical, statistical and numerical instruments. Although it presents only the keynotes, outlines and ideas, the formalisation and precision of presentation required in that case makes the fragment of the paper slightly hermetic — a reader less interested in the techniques may omit that chapter. The further parts of the paper refer to specification, results of estimations and properties of the DSGE SOEPL−2009 model. We present, therefore, a general non-technical outline of the basic features of the model, illustrating at the same time the correlations with other DSGE models (Chapter 3). The next chapter defines decision-making problems of the optimising agents, their equilibrium conditions as well as characteristics of behaviours of the non- optimising agents. The description of the model specification is completed with balance conditions on a macro scale. The SOEPL−2009 model has been estimated with the use of Bayesian techniques. Identically as in all estimated DSGE models we are aware of, the Bayesian estimation refers solely to some of the parameters (the rest of the parameters have been calibrated). Although due to the application of the Bayesian techniques, the number of calibrated parameters has been clearly reduced, being aware of the consequences of faulty calibration we conducted a sort of sensitivity analysis (examination of the influence of changes in the calibration of parameters on the characteristics of the model). The presented SOEPL−2009 version takes into account the conclusions we arrived at based on the analysis. For the purposes of this paper and the first forecast experiments we use only point estimates of the parameters reflecting the modal value of posterior distribution, in other words our reasoning omits — hopefully temporarily — the issue of uncertainty of the parameters. The results of the estimation of parameters and assumptions made at the subsequent stages of the work (calibrated values, characteristics of prior distributions) have been presented in Chapter 6. A synthetic image of the model characteristics has been presented in Chapters 7–8, which describes the responses of observable variables to structural disturbances taken into account in the model (i.e. impulse response functions), variances decompositions (formally — forecast error decomposition), thanks to which the structure (relative role) of the impact of shocks on the observable variables may be assessed, estimation (identification) of structural disturbances in the sample, examples of historical decompositions (counterfactual experiments) and information about the ex post accuracy of forecasts — this is, thus, a typical set of information allowing understanding the consequences of the assumptions made at the stage of constructing decisionmaking problems (model specification) and choice of parameters. The Appendix presents structural form equations, equations used to determine value at a steady state and a list of variables of the SOEPL−2009 model.
    Date: 2011
  13. By: Emine Boz (IMF); Christian Daude (OECD); C. Bora Durdu (FRB)
    Abstract: We build an equilibrium business cycle model in which agents cannot perfectly distinguish between the permanent and transitory components of TFP shocks and learn about those components using the Kalman filter. Calibrated to Mexico, the model predicts a higher variability of consumption relative to output and a strongly negative correlation between the trade balance and output for a wide range of variability and persistence of permanent shocks vis-a-vis the transitory shocks. Moreover, our estimation for Mexico and Canada suggests more severe informational frictions in emerging markets than in developed economies.
    Keywords: emerging markets, business cycles, learning, Kalman filter
    JEL: F41 E44 D82
    Date: 2011–04
  14. By: Bartosz Maćkowiak (CEPR and European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Mirko Wiederholt (Department of Economics, Northwestern University, 2001 Sheridan Road, Evanston, IL 60208, USA.)
    Abstract: We develop a dynamic stochastic general equilibrium model with rational inattention by households and firms. Consumption responds slowly to interest rate changes because households decide to pay little attention to the real interest rate. Prices respond quickly to some shocks and slowly to other shocks. The mix of fast and slow responses of prices to shocks matches the pattern found in the empirical literature. Changes in the conduct of monetary policy yield very different outcomes than in models currently used at central banks because systematic changes in policy cause reallocation of attention by decision-makers in households and firms. JEL Classification: D83, E31, E32, E52.
    Keywords: information choice, rational inattention, monetary policy, business cycles.
    Date: 2011–04
  15. By: Fernandez-Corugedo, Emilio (Bank of England); McMahon, Michael (University of Warwick, and Centre for Economic Performance, LSE); Millard, Stephen (Bank of England); Rachel, Lukasz (Bank of England)
    Abstract: The most recent recession has been associated with a financial crisis that led to a large widening of spreads and quantitative restrictions on lending. As well as affecting investment, such a credit contraction is likely to have had a large effect on the working capital positions of UK firms and this, in turn, is likely to have affected the United Kingdom’s supply potential, at least temporarily. However, the role of such disruptions in the business cycle is not well understood. In this paper we first document the behaviour of working capital in the United Kingdom. In order to understand the effects of working capital on macroeconomic variables, we then solve and calibrate a DSGE model that introduces an explicit role for the components of working capital (net cash, inventories, and trade credit). We find that this model produces the standard responses of macroeconomic variables to productivity shocks, but we also find that financial intermediation shocks, similar to those experienced in the United Kingdom post-2007, have persistent negative effects on economic activity; these effects are reinforced by reductions in trade credit. Our model also documents a crucial role for monetary policy to offset such shocks.
    Keywords: Working capital; business cycle model; spreads; financial crisis.
    JEL: E20 E51 E52
    Date: 2011–04–18
  16. By: Thomas Philippon; Virgiliu Midrigan
    Abstract: A salient feature of the recent U.S. recession is that output and employment have declined more in regions (states, counties) where household leverage had increased more during the credit boom. This pattern is difficult to explain with standard models of financing frictions. We propose a theory that can account for these cross-sectional facts. We study a cash-in-advance economy in which home equity borrowing, alongside public money, is used to conduct transactions. A decline in home equity borrowing tightens the cash-in-advance constraint, thus triggering a recession. We show that the evidence on house prices, leverage and employment across US regions identifies the key parameters of the model. Models estimated with cross-sectional evidence display high sensitivity of real activity to nominal credit shocks. Since home equity borrowing and public money are, in the model, perfect substitutes, our counter-factual experiments suggest that monetary policy actions have significantly reduced the severity of the recent recession.
    JEL: E2 E4 E5 G0
    Date: 2011–04
  17. By: Chen, Hung-Ju; Fang, I-Hsiang
    Abstract: This paper studies the effect of population aging on economic performance in an overlapping-generations model with international migration. Fertility is endogenized so that immigrants and natives can have different fertility rates. Fertility is an important determinant to the tax burden of social security since it affects the quantity and quality of future tax payers. We find that introducing immigrants into the economy can reduce the tax burden of social security. If life expectancy (or the replacement ratio) is high enough, the growth rate of GDP per worker for an economy with international migration will be higher than for a closed economy. Regarding migration policies, our numerical results indicate that economic growth rate of GDP per worker will first decrease then increase as the flow of immigrants increases. Increasing the quality of immigrants will enhance economic growth.
    Keywords: Economic growth; Fertility; Migration; Social security.
    JEL: F22 H55 O15
    Date: 2011
  18. By: Chen, Hung-Ju
    Abstract: This study examines the effects of monetary policy in a two-sector cash-in-advance economy of human capital accumulation. Agents concern about their social status represented by the relative physical capital and relative human capital. We find that if the desire for social status depends only on relative physical capital, money is superneutral in the growth-rate sense. However, if the desire for social status depends on relative human capital, the money growth rate will have a positive effect on the long-run economic growth rate. Furthermore, an increase in the desire to pursue human capital will raise the long-run growth rate, but an increase in the desire to pursue physical capital will lower it.
    Keywords: Cash-in-advance economy; Endogenous growth; Social status.
    JEL: O42 E52 C62
    Date: 2011
  19. By: Lisi, Domenico (University of Catania, Department of Economics and Quantitative Methods)
    Abstract: The standard analysis of the impact of EPL on labour market outcomes concentrates mainly on unemployment, disregarding the possible effect on productivity. In this paper we make (a component of) labour productivity endogenous and analyze how the presence of a stringent protection legislation affects labour market in an equilibrium matching model with endogenous job destruction. Indeed, considering labour productivity an endogenous could be important not only in the case of EPL, but also for all kind of personnel policy evaluation. In this framework high labour productivity on one hand is costly in terms of effort, on the other hand is beneficial in terms of lower job destruction. We find that high firing costs partially substitute high labour productivity in reducing job destruction and this, consequently, brings down the optimal level of productivity. Moreover, the impact of EPL on unemployment is ambiguous but numerical exercises show unambiguously how higher firing restrictions reduce different measures of aggregate welfare. To some extent, the clear emergence of these results is full of policy implication and, indeed, rationalizes the recent empirical evidence on the impact of EPL.
    Keywords: Employment protection; Endogenous labour productivity; Job destruction
    JEL: J24 J38 J63 J64
    Date: 2010–04–01
  20. By: Sa, Filipa (Trinity College, University of Cambridge); Viani, Francesca (Banco de España)
    Abstract: Reversals in capital inflows can have severe economic consequences. This paper develops a dynamic general equilibrium model to analyse the effect on interest rates, asset prices, investment, consumption, output, the exchange rate and the current account of a shift in portfolio preferences of foreign investors. The model has two countries and two asset classes (equities and bonds). It is characterised by imperfect substitutability between assets and allows for endogenous adjustment in interest rates and asset prices. Therefore, it accounts for capital gains arising from equity price movements, in addition to valuation effects caused by changes in the exchange rate. To illustrate the mechanics of the model, we calibrate it to analyse the consequences of an increase in the importance of sovereign wealth funds (SWFs). Specifically, we ask what would happen if ‘excess’ reserves held by emerging markets were transferred from central banks to SWFs. We look separately at two diversification paths: one in which SWFs keep the same allocation across bonds and equities as central banks, but move away from dollar assets (path 1); and another in which they choose the same currency composition as central banks, but shift from US bonds to US equities (path 2). In path 1, the dollar depreciates and US net debt falls on impact and increases in the long run. In path 2, the dollar depreciates and US net debt increases in the long run. In both cases, there is a reduction in the ‘exorbitant privilege’, ie, the excess return the United States receives on its assets over what it pays on its liabilities. The model is applicable to other episodes in which foreign investors change the composition of their portfolios.
    Keywords: Portfolio preferences; sudden stops; imperfect substitutability; global imbalances; sovereign wealth funds.
    JEL: F32
    Date: 2011–04–18
  21. By: Lipinska, Anna (Bank of England); Millard, Stephen (Bank of England)
    Abstract: In this paper, we analyse the impact of a persistent productivity increase in a set of countries – which we think of as the BRIC economies – on inflation in their trading partners, the G7. In particular we want to understand conditions under which this shock can lead to tailwinds or headwinds in the economies of trading partners. We build a three-country DSGE model in which there are two oil-importing countries (home and foreign) and one oil-exporting country. We perform several experiments where we try to disentangle the importance of different factors that can shape inflation dynamics in the home country when the foreign country is hit by a persistent productivity shock. These factors are wage stickiness, the role of the oil sector and its share in both consumption and production, foreign monetary policy and the degree of completeness of financial markets. We find that the tailwinds effect, lowering inflation in the home economy, dominates the headwinds effect as long as there is scope for borrowing and lending across countries and the foreign country’s production is not too oil intensive.
    Date: 2011–04–15
  22. By: James Costain (Banco de España, Calle Alcalá 48, 28014 Madrid, Spain.); Anton Nakov (Banco de España and European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: Starting from the assumption that firms are more likely to adjust their prices when doing so is more valuable, this paper analyzes monetary policy shocks in a DSGE model with firm-level heterogeneity. The model is calibrated to retail price microdata, and inflation responses are decomposed into “intensive”, “extensive”, and “selection” margins. Money growth and Taylor rule shocks both have nontrivial real effects, because the low state dependence implied by the data rules out the strong selection effect associated with fixed menu costs. The response to firm-specific shocks is gradual, though inappropriate econometrics might make it appear immediate. JEL Classification: E31, E52, D81.
    Keywords: Nominal rigidity, state-dependent pricing, menu costs, heterogeneity, Taylor rule.
    Date: 2011–04
  23. By: Ángel Gavilán (Banco de España); Pablo Hernández de Cos (Banco de España); Juan F. Jimeno (Banco de España); Juan A. Rojas (Banco de España)
    Abstract: This paper builds a large overlapping generations model of a small open economy featuring imperfect competition in the labor and product markets to understand i) which were the main determinants of the large expansionary phase experienced in Spain from the mid-1990s until the arrival of the global financial crisis in 2007-2008, ii) what role fiscal policy and structural reforms could have played to avoid the build-up of large external imbalance over this period, and iii) how these policies could affect the recovery of economic activity in Spain after the crisis. Our results indicate that falling interest rates and demographic changes were the main drivers of the Spanish expansionary phase. As for the macroeconomic behavior of the Spanish economy after the crisis, our results suggest that a front-loading in fiscal consolidation together with structural reforms that eliminate distortions in the goods and labor markets could make the recovery of economic activity in Spain more successful.
    Keywords: overlapping generations, imperfect competition, fiscal consolidation, demographic change, structural reforms
    JEL: E62 H30 J11
    Date: 2011–04
  24. By: Lengnick, Matthias
    Abstract: This paper develops a baseline agent-based macroeconomic model and contrasts it with the common dynamic stochastic general equilibrium approach. Although simple, the model can reproduce a lot of the stylized facts of business cycles. The author argues that agent-based modeling is an adequate response to the recently expressed criticism of macroeconomic methodology. It does not depend on the strict assumption of rationality and allows for aggregate behavior that is more than simply a replication of microeconomic optimization decisions. At the same time it allows for absolutely consistent micro foundations. Most importantly, it does not depend on equilibrium assumptions or fictitious auctioneers and does therefore not rule out coordination failures, instability and crisis by definition. --
    Keywords: agent-based modeling,complex adaptive systems,microfoundations of macroeconomics
    JEL: B4 E1 E50
    Date: 2011
  25. By: Eva Ortega (Banco de España); Margarita Rubio (Banco de España); Carlos Thomas (Banco de España)
    Abstract: One of the most salient feature of the Spanish housing market, compared to other European economies, is its relatively low rental share. This may be partly attributed to the existence of fiscal distortions in Spain favoring ownership. In this paper, we simulate the potential efects of different policy measures aimed at homogenizing the fiscal treatment of ownership and renting and improving the efficiency of the rental market. We do so in the context of a DSGE model featuring a market for owner-occupied and rented housing, as well as collateral constraints in loan markets. We find that eliminating the existing subsidy to house purchases, introducing a comparable subsidy to rental payments or increasing the efficiency in the production of housing rental services raise the rental share by a similar amount. However, their implications in terms of the construction sector differ.
    Keywords: Rental market share, subsidy to house purchases, subsidy to rents, rental market efficiency
    JEL: E21 E3 E51 E6
    Date: 2011–04
  26. By: Anja Sautmann
    Abstract: Consider a marriage market with continuous-time two-sided search and trans- ferable utility in which the match payo depends on age. This paper characterizes a set of payo functions consistent with two salient marriage age patterns: (1) assortative match- ing by age, and (2) \dierential age matching", a formalization of the age dierence at marriage between men and women. The payo function has to satisfy certain conditions on its slope and curvature in age. However, to achieve sorting it need not be supermodular (submodular) in partners' ages, unlike in search models where the match payo depends on the xed \type" of each individual.
    Date: 2011
  27. By: Rajnish Mehra; Facundo Piguillem; Edward C. Prescott
    Abstract: The neoclassical growth model is extended to include costly intermediated borrowing and lending between households. This is an important extension as substantial resources are used in intermediating the large amount of borrowing and lending between households. In 2007, in the United States, the amount intermediated was 1.7 times GNP, and the resources used in this intermediation amounted to at least 3.4 percent of GNP. The theory implies that financial intermediation services are an intermediate good and that the spread between borrowing and lending rates measures the efficiency of the financial sector. ; This paper was previously published as Working Paper 655 and Staff Report 405 under the title "Intermediated Quantities and Returns."
    Date: 2011
  28. By: Alfredo Marvão Pereira (Department of Economics, The College of William and Mary); Rui M. Pereira (Department of Economics, University of the Algarve)
    Abstract: This paper explores the capacity for environmental reform to reduce CO2 emissions, stimulate economic performance, and promote fiscal sustainability. Simulation results suggest that reforms based on CO2 taxation stimulate GDP when tax revenues are used to promote private or public investment and employment when used to finance reductions in personal income taxation or firms' social security contributions. More generally, reforms allow for reductions in the costs of climate policy, a weaker realization of the second dividend. In addition, several reforms lead to reductions in public debt, the realization of a third dividend. When political constraints on reducing public spending are considered, however, this third dividend only materializes when revenues finance public investment or reductions in the firms' social security contributions. Overall, our results suggest that low growth and high public debt need not be regarded as hindrances for environmental fiscal reform but can actually be seen as catalysts.
    Keywords: Carbon Tax, Environmental Fiscal Reform, Economic Growth, Budgetary Consolidation,Dynamic General Equilibrium, Endogenous Growth
    JEL: D58 H54 H63 Q48 Q54
    Date: 2011–04–20
  29. By: Lionel De Boisdeffre (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I)
    Abstract: We consider a pure exchange economy, with incomplete financial markets, where agents face an "exogenous uncertainty", on the future state of nature and an "endogenous uncertainty", on the future price in each random state. Namely, every agents forms price anticipations on each spot market, distributed along an idiosyncratic probability law. At a sequential equilibrium, all agents expect the "true" price as a possible outcome and elect optimal strategies at the first period, which clear on all markets at every time period. We show that, provided the endogenous uncertainty is large enough, a sequential equilibrium exists under standard conditions, for all types of financial structures (i.e., with real, nominal and mixed assets). This result suggests that standard existence problems of sequential equilibrium models, following Hart (1975), stem form the single price expectation assumption.
    Keywords: General equilibrium, incomplete markets, existence of equilibrium, anticipations.
    Date: 2011–03
  30. By: Fiorella De Fiore; Harald Uhlig
    Abstract: We present a dynamic general equilibrium model with agency costs where: i) firms are heterogeneous in the risk of default; ii) they can choose to raise finance through bank loans or corporate bonds; and iii) banks are more efficient than the market in resolving informational problems. The model is used to analyze some major long-run differences in corporate finance between the US and the euro area. We suggest an explanation of those differences based on information availability. Our model replicates the data when the euro area is characterized by limited availability of public information about corporate credit risk relative to the US, and when european firms value more than US firms the flexibility and information acquisition role provided by banks.
    JEL: C68 E20 E44
    Date: 2011–04
  31. By: Marlène Isoré
    Abstract: This paper develops a two-country multi-frictional model where the freeze on liquidity access to commercial banks in one country raises unemployment rates via credit rationing in both countries. The expenditure-switching channel, whereby asymmetric monetary shocks traditionally lead to negative comovements of home and foreign outputs, is considerably weakened via opposite forces driving the exchange rate. Meanwhile, it is proved that financial market integration forms a transmission channel per se, without resorting to international cross-holdings of risky assets. The search and matching modeling serves two purposes. First, it accounts for the time needed to restore a normal level of confidence following financial market disruptions. Second, it allows dissociating pure liquidity contractions from non-walrasian financial shocks, arriving despite global excess savings and due to heterogeneity in the quality of the banking system. The former induce negative comovements of home and foreign outputs, in accordance with the literature, whereas the new type of financial shocks does generate financial contagion.
    Keywords: matching theory, financial markets, credit rationing, financial multiplier, international transmission, financial crises, open economy macroeconomics
    JEL: C78 E44 E51 F41 F42 G15
    Date: 2011–04
  32. By: Pascal Stiefenhofer
    Abstract: The paper generalizes the natural projection approach introduced by Balasko (1988) to production economies with uncertainty. It explores the equilibrium structure of the long run and short run private ownership production model. It is shown that qualitative equilibrium properties of the production model are those of the exchange model with production adjusted demand functions.
    Keywords: Existence of Equilibrium, Equilibrium Structure, Uncertainty, Production.
    JEL: D62 D52 D53
    Date: 2011–04
  33. By: Hintermaier, Thomas (University of Bonn); Koeniger, Winfried (Queen Mary, University of London)
    Abstract: We provide a model with endogenous portfolios of secured and unsecured household debt. Secured debt is collateralized by owner-occupied housing whereas unsecured debt can be discharged according to bankruptcy regulations. We show that the calibrated model matches important quantitative characteristics of observed wealth and debt portfolios for prime-age consumers in the U.S. We then establish the quantitative result that home equity does not serve as informal collateral for unsecured debt since, as in the data, unsecured debtors hold small amounts of home equity in equilibrium. Thus, observed variations in homestead exemptions, which are an important part of U.S. bankruptcy regulation, have a small effect on the quantity and price of unsecured debt.
    Keywords: household debt portfolios, housing, collateral, bankruptcy, commitment, income risk
    JEL: E21 D91
    Date: 2011–04
  34. By: Marco Bassetto; Leslie McGranahan
    Abstract: In this paper, we investigate the relationship between public capital spending and population dynamics at the state level. Empirically, we document two robust facts. First, states with faster population growth do not spend more (per capita) to accommodate the needs of their growing population. Second, states whose population is more likely to leave do tend to spend more per capita than states with low gross emigration rates. To interpret these facts, we introduce an explicit, quantitative political-economy model of government spending determination, where mobility and population growth generate departures from Ricardian equivalence by shifting some of the costs and benefits of public projects to future residents. The magnitude of the empirical response of capital spending to mobility is at the upper end of what can be explained by the theory with a plausible calibration. In the model, more mobile voters favor more spending because the maturity of states' debt is very long term and costs are shifted into the future more than benefits.
    JEL: E62 H41 H71
    Date: 2011–04
  35. By: Ken-Ichi Akao (School of Social Sciences, Waseda University); Takashi Kamihigashi (Research Institute for Economics and Business Administration, Kobe University); Kazuo Nishimura (KIER, Kyoto University)
    Abstract: We show that the critical capital stock in the Dechert-Nishimura (1983) model is a decreasing and continuous function of the discount factor. We also show that the critical capital stock merges with a positive steady state as the discount factor decreases to a boundary value, and that the critical capital stock converges to the minimum sustainable capital stock as the discount factor increases to the other boundary value.
    Keywords: Dechert-Nishimura model; nonconvexity; optimal growth; critical capital stock
    JEL: C61 D90 O41
    Date: 2011–04
  36. By: L. Mauro; Francesco Pigliaru
    Abstract: Since Putnam s work on social capital, the Italian regional case has been a very rich source of both data and theories about the origins of large and persistent differences in local stocks of social capital, and about the impact of such differences on economic performances. The Italian case is widely interpreted as supporting the idea that persistent regional divides are largely explained by local differences in social capital. In this paper we maintain that this interpretation fails to recognize that the current large regional gap in Italy is significantly linked to two policy decisions taken by the central State at the beginning of the 1970s. In particular, we focus on the possibility that social capital became a binding constraint for the growth of southern Italy’s mainly as a consequence of the deep process of governmental decentralization that began in the1970s. We formalize this hypothesis by using an endogenous growth model with public capital. In this model, the accumulation of public capital is characterized by the presence of iceberg costs that depend on social capital. Decentralization affects these costs because the impact of the local stocks of social capital on public investment increases when the latter is managed locally. To assess the role of decentralization as a trigger of the influence of local social capital on growth, we control for the impact of labor market reforms, a second and almost simultaneous institutional shock that took place in Italy and that made regional labor markets far more rigid than in the previous decades. In the second part of our paper, we use the large empirical literature on the Italian regions to restrict the values of the parameters of our model in order to perform a simple simulation exercise. In this exercise, the model turns out to be able to account for the major swings in the convergence of southern regions towards the center-northern regions since 1861. The general lessons we can draw from this further analysis of the Italian regional case are as follows. First, we show that the strength of social capital as a determinant of long-run growth may depend on some well-defined characteristic of the institutional context. Second, our model suggests that the economic success of decentralization policies -- even when the budget constraint is not "soft" -- depends on the local endowment of social capital.
    Keywords: Growth; Decentralization; Convergence; Social Capital
    JEL: O4 R5
    Date: 2011
  37. By: Mele, Antonio
    Abstract: This paper shows how to solve dynamic agency models by extending recursive Lagrangean techniques à la Marcet and Marimon (2011) to problems with hidden actions. The method has many advantages with respect to promised utilities approach (Abreu, Pearce and Stacchetti (1990)): it is a significant improvement in terms of simplicity, tractability and computational speed. Solutions can be easily computed for hidden actions models with several endogenous state variables and several agents, while the promised utilities approach becomes extremely difficult and computationally intensive even with just one state variable or two agents. Several numerical examples illustrate how this methodology outperforms the standard approach.
    Keywords: repeated moral hazard; collocation method; dynamic models with private information; recursive contracts
    JEL: D86 C63 C61
    Date: 2011–04–11
  38. By: Antoci, Angelo; Sabatini, Fabio; Sodini, Mauro
    Abstract: We set up a theoretical framework to analyze the possible role of economic growth and technical progress in the erosion of social capital. Under certain parameters, the relationship between technical progress and social capital can take the shape of an inverted U curve. We show the circumstances allowing the economy to follow trajectories where the stock of social capital grows endogenously and unboundedly.
    Keywords: Social capital; technological progress; economic growth; social interactions
    JEL: O11 J22 O33 Z13 O12
    Date: 2011–04–15

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