nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2011‒05‒14
28 papers chosen by
Christian Zimmermann
University of Connecticut

  1. Implementing steady state efficiency in overlapping generations economies with environmental externalities. By Nguyen Thang Dao; Julio Dávila
  2. Pro-Cyclical Unemployment Benefits? Optimal Policy in an Equilibrium Business Cycle Model By Kurt Mitman; Stanislav Rabinovich
  3. Technical change in a neoclassical two-sector model of optimal growth By Mehdi Senouci
  4. A calibrated Growth Model of Global Imbalances By Lionel Artige; Laurent Cavenaile
  5. Abatement Technology and the Environment-Growth Nexus with Education By Xavier Pautrel
  6. Deregulation shock in product market and unemployment By Luisito Bertinelli; Olivier Cardi; Partha Sen
  7. Efficient Ramsey Equilibria By Becker, Robert; Mitra, Tapan
  8. Variety Matters By Oscar Pavlov; Mark Weder
  9. Macroeconomic Costs of Higher Bank Capital and Liquidity Requirements By Jan Vlcek; Scott Roger
  10. Credit Risk and Disaster Risk By Francois Gourio
  11. On equilibrium dynamics with many agents and wages paid ex ante By Kirill Borissov
  12. Macro-prudential Policy on Liquidity: What Does a DSGE Model Tell Us? By Jagjit S. Chadha; Luisa Corrado
  13. New Shocks and Asset Price Volatility in General Equilibrium By Akito Matsumoto; Pietro Cova; Massimiliano Pisani; Alessandro Rebucci
  14. Coordination in the Labor Market By Marja-Liisa Halko; Juha Virrankoski
  15. Emissions Targets and the Real Business Cycle: Intensity Targets versus Caps or Taxes By Fischer, Carolyn; Springborn, Michael R.
  16. Fire-Sales Externalities and International Cooperation By Dmitriev, Mikhail
  17. International Business Cycles with Mutliple Input Investments By Oviedo, P. Marcelo; Singh, Rajesh
  18. Sustainable growth in a model with dual-rate discounting By Kirill Borissov; Kirill Shakhnov
  19. Whom to Send to Doha? The Shortsighted Ones! By Mario Larch; Wolfgang Lechthaler
  20. Finiteness of the Number of Equilibria in a Production Economy with Uncertainty By Pascal Stiefenhofer
  21. Savings behavior with imperfect capital markets : when hyperbolic discounting leads to discontinuous strategies. By Bertrand Wigniolle
  22. Structural reforms and macroeconomic performance in the euro area countries: a model-based assessment By Sandra Gomes; P. Jacquinot; M. Mohr; M. Pisani
  23. A Generalized Endogenous Grid Method for Non-concave Problems By Giulio Fella
  24. Corruption and Environmental Policy: An Alternative Perspective By Athanasios Lapatinas; Anastasia Litina; Eftichios S. Sartzetakis
  25. Anticipation, learning and welfare: the case of distortionary taxation By Gasteiger, Emanuel; Zhang, Shoujian
  26. Ambiguity and Volatility: Asset Pricing Implications By Pataracchia, B.
  27. A study of the dynamic of influence through differential equations. By Aditya Goenka; Cuong Le Van; Manh-Hung Nguyen
  28. The animal spirits hypothesis and the Benhabib-Farmer condition for indeterminacy By Guerrazzi, Marco

  1. By: Nguyen Thang Dao (Center for Operations Research and Econometrics (CORE)- Université Catholique de Louvain); Julio Dávila (Centre d'Economie de la Sorbonne)
    Abstract: We consider in this paper overlapping generations economies with polution resulting from both consumption and production. The competitive equilibrium steady state is compared to the optimal steady state from the social planner's viewpoint. We show that any competitive equilibrium steady state whose capital-labor ratio exceeds the golden rule ratio is dynamically inefficient. Moreover, the range of dynamically efficient steady states capital ratios increases with the effectiveness of the environment maintainance technology, and decreases for more polluting production technologies. We characterize some tax and transfer policies that decentralize as a competitive equilibrium outcome the social planner's steady state.
    Keywords: Overlapping generations, environmental externality, tax and transfer policy.
    JEL: D62 E21 H21 H41
    Date: 2010–12
  2. By: Kurt Mitman (Department of Economics, University of Pennsylvania); Stanislav Rabinovich (Department of Economics, University of Pennsylvania)
    Abstract: We study the optimal provision of unemployment insurance (UI) over the business cycle. We consider an equilibrium Mortensen-Pissarides search and matching model with risk-averse workers and aggregate shocks to labor productivity. Both the vacancy creation decisions of firms and the search effort decisions of workers respond endogenously to aggregate shocks as well as to changes in UI policy. We characterize the optimal history-dependent UI policy. We find that, all else equal, the optimal benefit is decreasing in current productivity and decreasing in current unemployment. Optimal benefits are therefore lowest when current productivity is high and current unemployment is high. The optimal path of benefits reacts non-monotonically to a productivity shock. Following a drop in productivity, benefits initially rise in order to provide short-run relief to the unemployed and stabilize wages, but then fall significantly below their pre-recession level, in order to speed up the subsequent recovery. Under the optimal policy, the path of benefits is pro-cyclical overall. As compared to the existing US UI system, the optimal history-dependent benefits smooth cyclical fluctuations in unemployment and deliver non-negligible welfare gains.
    Keywords: Unemployment Insurance, Business Cycles, Optimal Policy, Search and Matching
    JEL: E24 E32 H21 J65
    Date: 2011–02–15
  3. By: Mehdi Senouci (PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - Ecole des Ponts ParisTech - Ecole Normale Supérieure de Paris - ENS Paris - INRA, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: This paper investigates into the asymmetrical consequences of consumption-specific and investment-specific technical change in a two-sector growth framework. Hicks-neutral technological shocks of the former type increase steady-state consumption one-for-one, and Hicks-neutral technological shocks of the latter type increase steady-state consumption by a factor equal to the ratio of the macroeconomic capital share to labor share. As this ratio does not necessarily tend to zero as investment-specific total factor productivity goes to infinity, we conclude that consumption can grow asymptotically even in the absence of gains of productivity in the consumption sector, through capital accumulation within the consumption sector alone - this accumulation itself being driven by technical progress within the investment sector. We illustrate this result when the production functions are of Cobb-Douglas type in both sectors, and present in this case a steady growth theorem.
    Keywords: Productivity ; optimal growth ; golden rule ; two-sector models
    Date: 2011–04
  4. By: Lionel Artige; Laurent Cavenaile
    Abstract: Global imbalances are considered as one of the main culprits of the financial crisis which started in the United States in 2007. This paper aims to build a two- country deterministic growth framework with overlapping generations to investigate the macroeconomic effects of global imbalances that originate from forced saving in one country. This framework allows us to study the existence of a dynamic equi- librium with global imbalances, the impact on the world interest rate, and the short-run and long-run welfare implications on the young and old generations in both countries. In particular, we show that global imbalances worsen the welfare of the young generations of both countries in the short run and can offset the potential gain of the international integration of capital markets.
    Date: 2011
  5. By: Xavier Pautrel (Université de Nantes, Laboratoire d’Économie et de Management de Nantes (LEMNA), Institut d’Économie et de Management de Nantes – IAE)
    Abstract: This article challenges the conventional result that a tighter environmental tax has no long-run effect on human capital accumulation in the presence of pollution arising from final output production. It demonstrates that the technology used in the abatement sector determines the existence and the direction of the growth-effect. A tighter environmental tax rises (respectively reduces) human capital accumulation in the presence of pollution arising from final production, if the abatement sector is relatively more intensive in human (resp. physical) capital than final sector. That result always holds for finite lifetime but for infinite lifetime it only holds when labor supply is endogenous. The transitional impact of a tighter environmental policy is also investigated.
    Keywords: Growth, Environment, Overlapping Generations, Human Capital, Abatement
    JEL: Q5 Q58
    Date: 2011–02
  6. By: Luisito Bertinelli (Faculty of Law, Economics and Finance - University of Luxembourg); Olivier Cardi (ERMES - Equipe de recherche sur les marches, l'emploi et la simulation - CNRS : UMR7017 - Université Panthéon-Assas - Paris II, Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X); Partha Sen (Dehli School of Economics - Dehli School of Economics)
    Abstract: In a dynamic general equilibrium model with endogenous markups and labor market frictions, we investigate the effects of increased product market competition. Unlike most macroeconomic models of search, we endogenize the labor supply along the extensive margin. We show that beneficial effects in labor market outcomes require that the condition for saddle-path stability must be fulfilled whereas instability yields detrimental effects. Additionally, we find numerically that most of the decline in the unemployment rate can be attributed to the increase in the labor force, while the number of job seekers remains fairly unchanged. For a calibration capturing alternatively European and the U.S. labor markets, a deregulation episode, which lowers the markup by 3 percentage points, results in a fall in the unemployment rate by 0.1 and 0.05 percentage point, respectively, while the labor share is almost unaffected in the long-run.
    Keywords: Imperfect competition; Endogenous markup; Search theory; Unemployment; Deregulation.
    Date: 2011–04–28
  7. By: Becker, Robert (IN University); Mitra, Tapan (Cornell University)
    Abstract: Ramsey equilibrium models with heterogeneous agents and borrowing constraints are shown to yield efficient equilibrium sequences of aggregate capital and consumption. The proof of this result is based on verifying that equilibrium sequences of prices satisfy the Malinvaud criterion for efficiency.
    Date: 2011–03
  8. By: Oscar Pavlov; Mark Weder
    Abstract: Countercyclical markups are a key transmission mechanism in many endogenous business cycle models. Yet, recent findings suggest that aggregate markups in the US are procyclical. The current model addresses this issue. It extends Gall's (1994) composition of aggregate demand model by endogenous entry and exit of firms and by product variety effects. Endogenous business cycles emerge with procyclical markups that are within empirically plausible ranges.
    Keywords: Sunspot equilibria, Indeterminacy, Markups, Variety effects, Business cycles.
    JEL: E32
    Date: 2011–03
  9. By: Jan Vlcek; Scott Roger
    Abstract: This paper uses a DSGE model with banks and financial frictions in credit markets to assess the medium-term macroeconomic costs of increasing capital and liquidity requirements. The analysis indicates that the macroeconomic costs of such measures are sensitive to the length of the implementation period as well as to the adjustment strategy used by banks, and the scope for monetary policy to respond to the regulatory changes.
    Date: 2011–05–04
  10. By: Francois Gourio
    Abstract: Corporate credit spreads are large, volatile, countercyclical, and significantly larger than expected losses, but existing macroeconomic models with financial frictions fail to reproduce these patterns, because they imply small and constant aggregate risk premia. Building on the idea that corporate debt, while safe in normal times, is exposed to the risk of economic depression, this paper embeds a trade-off theory of capital structure into a real business cycle model with a small, time-varying risk of large economic disaster. This simple feature generates large, volatile and countercyclical credit spreads as well as novel business cycle implications. In particular, financial frictions substantially amplify the effect of shocks to the disaster probability.
    JEL: E22 E32 E44 G12
    Date: 2011–05
  11. By: Kirill Borissov
    Abstract: A model of economic growth with many agents and borrowing constraints is considered under the assumption that wages are paid ex ante. It is shown that, in contrast to the traditional case where wages are paid ex post, the convergence of equilibrium paths to a steady-state equilibrium occurs regardless of specifications of technology.
    Keywords: economic growth, heterogeneous agents, stability
    JEL: D91 O41 C61
    Date: 2011–04–21
  12. By: Jagjit S. Chadha (Keynes College, University of Kent); Luisa Corrado (Faculty of Economics, University of Rome "Tor Vergata")
    Abstract: The financial crisis has led to the development of an active debate on the use of macro-prudential instruments for regulating the banking system, in particular for liquidity and capital holdings. Within the context of a micro-founded macroeconomic model, we allow commercial banks to choose their optimal mix of asset creation, apportioning this to either reserves or private sector loans. We examine the implications for quantities, relative non-financial and financial prices from standard macroeconomic shocks alongside shocks to the expected liquidity of banks and to the efficiency of the banking sector. We focus on the response by the monetary sector, in particular the optimal reserve-deposit ratio adopted by commercial banks. Overall we find some rationale for Basel III in providing commercial banks with an incentive to hold liquid assets, such as reserves, as this acts to limit the procyclicality of lending to the private sector.
    Keywords: Liquidity, interest on reserves, policy instruments, Basel.
    JEL: E31 E40 E51
    Date: 2011–05–02
  13. By: Akito Matsumoto; Pietro Cova; Massimiliano Pisani; Alessandro Rebucci
    Abstract: We study equity price volatility in general equilibrium with news shocks about future productivity and monetary policy. As West (1988) shows, in a partial equilibrium present discounted value model, news about the future cash flow reduces asset price volatility. We show that introducing news shocks in a canonical dynamic stochastic general equilibrium model may not reduce asset price volatility under plausible parameter assumptions. This is because, in general equilibrium, the asset cash flow itself may be affected by the introduction of news shocks. In addition, we show that neglecting to account for policy news shocks (e.g., policy announcements) can potentially bias empirical estimates of the impact of monetary policy shocks on asset prices.
    Date: 2011–05–06
  14. By: Marja-Liisa Halko (Department of Accounting and Finance, Aalto University School of Economics); Juha Virrankoski (Department of Economics, University of Turku)
    Abstract: We solve the equilibrium market structure in a labor market where vacancies and unemployed workers can meet either in an intermediated market where wages are determined by take-it-orleave- it offers, or in a directed search market where firms post wages. By using an intermediary agents avoid the coordination problem which prevails in the search market. We study a monopolistic intermediary and perfect competition between intermediaries, and we consider the welfare properties of an intermediary institution, compared to an economy with an uncoordinated search process only.
    Keywords: intermediary, matching, labor market
    JEL: D40 J41 J64
    Date: 2011–02
  15. By: Fischer, Carolyn (Resources for the Future); Springborn, Michael R.
    Abstract: For reducing greenhouse gas emissions, intensity targets are attracting interest as a flexible mechanism that would better allow for economic growth than emissions caps. For the same expected emissions, however, the economic responses to unexpected productivity shocks differ. Using a real business cycle model, we find that a cap dampens the effects of productivity shocks in the economy on all variables except for the shadow value of the emissions constraint. An emissions tax leads to the same expected outcomes as a cap but with greater volatility. Certainty-equivalent intensity targets maintain higher levels of labor, capital, and output than other policies, with lower expected costs and no more volatility than with no policy.
    Keywords: emissions tax, cap-and-trade, intensity target, business cycle
    JEL: Q2 Q43 Q52 H2 E32
    Date: 2011–04–29
  16. By: Dmitriev, Mikhail
    Abstract: Private agents consider prices as given and do not take into account effects of their actions on other agents via prices. In the environment with a financial frictions this generates inefficiency (fire-sale externality). In particular consumers tend to overaccumulated dollarized liabilities in the decentralized economies and take excessive risk. On the other hand benevolent social planner internalizes these effects and tries to restrict speculative capital inflows and accumulate international reserves in order to insure against macroeconomic instability, caused by excessive and inefficient accumulation of dollar-denominated liabilities. In this paper I consider general equilibrium effects of such policies in a multi-country setup. I show that country-specific social planners fail to internalize the effect of their policies on the world interest rate. As a result in a uncooperative equilibrium developing countries insure against fire-sales externalities at the price of deteriorating terms of trade. This terms of trade effect can offset benefits from insurance, so that in uncooperative equilibrium country-specific social planners may have lower welfare relative to the decentralized economies. These results are robust to market completeness and correlation of shocks in developing economies.
    Keywords: Fire-Sales Externalities; International Cooperation
    JEL: F42 F41
    Date: 2011–01
  17. By: Oviedo, P. Marcelo; Singh, Rajesh
    Abstract: This paper studies a two country model with economies disaggregated into traded and nontraded sectors and in which investment goods as in practice are produced by combining inputs from all sectors. The model also accounts for nontraded distribution services employed in retailing traded goods to consumers. The results show that the model with multiple input investments outperforms the standard model in which sectoral output also serves as its capital. In particular, it substantially improves (a) the movements of trade balance and relative prices, (b) within country comovements of sectoral and aggregate quantities, and (c) cross-country comovements of output vis-à-vis consumption.
    Keywords: International business cycles; Quantity anomaly; Distribution costs; Cross-country correlations.
    JEL: F32 F34 F41
    Date: 2011–04–30
  18. By: Kirill Borissov; Kirill Shakhnov (Department of Economics, European University Institute)
    Abstract: In an important model of growth and pollution proposed by Stokey [Int. Econ. Rev. 39 (1998) 1] neither the rate of economic growth nor the rate of growth of emissions depends on the time preference of the representative agent, which seems somewhat paradoxical. To resolve this paradox, we introduce into Stokey's model the assumption of dual-rate discounting, prove the existence of a sustainable balanced growth optimal path, and show that the growth rates of output and emissions are increasing in the proportion between the consumption and the environmental discount factors of the representative agent.
    Keywords: growth, pollution, discounting
    JEL: C61
    Date: 2011–03–07
  19. By: Mario Larch; Wolfgang Lechthaler
    Abstract: Why are empirically observed tariffs so much lower than theoretically calculated Nash-equilibrium tariffs? We argue that this gap can be narrowed by using a dynamic model instead of a static model. This approach has two advantages. (i) It allows us to take account of the transitional process after a change in tariffs. (ii) It allows us to take account of the shortsightedness of policy makers. We show that Nash-equilibrium tariffs based on a dynamic trade model are lower than Nash-equilibrium tariffs based on a static model. We also show that shortsighted politicians tend to set lower tariffs than politicians with a long planning horizon
    Keywords: Bubbles, fiscal theory of the price level, collateral constraints, neutrality, transversality conditions
    JEL: F11 F12 F13
    Date: 2011–04
  20. By: Pascal Stiefenhofer
    Abstract: This paper shows that the inverse image of the natural projection defines a ramified covering with finite layers. Finiteness of equilibria for regular two period production economies with uncertainty follows from this property.
    Keywords: General Equilibrium, Uncertainty, Production.
    JEL: D20 D50 D51
    Date: 2011–05
  21. By: Bertrand Wigniolle (Centre d'Economie de la Sorbonne - Paris School of Economics)
    Abstract: This paper provides a detailed study of a simple life-cycle consumption model with quasi-hyperbolic discounting and an imperfect financial market. It gives a complete characterization of savings behaviors. The joint assumptions of quasi-hyperbolic discount factors and no-borrowing constraints may lead to non-convexities in selves' objective functions that may imply discontinuous equilibrium strategies. Savings function may undergo jumps and non-momotonicities when the income or the interest rate reach a threshold value. These "anomalies" may exist even for reasonable parameters values.
    Keywords: Quasi-hyperbolic preferences, no-borrowing constraint, discontinuous strategies.
    JEL: D91
    Date: 2011–04
  22. By: Sandra Gomes; P. Jacquinot; M. Mohr; M. Pisani
    Abstract: We quantitatively assess the macroeconomic effects of country-specific supply-side reforms in the euro area by simulating a large scale multi-country dynamic general equilibrium model. We consider reforms in the labor and services markets of Germany (or, alternatively, Portugal) and the rest of the euro area. Our main results are as follows. First, there are benefits from implementing unilateral structural reforms. A reduction of markup by 15 percentage points in the German (Portuguese) labor and services market would induce an increase in the long-run German (Portuguese) output equal to 8.8 (7.8) percent. As reforms are implemented gradually over a period of five years, output would smoothly reach its new long-run level in seven years. Second, cross-country coordination of reforms would add extra benefits to each region in the euro area, by limiting the deterioration of relative prices and purchasing power that a country faces when implementing reforms unilaterally. This is true in particular for a small and open economy such as Portugal. Specifically, in the long run German output would increase by 9.2 percent, Portuguese output by 8.6 percent. Third, cross-country coordination would make the macroeconomic performance of the different regions belonging to the euro area more homogeneous, both in terms of price competitiveness and real activity. Overall, our results suggest that reforms implemented apart by each country in the euro area produce positive effects, cross-country coordination produces larger and more evenly distributed (positive) effects.
    JEL: C53 E52 F47
    Date: 2011
  23. By: Giulio Fella (Queen Mary, University of London)
    Abstract: This paper extends Carroll's (2006) endogenous grid method and its combination with value function iteration by Barillas and Fernández-Villaverde (2007) to non-concave problems. The method is illustrated using a consumer problem in which consumers choose both durable and non-durable consumption. The durable choice is discrete and subject to non-convex adjustment costs. The algorithm yields substantial gains in accuracy and computational time relative to value function iteration, the standard solution choice for non-concave problems.
    Keywords: Endogenous grid method, Non-concavity
    JEL: C63
    Date: 2011–05
  24. By: Athanasios Lapatinas (University of Ioannina); Anastasia Litina (University of Ioannina); Eftichios S. Sartzetakis (University of Macedonia)
    Abstract: We construct an overlapping generations model in which agents live through two periods; childhood and adulthood. Each agent makes choices only as an adult, based on her utility that depends on her own consumption and the human capital and environmental quality endowed to her offspring. Entering adulthood, agents choose randomly between two occupations: citizens and politicians. Citizens are the only producers of a single good and choose the proportion of their income to declare to the tax authorities. Politicians decide upon the allocation of the tax revenue between environmental protection and education activities, taking as given the rates of peculation in each activity. In this context, two self-fulfilling stable equilibria can emerge, one associated with high and another with low corruption. Corrupted politicians induce high levels of tax evasion, reducing total public funds and thus environmental protection activities. This result is in accordance with existing empirical evidence and implies that environmental policies may fail in corrupt countries where they are used as means of supporting rent seeking activities instead of protecting the environment. A higher level political authority could intervene and force the low corruption equilibrium by choosing the appropriate tax rate and, through institutional changes, the rates of peculation.
    Keywords: Corruption, Environmental Policy
    JEL: H2 H26 H3 Q56 Q58
    Date: 2011–02
  25. By: Gasteiger, Emanuel; Zhang, Shoujian
    Abstract: We study the impact of anticipated fiscal policy changes in the Ramsey economy when agents form expectations using adaptive learning. We extend the existing framework by distortionary taxes as well as elastic labour supply, which makes agents' decisions non-predetermined but more realistic. We detect that the dynamic responses to anticipated tax changes under learning have oscillatory behaviour. Moreover, we demonstrate that this behaviour can have important implications for the welfare consequences of fiscal reforms.
    Keywords: Fiscal Policy; Adaptive Learning; Oscillations
    JEL: E62 E32 D84
    Date: 2011–04–18
  26. By: Pataracchia, B. (Tilburg University, Center for Economic Research)
    Abstract: Using a simple dynamic consumption-based asset pricing model, this paper explores the implications of a representative investor with smooth ambiguity averse preferences [Klibano¤, Marinacci and Mukerji, Econometrica (2005)] and provides a comparative analysis of risk aversion and ambiguity aversion. The perception of ambiguity is described by a hidden Markovian consumption growth process. The hidden states di¤er both for the mean and the volatility. We show that the ambiguity-averse investor downweights high-mean states in favor of low-mean ones. However, such distortion appears much stronger in low-volatility regimes: high volatility attenuates the distortion due to ambiguity concerns. It follows that (i) ambiguity aversion always implies higher equity premia but sustained levels of ambiguity aversion do not help explaining the high volatility of the equity premium observed in the data (volatility puzzle); (ii) our calibrated model can match the moments of the equity premium and risk free rate and can generate asset-price stylized facts like a procyclical price-dividend ratio and countercyclical conditional equity premia; however, (iii) high levels of ambiguity aversion, necessary to explain high equity returns, produce counterfactual price-dividend ratio time series across volatility states.
    Keywords: Ambiguity aversion;volatility;asset pricing puzzles;robustness.
    JEL: D81 E44 G12
    Date: 2011
  27. By: Aditya Goenka (National University of Singapore (NUS)); Cuong Le Van (Centre d'Economie de la Sorbonne et VCREME); Manh-Hung Nguyen (Toulouse School of Economics (LERNA-INRA) et VCREME)
    Abstract: This paper proves the existence of competitive equilibrium in a single-sector dynamic economy with heterogeneous agents, elastic labor supply and complete assets markets. The method of proof relies on some recent results concerning the existence of Lagrande multipliers in infinite dimensional spaces and their representation as a summable sequence and a direct application of the inward boundary fixed point theorem.
    Keywords: Optimal growth model, Lagrange multipliers, competitive equilibrium, individually rational pareto optimum, elastic labor supply.
    JEL: C61 D51 E13 O41
    Date: 2011–04
  28. By: Guerrazzi, Marco
    Abstract: This paper provides a self-contained review of the introduction of the animal spirits hypothesis into the infinite horizon optimal growth model. The analysis begins with an economic discussion of Pontryagin’s maximum principles. Thereafter, I develop a version of the increasing-returns Benhabib-Farmer model by showing the possible sub-optimality of the central planner solution and deriving the bifurcation condition for indeterminacy. Moreover, I give some insights on how to model intrinsic and extrinsic uncertainty. Finally, analysing the equilibrium condition of the labour market, I provide an intuitive rationale for the mechanism that in this model might lead prophecies to be self-fulfilling.
    Keywords: Maximum problems in continuous time; indeterminate equilibrium paths; self-fulfilling prophecies.
    JEL: E32 C0 E21
    Date: 2011–05–01

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