nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2011‒05‒30
33 papers chosen by
Christian Zimmermann
University of Connecticut

  1. Bayesian Estimation of a DSGE Model with Inventories By Marcel Foerster
  2. Implementing steady state efficiency in overlapping generations economies with environmental externalities By Nguyen Thang Dao; Julio Davila
  3. On the amplification role of collateral constraints By Caterina Mendicino
  4. Fiscal Policy in Brazil through the Lens of an Estimated DSGE Model By Fabia A. de Carvalho; Marcos Valli
  5. Private equity premium in a general equilibrium model of uninsurable investment risk By Francisco Covas; Shigeru Fujita
  6. Market Inefficiency, Insurance Mandate and Welfare: U.S. Health Care Reform 2010 By Chung Tran; Juergen Jung
  7. Rent-seeking competition from state coffers in Greece: a calibrated DSGE model By Konstantinos Angelopoulos; Sophia Dimeli; Apostolis Philippopoulos; Vanghelis Vassilatos
  8. When do inventories destabilize the economy? an analytical approach to (S,s) policies By Pengfei Wang; Yi Wen; Zhiwei Xu
  9. Search frictions and the labor wedge By Andrea Pescatori; Murat Tasci
  10. Demographic Trends and International Capital Flows in an Integrated World By Luca Marchiori
  11. Endogenous market structures and labour market dynamics By Colciago , Andrea; Rossi, Lorenza
  12. Ambiguity and the historical equity premium By Fabrice Collard; Sujoy Mukerji; Kevin Sheppard; Jean-Marc Tallon
  13. Policy Analysis Tool Applied to Colombian Needs: PATACON Model Description By Andrés González; Lavan Mahadeva; Juan D. Prada; Diego Rodríguez
  14. Évaluation de la politique monétaire dans un modèle DSGE pour la zone euro By Adjemian, Stéphane; Devulder, Antoine
  15. International Capital Flows and Aggregate Output By von Hagen, Jürgen; Zhang, Haiping
  16. Savings behavior with imperfect capital markets : when hyperbolic discounting leads to discontinuous strategies By Bertrand Wigniolle
  17. Is there a trade-off between inflation and output stabilization? By Alejandro Justiniano; Giorgio E. Primiceri; Andrea Tambalotti
  18. Firm Migration and Stock Returns By Giovanni W. Puopolo
  19. The World Has More Than Two Countries: Implications of Multi- Country International Real Business Cycle Models By Hirokazu Ishise
  20. Financial capital and the macroeconomy: a quantitative framework By Michael T. Kiley; Jae W. Sim
  21. Financial capital and the macroeconomy: policy considerations By Michael T. Kiley; Jae W. Sim
  22. How applicable are the new keynesian DSGE models to a typical low-income economy? By Senbeta , Sisay
  23. Corruption and environmental policy: An alternative perspective By Athanasios Lapatinas; Anastasia Litina; Eftichios S. Sartzetakis
  24. The natural projection approach to production and uncertainty By Stiefenhofer, Pascal
  25. The Voracity Effect: Comment By Strulik, Holger
  26. The Daycare Assignment Problem By John Kennes; Daniel Monte; Norovsambuu Tumennasan
  27. Poverty, Voracity, and Growth By Strulik, Holger
  28. An Exploration of Optimal Stabilization Policy By N. Gregory Mankiw; Matthew C. Weinzierl
  29. War Signals: A Theory of Trade, Trust and Conflict By Dominic Rohner; Mathias Thoenig; Fabrizio Zilibottix
  30. Bank capital regulation and structured finance By Antoine Martin; Bruno M. Parigi
  31. On Variable Discounting in Dynamic Programming: Applications to Resource Extraction and Other Economic Models By Jaśkiewicz, Anna; Matkowski, Janusz; Nowak, Andrzej S.
  32. Recursive Contracts, Lotteries and Weakly Concave Pareto Sets By Harold L. Cole; Felix Kubler
  33. Technology capital transfer By Thomas J. Holmes; Ellen R. McGrattan; Edward C. Prescott

  1. By: Marcel Foerster (University of Giessen)
    Abstract: This paper introduces inventories in an otherwise standard Dynamic Stochastic General Equilibrium Model (DSGE) of the business cycle. Firms accumulate inventories to facilitate sales, but face a cost of doing so in terms of costly storage of intermediate goods. The paper’s main contribution is to present a DSGE model with inventories that is estimated using Bayesian methods. Based on U.S. data we show that accounting for inventory dynamics has a significant impact on parameter estimates and impulse responses. Our analysis also reveals that the contribution of structural shocks to variations in the observable variables changes significantly when we allow for inventories. Moreover, we find that inventories enter the Phillips curve as an additional and significant driving variable of inflation and make the inflation process less backward-looking.
    Keywords: Inventories, Bayesian Estimation, DSGE model, Business Cycles
    JEL: C13 E20 E30
    Date: 2011
  2. By: Nguyen Thang Dao (CORE - Center of Operation Research and Econometrics [Louvain] - Université Catholique de Louvain); Julio Davila (CORE - Center of Operation Research and Econometrics [Louvain] - Université Catholique de Louvain, CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    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.
    Date: 2010–12
  3. By: Caterina Mendicino
    Abstract: How important are collateral constraints for the propagation and amplification of shocks? To address this question, we analyze a stochastic general equilibrium version of the model by Kiyotaki and Moore (JPE, 1997) in which all agents face concave production and utility functions and are generally identical, except for the subjective discount factor. We document that the existence of costly debt enforcement plays an important role in the endogenous amplification generated by the model. Limiting the amount of borrowing up to a reasonable fraction of the value of the collateral asset, makes the amplification generated by collateral constraints sizable and significantly larger than what we observe either in the representative agent version of the model, or in the version of the model where inefficiencies in the liquidation of the collateralized asset are neglected.
    JEL: E20 E3 E21
    Date: 2011
  4. By: Fabia A. de Carvalho; Marcos Valli
    Abstract: This paper takes Brazilian data to an open economy DSGE model that features realistic aspects of fiscal policy in Brazil. The model incorporates primary surplus targets, cyclical expenditures and social programs in the form of public transfers, public investment and distortive taxation. We test for two competing specifications of the role of public capital in the real economy. Bayesian model comparison favors the infrastructure approach to public capital. The presence of non-Ricardian households allows fiscal policy shocks to affect real economy aggregates and distribution. The model is used to address questions regarding the effect of shocks to different fiscal policy instruments upon the business cycle. We also investigate whether recent fiscal policy in Brazil has exerted significant inflationary pressures.
    Date: 2011–04
  5. By: Francisco Covas; Shigeru Fujita
    Abstract: This paper studies the quantitative properties of a general equilibrium model where a continuum of heterogeneous entrepreneurs are subject to aggregate as well as idiosyncratic risks in the presence of a borrowing constraint. The calibrated model matches the highly skewed wealth and income distributions of entrepreneurs. The authors provide an accurate solution to the model despite the significant nonlinearities that are absent in the economy with uninsurable labor income risk. The model is capable of generating the average private equity premium of roughly 3 percent and a low risk-free rate. The model also produces procyclicality of the risk-free rate and countercyclicality of the average private equity premium. The countercyclicality of the average equity premium is largely driven by tightening (loosening) of financing constraints during recessions (booms).
    Keywords: Risk ; Private equity ; Business cycles
    Date: 2011
  6. By: Chung Tran; Juergen Jung
    Abstract: In this paper we develop a stochastic dynamic general equilibrium overlapping generations (OLG) model with endogenous health capital to study the macroeconomic effects of the Affordable Care Act of March 2010 also known as the Obama health care reform. We find that the insurance mandate enforced with fines and premium subsidies successfully reduces adverse selection in private health insurance markets and subsequently leads to almost universal coverage of the working age population. On other hand, spending on health care services increases by almost 6 percent due to moral hazard of the newly insured. Notably, this increase in health spending is partly financed by the larger pool of insured individuals and by government spending. In order to finance the subsidies the government needs to either introduce a 2.7 percent payroll tax on individuals with incomes over $200, 000, increase the consumption tax rate by about 1.1 percent, or cut government spending about 1 percent of GDP. A stable outcome across all simulated policies is that the reform triggers increases in health capital, decreases in labor supply, and decreases in the capital stock due to crowding out effects and tax distortions. As a consequence steady state output decreases by up to 2 percent. Overall, we find that the reform is socially beneficial as welfare gains are observed for most generations along the transition path to the new long-run equilibrium.
    JEL: H51 I18 I38 E21 E62
    Date: 2011–02
  7. By: Konstantinos Angelopoulos (University of Glasgow); Sophia Dimeli (Athens University of Economics and Business); Apostolis Philippopoulos (Athens University of Economics and Business, University of Glasgow and Visiting Scholar at the Bank of Greece); Vanghelis Vassilatos (Athens University of Economics and Business)
    Abstract: We incorporate an uncoordinated redistributive struggle for extra fiscal privileges and favors into an otherwise standard dynamic stochastic general equilibrium model. Our aim is to quantify the extent of rent seeking and its macroeconomic implications. The model is calibrated to Greek quarterly data over 1961:1-2005:4. Our work is motivated by the rich and distorting tax-spending system in Greece, as well as the common belief that interest groups compete with each other for fiscal privileges at the expense of the general public interest. We find that (i) the introduction of rent seeking moves the model in the right direction vis-à-vis the data (ii) an important fraction of GDP is extracted by rent seekers (iii) there can be substantial welfare gains from reducing rent seeking activities.
    Keywords: Fiscal policy;rent seeking;welfare
    JEL: E62 E32 O17
    Date: 2010–11
  8. By: Pengfei Wang; Yi Wen; Zhiwei Xu
    Abstract: Conventional wisdom has it that inventory investment destabilizes the economy because it is procyclical to sales. Khan and Thomas (2007) show that the conventional wisdom is wrong in a general equilibrium (S,s) model with capital. We argue that their finding is not robust—the conventional wisdom can still hold in general equilibrium if firms can adjust output by varying the capacity utilization rate. Our result also holds true if there exist investment adjustment costs. Unlike the existing (S,s) inventory literature that relies on the Krusell-Smith (1998) numerical solution methods, we characterize (S,s) inventory policies in closed form despite the large state space in our general equilibrium model. Standard log-linearization methods can be used to solve the model and generate impulse response functions.>
    Keywords: Inventories ; Business cycles
    Date: 2011
  9. By: Andrea Pescatori; Murat Tasci
    Abstract: This paper assesses whether labor market frictions, in the form of searching and matching, can help explain movements in the labor wedge--the gap between the marginal rate of substitution (MRS) and the marginal productivity of labor in a perfectly competitive business cycle model. Results suggest that those frictions are not able to explain fluctuations in the labor wedge, per se. However, the introduction of extensive and intensive margin shows that measuring the MRS in terms of total hours artificially introduces procyclicality in the MRS. When the MRS is correctly measured in terms of hours per worker, the labor wedge obtained is less variable than the one of the perfectly competitive model. A Frisch elasticity of 2.8, as in most macro models, implies a 20 percent decline in the variability of the labor wedge. A Frisch elasticity closer to micro estimates implies an even higher reduction. Finally, we show that it is possible to measure a strongly procyclical labor wedge as in CKM (2007) even if the actual data generating process does not have any labor wedge but has search frictions that allow for movements in both labor margins.
    Keywords: Labor market ; Business cycles
    Date: 2011
  10. By: Luca Marchiori (CREA, University of Luxembourg)
    Abstract: This paper examines the impact of projected demographic trends on international capital flows. The analysis builds upon a ten-region overlapping generations’model of the world economy where capital is mobile across regions. Results show that, over the first half of the century, emerging regions will finance the demand of capital coming from the developed world where population aging is relatively advanced. In particular, the findings suggest that in the coming decades China will be the world’s main creditor region. However, in the second half of the century, India will take over this leading position because of the predicted decline in the Chinese labor force. An additional analysis demonstrates that the economic consequences of demographic changes depend on the degree of capital market integration between regions.
    Keywords: Demographic trends; capital flows; overlapping generations; general equilibrium; multi-regional model
    JEL: J11 F21 D91 C68
    Date: 2011
  11. By: Colciago , Andrea (University of Milano-Bicocca, Department of Economics); Rossi, Lorenza (University of Pavia, Department of Economics)
    Abstract: We propose a flexible prices model where endogenous market structures and search and matching frictions in the labour market interact endogenously. The interplay between firms’ endogenous entry, strategic interactions among producers and labour market frictions represents a strong amplification channel for technology shocks on labour market variables and helps in addressing the unemployment- volatility puzzle. Consistently with US evidence, new firms create a large fraction of new jobs and grow faster than more mature firms, net entry of firms is procyclical and the price mark-up is countercyclical.
    Keywords: endogenous market structures; firms’ entry; search and matching; friction
    JEL: E24 E32 L11
    Date: 2011–05–19
  12. By: Fabrice Collard (Department of Economics - University of Bern - University of Bern); Sujoy Mukerji (Department of Economics and University College - University of Oxford); Kevin Sheppard (Department of Economics and Oxford-Man Institute of Quantitative Finance - University of Oxford); Jean-Marc Tallon (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: This paper assesses the quantitative impact of ambiguity on the historically observed equity premium. We consider a Lucas-tree pure-exchange economy with a single agent where we introduce two key non-standard assumptions. First, the agent's beliefs about the dividend/consumption process is ambiguous. Second, the agent's preferences are sensitive to this ambiguity. We further extend the model to allow for uncertainty about the magnitude of the persistence of the latent state. The agent's beliefs are ambiguous due to the uncertainty about the conditional mean of the probability distribution on consumption and dividends in the next period. This results in an endogenously volatile and (counter-) cyclical equity premium. We calibrate the level of ambiguity aversion to match only the first moment of the risk-free rate in data, and ambiguity to match the uncertainty conditional on the historical growth path, and evaluate the model using moderate levels of risk aversion. We find that this simple modification of Lucas-tree model accounts for a large part of the historical equity premium, both in terms of its level and variation over time.
    Keywords: Equity premium, ambiguity.
    Date: 2011–05
  13. By: Andrés González; Lavan Mahadeva; Juan D. Prada; Diego Rodríguez
    Abstract: In this document we lay out the microeconomic foundations of a dynamic stochastic general equilibrium model designed to forecast and to advice monetary policy authorities in Colombia. The model is called Policy Analysis Tool Applied to Colombian Needs (PATACON). In companion documents we present other aspects of the model and its platform, including the estimation of the parameters that affect the dynamics and the impulse responses functions.
    Date: 2011–05–17
  14. By: Adjemian, Stéphane; Devulder, Antoine
    Abstract: Dans cet article nous présentons de façon détaillée un modèle DSGE canonique et montrons comment celui-ci peut être simulé puis estimé. Nous proposons deux applications sur la base du modèle estimé. Dans la première nous évaluons les conséquences sur le bien être social de la forme de la politique monétaire. On montre que le bien être social est significativement dégradé si la Banque Centrale ne prend pas en compte l’écart de production. Dans la seconde, nous interrogeons le modèle sur la publicité que la Banque Centrale doit faire autour de sa politique. Nous montrons que face à un choc de productivité négatif il est préférable de ne pas annoncer une politique monétaire accommodante, afin de limiter l’ampleur des tensions inflationnistes.
    Date: 2011–05
  15. By: von Hagen, Jürgen; Zhang, Haiping
    Abstract: We show in a tractable, multi-country OLG model that cross-country differences in financial development explain three recent empirical patterns of international capital flows. International capital mobility affects output in each country directly through the size of domestic investment as well as indirectly through the composition of domestic investment and the level of domestic savings. In contrast to earlier literature, our model admits the possibility that the indirect effects dominate the direct effects and international capital mobility raises output in the poor country and globally, although net capital flows are in the direction of the rich country. Our model adds to the understanding of the benefits of international capital mobility in the presence of financial frictions.
    Keywords: capital market imperfections; financial development; financial frictions; foreign direct investment; international capital movements
    JEL: E44 F41
    Date: 2011–05
  16. By: Bertrand Wigniolle (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    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.
    Date: 2011–04
  17. By: Alejandro Justiniano; Giorgio E. Primiceri; Andrea Tambalotti
    Abstract: Not in an estimated DSGE model of the US economy, once we account for the fact that most of the high-frequency volatility in wages appears to be due to noise, rather than to variation in workers' preferences or market power.
    JEL: E30 E52
    Date: 2011–05
  18. By: Giovanni W. Puopolo
    Abstract: This paper studies the asset pricing implications of a general equilibrium model in which real investment is reversible at a cost. Firms face higher costs in contracting than in expanding their capital stock and decide to invest when their productive capital is scarce relative to the overall capital of the economy. Positive shocks to the production process of the firm increase the size of the firm and reduce the value of growth options. As a result, the firm is burdened with more unproductive capital and its value lowers with respect to the accumulated capital. The optimal consumption policy alters the optimal allocation of resources and affects firm's value, generating mean-reverting dynamics for the M/B ratios. The model (1) captures convergence of price-to-book ratios - negative for growth stocks and positive for value stocks - (firm migration), (2) generates deviations from the classic CAPM in line with the cross-sectional variation in expected stock returns and (3) generates a non-monotone relationship between Tobin's q and conditional volatility consistent with the empirical evidence.
    Date: 2011
  19. By: Hirokazu Ishise (Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:
    Abstract: The cross-country correlations of international real business cycle models depend critically on the number of countries in the models. A positive productivity shock in one country will stimulate investment in the country that has experienced the shock, while reducing internal investment in the other countries, which will then simultaneously experience a slump. This comovement mechanism is absent in two-country models.
    Keywords: International Real Business Cycles, Cross-Country Correlations, Multi-Country, Country Size
    JEL: E32 F41
    Date: 2011–05
  20. By: Michael T. Kiley; Jae W. Sim
    Abstract: Financial intermediation transforms short-term liquid assets into long-term capital assets. As a result, risk taking, in the form of long-term commitments despite unresolved short-term funding risk, is an essential element of intermediation. If such funding risk must be addressed by costly recapitalization and/or distressed asset sales due to capital market frictions, an increase in uncertainty can cause a disruption in the intermediation process by forcing risk-neutral intermediaries to behave in a risk-averse manner. Our analysis examines this behavior theoretically and empirically. We first develop a dynamic macroeconomic model in which the balance sheet/liquidity condition of financial intermediaries plays an important role in the determination of asset prices and economic activity under time-varying uncertainty. Second, we present new evidence on the importance of uncertainty facing financial intermediaries for credit terms and volume and for aggregate economic activity, thereby partially quantifying the significance of capital market frictions. We adopt a structural identification strategy in which the predictions of our theory, in the form of sign restrictions, play an important role.
    Date: 2011
  21. By: Michael T. Kiley; Jae W. Sim
    Abstract: We develop a macroeconomic model in which the balance sheet/liquidity condition of financial institutions plays an important role in the determination of asset prices and economic activity. The financial intermediaries in our model are required to make investment commitments before a complete resolution of idiosyncratic funding risk that can be addressed only by costly refinancing, forcing them to behave in a risk-averse manner. The model shows that the balance sheet condition of intermediaries can drive asset values away from their fundamentals, causing aggregate investment and output to respond to shocks to intermediaries. We use this model to evaluate several public policies designed to address balance sheet problems at financial institutions. With regard to short-run policies, we find that capital injections conditioned upon voluntary recapitalization can be a more effective tool than direct lending/asset purchases. With regard to long-run policies, we demonstrate that higher capital requirements can have sizable short-run effects on economic activity if not implemented carefully, and that a long transition period helps avoid such effects.
    Date: 2011
  22. By: Senbeta , Sisay
    Abstract: This paper assesses the applicability of new Keynesian DSGE models to a typical low income economy like those in Sub Saharan Africa. To this effect, we first review the development, criticisms and recent advances in DSGE modeling. Then we assess the implications of the assumptions of the standard open economy New Keynesian DSGE model within the context of the economic environment of a typical low income economy. Our assessment shows the following two points. First, though there are many criticisms to these models, most recent advances seem to have addressed most of these criticisms. However, there are still some outstanding criticisms that are serious challenges not only to DSGE models but also to all conventional economic models. Second, the current tendency of applying these models to explain or predict economic phenomenon in low income countries without incorporating the structural specificities of these countries cannot be justified. In stead, for these models to be helpful to understand the economic events in low income countries, most of their components must be changed or modified so that these models capture some salient specificities of low income economies. In this study we identify some of these components and suggest the possible changes or modifications.
    Keywords: New Keynesian DSGE, Open economy macroeconomics, Fluctuations, Sub-Saharan Africa
    JEL: E32 O55 F41
    Date: 2011–05–16
  23. By: Athanasios Lapatinas (Department of Economics, University of Ioannina); Anastasia Litina (Department of Economics, University of Ioannina); Eftichios S. Sartzetakis (Department of Economics, University of Macedonia)
    Abstract: We construct an overlapping generations model comprising of two distinct groups of agents, citizens and politicians. Each agent lives through two periods; childhood and adulthood. She makes choices only as an adult, based on her utility that depends on her own con- sumption and the human capital and environmental quality endowed to her o¤spring. Citizens decide upon the proportion of their income that declare to the tax authorities, balancing between their own con- sumption and their o¤springs?s well being. Politicians on the other hand can peculate a part of the tax revenue allocated to education and environmental protection with the rates of peculation for each ac- tivity exogenously given. Politicians decide upon the allocation of the tax revenue between the two activities balancing a similar trade-o¤ to that of citizens. In this context, two self-ful?lling stable equilib- ria can emerge, one with high tax evasion and high allocation to the more rent-seeking activity and one with low tax evasion and low al- location to the more rent-seeking activity. This outcome accords well with existing empirical evidence and outlines that environmental poli- cies may fail in corrupt countries if they are meant to increase rent seeking instead of protecting the environment.
    Date: 2011–06
  24. By: Stiefenhofer, Pascal
    Abstract: The paper generalizes the natural projection approach introduced by Balasko (1988) for the study of the qualitative equilibrium structure of exchange economies to a two period private ownership production model with uncertainty. It shows that long run equilibrium properties of the production model are those of the pure exchange economy with production adjusted demand functions. Associated with every long run equilibrium there exist a finite, odd number of short run equilibria. --
    Keywords: existence of equilibrium,uncertainty,production
    JEL: D62 D52 D53
    Date: 2011
  25. By: Strulik, Holger
    Abstract: In an influential article Tornell and Lane (1999) considered an economy populated by multiple powerful groups in which property rights in the formal sector of production are not protected. They obtained conditions under which the groups appropriate output from the formal sector in order to invest it in an informal sector in which productivity is lower and private property is protected. They also obtained conditions under which voracity occurs such that a permanent positive shock in the formal sector leads to lower growth. Here I show that not investing in the informal sector is a pareto-superior Nash equilibrium under the mild condition of an elasticity of intertemporal substitution in consumption smaller than unity. As a corollary, voracity disappears.
    Keywords: economic growth, common pool resources, voracity
    JEL: F43 O10 O23 O40
    Date: 2011–05
  26. By: John Kennes (School of Economics and Management, Aarhus University, Denmark); Daniel Monte (Department of Economics, Simon Fraser University, Canada); Norovsambuu Tumennasan (School of Economics and Management, Aarhus University, Denmark)
    Abstract: In this paper we take the mechanism design approach to the problem of assigning children of different ages to daycares, motivated by the mechanism currently in place in Denmark. This problem is similar to the school choice problem, but has two distinguishing features. First, it is characterized by an overlapping generations structure. For example, children of different ages may be allocated to the same daycare, and the same child may be allocated to different daycares across time. Second, the daycares' priorities are history-dependent: a daycare gives priority to children currently enrolled in it, as is the case with the Danish system. We first study the concept of stability, and, to account for the dynamic nature of the problem, we propose a novel solution concept, which we call strong stability. With a suitable restriction on the priority orderings of schools, we show that strong stability and the weaker concept of static stability will coincide. We then extend the well known Gale-Shapley deferred acceptance algorithm for dynamic problems and show that it yields a matching that satisfies strong stability. It is not Pareto dominated by any other matching, and, if there is an efficient stable matching, it must be the Gale-Shapley one. However, contrary to static problems, it does not necessarily Pareto dominate all other strongly stable mechanisms. Most importantly, we show that the Gale-Shapley algorithm is not strategy-proof. In fact, one of our main results is a much stronger impossibility result: For the class of dynamic matching problems that we study, there are no algorithms that satisfy strategy-proofness and strong stability. Second, we show that the also well known Top Trading Cycles algorithm is neither Pareto efficient nor strategy-proof. We conclude by proposing a variation of the serial dictatorship, which is strategyproof and efficient.
    Keywords: daycare assignment, market design, matching, overlapping generations, weak and strong stability, efficiency
    JEL: C78 D61 D78 I20
    Date: 2011–05–23
  27. By: Strulik, Holger
    Abstract: This article investigates economic performance when enforceable property rights are missing and basic needs matter for consumption. It suggests a new view of the so-called voracity effect according to which windfall gains in productivity induce behavior that leads to lower economic growth. Taking into account that the rate of intertemporal substitution in consumption depends on the level of consumption, it is shown that "voracious behavior" is situation-specific. It occurs when an economy is in decline and suffciently close to stagnation.
    Keywords: economic growth, property rights, common pool resources, voracity, fractionalization.
    JEL: O11 O13 D74 P48
    Date: 2011–05
  28. By: N. Gregory Mankiw; Matthew C. Weinzierl
    Abstract: This paper examines the optimal response of monetary and fiscal policy to a decline in aggregate demand. The theoretical framework is a two-period general equilibrium model in which prices are sticky in the short run and flexible in the long run. Policy is evaluated by how well it raises the welfare of the representative household. While the model has Keynesian features, its policy prescriptions differ significantly from textbook Keynesian analysis. Moreover, the model suggests that the commonly used "bang for the buck" calculations are potentially misleading guides for the welfare effects of alternative fiscal policies.
    JEL: E52 E62 E63
    Date: 2011–05
  29. By: Dominic Rohner (Department of Economics, University of Zurich); Mathias Thoenig (Department of Economics, University of Lausanne); Fabrizio Zilibottix (Department of Economics, University of Zurich)
    Abstract: We construct a dynamic theory of civil conflict hinging on inter-ethnic trust and trade. The model economy is inhabited 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.
    Date: 2011–01
  30. By: Antoine Martin; Bruno M. Parigi
    Abstract: We construct a model in which bank capital regulation and financial innovation interact. Innovation takes the form of pooling and tranching of assets and the creation of separate structures with different seniority, different risk, and different capital charges, a process that captures some stylized features of structured finance. Regulation is motivated by the divergence of private and social interests in future profits. Capital regulation lowers bank profits and may induce banks to innovate in order to evade the regulation itself. We show that structured finance can improve welfare in some cases. However, innovation may also be adopted to avoid regulation, even in cases where it decreases welfare.
    Keywords: Bank capital ; Bank reserves ; Banking law
    Date: 2011
  31. By: Jaśkiewicz, Anna; Matkowski, Janusz; Nowak, Andrzej S.
    Abstract: This paper generalizes the classical discounted utility model introduced by Samuelson by replacing a constant discount rate with a function. The existence of recursive utilities and their constructions are based on Matkowski's extension of the Banach Contraction Principle. The derived utilities go beyond the class of recursive utilities studied in the literature and enable a discussion on subtle issues concerning time preferences in the theory of finance, economics or psychology. Moreover, our main results are applied to the theory of optimal growth with unbounded utility functions.
    Keywords: Dynamic programming Variable discounting Bellman equation
    JEL: D90 C61
    Date: 2011–01–05
  32. By: Harold L. Cole; Felix Kubler
    Abstract: Marcet and Marimon (1994, revised 1998, revised 2011) developed a recursive saddle point method which can be used to solve dynamic contracting problems that include participation, enforcement and incentive constraints. Their method uses a recursive multiplier to capture implicit prior promises to the agent(s) that were made in order to satisfy earlier instances of these constraints. As a result, their method relies on the invertibility of the derivative of the Pareto frontier and cannot be applied to problems for which this frontier is not strictly concave. In this paper we show how one can extend their method to a weakly concave Pareto frontier by expanding the state space to include the realizations of an end of period lottery over the extreme points of a flat region of the Pareto frontier. With this expansion the basic insight of Marcet and Marimon goes through – one can make the problem recursive in the Lagrangian multiplier which yields significant computational advantages over the conventional approach of using utility as the state variable. The case of a weakly concave Pareto frontier arises naturally in applications where the principal's choice set is not convex but where randomization is possible.
    JEL: C61 D82
    Date: 2011–05
  33. By: Thomas J. Holmes; Ellen R. McGrattan; Edward C. Prescott
    Abstract: It is widely believed that an important factor underlying the rapid growth in China is increased foreign direct investment (FDI) and the transfer of foreign technology capital, which is accumulated know-how from investment in research and development (R&D), brands, and organizations that is not specific to a plant. In this paper, we study two channels through which FDI can contribute to upgrading of the stock of technology capital: knowledge spillovers and appropriation. Knowledge spillovers lead to new ideas that do not directly compete or devalue the foreign affiliate’s stock. Appropriation, on the other hand, implies a redistribution of property rights over patents and trademarks; the gain to domestic companies comes at a loss to the multinational company (MNC). In this paper we build these sources of technology capital transfer into the framework developed by McGrattan and Prescott (2009, 2010) and introduce an endogenously-chosen intensity margin for operating technology capital in order to capture the trade-offs MNCs face when expanding their markets internationally. We show that economic outcomes differ dramatically depending on the source of greater openness and the channel with which technology capital transfer is operative.
    Date: 2011

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