nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2011‒06‒04
sixteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. FiMod - a DSGE model for fiscal policy simulations By Nikolai Stähler; Carlos Thomas
  2. Monetary Policy, Capital Inflows, and the Housing Boom By Sá, F.; Wieladek, T.
  3. An OLG model of growth with longevity: when grandparents take care of grandchildren By Fanti, Luciano; Gori, Luca
  4. On Identification of Bayesian DSGE Models By Koop, G.; Pesaran, M.H.; Smith, R.
  5. Efficiency of skill training for acquiring sector-specific skills with search frictions By Keisuke Kawata
  6. Exploring the Causes of Frictional Wage Dispersion By Volker Tjaden; Felix Wellschmied
  7. Exact likelihood computation for nonlinear DSGE models with heteroskedastic innovations By Gianni Amisano; Oreste Tristani
  8. Shifts in portfolio preferences of international investors: an application to sovereign wealth funds By Filipa Sá; Francesca Viani
  9. Welfare Analysis of Free Entry in a Dynamic General Equilibrium Model By Koichi Futagami; Tatsuro Iwaisako; Makoto Okamura
  10. The Time-to-Build Tradition in Business Cycle Modelling By N. Dharmaraj; K. Vela Velupillai
  11. War Signals: A Theory of Trade, Trust and Conflict By Rohner, D.; Thoenig, M.; Zilibotti, F.
  12. Life-Cycle Unemployment, Retirement and Parametric Pension Reform By Keuschnigg, Christian; Fisher, Walter
  13. The Evolution of Wealth Distribution in a Model of Educational Investment with Heterogenous Agents By D'AMATO, Marcello; DI PIETRO, Christian
  14. Which factor bears the cost of currency crises? By Paul Maarek (Banque de France); Elsa Orgiazzi (CREM-CNRS)
  15. Envelope theorems in Banach lattices By Anna Battauz; Marzia De Donno; Fulvio Ortu
  16. On the Solution of Markov-switching Rational Expectations Models By Francesco Carravetta; Marco M. Sorge

  1. By: Nikolai Stähler (Deutsche Bundesbank); Carlos Thomas (Banco de España)
    Abstract: This paper develops a medium-scale dynamic, stochastic, general equilibrium (DSGE) model for fiscal policy simulations. Relative to existing models of this type, our model incorporates two important features. First, we consider a two-country monetary union structure, which makes it well suited to simulate fiscal measures by relatively large countries in a currency area. Second, we provide a notable degree of disaggregation on the government expenditures side, by explicitly distinguishing between (productivity-enhancing) public investment, public purchases and the public sector wage bill. In addition, we consider a labor market characterized by search and matching frictions, which allows to analyze the response of equilibrium unemployment to fiscal measures. In order to illustrate some of its applications, and motivated by recent policy debate in the Euro Area, we calibrate the model to Spain and the rest of the area and simulate a number of fiscal consolidation scenarios. We find that, in terms of output and employment losses, fiscal consolidation is the least damaging when achieved by reducing the public sector wage bill, whereas it is most damaging when carried out by cutting public investment.
    Keywords: DSGE model, fiscal policy, two-country monetary union, disaggregation of fiscal expenditures, labor market frictions
    JEL: E62 H30
    Date: 2011–05
  2. By: Sá, F.; Wieladek, T.
    Abstract: We estimate an open economy VAR model to quantify the effect of monetary policy and capital inflows shocks on the US housing market. The shocks are identified with sign restrictions derived from a standard DSGE model. We find that monetary policy shocks have a limited effect on house prices and residential investment. In contrast, capital inflows shocks driven by an increase in foreign savings have a positive and persistent effect on both housing variables. Other sources of capital inflows shocks, such as foreign monetary expansion or an increase in aggregate demand in the US, have a more limited role.
    JEL: E5 F3
    Date: 2011–05–30
  3. By: Fanti, Luciano; Gori, Luca
    Abstract: By assuming that grandparents take care of grandchildren, in this paper we aim at studying the effects of longevity on economic growth in the basic OLG model with endogenous fertility. We show that a rise in longevity can actually reduce long-run growth. Moreover, we also find that an increasing longevity (i) increases the supply of labour by the young parents, and (ii) causes fertility either to increase of decrease depending on the size of the grandparental child rearing time.
    Keywords: Longevity; OLG model
    JEL: J13 O41 J22
    Date: 2011–05–28
  4. By: Koop, G.; Pesaran, M.H.; Smith, R.
    Abstract: In recent years there has been increasing concern about the identification of parameters in dynamic stochastic general equilibrium (DSGE) models. Given the structure of DSGE models it may be difficult to determine whether a parameter is identified. For the researcher using Bayesian methods, a lack of identification may not be evident since the posterior of a parameter of interest may differ from its prior even if the parameter is unidentified. We show that this can even be the case even if the priors assumed on the structural parameters are independent. We suggest two Bayesian identification indicators that do not suffer from this difficulty and are relatively easy to compute. The first applies to DSGE models where the parameters can be partitioned into those that are known to be identified and the rest where it is not known whether they are identified. In such cases the marginal posterior of an unidentified parameter will equal the posterior expectation of the prior for that parameter conditional on the identified parameters. The second indicator is more generally applicable and considers the rate at which the posterior precision gets updated as the sample size (<em>T</em>) is increased. For identified parameters the posterior precision rises with <em>T</em>, whilst for an unidentified parameter its posterior precision may be updated but its rate of update will be slower than <em>T</em>. This result assumes that the identified parameters are <img src="" width="21" height="15" />-consistent, but similar differential rates of updates for identified and unidentified parameters can be established in the case of super consistent estimators. These results are illustrated by means of simple DSGE models.
    JEL: C11 C15 E17
    Date: 2011–03–30
  5. By: Keisuke Kawata (Graduate School of Economics, Osaka University)
    Abstract: This paper develops a simple search model in which sector-specific trainings are endogenously determined with or without a negotiation between a worker and an employer, and characterizes the allocation of two types of training. If a worker and an employer can negotiate over the amount of skill training, the training hours to acquire a skill specific to this employer's sector may be longer or shorter in the decentralized allocation than in the socially efficient allocation. Meanwhile, if they cannot negotiate, the training hours are definitely longer in the decentralized allocation than in the socially efficient allocation.
    Keywords: Excess entry; sector-specific skills, job search, wage bargaining
    JEL: J24 J64
    Date: 2011–05
  6. By: Volker Tjaden; Felix Wellschmied
    Abstract: Standard search models are inconsistent with the amount of frictional wage dis- persion found in U.S. data. We resolve this apparent puzzle by modeling skill development (learning by doing on the job, skill loss during unemployment) and duration dependence in unemployment benets in a random on the job search model featuring two-sided heterogeneity. The model's key parameters are calibrated using micro data on employment mobility and wages from the Survey of Income and Program Participation (SIPP). Our model is consistent with the amount of frictional wage dispersion found in the data. Skill develop- ment on the job is the most important driver behind this result. Meanwhile, firm heterogeneity never accounts for more than 20% of overall wage inequality within an age cohort.
    Keywords: Frictional wage dispersion; Search model; Heterogeneity
    JEL: J24 J31 J64
    Date: 2011–05
  7. By: Gianni Amisano (DG-Research, European Central Bank, Kaiserstrasse 29, D-60311, Frankfurt am Main, Germany and Department of Economics University of Brescia.); Oreste Tristani (DG-Research, European Central Bank, Kaiserstrasse 29, D-60311, Frankfurt am Main, Germany.)
    Abstract: Phenomena such as the Great Moderation have increased the attention of macro-economists towards models where shock processes are not (log-)normal. This paper studies a class of discrete-time rational expectations models where the variance of exogenous innovations is subject to stochastic regime shifts. We first show that, up to a second-order approximation using perturbation methods, regime switching in the variances has an impact only on the intercept coefficients of the decision rules. We then demonstrate how to derive the exact model likelihood for the second-order approximation of the solution when there are as many shocks as observable variables. We illustrate the applicability of the proposed solution and estimation methods in the case of a small DSGE model. JEL Classification: E0, C63.
    Keywords: DSGE models, second-order approximation, regime switching, time-varying volatility.
    Date: 2011–05
  8. By: Filipa Sá (University of Cambridge); Francesca Viani (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: 2011–05
  9. By: Koichi Futagami (Graduate School of Economics, Osaka University); Tatsuro Iwaisako (Graduate School of Economics, Osaka University); Makoto Okamura (Economics Department, Hiroshima University)
    Abstract: This paper presents a welfare analysis of free entry equilibrium in dynamic general equilibrium environments with oligopolistic competition. First, we show that a marginal decrease in the number of firms at the free entry equilibrium improves social welfare. Second, we show that if a government can control the number of entrants intertemporally so as to maximize the level of social welfare, the number of entrants under free entry may be less than the second-best number of entrants. Capital accumulation plays an important role in determining whether excess entry occurs.
    Keywords: Excess entry; Oligopolistic competition; Dynamic general equilibrium
    JEL: D43 L50 O41
    Date: 2011–05
  10. By: N. Dharmaraj; K. Vela Velupillai
    Abstract: An important frontier of business cycle theorising is the 'time-to-build' tradition that lies at the heart of Real Business Cycle theory. Kydland and Prescott (1982) did not acknowledge the rich tradition of 'time-to-build' business cycle theorising - except in a passing, non-scholarly, non-specific, reference to Böhm-Bawerk's classic on Capital Theory (Böhm-Bawerk [1899]), which did not, in any case, address cycle theoretic issues. The notion of ‘time-to-build’ is intrinsic to any process oriented production theory which is incorporated in a macrodynamic model. We provide an overview of this tradition, focusing on some of the central business cycle classics, and suggest that the Neo-Austrian revival should be placed in this class of dynamic macroeconomics, albeit ‘traverse dynamics’ is itself to be considered as a fluctuating path from one equilibrium to another.
    Date: 2011
  11. By: Rohner, D.; Thoenig, M.; Zilibotti, F.
    Abstract: We construct a dynamic theory of civil conflict hinging on inter-ethnic trust and trade. The model economy is inhabitated by two ethnic groups. Inter-ethnic trade requires imperfectly observed bilateral investments and one group has to form beliefs on the average propensity to trade of the other group. Since conflict disrupts trade, the onset of a conflict signals that the aggressor has a low propensity to trade. Agents observe the history of conflicts and update their beliefs over time, transmitting them to the next generation. The theory bears a set of testable predictions. First, war is a stochastic process whose frequency depends on the state of endogenous beliefs. Second, the probability of future conflicts increases after each conflict episode. Third, "accidental" conflicts that do not reflect economic fundamentals can lead to a permanent breakdown of trust, plunging a society into a vicious cycle of recurrent conflicts (a war trap). The incidence of conflict can be reduced by policies abating cultural barriers, fostering inter-ethnic trade and human capital, and shifting beliefs. Coercive peace policies such as peacekeeping forces or externally imposed regime changes have instead no persistent effects.
    JEL: D74 D83 O15 Q34
    Date: 2011–04–11
  12. By: Keuschnigg, Christian; Fisher, Walter
    Abstract: This paper investigates the consequences of pension reform for life-cycle unemployment and retirement. We find that (i) improving actuarial fairness in pension assessment not only boosts old age participation but also reduces unemployment among prime age workers and raises welfare; (ii) strengthening the tax benefit link boosts life-cycle labor supply on all margins and welfare; (iii) excluding unemployment benefits from the pension assessment base reduces unemployment, encourages later retirement and boosts efficiency; and (iv) extending the calculation period favors employment of young workers, might possibly lead to more unemployment among older ones, encourages postponed retirement and most likely yields positive welfare gains.
    Keywords: Pensions, tax benefit link, retirement, unemployment.
    JEL: H55 J26
    Date: 2011–05
  13. By: D'AMATO, Marcello (CELPE - Centre of Labour Economics and Economic Policy, University of Salerno - Italy); DI PIETRO, Christian (CELPE - Centre of Labour Economics and Economic Policy, University of Salerno - Italy)
    Abstract: The implications of individual heterogeneity for the evolution of wealth distribution are studied in a standard model of occupational choice with financial market imperfections and local non convexities in education investment technology. We consider heterogeneity in the cost of educational investment, interpreted as genetic variation at the level of lineage. Ergodicity of the wealth distribution is obtained whenever the (exogenous)distribution of education costs entails the presence of ability types for which the educational investment is inefficient vis a vis financial investment, regardless of how ”large” the support is. Conversely, poverty traps can emerge only if investment is efficient for every single agent in the economy. We show that under quite general conditions, the accumulation of wealth at the lineage level does not eliminate financial market imperfections over the long run, motivating our exploration of policy implications. In particular heterogeneity requires more persitent policies to achieve similar results as in the standard case. On the other hand policies can be effective in environments where they would fail under the assumption of homogeneous costs.
    Keywords: intergenerational mobility; inequality dynamics; occupational choice; educational investment; borrowing constraints
    JEL: D31 D91 I21 J24 O15
    Date: 2011–05–25
  14. By: Paul Maarek (Banque de France); Elsa Orgiazzi (CREM-CNRS)
    Abstract: This paper identifies which of the two factors, namely labour and capital, bears the cost of currency crises and for what reasons. It analyzes two main types of effects that currency crises may have on the labour share: across sector effects and within sector effects. We build a descriptive model with a tradable sector and a non-tradable one which can differ in their capital intensities so that structural changes occurring during currency crises may change the aggregate level of the labour share. The model also highlights that crises erode the bargaining power of workers so that within sectors, crises lower the labour share. We perform estimations on manufacturing sectoral panel data for 20 countries which have experienced currency crises. We conclude that currency crises lower the aggregate manufacturing labour share by 2 points on average and that this decline reflects mostly changes within sectors.
    Keywords: Currency crisis ; Labour share ; Factor reallocation ; Matching frictions
    JEL: E25 J42
    Date: 2011
  15. By: Anna Battauz; Marzia De Donno; Fulvio Ortu
    Abstract: We derive envelope theorems for optimization problems in which the value function takes values in a general Banach lattice, and not necessarily in the real line. We impose no restriction whatsoever on the choice set. Our result extend therefore the ones of Milgrom and Segal (2002). We apply our results to discuss the existence of a well-defined notion of marginal utility of wealth in optimal consumption-portfolio problems in which the utility from consumption is additive but possibly state-dependent and, most importantly, the information structure is not required to be Markovian. In this general setting, the value function is itself a random variable and, if integrable, takes values in a Banach lattice so that our general results can be applied.
    Date: 2011
  16. By: Francesco Carravetta; Marco M. Sorge
    Abstract: This paper describes a method for solving a class of forward-looking Markov-switching Rational Expectations models under noisy measurement, by specifying the unobservable expectations component as a general-measurable function of the observable states of the system, to be determined optimally via stochastic control and filtering theory. Solution existence is proved by setting this function to the regime-dependent feedback control minimizing the mean-square deviation of the equilibrium path from the corresponding perfect-foresight autoregressive Markov jump state motion. As the exact expression of the conditional (rational) expectations term is derived both in finite and infinite horizon model formulations, no (asymptotic) stationarity assumptions are needed to solve forward the system, for only initial values knowledge is required. A simple sufficient condition for the mean-square stability of the obtained rational expectations equilibrium is also provided.
    Keywords: Rational Expectations, Markov-switching dynamic systems, Dynamic programming, Time-varying Kalman filter
    JEL: C5 C61 C62 C63
    Date: 2011–05

This nep-dge issue is ©2011 by Christian Zimmermann. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.