nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2011‒06‒11
twenty-two papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Is Fiscal Policy Alone Enough for Growth ? A Simulation Analysis for Bolivia By Carlos Gustavo Machicado; Paul Estrada; Ximena Flores
  2. Potential Output in DSGE Models By Igor Vetlov; Tibor Hlédik; Magnus Jonsson; Henrik Kucsera; Massimiliano Pisani
  3. The Intensive Margin Puzzle and Labor Market Adjustment Costs By Dennis Wesselbaum
  4. Financial Crises and Macro-Prudential Policies By Gianluca Benigno; Huigang Chen; Christopher Otrok; Alessandro Rebucci; Eric R. Young
  5. Search Frictions and the Labor Wedge By Andrea Pescatori; Murat Tasci
  6. The Tragedy of Annuitization By Heijdra, Ben J.; Mierau, Jochen O.; Reijnders, Laurie S.M.
  7. Do Matching Frictions Explain Unemployment? Not in Bad Times By Pascal Michaillat
  8. On Identification of Bayesian DSGE Models* By Gary Koop; M. Hashem Pesaran; Ron Smith
  9. A dynamic school choice model By Juan Sebastián Pereyra
  10. House allocation with overlapping generations By Kurino Morimitsu
  11. Inequality and the Lifecycle By Greg Kaplan
  12. Firm Migration and Stock Returns By Giovanni W. Puopolo
  13. Life-Cycle Unemployment, Retirement, and Parametric Pension Reform By Fisher, Walter H.; Keuschnigg, Christian
  14. Consumption, Savings, and Investments over the Life Cycle. By Peijnenburg, J.M.J.
  15. Can't SBTC explain the U.S. wage inequality dynamics? By YIP, Chi Man
  16. A Simple Characterization of Dynamic Completeness in Continuous Time By Theodoros M. Diasakos
  17. Size and The City: Productivity, Match Quality and Wage Inequality By YIP, Chi Man
  18. The Cyclicality of Productivity Dispersion By Matthias Kehrig
  19. Financial Innovation and Endogenous Growth By Stelios Michalopoulos; Luc Laeven; Ross Levine
  20. New Firm Creation and Failure: A Matching Approach By Thomas Gries; Stefan Jungblut; Wim Naude
  21. Second-Order Approximation of Dynamic Models with Time-Varying Risk By Gianluca Benigno; Pierpaolo Benigno; Salvatore Nisticò
  22. Venezuela\'s Growth Experience By Omar D Bello; Juan S Blyde; Diego Restuccia

  1. By: Carlos Gustavo Machicado; Paul Estrada; Ximena Flores
    Abstract: This paper develops a dynamic stochastic general equilibrium (DSGE) model to analyze the growth effects of fiscal policy in Bolivia. It is a multi-sector model with five representative sectors for the Bolivian economy: Non-tradables, importables, hydrocarbons, mining and agriculture. Public capital is included as a production factor in each of these sectors. The model is calibrated and a number of interesting scenarios are simulated by modifying each of the available fiscal policy instruments. In particular, we analyze the sustainability of Bolivian social policy based on government transfers to households along with the short- and long-run implications of fiscal policy for growth and welfare. We find that fiscal policy alone is unable to generate high rates of growth: it must be accompanied by an efficient provision of public capital and productivity boosts in the economic sectors.
    Keywords: Fiscal policy, Infrastructure, multi-sector growth model
    JEL: E62 H54 O41
    Date: 2011
  2. By: Igor Vetlov (Bank of Lithuania); Tibor Hlédik (Czech National Bank); Magnus Jonsson (Sveriges Riksbank); Henrik Kucsera (Magyar Nemzeti Bank); Massimiliano Pisani (Banca d'Italia)
    Abstract: In view of the increasing use of Dynamic Stochastic General Equilibrium (DSGE) models in the macroeconomic projections and the policy process, this paper examines, both conceptually and empirically, alternative notions of potential output within DSGE models. Furthermore, it provides historical estimates of potential output/output gaps on the basis of selected DSGE models developed by the European System of Central Banks’ staff. These estimates are compared to the corresponding estimates obtained applying more traditional methods. Finally, the paper assesses the usefulness of the DSGE model-based output gaps for gauging inflationary pressures.
    Keywords: potential output, simulation and forecasting models, monetary policy
    JEL: E32 E37 E52
    Date: 2011–06–03
  3. By: Dennis Wesselbaum
    Abstract: This paper documents a puzzling fact, namely that there is a significant negative relation between employment protection legislation and the usage of the intensive margin of labor market adjustments. We then make use of a Real Business Cycle model and introduce search and matching frictions as well as adjustment costs along the extensive and the intensive labor market margins. We show that the model is able to replicate the observed pattern, if we assume low firing costs and relatively large hours adjustment costs. Furthermore, the model requires those values to replicate the U.S. business cycle statistics
    Keywords: Adjustment Costs, Extensive Margin, Intensive Margin
    JEL: C10 E32 J41
    Date: 2011–05
  4. By: Gianluca Benigno; Huigang Chen; Christopher Otrok; Alessandro Rebucci; Eric R. Young
    Abstract: Stochastic general equilibrium models of small open economies with occasionally binding financial frictions are capable of mimicking both the business cycles and the crisis events associated with the sudden stop in access to credit markets (Mendoza, 2010). In this paper we study the inefficiencies associated with borrowing decisions in a two-sector small open production economy. We find that this economy is much more likely to display "under-borrowing" rather than "over-borrowing" in normal times. As a result, macro-prudential policies (i.e. Tobin taxes or economy-wide controls on capital inflows) are costly in welfare terms in our economy. Moreover, we show that macro-prudential policies aimed at minimizing the probability of the crisis event might be welfare-reducing in production economies. Our analysis shows that there is a much larger scope for welfare gains from policy interventions during financial crises. That is to say that, within our modeling approach, ex post or crisis-management policies dominate ex ante or macro-prudential ones.
    Keywords: Capital controls, crises, financial frictions, macro prudential policies, bailouts,overborrowing
    JEL: E52 F37 F41
    Date: 2010–12
  5. By: Andrea Pescatori (International Monetary Fund); Murat Tasci (Federal Reserve Bank of Cleveland)
    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 Search; Business Cycle Accounting; Labor Wedge
    JEL: E24 E32 J64
    Date: 2011–05
  6. By: Heijdra, Ben J. (Faculty of Economics and Business, University of Groningen, The Netherlands, and Institute for Advanced Studies, CESifo, Netspar); Mierau, Jochen O. (Faculty of Economics and Business, University of Groningen, The Netherlands); Reijnders, Laurie S.M. (Faculty of Economics and Business, University of Groningen, The Netherlands)
    Abstract: We construct a tractable discrete-time overlapping generations model of a closed economy and use it to study government redistribution of accidental bequests and private annuities in general equilibrium. Individuals face longevity risk as there is a positive probability of passing away before the retirement period. We find non-pathological cases where it is better for longrun welfare to waste accidental bequests than to give them to the elderly. Next we study the introduction of a perfectly competitive life insurance market offering actuarially fair annuities. There exists a tragedy of annuitization: although full annuitization of assets is privately optimal it is not socially beneficial due to adverse general equilibrium repercussions.
    Keywords: Longevity risk, Risk sharing, Overlapping generations, Intergenerational transfers, Annuity markets
    JEL: D52 D91 E10 J20
    Date: 2011–05
  7. By: Pascal Michaillat
    Abstract: This paper models unemployment as the result of matching frictions and job rationing. Job rationing is a shortage of jobs arising naturally in an economic equilibrium from the combination of some wage rigidity and diminishing marginal returns to labor. During recessions, job rationing is acute, driving the rise in unemployment, whereas matching frictions contribute little to unemployment. Intuitively, in recessions jobs are lacking, the labor market is slack, recruiting is easy and inexpensive, so matching frictions do not matter much. In a calibrated model, cyclical fluctuations in the composition of unemployment are quantitatively large.
    Keywords: Unemployment, matching frictions, job rationing
    JEL: E24 E32 J64
    Date: 2010–11
  8. By: Gary Koop (Department of Economics, University of Strathclyde); M. Hashem Pesaran (Faculty of Economics, University of Cambridge); Ron Smith (Department of Economics, Mathematics and Statistics, University of Birkbeck)
    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 di¢ cult to deter- mine whether a parameter is identi?ed. For the researcher using Bayesian methods, a lack of identi?cation may not be evident since the posterior of a parameter of interest may di¤er 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 su¤er 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 identi?ed. In such cases the marginal posterior of an unidenti?ed 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 (T) is increased. For identi?ed parameters the posterior precision rises with T, whilst for an unidentified parameter its posterior precision may be updated but its rate of update will be slower than T. This result assumes that the identified parameters are pT-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.
    Keywords: Bayesian identification, DSGE models, posterior updating, New Keynesian Phillips Curve.
    JEL: C11 C15 E17
    Date: 2011–03
  9. By: Juan Sebastián Pereyra (El Colegio de México)
    Abstract: This paper considers a real-life assignment problem faced by the Mexican Ministry of Public Education. Inspired by this situation, we introduce a dynamic school choice problem that consists in assigning positions to overlapping generations of teachers. From one period to another, agents are allowed either to retain their current position or to choose a preferred one. In this framework, a solution concept that conciliates the fairness criteria with the individual rationality condition is introduced. It is then proved that a fair matching always exists and that it can be reached by a modified version of the deferred acceptance algorithm of Gale and Shapley. We also show that the mechanism is dynamic strategy-proof, and respects improvements whenever the set of orders is lexicographic by tenure.
    Keywords: school choice, overlapping agents, dynamic matching, deferred acceptance algorithm
    JEL: C71 C78 D71 D78 I28
    Date: 2011–05
  10. By: Kurino Morimitsu (METEOR)
    Abstract: Many real-life applications of house allocation problems are dynamic. For example, each year college freshmen move in and seniors move out of on-campus housing. Each student stays on campus for only a few years. A student is a `newcomer’ in the beginning and then becomes an ''existing tenant.’ Motivated by this observation, we introduce a model of house allocation with overlapping generations. In terms of a dynamic rule without monetary transfers, we examine two static rules of serial dictatorship (SD) and top trading cycles (TTC), both of which are based on an ordering of agents and give a higher-order agent a more advantageous position in the assignment procedure. We support a seniority-based SD rule by showing its dynamic Pareto efficiency. Similarly, we support a seniority-based TTC rule under time-invariant preferences by showing its dynamic Pareto efficiency and incentive compatibility.
    Keywords: microeconomics ;
    Date: 2011
  11. By: Greg Kaplan (Department of Economics, University of Pennsylvania)
    Abstract: I structurally estimate an incomplete markets lifecycle model with endogenous labor supply, using data on the joint distribution of wages, hours and consumption. The model is successful at matching the evolution of both the first and second moments of the data over the lifecycle. The key challenge for the model is to generate declining inequality in annual hours worked over the first half of the working life, while respecting the constraints imposed by the data on consumption and wages. I argue that this is a robust feature of the data on lifecycle labor supply that is strongly at odds with the intra-temporal first order condition for labor supply. Allowing for a realistic degree of involuntary unemployment, coupled with preferences that feature nonseparability in the disutility of the extensive and intensive margins of hours worked, allows the model to overcome this challenge. The results imply that labor market frictions are important in jointly accounting for observed cross-sectional inequality in labor supply and consumption and may have quantitative relevance for analyses that exploit the intra-temporal first-order condition for labor.
    Keywords: Structural Estimation, Inequality, Lifecycle, Labor Supply, Incomplete Markets, Consumption, Unemployment
    JEL: D10 D31 E21 J22
    Date: 2011–05–28
  12. By: Giovanni W. Puopolo (Bocconi University, IGIER and CSEF)
    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.
    Keywords: Investment; General equilibrium; Firm migration; Cross-section of returns; Book-to-market
    JEL: G12 D92 D51 D21 D24
    Date: 2011–05–31
  13. By: Fisher, Walter H. (Department of Economics and Finance, Institute for Advanced Studies, Vienna, Austria); Keuschnigg, Christian (University of St. Gallen (FGN-HSG), CEPR, CESifo and Netspar, Switzerland)
    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
  14. By: Peijnenburg, J.M.J. (Universiteit van Tilburg)
    Date: 2011
  15. By: YIP, Chi Man
    Abstract: Based on the effect of skill-biased technology change (SBTC), this paper builds a search model with heterogeneous firms and workers to explain the dynamics of the wage inequality in the U.S. from 1963-2005. Firms differ in capital intensity (technology content) of the job created and workers differ in their education level. As the match-specific productivity is stochastic, the productivity threshold of employment of each education-job pair matched is endogenously determined. The advance in skill-biased technology increases the productivity of the highly educated workers as well as the capital intensity facing firms when creating high-tech jobs. We argue that in response to the rise in the capital intensity, high-tech firms increase the productivity thresholds of hiring, which leads to wage increment in the high-tech sector, and thus widening the residual wage inequality. Meanwhile, the increase in the productivity of the highly educated worker in the high-tech sector results in higher education premium in both the high-tech and low-tech sectors. Using the historical U.S. data, calibration shows that SBTC can explain the general trends in the education premium and the residual wage inequality from 1963-2005. In particular, it solves the puzzle why the education premium fell but the residual wage inequality grew in the early 1970s.
    Keywords: SBTC; Education Premium; Residual Wage Inequality; Capital Intensity
    JEL: J31 J41 J24
    Date: 2010–08
  16. By: Theodoros M. Diasakos
    Abstract: I establish a necessary and sufficient condition for the securities' market to be dynamically-complete in a single-commodity, pure-exchange economy with many Lucas' trees whose dividends are geometric Brownian motions. Even though my analysis is based upon the representative-agent version of this economy, the condition depends neither on the utility function of the representative agent, nor on the functional form of her endowment. As a consequence, it characterizes dynamic completeness in this economy even in the presence of many heterogenous agents.
    Keywords: Dynamically-Complete Markets; Continuous Time; General Equilibrium
    JEL: G10 G12
    Date: 2011
  17. By: YIP, Chi Man
    Abstract: This paper elucidates the impact of city growth on wage and wage inequality using a search-theoretical approach. Firms differ in capital intensity and land intensity of the jobs created. When a worker meets a job via a matching technology, a match-specific productivity level is realized and they sign a job contract when they agree with the bargaining wage. A rise in population density leads to rental increment. As a consequence, a higher expected flow profit is required for the creation of a good job. Rent-sharing ensures an increase of the average wage in the good-job sector. This, in turn, increases the reservation wage of workers in the equilibrium. Although the rental increment does not affect the setup costs in the bad-job sector, higher realized productivity level is required to cover higher reservation wage. Since only job contacts with realized productivity levels exceeding reservation productivity threshold are observed, such increase in the threshold raises also the average wage in the bad-job sector. Hence, the average productivity, the match quality and wage go up in each sector unambiguously, giving rise to urban wage premium. In addition, this paper predicts that urbanization widens residual wage inequality of a city. Existing empirical evidence is presented to support the implications of this model.
    Keywords: Urban Wage Premium; Match Quality; Job Match
    JEL: J31 O15 J64
    Date: 2011–04–11
  18. By: Matthias Kehrig
    Abstract: Using plant-level data, I show that the dispersion of total factor productivity in U.S. durable manufacturing is greater in recessions than in booms. This cyclical property of productivity dispersion is much less pronounced in non-durable manufacturing. In durables, this phenomenon primarily reflects a relatively higher share of unproductive firms in a recession. In order to interpret these findings, I construct a business cycle model where production in durables requires a fixed input. In a boom, when the market price of this fixed input is high, only more productive firms enter and only more productive incumbents survive, which results in a more compressed productivity distribution. The resulting higher average productivity in durables endogenously translates into a lower average relative price of durables. Additionally, my model is consistent with the following business cycle facts: procyclical entry, procyclical aggregate total factor productivity, more procyclicality in durable than non-durable output, procyclical employment and countercyclicality in the relative price of durables and the cross section of stock returns.
    Keywords: Productivity, Plant-level Risk, Entry and Exit, Business Cycles, Manufacturing, Plant-Level Data
    JEL: D24 E32 L11 L25 L60
    Date: 2011–05
  19. By: Stelios Michalopoulos (Tufts University); Luc Laeven (IMF and CEPR); Ross Levine (Brown University and NBER)
    Abstract: We model technological and ?nancial innovation as re?ecting the decisions of pro?t maximizing agents and explore the implications for economic growth. We start with a Schumpeterian growth model where entrepreneurs earn pro?ts by inventing better goods and ?nanciers arise to screen entrepreneurs. A novel feature of the model is that ?nanciers also engage in the costly, risky, and potentially pro?table process of innovation: Financiers can invent more e¤ective processes for screening entrepreneurs. Every screening process, however, becomes less e¤ective as technology advances. Consequently, technological inno- vation and economic growth stop unless ?nanciers continually innovate. The model also allows for rent-seeking ?nancial innovation, in which ?nanciers engage in privately pro?table but socially ine¢ cient innovation that slows growth. Empirical evidence is more consistent with this dynamic, synergistic model of ?nancial and technological innovation than with existing theories.
    Keywords: Invention, Economic Growth, Corporate Finance, Technological Change, Entrepreneurship
    JEL: G0 O31 O4
    Date: 2011–05
  20. By: Thomas Gries (University of Paderborn); Stefan Jungblut (University of Paderborn); Wim Naude (United Nations University)
    Abstract: We propose that the rate of creation and failure of new firm start-ups can be modelled as a search and matching process, as in labor market matching models. Deriving an "entrepreneurial" Beveridge curve, we show that a successful start-up depends on the efficiency with which entrepreneurial ability is matched with business opportunity, and outline a number of possible applications of this matching approach to assist in formalizing the economics of entrepreneurship.
    Keywords: Entrepreneurship, start-ups, labor market matching
    JEL: L26 M13 O10 O14
    Date: 2011–06
  21. By: Gianluca Benigno; Pierpaolo Benigno; Salvatore Nisticò
    Abstract: This paper provides first and second-order approximation methods for the solution of nonlinear dynamic stochastic models in which the exogenous state variables follow conditionally-linear stochastic processes displaying time-varying risk. The first-order approximation is consistent with a conditionally-linear model in which risk is still timevarying but has no distinct role - separated from the primitive stochastic disturbances - in influencing the endogenous variables. The second-order approximation of the solution, instead, is sufficient to get this role. Moreover, risk premia, evaluated using only a first-order approximation of the solution, will be also time varying.
    Keywords: stochastic volatility, second order approximation
    JEL: C63
    Date: 2010–12
  22. By: Omar D Bello; Juan S Blyde; Diego Restuccia
    Abstract: The standard of living, measured as gross domestic product (GDP) per capita, increased dramatically in Venezuela relative to that of the United States from 20 percent in 1920 to 90 percent in 1958, but since then has collapsed to around 30 percent nowadays. What explains these remarkable growth and collapse episodes? Using a standard development accounting framework, we show that the growth episode is mainly accounted for by an increase in capital accumulation and knowledge transfer associated with the foreign direct investment in the booming oil industry. The collapse episode is accounted for equally by a fall in total factor productivity and in capital accumulation. We analyze Venezuela during the collapse episode in the context of a model of heterogeneous production units were policies and institutions favour unproductive in detriment of more productive activities. These policies generate misallocation, lower TFP, and a decline in capital accumulation. We show in the context of an heterogeneous-establishment growth model that distortionary policies can explain between 80 to 95 percent of the current differences in TFP, capital accumulation, and income per capita between Venezuela and the United States.
    Keywords: Productivity, physical capital, misallocation, policies
    JEL: O4
    Date: 2011–06–03

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