nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2011‒06‒25
twenty-two papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. A Steady-State Model of a Non-Walrasian Economy with Three Imperfect Markets By Wasmer, Etienne
  2. The Increased Importance of Asset Price Misalignments for Business Cycle Dynamics By Bask, Mikael; Madeira, João
  3. Child Labor, Idiosyncratic Shocks, and Social Policy By Alice Fabre; Stéphane Pallage
  4. Macroeconomic Dynamics in a Model of Goods, Labor and Credit Market Frictions By Petrosky-Nadeau, Nicolas; Wasmer, Etienne
  5. Productivity Shocks, Stabilization Policies and the Dynamics of Net Foreign Assets By Giorgio Di Giorgio; Salvatore Nistico'
  6. A General Equilibrium Model of Sovereign Default and Business Cycles By Enrique G. Mendoza; Vivian Z. Yue
  7. Global Imbalances and Imported Disinflation in the Euro Area By Barthélemy, J.; Cléaud, G.
  8. Labor Mobility and Productivity Growth By Xavier Raurich; Fernando Sanchez-Losada; Montserrat Vilalta-Bufi
  9. From growth to cycles through beliefs By Christopher M. Gunn
  10. Hiring chains and the dynamic behavior of job and worker flows By Christopher Reicher
  11. Does Child Support Increase the Number of Children? An Involuntary Employment-Specific Approach By Ryouichi Ikeda
  12. Vintage capital growth theory: Three breakthroughs By Raouf Boucekkine; David de la Croix; Omar Licandro
  13. Fiscal stimulus and distortionary taxation By Drautzburg, Thorsten; Uhlig, Harald
  14. The loss from uncertainty on policy targets By Giorgio Di Giorgio; Guido Traficante
  15. Monetary Policy, Liquidity Stress and Learning Dynamics By Stefano Marzioni
  16. Estimates of the steady state growth rates for the Scandinavian countries: a knowledge economy approach By Casadio, Paolo; Paradiso, Antonio; Rao, B. Bhaskara
  17. Time-Varying Returns, Intertemporal Substitution and Cyclical Variation in Consumption By Emmanuel De Veirman; Ashley Dunstan
  18. Getting Normalization Right: Dealing with ÔDimensional ConstantsÕ in Macroeconomics By Cristiano Cantore; Raffaele Paul Levine
  19. Learning about Education By Emerson, Patrick M.; McGough, Bruce
  21. Systemic risk and financial development in a monetary model By Philippe Moutot
  22. An Estimation of Economic Models with Recursive Preferences By Xiaohong Chen; Jack Favilukis; Sydney C. Ludvigson

  1. By: Wasmer, Etienne (Sciences Po, Paris)
    Abstract: Unemployment may depend on equilibrium in other markets than the labor markets. This paper adresses this old idea by introducing search frictions on several markets: in a model of credit and labor market imperfections as in Wasmer and Weil (2004), I further introduce search on the goods market. The model can be solved by blocks: on two of the three markets, the relevant "market tightness" is a constant of parameters. In particular, goods market tightness, expressed as the ratio of unmatched consumers to unmatched firms, is equal to 1 which corresponds to a stochastic Say's law: demand and supply are stochastically in equilibrium. Financial market tightness is also a function of three parameters related to financial frictions. Job creation and employment depend on the equilibrium in the other markets. Reciprocally, higher job destruction implies more volatility of income of individual consumers and higher destruction of consumption matches. This lowers profits and further reduces job creation. Finally, there are complementarities between frictions in each market: in particular, the marginal effect of financial frictions on equilibrium unemployment is amplified by goods market frictions and vice versa.
    Keywords: search, matching, unemployment, goods market imperfections
    JEL: J6 E12 E13
    Date: 2011–06
  2. By: Bask, Mikael (Department of Economics); Madeira, João (University of Exeter Business School)
    Abstract: We outline a dynamic stochastic general equilibrium (DSGE) model with trend extrapolation in asset pricing that we fit to quarterly U.S. macroeconomic time series with Bayesian techniques. To be more precise, we modify the DSGE model in Smets and Wouters (2007) by incorporating asset traders who use a mix of fundamental analysis and trend extrapolation in asset pricing. We conclude that trend extrapolation in asset pricing is quantitatively relevant, statistically significant and results in a substantial improvement of the model’s fit to the data. We also find that the strength in trend extrapolation is much stronger during the Great Moderation than it was prior to this period. Moreover, allowing for asset mispricing leads to more pronounced hump-shaped dynamics of the asset price and investment. Thus, asset price misalignments should be an important ingredient in DSGE models that aim to understand business cycles dynamics in general and the interaction between the real and financial sectors in particular.
    Keywords: Asset Price Bubble; Bayesian Technique; Business Cycle; DSGE Model; Fundamental Analysis; Trend Extrapolation
    JEL: E32 E44
    Date: 2011–06–08
  3. By: Alice Fabre; Stéphane Pallage
    Abstract: In this paper, we measure the welfare effects of banning child labor in an economy with strong idiosyncratic shocks to employment. We then design two different policies: an unemployment insurance program and a universal basic income system. We show that they can often lead to an endogenous elimination of child labor. We work within a dynamic, general equilibrium model calibrated to South Africa in the 1990s.
    Keywords: Child labor, Idiosyncratic shocks, Unemployment insurance, Universal basic income, Heterogeneous agents, Child labor ban
    JEL: E20 D58 J65
    Date: 2011
  4. By: Petrosky-Nadeau, Nicolas (Carnegie Mellon University); Wasmer, Etienne (Sciences Po, Paris)
    Abstract: Building a model with three imperfect markets – goods, labor and credit – representing a product's life-cycle, we find that goods market frictions drastically change the qualitative and quantitative dynamics of labor market variables. The calibrated model leads to a significant reduction in the gap with the data, both in terms of persistence and volatility while search models of the labor market fail in one of the two dimensions. Two factors related to goods market frictions generate these results: i) the expected dynamics of consumers' search for goods, itself depending on the income redistributed by firms and the entry of new products; and ii) the expected dynamics of prices, which alter future profit flows.
    Keywords: search, matching, business cycle, goods market imperfection
    JEL: J6 E12 E13 E3
    Date: 2011–06
  5. By: Giorgio Di Giorgio (LUISS Guido Carli University); Salvatore Nistico' (La Sapienza University of Rome and LUISS Guido Carli University)
    Keywords: Fiscal Deficit, Net Foreign Assets, DSGE Models, Monetary and Fiscal Policy.
    JEL: E43 E44 E52 E58
    Date: 2011
  6. By: Enrique G. Mendoza; Vivian Z. Yue
    Abstract: Emerging markets business cycle models treat default risk as part of an exogenous interest rate on working capital, while sovereign default models treat income fluctuations as an exogenous endowment process with ad-hoc default costs. We propose instead a general equilibrium model of both sovereign default and business cycles. In the model, some imported inputs require working capital financing; default triggers an efficiency loss as these inputs are replaced by imperfect substitutes; and default on public and private obligations occurs simultaneously. The model explains several features of cyclical dynamics around defaults, countercyclical spreads, high debt ratios, and key business cycle moments.
    JEL: E32 E44 F32 F34
    Date: 2011–06
  7. By: Barthélemy, J.; Cléaud, G.
    Abstract: We estimate a medium-scale DSGE model for the euro area in an open economy framework. The model includes structural trends on all variables, which allow us to estimate on gross data. We first provide a theoretical balanced growth path consistent with permanent productivity shocks, inflation target changes, and permanent shocks to the openness of the economies. We then define the cycle as the gap between this sustainable trajectory and the gross data, thus our model properly deals with deviations of the trade balance. Finally, we find persistent and strong effects from the asymmetric increase of euro area imports during the last ten years on domestic inflation. From the first quarter of 2000 to the last quarter of 2008, we estimate the contribution of the imbalanced development of international trade on euro area inflation to an average of -0.7%, and on the 3-Month interest rate to an average of -1.4%.
    Keywords: Global Imbalances, Disinflation, Business Fluctuations, Open Economy Macroeconomics.
    JEL: E32 F41
    Date: 2011
  8. By: Xavier Raurich; Fernando Sanchez-Losada; Montserrat Vilalta-Bufi (Universitat de Barcelona)
    Abstract: Growth models of learning-by-doing assume that knowledge learned in produc- tion gets freely and instantly spread to the whole economy. As a result, the econ- omy exhibits aggregate increasing returns and the total factor productivity (TFP) growth is endogenous. However, the assumption of instant diusion of knowledge seems unrealistic. Diusion of knowledge takes time and requires some channel of transmission. In this paper we assume this transmission channel is learning-by- hiring, since knowledge is embodied in workers. We present a model where the free and instant diusion of knowledge may exist only within sectors, but not across sectors. Diusion of knowledge across sectors can only occur through the mobility of labor and, therefore, the labor market determines both the level and growth of TFP. We investigate how labor mobility costs modify the equilibrium outcome of such an economy considering two scenarios: endogenous and exogenous growth. Moreover, we show that other labor market ine ciencies, such as labor income taxes or labor search costs, may reduce labor mobility and therefore modify TFP.
    Keywords: labor mobility, economic growth, learning-by-hiring, learning-by-doing
    JEL: O41
    Date: 2011
  9. By: Christopher M. Gunn
    Abstract: I present a theoretical model where the economy endogenously adopts the technological ideas of a slowly evolving technological frontier, and show that the presence of a "technological gap" between unadopted ideas and current productivity can lead to multiple equilibria and therefore the possibility that changes in beliefs can be self-fulfilling, often referred to as sunspots. In the model these sunspots take the form of beliefs about the value of adopting the new technological ideas, and unleash both a boom in aggregate quantities as well as eventual productivity growth, increasing the value of adoption and self-confirming the beliefs. Moreover, I demonstrate that the scope for these indeterminacies is a function of the steady-state growth rate of the underlying technological frontier of ideas, and that during times of low growth in ideas, the potential for indeterminacies disappears. Under this view, technology becomes important for cycles not necessarily because of sudden shifts in the technological frontier, but rather, because it defines a technological regime for the economy such that expectations about its value can produce aggregate fluctuations where in a different regime they could not.
    Keywords: expectations-driven business cycle, sunspot, multiple equilibria, indeterminacy, technology, news shock, intangible capital, investment-specific technical change, embodied, technological transition, technological adoption.
    JEL: C62 C68 E00 E2 E3 O3 O4
    Date: 2011–06
  10. By: Christopher Reicher
    Abstract: In this paper, I discuss three sets of links which I uncover in the data on aggregate US job and worker flows. Job flows are strongly related to aggregate employment growth, while worker flows are strongly related to employment growth and the unemployment rate. I show that a simple frictionless business cycle model with heterogeneity and a simple form of on-the-job search can explain these links. Job flows respond simply to the cross-section of firm growth, which responds to aggregate employment growth. Worker flows are related to both employment growth and the unemployment rate, and quits and hires are particularly tightly related to each other. Quits and hires interact to form a hiring chain—hires beget quits through on-the-job search, and quits beget hires to replace quitters. High unemployment crowds out quits, shortens the hiring chain, reduces the number of hires, and also results in an elevated layoff rate. The simple hiring chain model fits the data surprisingly well
    Keywords: Job flows, worker flows, heterogeneity, on-the-job search, hiring chain
    JEL: E32 J63 J21
    Date: 2011–06
  11. By: Ryouichi Ikeda (Graduate School of Economics, Osaka University)
    Abstract: Recently, as low birth rates and the aging of society have intensified, considerable analysis is being conducted using overlapping generations models with endogenous birth rates. However, most previous studies have assumed full employment. Since it is the case that unemployment does exist in reality, this paper employs a labor-union wage-negotiation model that models unemployment to analyze the effects of child-support tax on employment and number of children. First, an increase in child-support tax increases the unemployment rate and decreases capital stock. A new finding is that an increase in unemployment decreases the number of children through decreasing disposable income. Also, when certain conditions are satisfied the number of children per capita in the economy as a whole also decreases with introduction of child-support tax. This paper concludes that excessive child-support tax can have opposite the intended effect. Another new finding is that an increase in the unemployment insurance benefits rate decreases the number of children by decreasing disposable income through increasing unemployment.
    Keywords: Child-support, The number of children, Unemployment, Union, Overlapping generations model
    JEL: J13 J64 J51
    Date: 2011–06
  12. By: Raouf Boucekkine; David de la Croix; Omar Licandro
    Abstract: Vintage capital growth models have been at the heart of growth theory in the 60s. This research line collapsed in the late 60s with the so-called embodiment controversy and the technical sophisitication of the vintage models. This paper analyzes the astonishing revival of this literature in the 90s. In particular, it outlines three methodological breakthroughs explaining this resurgence: a growth accounting revolution, taking advantage of the availability of new time series, an optimal control revolution allowing to safely study vintage capital optimal growth models, and a vintage human capital revolution, along with the rise of economic demography, accounting for the vintage structure of human capital similarly to physical capital age structuring. The related literature is surveyed.
    Keywords: Vintage capital, embodied technical progress, growth accounting, optimal control, endogenous growth, vintage human capital, demography.
    JEL: D63 D64 C61
    Date: 2011–06–15
  13. By: Drautzburg, Thorsten; Uhlig, Harald
    Abstract: We quantify the fiscal multipliers in response to the American Recovery and Reinvestment Act (ARRA) of 2009. We extend the benchmark Smets-Wouters (Smets and Wouters, 2007) New Keynesian model, allowing for credit-constrained households, the zero lower bound, government capital and distortionary taxation. The posterior yields modestly positive short-run multipliers around 0.52 and modestly negative long-run multipliers around -0.42. The multiplier is sensitive to the fraction of transfers given to credit-constrained households, the duration of the zero lower bound and the capital. The stimulus results in negative welfare effects for unconstrained agents. The constrained agents gain, if they discount the future substantially. --
    Keywords: Fiscal Stimulus,New Keynesian model,liquidity trap,zero lower bound,fiscal multiplier
    JEL: E62 E63 E65 H20 H62
    Date: 2011
  14. By: Giorgio Di Giorgio (LUISS Guido Carli University); Guido Traficante (Universita' Europea di Roma and LUISS Guido Carli University)
    Abstract: What is the welfare loss arising from uncertainty about true policy targets? We quantify these effects in a DSGE model where private agents are unable to distinguish between temporary shocks to potential output and to the inßation target. Agents use optimal Þltering techniques to construct estimates of the unknown variables. We Þnd that the welfare costs of not observing the inßation target and potential output are relevant even in the case of a small measurement error. We also show that, in our framework, uncertainty about the inßation target is more costly than uncertainty about potential output.
    Keywords: Monetary Policy, Kalman Filter, Potential Output.
    JEL: E5 E37 E52 E58
    Date: 2011
  15. By: Stefano Marzioni (LUISS Guido Carli University)
    Abstract: This paper examines the interactions between monetary policy and stability of interbank money markets. After showing some empirical evidence of a central bank's concern for money market stability I derive a forward smoothing interest rate rule moving from an explicit target in terms of a liquidity stress indicator. The implications of this approach on equilibrium determinacy and learnability are analyzed. I show that equilibrium uniqueness is not necessarily compatible with equilibrium learnability, and learnability, in general, has tighter requirements than determinacy.
    Keywords: LIBOR-OIS spread, Taylor Rule, Adaptive Learning, DSGE models, Monetary Policy.
    JEL: E43 E44 E52 E58
    Date: 2011
  16. By: Casadio, Paolo; Paradiso, Antonio; Rao, B. Bhaskara
    Abstract: This paper estimates the steady state growth rate for Scandinavian countries with a “knowledge economy” approach. We shall use an extended version of the Solow (1956) growth model, in which total factor productivity is assumed to be a function of human capital (measured by average years of education), trade openness and investment ratio. Using this framework we show that these factors, and in particular the education variable, have played an important role to determine the long run growth rates of the Scandinavian countries. Some policy measures are identified to improve the long-run growth rates for these countries.
    Keywords: Endogenous growth models; Trade openness; human capital; investment ratio; Steady state growth rate; Scandinavian countr
    JEL: C22 O52 O40
    Date: 2011–05–30
  17. By: Emmanuel De Veirman; Ashley Dunstan
    Abstract: This paper studies the importance of intertemporal substitution in consumption for the cyclical co-movement of consumption, net worth and income. We can largely explain the empirical hump-shaped consumption response to a transitory wealth increase by allowing for time-varying returns in an otherwise standard Permanent Income Hypothesis (PIH) model. At the net worth peak, households bring consumption forward in anticipation of low returns on saving. The PIH model fully explains the empirical response when households initially expect the net worth shock to be permanent, but gradually learn that it is in fact transitory.
    JEL: C22 C32 E21
    Date: 2011–06
  18. By: Cristiano Cantore (University of Surrey); Raffaele Paul Levine (University of Surrey)
    Abstract: We contribute to a recent literature on the normalization, calibration and estimation of CES production functions. The problem arises because CES ÔshareÕ parameters are not in fact shares, but depend on underlying dimensions - they are Ôdimensional constantsÕ in other words. It follows that such parameters cannot be calibrated, nor estimated unless the choice of units is made explicit. We use an RBC model to demonstrate two equivalent solutions. The standard one expresses the production function in deviation form about some reference point, usually the steady state of the model. Our alternative, Ôre-parametrizationÕ, expresses dimensional constants in terms of a new dimensionless (share) parameter and all remaining dimensionless ones. We show that our Ôre-parametrizationÕ method is equivalent and arguably more straightforward than the standard normalization in deviation form. We then examine a similar problem of dimensional constants for CES utility functions in a two-sector model and in a small open economy model; then re-parametrization is the only solution to the problem, showing that our approach is in fact more general.
    JEL: E23 E32 E37
    Date: 2011–06
  19. By: Emerson, Patrick M. (Oregon State University); McGough, Bruce (Oregon State University)
    Abstract: Limited human capital investment is a common characteristic of low-income countries despite the fact that estimated returns to educational investment in low-income countries are generally higher than in high-income countries. Empirical evidence suggests that income and credit constraints can only account for a small part of this underinvestment. Recent experimental evidence shows that families' misperceptions about the returns to education play a large role in their low investment levels. This paper builds a model of human capital and growth that incorporates an adaptive learning mechanism to capture the way agents form perceptions about returns to education. In an economy where human capital investments have both private and public returns, we find multiple learnable equilibria, including those which are characterized by low investment and low returns. We also find that even when the rational equilibrium corresponds to a high level of human capital investment, the learning mechanism, influenced by the agents' priors and cultural bias, may impart low human capital investment for extended periods. Policies that can speed up the learning process are examined and it is found that faster rates of growth can be achieved through interventions.
    Keywords: growth, education, learning
    JEL: O40 O15
    Date: 2011–06
  20. By: Jason Collins (UWA Business School, The University of Western Australia); Boris Baer (Plant Energy Biology ARC Centre of Excellence, The University of Western Australia); Ernst Juerg Weber (UWA Business School, The University of Western Australia)
    Abstract: This paper presents a quantitative analysis of the model developed in Galor and Moav, Natural Selection and the Origin of Economic Growth (2002), in which agents vary genetically in their preference for quality and quantity of children. We simulate a parametric form of the model, enabling examination of the transition from Malthusian stagnation to modern rates of economic growth. The simulations allow an assessment of the strength of the biological foundations of the model and demonstrate the susceptibility of the modern high-growth state to invasion by cheaters. Extending the model from two to three genotypes suggests the possibility of a return to Malthusian conditions rather than a permanent state of modern growth.
    Date: 2011
  21. By: Philippe Moutot (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: In a stochastic pure endowment economy with money but no financial markets, two types of agents trade one non-durable good using two alternative types of cash constraints. Simulations of the corresponding variants are compared to Arrow-Debreu and Autarky equilibriums. First, this illustrates how financial innovation or financial regression, including systemic risk, may arise in a neo-classical model with rational expectations and may or may not be countered. Second, the price and money partition dynamics that the two variants generate absent any macroeconomic shock, exhibit jumps as well as fat-tails and vary depending on the discount rate. JEL Classification: E44.
    Keywords: Financial development, Systemic Risk, Heterogeneity, Rational expectations, Monetary model, Cash constraints.
    Date: 2011–06
  22. By: Xiaohong Chen; Jack Favilukis; Sydney C. Ludvigson
    Abstract: This paper presents estimates of key preference parameters of the Epstein and Zin (1989, 1991) and Weil (1989) (EZW) recursive utility model, evaluates the model's ability to fit asset return data relative to other asset pricing models, and investigates the implications of such estimates for the unobservable aggregate wealth return. Our empirical results indicate that the estimated relative risk aversion parameter ranges from 17-60, with higher values for aggregate consumption than for stockholder consumption, while the estimated elasticity of intertemporal substitution is above one. In addition, the estimated model-implied aggregate wealth return is found to be weakly correlated with the CRSP value-weighted stock market return, suggesting that the return to human wealth is negatively correlated with the aggregate stock market return.
    JEL: E21 G12
    Date: 2011–06

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