nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2011‒07‒02
twenty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Business cycle with nominal contracts and search frictions By Moon, Weh-Sol
  2. Real Business Cycles with Capital Maintenance By Alice Albonico; Sarantis Kalyvitis; Evi Pappa
  3. A labor market with targeted wage offers By József Sákovic
  4. Endogenous Market Structures and Labor Market Dynamics By Andrea Colciago; Lorenza Rossi
  5. Partisan cycles and the consumption volatility puzzle By Marina Azzimonti; Matthew Talbert
  6. Search Frictions and the Labor Wedge By Andrea Pescatori; Murat Tasci
  7. Quantifying the shadow economy: measurement with theory By Pere Gomis-Porqueras; Adrian Peralta-Alva; Christopher J. Waller
  8. Oil Price Dynamics in a Real Business Cycle Model By Vipin Arora; Pedro Gomis-Porqueras
  9. Monetary aggregates, financial intermediate and the business cycle By Hong, Hao
  10. Credit Market Imperfection and Sectoral Asymmetry of Chinese Business Cycle By Yuanyan Sophia Zhang
  11. The quantitative role of child care for female labor force participation and fertility By Bick, Alexander
  12. Policy Games with Liquidity Constrained Consumers By Alice Albonico; Lorenza Rossi
  13. Welfare-improving Government Behaviour and Inequality - Inspection Using a Heterogeneous-agent Model By Miguel Viegas; Ana Paula Ribeiro
  14. Can a pure real business cycle model explain the real exchange rate: the case of Ukraine By Onishchenko, Kateryna
  15. Government bias in education, schooling attainment and growth By Basu, Parantap; Bhattarai, Keshab
  16. Life-cycle consumption: can single agent models get it right? By Bick, Alexander; Choi, Sekyu
  17. Precautionary Savings and Global Imbalances in World General Equilibrium By Damiano Sandri
  18. Assessing the sensitivity of inflation to economic activity By Konstantins Benkovskis; Michele Caivano; Antonello D’Agostino; Alistair Dieppe; Samuel Hurtado; Tohmas Karlsson; Eva Ortega; Tímea Várnai
  19. Recursive Contracts By Albert Marcet; Ramon Marimon
  20. A Contribution to the Economic Theory of Fertility By Cordoba, Juan Carlos; Ripoll, Marla
  21. Persistently optimal policies in stochastic dynamic programming with generalized discounting By Jaśkiewicz, Anna; Matkowski, Janusz; Nowak, Andrzej S.

  1. By: Moon, Weh-Sol
    Abstract: This paper examines a dynamic stochastic general equilibrium (DSGE) model containing exible prices, search frictions and nominal wage contracts. It is assumed that the nominal hourly wage rate and the hours of work are jointly determined, so-called efficient bargaining, for each period. The frictional labor markets reasonably reflect the volatility of real variables and the fact that productivity is no longer countercyclical. As contract length increases, the volatilities of the unemployment rate and the vacancy rate increase sharply, but those of output and total hours worked do not appreciably change.
    Keywords: Business Cycles; Labor Market Frictions; Nominal Wage Contracts
    JEL: E32 E24 J41 J64
    Date: 2011–06–20
  2. By: Alice Albonico (Department of Economics and Quantitative Methods, University of Pavia); Sarantis Kalyvitis (Department of International and European Economic Studies, Athens University of Economics and Business); Evi Pappa (Departament de Economia y d’Historia Economica, Universitat Autonoma de Barcelona and CEPR)
    Abstract: We develop a stochastic general equilibrium model in which maintenance endogenously affects the capital depreciation rate. The model performs well in generating maintenance series that match closely existing survey-based measures for Canada. Maintenance is procyclical and comoves almost always with output. Investmentspecific shocks are the only disturbances that induce a negative correlation between output and maintenance. This feature is crucial for the identification of such shocks in the short run. We use Bayesian estimation to obtain the time profile of equipment capital depreciation in Canadian manufacturing. The depreciation rate has been quite volatile and procyclical over the last 50 years.
    Keywords: real business cycle, technology shocks, endogenous capital depreciation, maintenance
    JEL: E22 E32 E37
    Date: 2011–06
  3. By: József Sákovic
    Abstract: We model a market for highly skilled workers, such as the academic job market. The outputs of ?rm-worker matches are heterogeneous and common knowledge. Wage setting is synchronous with search: ?rms simultaneously make one personalized offer each to the worker of their choice. With large frictions (delay costs), efficient coordination is not possible, but for small frictions efficient matching with Diamond-type monopsony wages is an equilibrium.
    Date: 2011–06–24
  4. By: Andrea Colciago (Department of Economics, University of Milano Bicocca); Lorenza Rossi (Department of Economics and Quantitative Methods, University of Pavia)
    Abstract: We propose a flexible prices model where endogenous market structures and search and matching frictions in the labor market interact endogenously. The interplay between firms endogenous entry, strategic interactions among producers and labor market frictions represents a strong amplification channel of technology shocks on labor market variables, and helps addressing the unemployment-volatility puzzle. Consistently with U.S. evidence, new firms create a large fraction of new jobs and grow faster than more mature firms, net firms’ entry is procyclical and the price mark up is countercyclical.
    Keywords: Endogenous Market Structures, Firms’ Entry, Search and Matching Frictions
    JEL: E24 E32 L11
    Date: 2011–02
  5. By: Marina Azzimonti; Matthew Talbert
    Abstract: Standard real business cycle theory predicts that consumption should be smoother than output, as observed in developed countries. In emerging economies, however, consumption is more volatile than income. In this paper the authors provide a novel explanation of this phenomenon, the ‘consumption volatility puzzle,’ based on political frictions. They develop a dynamic stochastic political economy model where parties that disagree on the size of government (right-wing and left-wing) alternate in power and face aggregate uncertainty. While productivity shocks affect only consumption through responses to output, political shocks (switches in political ideology) change the composition between private and public consumption for a given output size via changes in the level of taxes. Since emerging economies are characterized by less stable governments and more polarized societies, the effects of political shocks are more pronounced. For a reasonable set of parameters the authors confirm the empirical relationship between political polarization and the ratio of consumption volatility to output volatility across countries.
    Keywords: Business cycles ; Developing countries
    Date: 2011
  6. By: Andrea Pescatori; Murat Tasci
    Abstract: This paper shows that labor market search frictions do not explain fluctuations in the labor wedge per se. However, the introduction of extensive and intensive margin clarifies 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 competitive model. Finally, we show that it is possible to measure a strongly procyclical labor wedge when the actual data generating process is a search model that allows for movements in both margins.
    Keywords: Accounting , Business cycles , Economic models , Employment , Labor markets , Unemployment ,
    Date: 2011–05–23
  7. By: Pere Gomis-Porqueras; Adrian Peralta-Alva; Christopher J. Waller
    Abstract: We construct a dynamic, general equilibrium model of tax evasion where agents choose to report some of their income. Unreported income requires using a payment method that avoids recordkeeping – cash. Trade using cash to avoid taxes is the theoretical measure of the shadow economy from our model. We then calibrate our model using money, interest rate and GDP data to back out the size of the shadow economy for a sample of 30 countries and compare our estimates to traditional ad hoc estimates. Our results generate reasonably larger estimates for the size of the shadow economy than exist in previous literature.>
    Keywords: Informal sector (Economics) ; Taxation ; Credit
    Date: 2011
  8. By: Vipin Arora; Pedro Gomis-Porqueras
    Abstract: We show the importance of endogenous oil prices and production in the real business cycle framework. Endogenising these variables improves the model’s predictions of business cycle statistics, oil related and non-oil related, relative to a situation where either is exogenous. This result is robust to the standard extensions (variable capacity utilisation and monopolistic competition) used in the literature. In particular, we first show that with either exogenous oil prices or production the standard real business cycle model and variants cannot match the oil-related and business cycle facts. In contrast, when both of these variables are endogenous, we can substantially improve the corresponding co-movements and slightly improve standard business cycle properties for consumption and investment.
    JEL: E37 F47 Q43
    Date: 2011–06
  9. By: Hong, Hao (Cardiff Business School)
    Abstract: This paper explains and evaluates the transmissions and effectiveness of monetary policy shock in a simple Cash-in-Advance (CIA) economy with financial intermediates. Lucas-Fuerst's (1992) limited participation CIA models are able to explain decreasing nominal interest rates and increasing real economic activity with monetary expansion through limited participation monetary shock and the cost channel of monetary policy. Calvo's (1983) sticky price monetary model examines the real effects of money injections through firms price setting behaviour, but it fails to generate a negative correlation between nominal interest rates and money growth rate, which has been observed in the data. This paper employs McCandless (2008) financial intermediates CIA model to explain the transmissions and impacts of monetary shocks. The model does not request limited participation monetary shock or Keynesian type of sticky price/wage, to examine the lower nominal interest rate and increasing real economic activity with monetary expansion. By extending the model with Stockman's (1981) CIA constraint, it is able to account for both positive response of consumption subject to monetary innovations, which has been found in Leeper et al. (1996) and the positive correlation between output and consumption which has been observed in the data.
    Keywords: Monetary business cycle; financial intermediate; cash-in-advance model
    JEL: E44 E52
    Date: 2011–06
  10. By: Yuanyan Sophia Zhang
    Abstract: This paper analyzes the role of credit market imperfection and sectoral asymmetry as a means through which shocks to the real economy are propagated and amplified. Drawing on firm-level data to calibrate the model, our simulations capture two key stylized facts of the Chinese economy: that credit constraints are more binding in nontradable sectors than in tradable industries and that output volatility is much greater in China than in industrial economies. We find that the driving force behind our simulation results is strongly related to the non-uniform nature of credit market imperfections in China and their implications for resource allocation and the way in which the economy reacts to shocks. Correctly capturing these macro-financial interactions are essential to understand the dynamic behavior of the Chinese economy.
    Keywords: Business cycles , China , Credit , Economic models ,
    Date: 2011–05–23
  11. By: Bick, Alexander
    Abstract: Consistent with facts for a cross-section of OECD countries, I document that the labor force participation rate of West German mothers with children aged zero to two exceeds the corresponding child care enrollment rate whereas the opposite is true for mothers with children aged three to mandatory school age. I develop a life-cycle model that explicitly accounts for this age-dependent relationship through various types of non-paid and paid child care. The calibrated version of the model is used to evaluate two policy reforms concerning the supply of subsidized child care for children aged zero to two. These counterfactual policy experiments suggest that the lack of subsidized child care constitutes indeed for some females a barrier to participate in the labor market and depresses fertility.
    Keywords: Child Care; Fertility; Life-cycle Female Labor Supply
    JEL: J13 J22 D10
    Date: 2011–06–17
  12. By: Alice Albonico (Department of Economics and Quantitative Methods, University of Pavia); Lorenza Rossi (Department of Economics and Quantitative Methods, University of Pavia)
    Abstract: In the light of the recent financial crisis, we investigate the effects generated by limited asset market participation on optimal monetary and fiscal policy, where monetary and fiscal authority are independent and play strategically. We find that limited asset market participation strongly affects the optimal steady state and the optimal dynamics of the different policy regimes considered. In particular: (i) both in the long run and in short run equilibrium, a greater inflation bias is optimal than in the standard representative agent economy; (ii) in response to a markup shock, fiscal policy becomes more active as the fraction of liquidity constrained agents increases; (iii) optimal discretionary policies imply welfare losses for Ricardian, while liquidity constrained consumers experience welfare gains with respect to Ramsey.
    Keywords: liquidity constrained consumers, optimal monetary and fiscal policy, strategic interaction, inflation bias
    JEL: E3 E5
    Date: 2011–02
  13. By: Miguel Viegas (GOVCOPP, DEGEI, Universidade de Aveiro); Ana Paula Ribeiro (Faculdade de Economia da Universidade do Porto and CEF.UP)
    Abstract: Governments behavior is expected to be non-neutral in terms of impacts on both welfare and inequality. In spite of their multivariate form, a tentative assessment of such inequality impacts can be provided by using a general equilibrium model with heterogeneous-agents and where wealth and income distribution is determined endogenously. Using a model capable of exploring the relationship between fiscal policy variables and the endogenous cross-section distribution of income, wealth, consumption and leisure, this paper produces a welfare and inequality analysis of several equilibriums resulting from different combinations of debt levels and of government budget variables. Moreover, such assessment is based on the empirical reality of the EU countries.
    Keywords: government budget composition and debt, heterogeneous agent model, idiosyncratic shock, inequality, welfare.
    JEL: E17 E60 H60 I30
    Date: 2011–06
  14. By: Onishchenko, Kateryna (Cardiff Business School)
    Abstract: Real exchange rate (RER) is an important instrument for restoring sustainable economic growth in the small open economy with large export share. RER of Ukrainian currency can be explained within the real business cycle (RBC) framework without any forms of nominal rigidities. Fitting Ukrainian quarterly data for the period of 1996:Q1-2009:Q3 into the small open economy real business cycle model and testing it by method of indirect inference shows that RER can be reproduced by RBC framework. The generated pseudo-samples for RER by method of bootstrapping allow to obtain the distribution of the best fit ARIMA(2,1,4) parameters and to show with the Wald statistics that those parameters lie within 95% confidence intervals of those estimated for bootstrapped pseudo Q parameters.
    Keywords: sustainable economic growth; business cycle; real exchange rates; small open economy; indirect inference; ARIMA
    JEL: E31 E32 E37 F31 F37
    Date: 2011–06
  15. By: Basu, Parantap; Bhattarai, Keshab
    Abstract: A surprising cross country stylized fact is that a higher public spending on education tends to lower the long run per capita growth rate and schooling returns. This is contrary to the conventional wisdom that education is a major driver of growth. In this paper, we revisit this issue and try to understand these puzzling facts in terms of an endogenous growth model. Our cross country calibration of the growth model predicts that countries with a greater government involvement in education experience lower schooling efforts and lower growth.
    Keywords: endogenous growth; public spending on education
    JEL: E62 N10
    Date: 2011–03–02
  16. By: Bick, Alexander; Choi, Sekyu
    Abstract: In the quantitative macroeconomics literature, single agent models are widely used to explain ``per-adult equivalent'' data, which are obtained at the household level. In this paper we suggest a simple framework to understand the sources of bias when these models are used to make predictions for aggregate consumption. In both a theoretical and a quantitative exercise, we find that economies of scale in consumption inside the household are positively related to the bias introduced by the single agent approach in predicted consumption profiles over the life-cycle. We also do an external validation exercise, which suggests that economies of scale inside the household are rather large, pointing out the need to approach life-cycle consumption with models that consider households rather than single agents.
    Keywords: Consumption, Life-Cycle Models, Households
    JEL: J10 D12 D91 E21
    Date: 2011–02
  17. By: Damiano Sandri
    Abstract: In this paper we assess the implications of precautionary savings for global imbalances by considering a world economy model composed by the US, the Euro Area, Japan, China, oil-exporting countries, and the rest of the world. These areas are assumed to differ only with respect to GDP volatility which is calibrated based on the 1980-2008 period. The model predicts a wide dispersion in net foreign asset positions, with the highly volatile oil-exporting countries accumulating very large asset holdings. While heterogeneity in GDP volatility may lead to large imbalances in international investment positions, its impact on current accounts is much weaker. This is because countries are expected to move towards their optimal NFA at a very slow pace.
    Date: 2011–05–31
  18. By: Konstantins Benkovskis (Bank of Latvia, K. Valdemara street 2A, Riga, LV-1050, Latvia.); Michele Caivano (Banca d’Italia, Italy.); Antonello D’Agostino (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Alistair Dieppe (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Samuel Hurtado (Banco de España, Spain.); Tohmas Karlsson (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Eva Ortega (Banco de España, Spain.); Tímea Várnai (National Bank of Hungary, 1054 Szabadság tér 8/9, 1850 Budapest.)
    Abstract: A number of academic studies suggest that from the mid-1990s onwards there were changes in the link between inflation and economic activity. However, it remains unclear the extent to which this phenomenon can be ascribed to a change in the structural relationship between inflation and output, as opposed to a change in the size and nature of the shocks hitting the economy. This paper uses a suite of models, such as time-varying VAR techniques, traditional macro models, as well as DSGE models, to investigate, for various European countries as well as for the euro area, the evolution of the link between inflation and resource utilization and its dependence on the nature and size of the shocks. Our analysis suggests that the relationship between inflation and activity has indeed been changing over time, while remaining positive, with the correlation peaking during recessions. Quantitatively, the link between output and inflation is found to be highly dependent on which type of shocks hit the economy: while, in general, all demand shocks to output imply a reaction of inflation of the same sign, the latter will be less pronounced when output fluctuations are driven by supply shocks. In addition, a sharp deceleration of activity, as opposed to a subdued but protracted slowdown, results in a swifter decline in inflation. Inflation exhibits a rather strong persistence, with a negative impact still visible three years after the initial shock. JEL Classification: E31, E32, E37.
    Keywords: Demand shock, inflation response, macro model, output growth, Phillips curve.
    Date: 2011–06
  19. By: Albert Marcet; Ramon Marimon
    Abstract: We obtain a recursive formulation for a general class of contracting problems involving incentive constraints. These constraints make the corresponding maximization (sup) problems non recursive. Our approach consists of studying a recursive Lagrangian. Under standard general conditions, there is a recursive saddle-point (infsup) functional equation (analogous to a Bellman equation) that characterizes the recursive solution to the planner's problem and forward-looking constraints. Our approach has been applied to a large class of dynamic contractual problems, such as contracts with limited enforcement, optimal policy design with implementability constraints, and dynamic political economy models.
    Keywords: Transactional relationships, contracts and reputation, recursive formulation,participation constraint
    JEL: D80 L14
    Date: 2011–06
  20. By: Cordoba, Juan Carlos; Ripoll, Marla
    Abstract: The evidence strongly suggests a robust negative relationship between income and fertility, and a positive relationship between income and longevity. This is puzzling for standard dynamic models. For instance, altruistic models that use the most standard preferences in macro --time separable CRRA with low elasticity of intertemporal substitution (EIS)-- correctly predict a positive longevity-income relationship for rich individuals, but also predict a positive fertility-income relationship, contrary to the data. We show that a non-separable formulation of preferences that allows for a low EIS but a high "elasticity of intergenerational substitution" (EGS) can simultaneously account for the evidence of declining demand for children and increasing demand for longevity as income increases. The model with a single elasticity cannot account for both. Our results suggests a major role for a new parameter in macro, the EGS. While the EIS mostly influences short-term economic decisions, the EGS influences mostly long-term economic choices.
    Keywords: Fertility; Altruism; Non-separable Preferences; Frictions
    JEL: D00 D1 D6 D9 J1 O1 R2
    Date: 2011–06–20
  21. By: Jaśkiewicz, Anna; Matkowski, Janusz; Nowak, Andrzej S.
    Abstract: In this paper we study a Markov decision process with a non-linear discount function. Our approach is in spirit of the von Neumann-Morgenstern concept and is based on the notion of expectation. First, we define a utility on the space of trajectories of the process in the finite and infinite time horizon and then take their expected values. It turns out that the associated optimization problem leads to a non-stationary dynamic programming and an infinite system of Bellman equations, which result in obtaining persistently optimal policies. Our theory is enriched by examples.
    Keywords: Stochastic dynamic programming; Persistently optimal policies; Variable discounting; Bellman equation; Resource extraction; Growth theory
    JEL: D90 C61
    Date: 2011–06–21

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