New Economics Papers
on Dynamic General Equilibrium
Issue of 2011‒07‒27
fifteen papers chosen by

  1. Real Business Cycles with a Human Capital Investment Sector and Endogenous Growth: Persistence, Volatility and Labor Puzzles By Jing Dang; Max Gillman; Michal Kejak
  2. Longevity, Life-cycle Behavior and Pension Reform By Peter Haan; Victoria Prowse
  3. Does bargaining matter in the small firm's matching model? By Olivier l’Haridon; Franck Malherbet; Sébastien Pérez-Duarte
  4. Fiscal News and Macroeconomic Volatility By Benjamin Born; Alexandra Peter; Johannes Pfeifer
  5. Cycles, Gaps, and the Social Value of Information By George-Marios Angeletos; Luigi Iovino; Jennifer La'O
  6. Towards a micro-founded theory of aggregate labor supply By Andrés Erosa; Luisa Fuster; Gueorgui Kambourov
  7. Informality, Frictions and Monetary Policy By Nicoletta Batini; Paul Levine; Emanuela Lotti; Bo Yang
  8. Growth on a Finite Planet: Resources, Technology and Population in the Long Run By Pietro Peretto; Simone Valente
  9. The Era of the U.S.-Europe Labor Market Divide: What can we learn? By Philip, Jung; Moritz, Kuhn
  10. Contractual Dualism, Market Power and Informality By Basu, Arnab K; Chau, Nancy H; Kanbur, Ravi
  11. Bank Overleverage and Macroeconomic Fragility By Ryo Kato; Takayuki Tsuruga
  12. On the impact of the TFP growth on the employment rate: does training on-the-job matter? By Eva Moreno-Galbis
  13. International Recessions By Perri, Fabrizio; Quadrini, Vincenzo
  14. A Gains from Trade Perspective on Macroeconomic Fluctuations By Beaudry, Paul; Portier, Franck
  15. Sources of Entropy in Representative Agent Models By David Backus; Mikhail Chernov; Stanley E. Zin

  1. By: Jing Dang (State Grid Corporation of China (SGCC)); Max Gillman (Institute of Economics - Hungarian Academy of Sciences); Michal Kejak (The Center for Economic Research and Graduate Education of Charles University (CERGE EI))
    Abstract: An identical two-sector productivity shock causes Rybczynski (1955) and Stolper and Samuelson (1941) effects that release leisure time and initially raise the relative price of human capital investment so as to favor it over goods production. Modified by having the household sector produce human capital investment sector, the RBC model follows the international approach of Maffezzoli (2000) and so adds a second sector relative to Jones et al. (2005). This captures key major US RBC data: output growth persistence, with hump-shaped impulse responses; hump-shaped physical capital investment impulse responses; Gali's (1999) negative impulse response of labour supply; and hours volatility.
    Keywords: real business cycle, human capital, endogenous growth
    JEL: E24 E32 O41
    Date: 2011–06
  2. By: Peter Haan; Victoria Prowse
    Abstract: How can public pension systems be reformed to ensure fiscal stability in the face of increasing life expectancy? To address this pressing open question in public finance, we estimate a life-cycle model in which the optimal employment, retirement and consumption decisions of forward-looking individuals depend, inter alia, on life expectancy and the design of the public pension system. We calculate that, in the case of Germany, the fiscal consequences of the 6.4 year increase in age 65 life expectancy anticipated to occur over the 40 years that separate the 1942 and 1982 birth cohorts can be offset by either an increase of 4.34 years in the full pensionable age or a cut of 37.7% in the per-year value of public pension benefits. Of these two distinct policy approaches to coping with the fiscal consequences of improving longevity, increasing the full pensionable age generates the largest responses in labor supply and retirement behavior.
    Keywords: Life expectancy, public pension reform, retirement, employment, life-cycle models, consumption, tax and transfer system
    JEL: D91 J11 J22 J26 J64
    Date: 2011
  3. By: Olivier l’Haridon (Greg-HEC, Institut Universitaire de France and University Paris Sorbonne.); Franck Malherbet (Université de Rouen, CECO – Ecole Polytechnique, IZA and fRDB.); Sébastien Pérez-Duarte (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: In this article, we use a stylized model of the labor market to investigate the effects of three alternative and well-known bargaining solutions. We apply the Nash, the Egalitarian and the Kalai-Smorodinsky bargaining solutions in the small firm's matching model of unemployment. To the best of our knowledge, this is the first attempt to implement and systematically compare these solutions in search-matching economies. Our results are twofold. First from the theoretical and methodological viewpoint, we extend a somewhat flexible search-matching economy to alternative bargaining solutions. In particular, we prove that the Egalitarian and the Kalai-Smorodinsky solutions are easily implementable within search-matching economies. Second, our results show that even though the traditional results of bargaining theory apply in this context, they are generally qualitatively different from the standard results, and the differences are quantitatively weaker than expected. This is of particular relevance in comparison with the results established in the earlier literature. JEL Classification: C71, C78, J20, J60.
    Keywords: Search and matching models, Bargaining theory, Nash, Egalitarian, Kalai-Smorodinsky.
    Date: 2011–07
  4. By: Benjamin Born; Alexandra Peter; Johannes Pfeifer
    Abstract: This paper analyzes the contribution of anticipated capital and labor tax shocks to business cycle volatility in an estimated New Keynesian DSGE model. While fiscal policy accounts for 12 to 20 percent of output variance at business cycle frequencies, the anticipated component hardly matters for explaining fluctuations of real variables. Anticipated capital tax shocks do explain a sizable part of inflation and interest rate fluctuations, accounting for between 5 and 15 percent of total variance. In line with earlier studies, news shocks in total account for 20 percent of output variance. Further decomposing this news effect, we find that it is mostly driven by stationary TFP and non-stationary investment-specific technology.
    Keywords: Anticipated Tax Shocks; Sources of Aggregate Fluctuations; Bayesian Estimation
    JEL: E32 E62 C11
    Date: 2011–07
  5. By: George-Marios Angeletos; Luigi Iovino; Jennifer La'O
    Abstract: What are the welfare effects of the information contained in macroeconomic statistics, central-bank communications, or news in the media? We address this question in a business-cycle framework that nests the neoclassical core of modern DSGE models. Earlier lessons that were based on “beauty contests” (Morris and Shin, 2002) are found to be inapplicable. Instead, the social value of information is shown to hinge on essentially the same conditions as the optimality of output stabilization policies. More precise information is unambiguously welfare-improving as long as the business cycle is driven primarily by technology and preference shocks—but can be detrimental when shocks to markups and wedges cause sufficient volatility in “output gaps.” A numerical exploration suggests that the first scenario is more plausible.
    JEL: C7 D6 D8
    Date: 2011–07
  6. By: Andrés Erosa (IMDEA Social Sciences Institute); Luisa Fuster (IMDEA Social Sciences Institute); Gueorgui Kambourov (University of Toronto)
    Abstract: We document various facts about the labor supply decisions of male workers in the US over their life cycle. We then build a neoclassical model of labor markets with non-linear wages and heterogeneous agents. The key model feature for delivering periods of non-participation is the non-linear mapping between hours of work and earnings. We show that our model can go a long way towards capturing salient features of individual labor supply over the life cycle. Moreover, the aggregate response of labor supply to a one time unanticipated wage shock is much larger than predicted by the Frisch elasticity of labor supply.
    Keywords: aggregate labor supply; intensive margin; extensive margin; heterogeneous agents; life cycle
    JEL: D9 E2 E13 E62 J22
    Date: 2011–07–13
  7. By: Nicoletta Batini (University of Surrey and IMF); Paul Levine (University of Surrey); Emanuela Lotti (University of Southampton and University of Surrey); Bo Yang (University of Surrey)
    Abstract: How does informality in emerging economies affect the conduct of monetary policy? To answer this question we construct a two-sector, formal-informal new Keynesian closed-economy. The informal sector is more labour intensive, is untaxed, has a classical labour market, faces high credit constraints in financing investment and is less visible in terms of observed output. We compare outcomes under welfare-optimal monetary policy, discretion and welfare-optimized interest-rate Taylor rules building the model in stages; first with no frictions in these two markets, then with frictions in only the formal labour market and finally with frictions on both credit markets and the formal labour market. Our main conclusions are first, labour and financial market frictions, the latter assumed to be stronger in the informal sector, cause the time-inconsistency problem to worsen. The importance of commitment therefore in- creases in economies characterized by a large informal sector with the features we have highlighted. Simple implementable optimized rules that respond only to observed aggregate inflation and formal-sector output can be significantly worse in welfare terms than their optimal counterpart, but are still far better than discretion. Simple rules that respond, if possible, to the risk premium in the formal sector result in a significant welfare improvement.
    Keywords: Informal economy, emerging economies, labour market, credit market, tax policy, interest rate rules
    JEL: J65 E24 E26 E32
    Date: 2011–07
  8. By: Pietro Peretto; Simone Valente
    Abstract: We study the interactions between technological change, resource scarcity and population dynamics in a Schumpeterian model with endogenous fertility. There exists a pseudo-Malthusian equilibrium in which population is constant and income grows exponentially: the equilibrium population level is determined by resource scarcity but is independent of technology. The stability properties are driven by (i) the income reaction to increased resource scarcity and (ii) the fertility response to income dynamics. If labor and resources are substitutes in production, income and fertility dynamics are self-balancing and the pseudo-Malthusian equilibrium is the global attractor of the system. If labor and resources are complements, income and fertility dynamics are self-reinforcing and drive the economy towards either demographic explosion or human extinction. Introducing a minimum resource requirement, we obtain a second steady state implying constant population even under complementarity. The standard result of exponential population growth appears as a rather special case of our model.
    Keywords: Endogenous Innovation, Resource Scarcity, Population Growth, Fertility Choices
    JEL: E10 L16 O31 O40
    Date: 2011
  9. By: Philip, Jung; Moritz, Kuhn
    Abstract: Comparing labor markets in the United States and Germany as Europe’s largest economy over the period from 1980−2004 uncovers three stylized differences: (1) Germany’s mean transition rates from unemployment to employment (UE) were lower by a factor of 5 and transition rates from employment to unemployment (EU) were lower by a factor of 4. (2) The volatility of the UE rate was equal in both countries, but the EU rate was 2.3 times more volatile in Germany. (3) In Germany EU flows contributed 60−70% to unemployment volatility, whereas in the U.S. they contributed only 30−40%. Using a search and matching model we show theoretically that the joint analysis of first and second moments offers general identification restrictions on the underlying causes for these differences. We find that a lower efficiency in the matching process can consistently explain the facts while alternative explanations such as employment protection, the benefit system, union power, or rigid earnings can not. We document that a lower matching efficiency due to lower occupational and regional mobility in Germany finds strong support in the data. Finally, we show that the highlighted matching friction leads in the model calibrated to the German economy to a substantial amplification and propagation of shocks.
    Keywords: Business Cycle Fluctuations; Labor Market Institutions; Unemployment; Endogenous Firing
    JEL: E32 E24
    Date: 2011–07–19
  10. By: Basu, Arnab K; Chau, Nancy H; Kanbur, Ravi
    Abstract: Two stylized representations are often found in the academic and policy literature on informality and formality in developing countries. The first is that the informal (or unregulated) sector is more competitive than the formal (or regulated) sector. The second is that contract enforcement is easier in the formal sector than in the informal sector, precisely because the formal sector comes under the purview of state regulation. The basic contention of this paper is that these two representations are not compatible with each other. We develop a search-theoretic model of contractual dualism in the labor market where the inability to commit to contracts in the informal sector leads to employer market power in equilibrium, while an enforced minimum wage in the formal sector provides employers with a commitment technology but which reduces their market power in equilibrium. The contributions of this paper are three-fold. It (i) provides the micro-underpinnings for endogenous determination of employer market power in the formal and informal sectors due to contractual dualism in the two sectors, (ii) offers a unified and coherent setup whereby a host of salient features of developing country labor markets can be explained together, and (iii) places the original Stiglerian prescription of the optimal (unemployment minimizing) minimum wage in the broader context of labor markets where formal job creation is costly, and where formal employment, informal employment, and unemployment co-exist.
    Keywords: Contractual Dualism; Employer Market Power; Informality; Wage Dualism
    JEL: J3 J6 O17
    Date: 2011–07
  11. By: Ryo Kato (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:; Takayuki Tsuruga (Associate Professor, Graduate School of Economics, Kyoto University, (E-mail:
    Abstract: This paper develops a dynamic general equilibrium model that explicitly includes a banking sector with a maturity mismatch. We demonstrate that, despite the perfect competition in the banking sector, rational banks take on excessive risks systemically, resulting in overleverage and inefficiently high crisis probabilities. The model accounts for the banks' rational over-optimism regarding future capital prices which arises from pecuniary externalities on their own solvency. Using the model as an example, we introduce MSR (marginal systemic risk) as a general measure to assess the macroeconomic exposure to systemic risks.
    Keywords: Financial crisis, Liquidity shortage, Maturity mismatch, Pecuniary externalities
    JEL: E3 G21
    Date: 2011–07
  12. By: Eva Moreno-Galbis
    Keywords: TFP growth, unemployment, training, human capital depreciation, capitalization, creative destruction effect
    JEL: J23 J24 O33
    Date: 2010–12–15
  13. By: Perri, Fabrizio; Quadrini, Vincenzo
    Abstract: The 2008-2009 crisis was characterized by an unprecedented degree of international synchronization as all major industrialized countries experienced large macroeconomic contractions around the date of Lehman bankruptcy. At the same time countries also experienced large and synchronized tightening of credit conditions. We present a two-country model with financial market frictions where a credit tightening can emerge as a self-fulfilling equilibrium caused by pessimistic but fully rational expectations. As a result of the credit tightening, countries experience large and endogenously synchronized declines in asset prices and economic activity (international recessions). The model suggests that these recessions are more severe if they happen after a prolonged period of credit expansion.
    Keywords: credit tightness; international crisis
    JEL: E32 F3
    Date: 2011–07
  14. By: Beaudry, Paul; Portier, Franck
    Abstract: Business cycles reflect changes over time in the amount of trade between individuals. In this paper we show that incorporating explicitly intra-temporal gains from trade between individuals into a macroeconomic model can provide new insight into the potential mechanisms driving economic fluctuations as well as modify key policy implications. We first show how a "gains from trade" approach can easily explain why changes in perceptions about the future (including \news" about the future) can cause booms and bust. We then turn to fiscal policy, and discuss under what conditions fiscal multipliers can be observed. While much of our analysis is conducted in a fl exible price environment, we also present implications of our model for a sticky price environments, as it allows to understand stable-in ation boom-bust cycles. The source of the explicit gains from trade in our setup derives from simply assuming that in the short run workers are not perfect mobile across all sectors of the economy. We provide evidence from the PSID in support of this modeling assumption.
    Keywords: Business Cycle; Fiscal Policy; Heterogeneous Agents; Investment; Monetary Policy
    JEL: E32
    Date: 2011–07
  15. By: David Backus; Mikhail Chernov; Stanley E. Zin
    Abstract: We propose two metrics for asset pricing models and apply them to representative agent models with recursive preferences, habits, and jumps. The metrics describe the pricing kernel’s dispersion (the entropy of the title) and dynamics (time dependence, a measure of how entropy varies over different time horizons). We show how each model generates entropy and time dependence and compare their magnitudes to estimates derived from asset returns. This exercise — and transparent loglinear approximations — clarifies the mechanisms underlying these models. It also reveals, in some cases, tension between entropy, which should be large enough to account for observed excess returns, and time dependence, which should be small enough to account for mean yield spreads.
    JEL: E44 G12
    Date: 2011–07

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