nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2011‒10‒01
eighteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Optimal Unemployment Insurance Over the Business Cycle By Camille Landais; Pascal Michaillat; Emmanuel Saez
  2. Labor-Market Heterogeneity, Aggregation, and the Policy-(In)variance of DSGE Model Parameters By Yongsung Chang; Sun-Bin Kim; Frank Schorfheide
  3. Medium Term Business Cycles in Developing Countries By Comin, Diego; Loayza, Norman; Pasha, Farooq; Servén, Luis
  4. The role of demography on per capita output growth and saving rates By Miguel Sánchez Romero
  5. Age Before Beauty? Productivity and Work vs. Seniority and Early Retirement By Giovanni Mastrobuoni; Filippo Taddei
  6. Monetary policy in a non-representative agent economy: A survey By Michał Brzoza-Brzezina; Marcin Kolasa; Grzegorz Koloch; Krzysztof Makarski; Michal Rubaszek
  7. Clearing Up the Fiscal Multiplier Morass By Eric M. Leeper; Nora Traum; Todd B. Walker
  8. Fiscal Policy in Debt Constrained Economies By Mark A. Aguiar; Manuel Amador
  9. Labor Share Fluctuations in Emerging Markets: The Role of the Cost of Borrowing By Serdar Kabaca
  11. Precautionary price stickiness By James Costain; Anton Nakov
  12. DSGE model estimation on base of second order approximation By Sergey Ivashchenko
  13. Monetary policy and sunspot fluctuation in the U.S. and the Euro area By Hirose, Yasuo
  14. Financial-Friction Macroeconomics with Highly Leveraged Financial Institutions By Luk, Sheung Kan; Vines, David
  15. Driving Forces of the Swiss Output Gap By Stefan Leist
  16. Optimal Growth with Heterogeneous Agents and the Twisted Turnpike: An Example By Robert Becker
  17. International Recessions By Fabrizio Perri; Vincenzo Quadrini
  18. Means-Tested Subsidies and Economic Performance Since 2007 By Casey B. Mulligan

  1. By: Camille Landais; Pascal Michaillat; Emmanuel Saez
    Abstract: This paper characterizes optimal unemployment insurance (UI) over the business cycle using a model of equilibrium unemployment in which jobs are rationed in recession. It offers a simple optimal UI formula that can be applied to a broad class of equilibrium unemployment models. In addition to the usual statistics (risk aversion and micro-elasticity of unemployment with respect to UI), a macro-elasticity appears in the formula to capture the macroeconomic impact of UI on unemployment. In a model with job rationing, the formula implies that optimal UI is countercyclical. This result arises because in recession, jobs are lacking irrespective of job search. Therefore (1) a higher aggregate search effort cannot reduce aggregate unemployment much; and (2) individual search effort creates a negative externality by reducing other jobseekers' probability of finding a job as in a rat race. Hence the social benefits of job search are low. In a calibrated model, optimal UI increases significantly in recession. This quantitative result holds whether the government adjusts the level or duration of benefits; whether it balances its budget each period or uses deficit spending.
    Keywords: Unemployment insurance, business cycle, job rationing, matching frictions
    JEL: E24 E32 H21 H23
    Date: 2011–09
  2. By: Yongsung Chang (University of Rochester); Sun-Bin Kim (Yonsei University); Frank Schorfheide (University of Pennsylvania)
    Abstract: Data from a heterogeneous-agents economy with incomplete asset markets and indivisible labor supply are simulated under various fiscal policy regimes and an approximating representative-agent model is estimated. Preference and technology parameter estimates of the representative-agent model are not invariant to policy changes and the bias in the representative-agent model’s policy predictions is large compared to predictive intervals that reflect parameter uncertainty. Since it is not always feasible to account for heterogeneity explicitly, it is important to recognize the possibility that the parameters of a highly aggregated model may not be invariant with respect to policy changes.
    Keywords: Aggregation, DSGE Models, Fiscal Policy, Heterogeneous-Agents Economy, Policy Predictions, Representative-Agent Models
    JEL: C11 C32 E32 E62
    Date: 2011–09
  3. By: Comin, Diego; Loayza, Norman; Pasha, Farooq; Servén, Luis
    Abstract: Business cycle fluctuations in developed economies (N) tend to have large and persistent effects on developing countries (S). We study the transmission of business cycle fluctuations for developed to developing economies with a two-country asymmetric DSGE model with two features: (i) endogenous and slow diffusion of technologies from the developed to the developing country, and (ii) adjustment costs to investment flows. Consistent with the model we observe that the flow of technologies from N to S co-moves positively with output in both N and S. After calibrating the model to Mexico and the U.S., it can explain the following stylized facts: (i) U.S. and Mexican output co-move more than consumption; (ii) U.S. shocks have a larger effect on Mexico than in the U.S.; (iii) U.S. business cycles lead over medium term fluctuations in Mexico; (iv) Mexican consumption is more volatile than output.
    Keywords: business cycles in developing countries; co-movement between developed and developing economies; extensive margin of trade; FDI; product life cycle; volatility
    JEL: E3 O3
    Date: 2011–09
  4. By: Miguel Sánchez Romero (Max Planck Institute for Demographic Research, Rostock, Germany)
    Abstract: Computable OLG growth models and "convergence models" differ in their assessment of the extent to which demography influences economic growth. In this paper, I show that computable OLG growth models produce results similar to those of convergence models when more detailed demographic information is used. To do so, I implement a general equilibrium overlapping generations model to explain Taiwan's economic miracle during the period 1965-2005. I find that Taiwan's demographic transition accounts for 22% of per capita output growth, 16.4% of the investment rate, and 18.5% of the savings rate for the period 1965-2005. Decomposing the demographic effect into its components, I find that fertility alone explains the impact of demographic changes in per capita output growth, while both fertility and mortality explain investment and saving rates. Assuming a small open economy, I find that investment rates increase with more rapid population growth, while saving rates follows the dependence hypothesis (Coale and Hoover, 1958). Under a closed-economy, the population growth rate has a negative influence on economic growth.
    Keywords: Taiwan, demography, economic growth
    JEL: J1 Z0
    Date: 2011–09
  5. By: Giovanni Mastrobuoni (Collegio Carlo Alberto, CeRP and Netspar); Filippo Taddei (Collegio Carlo Alberto and CeRP)
    Abstract: We show how the age prole of earnings, retirement rules and retirement behavior are tightly linked through the general equilibrium of the economy. Generous Social Security benets nanced by large Social Security taxes discourage human capital accumulation. In Social Security systems where Social Security benets prioritize redistribution less productive workers with lower levels of human capital tend to retire earlier. These out ows of workers from the labor force tend to generate wage proles that are monotonically increasing over age and labor markets that display larger seniority premia. This paper theoretically rationalizes the links between retirement rules and the wage structures over the life cycle and uses data on European countries to show how social security taxes, the age prole of earnings, and retirement behavior are related.
    Keywords: Social Security tax, early retirement, age prole of earnings, human capital, seniority premium
    JEL: H53 H55 D72
    Date: 2011–05
  6. By: Michał Brzoza-Brzezina (National Bank of Poland, Economic Institute; Warsaw School of Economics); Marcin Kolasa (National Bank of Poland, Economic Institute; Warsaw School of Economics); Grzegorz Koloch (National Bank of Poland, Economic Institute); Krzysztof Makarski (National Bank of Poland, Economic Institute; Warsaw School of Economics); Michal Rubaszek (National Bank of Poland, Economic Institute; Warsaw School of Economics)
    Abstract: It is well-known that central bank policies affect not only macroeconomic aggregates, but also their distribution across economic agents. Similarly, a number of papers demonstrated that heterogeneity of agents may matter for the transmission of monetary policy on macro variables. Despite this, the mainstream monetary economics literature has so far been dominated by dynamic stochastic general equilibrium (DSGE) models with representative agents. This article aims to tilt this imbalance towards heterogeneous agents setups by surveying the main positive and normative findings of this line of the literature, and suggesting areas in which these models could be implemented. In particular, we review studies that analyze the heterogeneity of (i) households’ income, (ii) households’ preferences, (iii) consumers’ age, (iv) expectations, and (v) firms’ productivity and financial position. We highlight the results on issues that, by construction, cannot be investigated in a representative agent framework and discuss important papers modifying the findings from the representative agent literature.
    Keywords: Heterogeneous Agents; Monetary Policy
    JEL: E31 E32 E43 E44 E52
    Date: 2011
  7. By: Eric M. Leeper; Nora Traum; Todd B. Walker
    Abstract: Bayesian prior predictive analysis of five nested DSGE models suggests that model specifications and prior distributions tightly circumscribe the range of possible government spending multipliers. Multipliers are decomposed into wealth and substitution effects, yielding uniform comparisons across models. By constraining the multiplier to tight ranges, model and prior selections bias results, revealing less about fiscal effects in data than about the lenses through which researchers choose to interpret data. When monetary policy actively targets inflation, output multipliers can exceed one, but investment multipliers are likely to be negative. Passive monetary policy produces consistently strong multipliers for output, consumption, and investment.
    JEL: C11 E62 E63
    Date: 2011–09
  8. By: Mark A. Aguiar; Manuel Amador
    Abstract: We study optimal fiscal policy in a small open economy (SOE) with sovereign and private default risk. The SOE's government uses linear taxation to fund exogenous expenditures and uses public debt to inter-temporally allocate tax distortions. We characterize a class of environments in which the tax on labor goes to zero in the long run, while the tax on capital income may be non-zero, reversing the standard prediction of the Ramsey tax literature. The zero labor tax is an optimal long run outcome if the private agents are impatient relative to the international interest rate and the economy is subject to sovereign debt constraints. The front loading of labor taxes allows the economy to build a large (aggregate) debt position in the presence of limited commitment. We show that a similar result holds in a closed economy with imperfect inter-generational altruism.
    JEL: E62 F41 H63
    Date: 2011–09
  9. By: Serdar Kabaca (University of British Columbia (UBC), Department of Economics)
    Abstract: This paper contributes to the literature by documenting labor income share fluctuations in emerging economies and proposing an explanation for them. We show that emerging markets differ from developed markets in terms of changes in the labor share over the business cycle. Labor share is more volatile in emerging markets and is pro-cyclical with output, especially in countries facing counter-cyclical interest rates. On the contrary, labor share in developed markets is more stable and slightly counter-cyclical with output. A frictionless RBC model cannot account for these facts. We introduce working capital into an RBC model, which generates liquidity need for labor payments. The main result is that the behavior of the cost of borrowing along with working capital mechanisms can predict the right sign of the comovement between labor share and output, and can partly be responsible for the volatility of labor share. We also show that imperfect financial markets in the form of credit restrictions not only amplify the results for the variability of labor share but also help better explain some of the striking business cycle regularities in emerging markets such as strongly pro-cyclical investment and counter-cyclical net exports.
    Keywords: labor income share, emerging markets, working capital, credit constraints
    JEL: E25 F41 E44
    Date: 2011–09
  10. By: Mertens, Jean-Francois (CORE, Universite Catholique de Louvain); Rubinchik, Anna (Department of Economics, University of Haifa)
    Abstract: For two independent principles of intergenerational equity, the implied discount rate equals the growth rate of real per capita income, say, 2%, thus falling right into the range suggested by the U.S. Office of Management and Budget. To prove this, we develop a simple tool to evaluate small policy changes affecting several generations, by reducing the dynamic problem to a static one. A necessary condition is time invariance, which is satisfied by any common solution concept in an overlapping-generations model with exogenous growth. This tool is applied to derive the discount rate for cost-benefit analysis under two different utilitarian welfare functions: classical and relative. It is only with relative utilitarianism, and assuming time-invariance of the set of alternatives (policies), that the discount rate is well defined for a heterogeneous society at a balanced growth equilibrium, is corroborated by an independent principle equating values of human lives, and equals the growth rate of real per-capita income.
    Keywords: Overlapping Generations, Policy Reform, Intergenerational Equity, Cost-Benefit Analysis, Discount Rate, Utilitarianism
    JEL: D31 D61 D63 E60 H43
    Date: 2011–06–01
  11. By: James Costain (Banco de España); Anton Nakov (Banco de España)
    Abstract: This paper proposes two models in which price stickiness arises endogenously even though fi rms are free to change their prices at zero physical cost. Firms are subject to idiosyncratic and aggregate shocks, and they also face a risk of making errors when they set their prices. In our fi rst specifi cation, fi rms are assumed to play a dynamic logit equilibrium, which implies that big mistakes are less likely than small ones. The second specifi cation derives logit behavior from an assumption that precision is costly. The empirical implications of the two versions of our model are very similar. Since fi rms making suffi ciently large errors choose to adjust, both versions generate a strong “selection effect” in response to a nominal shock that eliminates most of the monetary nonneutrality found in the Calvo model. Thus the model implies that money shocks have little impact on the real economy, as in Golosov and Lucas (2007), but fi ts microdata better than their specifi cation.
    Keywords: Nominal rigidity, logit equilibrium, state-dependent pricing, (S,s) adjustment, near-rational behavior
    JEL: E31 D81 C72
    Date: 2011–09
  12. By: Sergey Ivashchenko
    Abstract: This article compares properties of different non-linear Kalman filters: well-known Unscented Kalman filter (UKF), Central Difference Kalman Filter (CDKF) and unknown Quadratic Kalman filter (QKF). Small financial DSGE model is repeatedly estimated by maximum quasi-likelihood methods with different filters for data generated by the model. Errors of parameters estimation are measure of filters quality. The result is that QKF has reasonable advantage in quality over CDKF and UKF with some loose in speed.
    Keywords: DSGE, QKF, CDKF, UKF, quadratic approximation, Kalman filtering
    JEL: C13 C32 E32
    Date: 2011–09–20
  13. By: Hirose, Yasuo
    Abstract: We estimate a two-country open economy version of the New Keynesian DSGE model for the U.S. and the Euro area, using Bayesian techniques that allow for both determinacy and indeterminacy of the equilibrium. Our empirical analysis shows that the worldwide equilibrium is indeterminate due to a passive monetary policy in the Euro area, even if U.S. policy is aggressive enough. We demonstrate that the impulse responses under indeterminacy exhibit different dynamics than those under determinacy and that sunspot shocks affect the Euro economy to a substantial degree, while the transmission of sunspots to the U.S. is limited.
    Keywords: Monetary Policy; Indeterminacy; Sunspot Shock; Open Economy Model; Bayesian Analysis
    JEL: E52 F41 C11 C62
    Date: 2010–11
  14. By: Luk, Sheung Kan; Vines, David
    Abstract: This paper adds a highly-leveraged financial sector to the Ramsey model of economic growth and shows that this causes the economy to behave in a highly volatile manner: doing this strongly augments the macroeconomic effects of aggregate productivity shocks. Our model is built on the financial accelerator approach of Bernanke, Gertler and Gilchrist (BGG), in which leveraged goods-producers, subject to idiosyncratic productivity shocks, borrow from a competitive financial sector. In the present paper, by contrast, it is the financial institutions which are leveraged and subject to idiosyncratic productivity shocks. Financial institutions can only obtain their funds by paying an interest rate above the risk-free rate, and this risk premium is anti-cyclical, and so augments the effects of shocks. Our parameterisation, based on US data, is one in which the leverage of the financial sector is two and a half times that of the goods-producers in the BGG model. This causes a much more significant augmentation of aggregate productivity shocks than that which is found in the BGG model.
    Keywords: financial accelerator; highly leveraged financial institutions; leverage; volatility
    JEL: E22 E32 E44
    Date: 2011–09
  15. By: Stefan Leist
    Abstract: Contrary to standard agnostic statistical approaches an output gap estimate based on a New Keynesian Small Open Economy model provides the possibility to analyze the driving forces of the variation in GDP caused by nominal rigidities. This paper makes use of this and provides an estimate of a model based output gap that corresponds well with conventional measures. The results confirm conventional wisdom that most of the variation is due to foreign shocks. But the risk premium shock in the uncovered interest rate parity equation also plays an important role. It has a procyclical effect on the output gap except for the last recession.
    Keywords: DSGE models; output gap; natural level of output; small open economy; business cycle; recessions
    JEL: C11 C51 E32 F41
    Date: 2011–09
  16. By: Robert Becker (Indiana University)
    Abstract: The dynamics of a welfare maximizing, heterogeneous agent, one sector optimal Ramsey model is analyzed assuming two agents, each with a distinct discount factor and log utility. Production is Cobb-Douglas. Explicit time varying policy functions are derived, one for each period. A Twisted Turnpike Property and eventually monotone dynamics are demonstrated to govern the evolution of the economy’s aggregate capital stock.
    Date: 2011–09
  17. By: Fabrizio Perri (University of Minnesota and Federal Reserve Bank of Minneapolis (email:; Vincenzo Quadrini (University of Southern California)
    Abstract: The 2008-2009 crisis was characterized by an unprecedented degree of international synchronization as all major industrialized countries experienced large macroeconomic contractions. Countries also experienced large and synchronized contractions in the growth of financial flows. In this paper we present a two-country model with financial markets frictions where credit-driven recessions can explain these features of the recent crisis. A credit contraction can emerge as a self-fulling equilibrium caused by pessi- mistic but fully rational expectations. As a result of the credit contraction, in a financially integrated world, countries experience large and, endogenously synchronized, declines in asset prices and economic activity ( international recessions).
    Date: 2011–09
  18. By: Casey B. Mulligan
    Abstract: The aggregate neoclassical growth model – with means-tested subsidies whose replacement rates began rising at the end of 2007 as its only impulse – produces time series for aggregate labor usage, consumption, investment, and real GDP that closely resemble actual U.S. time series. Despite having no explicit financial market, the model has investment fall steeply during the recession not because of any distortions with the supply of capital, but merely because labor is falling and labor is complementary with capital in the production function. Through the lens of the model, the fact that real consumption fell significantly below trend during 2008 suggests that labor usage per capita is expected to remain well below pre-recession levels for several years.
    JEL: E24 E32 H31 O41
    Date: 2011–09

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