nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2011‒12‒19
thirty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Search Frictions, Financial Frictions and Labor Market Fluctuations in Emerging Economies By Sumru Altug; Serdar Kabaca; Meltem Poyraz
  2. Optimal labor-market policy in recessions By Philip Jung; Keith Kuester
  3. Efficient Learning, Job Turnover and Wage Dispersion By Fei Li
  4. Skew-normal shocks in the linear state space form DSGE model By Grzegorz Grabek; Bohdan Klos; Grzegorz Koloch
  5. Temporary Bubbles and Discount Window Policy By Tarishi Matsuoka
  6. Data Revisions in the Estimation of DSGE models By Miguel Casares; Jesús Vázquez
  7. Intangible Capital, Relative Asset Shortages and Bubbles By Tiago Severo; Stefano Giglio
  8. Long-run Welfare under Externalities in Consumption, Leisure, and Production: A Case for Happy Degrowth vs. Unhappy Growth By Ennio Bilancini; Simone D’Alessandro
  9. Housing and debt over the life cycle and over the business cycle By Matteo Iacoviello; Marina Pavan
  10. Demographic Divide and Labor Migration in the Euro-Mediterranean Region By Tosun, Mehmet S.
  12. Effects on growth of environmental policy in a small open economy By Adu, George
  13. Loose commitment in medium-scale macroeconomic models: theory and applications By Davide Debortoli; Junior Maih; Ricardo Nunes
  14. Tradable pollution permits in dynamic general equilibrium: can optimality and acceptability be reconciled? By Thierry Bréchet; Pierre-André Jouvet; Gilles Rotillon
  16. Solving DSGE Models with a Nonlinear Moving Average By Hong Lan; Alexander Meyer-Gohde
  17. External Shocks and Monetary Policy in a Small Open Oil Exporting Economy By Jean Pierre Allegret; Mohamed Tahar Benkhodja
  18. The wrong shape of insurance? What cross-sectional distributions tell us about models of consumption-smoothing By Broer, Tobias
  19. News Shocks and Asset Price Volatility in General Equilibrium By Akito Matsumoto; Pietro Cova; Massimiliano Pisani; Alessandro Rebucci
  20. Technology news and the U.S. economy: Time variation and structural changes By Berg, Tim Oliver
  21. A Quantitative Model of Sovereign Debt, Bailouts and Conditionality By Fabian Fink; Almuth Scholl
  22. International recessions By Fabrizio Perri; Vincenzo Quadrini
  23. Bank Leverage Regulation and Macroeconomic Dynamics By Ian Christensen; Césaire Meh; Kevin Moran
  24. Can standard preferences explain the prices of out-of-the-money S&P 500 put options? By Luca Benzoni; Pierre Collin-Dufresne; Robert S. Goldstein
  25. DYNAMIC MATURITY TRANSFORATION By Anatoli Segura; Javier Suarez
  26. Welfare costs of reclassification risk in the health insurance market By Pashchenko, Svetlana; Porapakkarm, Ponpoje
  27. Unemployment insurance and home production By Taskin, Temel
  28. On efficiently financing retirement By Ellen R. McGrattan; Edward C. Prescott
  29. Self-Commitment-Institutions and Cooperation in Overlapping Generations Games By Francesco Lancia; Alessia Russo
  30. Do mood swings drive business cycles and is it rational? By Paul Beaudry; Deokwoo Nam; Jian Wang
  31. Collateral Constraints and Legal Protection of Lenders: A Macroeconomic Perspective By Kunieda, Takuma; Shibata, Akihisa

  1. By: Sumru Altug (Koc University and CEPR); Serdar Kabaca (Department of Economics, University of British Columbia); Meltem Poyraz (University of Virginia)
    Abstract: This paper examines the role of the extensive and intensive margins of work in the context of business cycles in emerging markets with a financial friction. The earlier literature analyzed the role of search frictions with only an extensive margin of work and showed that such a framework can address the distinguishable business-cycle characteristics of emerging markets such as highly volatile consumption, countercyclical net exports, highly volatile wages and pro-cyclical wages. One of our contributions is to show that in the presence of an endogenous hours choice, search frictions fail to predict not only these characteristics but also the positive co-movement of hours worked per worker and employment with output. This occurs due to the strong income effect on hours worked. On the other hand, introducing a financial friction, namely working capital, significantly increases the performance of the model and suggests frictions in both labor markets and financial markets are necessary for explaining emerging market business cycles.
    Keywords: search frictions, emerging markets, business cycles, working capital
    JEL: F41 E44 J40
    Date: 2011–12
  2. By: Philip Jung; Keith Kuester
    Abstract: The authors examine the optimal labor market-policy mix over the business cycle. In a search and matching model with risk-averse workers, endogenous hiring and separation, and unobservable search effort they first show how to decentralize the constrained-efficient allocation. This can be achieved by a combination of a production tax and three labor-market policy instruments, namely, a vacancy subsidy, a layoff tax and unemployment benefits. The authors derive analytical expressions for the optimal setting of each of these for the steady state and for the business cycle. Their propositions suggest that hiring subsidies, layoff taxes and the replacement rate of unemployment insurance should all rise in recessions. The authors find this confirmed in a calibration targeted to the U.S. economy.
    Keywords: Unemployment ; Labor market ; Business cycles
    Date: 2011
  3. By: Fei Li (Department of Economics, University of Pennsylvania)
    Abstract: This paper studies the aggregate consequences of individual learning in the labor market. Specifically, I examine this issue in a model of directed search on the job. Once matched, a firm-worker pair gradually learns the match-specific quality, taking the history of realized production as signals. Heterogeneity in beliefs about the match quality and in the job search behavior of workers naturally occurs, resulting from a variety of individual histories. I describe the efficient learning and searching strategy and implement the efficient allocations through a market mechanism in which the labor contract depends deterministically on tenure. Consistent with the stylized facts, the model successfully predicts the tenure effect on both the job separation rate and the probability of on-the-job search, and when search frictions are small, the model generates a dispersed wage distribution with a at tail, along the lines of observations.
    Keywords: Learning, Directed Search, Block Recursive Equilibrium, Turnover, Wage Dispersion
    JEL: D83 J31
    Date: 2011–11–28
  4. By: Grzegorz Grabek (National Bank of Poland, Economic Institute); Bohdan Klos (National Bank of Poland, Economic Institute); Grzegorz Koloch (National Bank of Poland, Economic Institute)
    Abstract: Observed macroeconomic data – notably GDP growth rate, inflation and interest rates – can be, and usually are skewed. Economists attempt to fit models to data by matching first and second moments or co-moments, but skewness is usually neglected. It is so probably because skewness cannot appear in linear (or linearized) models with Gaussian shocks, and shocks are usually assumed to be Gaussian. Skewness requires non-linearities or non-Gaussian shocks. In this paper we introduce skewness into the DSGE framework assuming skewed normal distribution for shocks while keeping the model linear (or linearized). We argue that such a skewness can be perceived as structural, since it concerns the nature of structural shocks. Importantly, the skewed normal distribution nests the normal one, so that skewness is not assumed, but only allowed for. We derive elementary facts about skewness propagation in the state space model and, using the well-known Lubik-Schorfheide model, we run simulations to investigate how skewness propagates from shocks to observables in a standard DSGE model. We also assess properties of an ad hoc two-steps estimator of models’ parameters, shocks’ skewness parameters among them.
    JEL: C12 C13 C16 D58 E32
    Date: 2011
  5. By: Tarishi Matsuoka (Japan Society for the Promotion of Science and Graduate School of Economics, Kyoto University)
    Abstract: This paper presents a monetary growth model where limited communication and random relocation create endogenous roles for money and banks. The economy can exhibit two different regimes. In the first, money is a dominated asset and banks economize cash reserves. In the second, money has the same return as capital and banks use the reserves as storage. I show that the economy can experience switching between the two regimes and that cyclical bubbles can occur. In addition, discount window lending is considered as a counter-bubble policy. I also show that the discount window can simultaneously lead the economy to the social optimum and stabilize bubbly fluctuations when the economy is dynamically inefficient.
    Keywords: overlapping generations, temporary bubbles, discount window
    JEL: D90 E32 E44
    Date: 2011–12
  6. By: Miguel Casares (Departamento de Economía-UPNA); Jesús Vázquez (Department FAE II, Universidad del País Vasco)
    Abstract: Revisions of US macroeconomic data are not white-noise. They are persistent, correlated with real-time data, and with high variability (around 80% of volatility observed in US real-time data). Their business cycle effects are examined in an estimated DSGE model that distinguishes real-time data from final data. Both the consumption habit formation and the price indexation to lagged inflation fall significantly in the estimation. The model also shows that revision shocks of both output and inflation are expansionary because they occur when real-time published data are too low and the Fed reacts by cutting interest rates. Consumption revisions, by contrast, are countercyclical as consumption habits mirror the observed reduction in real-time consumption. Finally, revisions of the three variables explain 9.3% of changes of output in its long-run variance decomposition.
    Keywords: data revisions, DSGE models, business cycles.
    JEL: C32 E30
    Date: 2011
  7. By: Tiago Severo; Stefano Giglio
    Abstract: We analyze an overlapping generations economy with financial frictions and accumulation of both physical and intangible capital. The key difference between them is that intangible capital cannot be used as collateral for borrowing. As intangibles become more important in production, financial frictions tighten and equilibrium interest rates decline, creating the conditions for the emergence of rational bubbles. We also analyze the question of dynamic efficiency, demonstrating that, in the presence of financial frictions, neither the interest rate test nor the test proposed by Abel et al. (1989) are appropriate. Finally we show that, in general, rational bubbles are not Pareto improving in our framework.
    Keywords: Asset prices , Bonds , Capital , Capital markets , Developed countries , Economic models , Financial assets ,
    Date: 2011–11–22
  8. By: Ennio Bilancini; Simone D’Alessandro
    Abstract: In this paper we contribute to the debate on the relationship between growth and well-being by examining an endogenous growth model where we allow for externalities in consumption, leisure, and production. We analyze three regimes: a decentralized economy where each household makes isolated choices without considering their external e_ects, a planned economy where a myopic planner fails to recognize both leisure and consumption externalities but recognizes production externalities, and a planned economy with a fully informed planner. We _rst compare the balanced growth paths under the three regimes and then we numerically investigate the transition to the optimal bilance growth path. We provide a number of _ndings. First, in a decentralized economy growth or labor (or both) are greater than in the regime with a fully informed planner, and hence are sub-optimal from a welfare standpoint. Second, a myopic intervention which overlooks consumption and leisure externalities leads to more growth and labor than in both the decentralized and the fully informed regime. Third, we provide a case for happy degrowth: a transition to the optimal balanced growth path that is associated with downscaling of production, a reduction in private consumption, and an ongoing increase in leisure and well-being.
    Keywords: degrowth; endogenous growth; consumption externalities; leisure externalities; production externalities;
    JEL: Q13 E62 H21 H23
    Date: 2011–10
  9. By: Matteo Iacoviello; Marina Pavan
    Abstract: We study housing and debt in a quantitative general equilibrium model. In the cross-section, the model matches the wealth distribution, the age pro.les of homeownership and mortgage debt, and the frequency of housing adjustment. In the time-series, the model matches the procyclicality and volatility of housing investment, and the procyclicality of mortgage debt. We use the model to conduct two experiments. First, we investigate the consequences of higher individual income risk and lower downpayments, and .nd that these two changes can explain, in the model and in the data, the reduced volatility of housing investment, the reduced procyclicality of mortgage debt, and a small fraction of the reduced volatility of GDP. Second, we use the model to look at the behavior of housing investment and mortgage debt in an experiment that mimics the Great Recession: we find that countercyclical financial conditions can account for large drops in housing activity and mortgage debt when the economy is hit by large negative shocks.
    Date: 2011
  10. By: Tosun, Mehmet S. (University of Nevada, Reno)
    Abstract: This paper provides a demographic outlook of the Euro-Mediterranean region and then shows the economic and fiscal consequences of such demographic differences within a two-region model with international labor mobility. International labor mobility is also examined through an externalities framework where brain drain from migration could be taxed by the home countries. Taxing the brain drain has a substantial limiting effect on labor migration and a small negative effect on per worker growth. On the other hand, it could be a solution to the negative externality problem associated with brain drain. It is also found that such tax can raise substantial tax revenue for the SMCs which could be used to enhance human capital in the region.
    Keywords: demographic divide, demographic deficit, population aging, youth bulge, labor mobility, brain drain, overlapping generations, endogenous tax policy, Mediterranean region
    JEL: E62 F22 H23 H24 H41
    Date: 2011–12
  11. By: Stefano D'Addona (University of Roma Tre); Frode Brevik (Free University Amsterdam)
    Abstract: We document an unpleasant feature of Epstein-Zin preferences in a stylized model economy of the long-run risk type now widespread in Asset Pricing: Agents with preference parameters commonly described as indicating a "preference for early resolution of uncertainty" achieve higher utility levels if they can commit to ignoring information on the state of the business cycle. For parameter choices similar to those used to explain asset prices, an agent can achieve utility gains equivalent to a more than 40 % increase in life-time consumption by committing to ignore information on the trend growth rate of the endowment good. We show that opting for such a coarser information set can be implemented and supported as an equilibrium strategy.
    Keywords: Recursive preferences; Epstein-Zin preferences; Uncertainty aversion; Information processing; Time inconsistency
    JEL: D83 D84 E32
    Date: 2011
  12. By: Adu, George
    Abstract: This paper examines the effect of environmental policy on economic growth in a small open economy in a neoclassical framework with pollution as an input. We show that environmental policy imposes a drag on long run growth in both the open and closed economy cases. The effect of environmental policy on growth is stronger in the open economy case relative to the closed economy model if the country has strong aversion to pollution and thus serves as a net exporter of capital in the international capital market. On the other hand, if the agents in the economy have low aversion to pollution and thus import capital, the effect of environmental care on growth is stronger in the closed economy relative to the open economy. Thus, from our set-up, environmental policy is harmful to growth but environmental sustainability need not be incompatible with continued economic growth.
    Keywords: Economic growth, Pollution tax, Capital-output ratio, Open economy, Capital flight, Environmental Economics and Policy, O40, O41, Q56,
    Date: 2011–11
  13. By: Davide Debortoli; Junior Maih; Ricardo Nunes
    Abstract: This paper proposes a method and a toolkit for solving optimal policy with imperfect commitment. As opposed to the existing literature, our method can be employed in medium- and large-scale models typically used in monetary policy. We apply our method to the Smets and Wouters (2007) model, where we show that imperfect commitment has relevant implications for interest rate setting, the sources of business cycle fluctuations, and welfare.
    Date: 2011
  14. By: Thierry Bréchet (Université catholique de Louvain, CORE and Chair Lhoist Berghmans in Environmental Economics and Management); Pierre-André Jouvet (EconomiX, Univ. Paris Ouest, Nanterre - La Défense, Climate Economics Chair, Paris); Gilles Rotillon (EconomiX, Univ. Paris Ouest, Nanterre - La Défense.)
    Abstract: In this paper we study the optimal growth path and its decentralization in a twosector overlapping-generations model with pollution. One sector (power generation) is polluting and the other (final good) is not. Pollution is regulated by tradable emission permits. The issue is whether the optimal growth path can be replicated in equilibrium with pollution permits, given that some permits must be issued free of charge for the sake of political acceptability. We provide a policy rule that allows optimality and acceptability to be reconciled.
    Keywords: general equilibrium, optimal growth, pollution, tradable emission permits, acceptability
    JEL: D61 D9 Q28
    Date: 2011–02
  15. By: Stefano D'Addona (University of Roma Tre); Christos Giannikos (Zicklin School of Business)
    Abstract: Standard Real Business Cycle (RBC) models are well known to generate counter-factual asset pricing implications. This paper provides a simple extension to the prior literature where we study an economy that follows a regimes switching process both in the mean and the volatility, in conjunction with Epstein-Zin preferences for the consumers. We provide a detailed theoretical and numerical analysis of the model’s predictions. We also show that a reasonable parameterization of our model conveys reasonable financial figures. Furthermore, we provide evidence in support of the necessity to model the decline of macroeconomic risk in this particular class of models.
    Keywords: Asset Pricing, Real Business Cycle Models, Recursive Preferences, Markov Switching Models
    JEL: G12 E32 E23
    Date: 2011
  16. By: Hong Lan; Alexander Meyer-Gohde
    Abstract: We introduce a nonlinear infinite moving average as an alternative to the standard state-space policy function for solving nonlinear DSGE models. Perturbation of the nonlinear moving average policy function provides a direct mapping from a history of innovations to endogenous variables, decomposes the contributions from individual orders of uncertainty and nonlinearity, and enables familiar impulse response analysis in nonlinear settings. When the linear approximation is saddle stable and free of unit roots, higher order terms are likewise saddle stable and first order corrections for uncertainty are zero. We derive the third order approximation explicitly and examine the accuracy of the method using Euler equation tests.
    Keywords: Perturbation, nonlinear impulse response, DSGE, solution methods
    JEL: C61 C63 E17
    Date: 2011–12
  17. By: Jean Pierre Allegret; Mohamed Tahar Benkhodja
    Abstract: To investigate the dynamic effect of external shocks on an oil exporting economy, we estimate, using Bayesian approach, a DSGE model based on the features of the Algerian economy. The main purpose is to investigate the dynamic effect of four external shocks (oil price shock, USD/EUR exchange rate shock, international inflation shock and international interest rate shock) and to examine the appropriate monetary policy strategy for Algerian economy, given its structural characteristics and the pattern of the external shocks. We analyze the impulse response functions of our external shocks according to alternative monetary rules. The welfare cost associated with each monetary policy rule has been considered. Our main findings show that, over the period 1990Q1-2010Q4, core inflation monetary rule allows better to stabilize both output and inflation. This rule also appears to be the best way to improve a social welfare.
    Keywords: Monetary policy, external shocks, oil exporting economy, Algeria, DSGE model.
    JEL: E3 E5 F4
    Date: 2011
  18. By: Broer, Tobias
    Abstract: This paper shows how two standard models of consumption risk-sharing - self-insurance through borrowing and saving and limited commitment to insurance contracts - replicate similarly well the standard, second-moment measures of insurance observed in US micro-data. A non-parametric analysis, however, reveals strongly contrasting and counterfactual joint distributions of consumption, income and wealth. Method of moments estimation shows how measurement error in consumption eliminates excessive skewness and concentration of consumption growth. Moreover, counterfactual non-linearities disappear at high estimated risk-aversion under self-insurance, but are a robust feature of limited commitment. Its "shape of insurance" thus argues strongly in favour of the self-insurance model.
    Keywords: Limited Commitment; Risk Sharing; Wealth and Consumption Distribution
    JEL: D31 D52 E21 E44
    Date: 2011–12
  19. By: Akito Matsumoto; Pietro Cova; Massimiliano Pisani; Alessandro Rebucci
    Abstract: This paper studies equity price volatility in general equilibrium with news shocks about future productivity and monetary policy. As West (1998) shows, in a partial equilibrium present discounted value model, news about the future cash flow reduces asset price volatility. This paper shows that introducing news shocks in canonical dynamic stochastic general equilibrium model may not reduce asset price volatility under plausible parameter assumptions. This is because, in general equilibrium, the asset cash flow itself may be affected by the introduction of new shocks. In addition, it is shown that neglecting to account for policy news shocks (e. g. , policy announcements) can potentially bias empirical estimates of the impact of monetary policy shocks on asset prices.
    JEL: E32 F30 F40 G11
    Date: 2011–06
  20. By: Berg, Tim Oliver
    Abstract: This paper examines the time varying impact of technology news shocks on the U.S. economy during the Post-World War II era using a structural time varying parameter vector autoregressive (TVP-VAR) model. The identification restrictions are derived froma standard new Keynesian dynamic stochastic general equilibrium (DSGE) model and hold for a wide range of parameter constellations. In addition, the set of restrictions is sufficient to discriminate technology news shocks from other supply and demand side disturbances - technology surprise shocks among them. Overall, there is little evidence that the variance of technology news shocks or their transmission to real activity and inflation has changed over time. However, I detect significant time variation in the endogenous monetary policy reaction to technology news shocks; responding strongly to inflation most of the time, but less during the Great Inflation period. The evidence of this paper thus supports the hypothesis that the high inflation rates of the mid and late 1970s were the result of bad policy rather than bad luck.
    Keywords: technology news shocks; business cycles; monetary policy; DSGE models; structural time varying parameter VARs
    JEL: E32 E52 C11
    Date: 2011
  21. By: Fabian Fink (Department of Economics, University of Konstanz, Germany); Almuth Scholl (Department of Economics, University of Konstanz, Germany)
    Abstract: International Financial Institutions provide temporary balance-of-payment support contingent on the implementation of specific macroeconomic policies. While several emerging markets repeatedly used conditional assistance, sovereign defaults occurred. This paper develops a dynamic stochastic model of a small open economy with endogenous default risk and endogenous participation rates in bailout programs. Conditionality enters as a constraint on fiscal policy. In a quantitative application to Argentina the model mimics the empirical duration and frequency of bailout programs. In equilibrium, conditional bailouts generate high and volatile interest spreads. A Laffer-curve in conditionality reflects the trade-off between fostering fiscal reform and creating incentives for non-compliance.
    Keywords: sovereign debt, sovereign default, interest rate spread, fiscal policy, bailouts, conditionality
    JEL: E44 E62 F34
    Date: 2011–11–30
  22. By: Fabrizio Perri; Vincenzo Quadrini
    Abstract: The 2007–2009 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.
    Date: 2011
  23. By: Ian Christensen; Césaire Meh; Kevin Moran
    Abstract: This paper assesses the merits of countercyclical bank balance sheet regulation for the stabilization of financial and economic cycles and examines its interaction with monetary policy. The framework used is a dynamic stochastic general equilibrium model with banks and bank capital, in which bank capital solves an asymmetric information problem between banks and their creditors. In this economy, the lending decisions of individual banks affect the riskiness of the whole banking sector, though banks do not internalize this impact. Regulation, in the form of a constraint on bank leverage, can mitigate the impact of this externality by inducing banks to alter the intensity of their monitoring efforts. We find that countercyclical bank leverage regulation can have desirable stabilization properties, particularly when financial shocks are an important source of economic fluctuations. However, the appropriate contribution of countercyclical capital requirements to stabilization after a technology shock depends on the size of the externality and on the conduct of the monetary authority.
    Keywords: Moral hazard, bank capital, countercyclical capital requirements, leverage, monetary policy
    JEL: E44 E52 G21
    Date: 2011
  24. By: Luca Benzoni; Pierre Collin-Dufresne; Robert S. Goldstein
    Abstract: The 1987 stock market crash occurred with minimal impact on observable economic variables (e.g., consumption), yet dramatically and permanently changed the shape of the implied volatility curve for equity index options. Here, we propose a general equilibrium model that captures many salient features of the U.S. equity and options markets before, during, and after the crash. The representative agent is endowed with Epstein-Zin preferences and the aggregate dividend and consumption processes are driven by a persistent stochastic growth variable that can jump. In reaction to a market crash, the agent updates her beliefs about the distribution of the jump component. We identify a realistic calibration of the model that matches the prices of shortmaturity at-the-money and deep out-of-the-money S&P 500 put options, as well as the prices of individual stock options. Further, the model generates a steep shift in the implied volatility ‘smirk’ for S&P 500 options after the 1987 crash. This ‘regime shift’ occurs in spite of a minimal impact on observable macroeconomic fundamentals. Finally, the model’s implications are consistent with the empirical properties of dividends, the equity premium, as well as the level and standard deviation of the risk-free rate. Overall, our findings show that it is possible to reconcile the stylized properties of the equity and option markets in the framework of rational expectations, consistent with the notion that these two markets are integrated.
    Keywords: Money ; Macroeconomics ; Pricing
    Date: 2011
  25. By: Anatoli Segura (CEMFI, Centro de Estudios Monetarios y Financieros); Javier Suarez (CEMFI, Centro de Estudios Monetarios y Financieros)
    Abstract: We develop an infinite horizon equilibrium model in which banks finance long term assets with non-tradable debt. Banks choose the amount of debt and its maturity taking into account investors’ preference for short maturities (which better accommodate their preference shocks) and the risk of systemic liquidity crises (during which refinancing is especially expensive). Unregulated debt maturities are inefficiently short due to pecuniary externalities in the market for funds during crises and their interaction with banks’ refinancing constraints. We show the possibility of improving welfare by means of limits to debt maturity, Pigovian taxes, and private and public liquidity insurance schemes.
    Keywords: Liquidity premium, maturity transformation, systemic crises, liquidity regulation, pecuniary externalities, liquidity insurance.
    JEL: G01 G21 G32
    Date: 2011–11
  26. By: Pashchenko, Svetlana (Uppsala Center for Fiscal Studies); Porapakkarm, Ponpoje (University of Macau)
    Abstract: One of the major problems of the U.S. health insurance market is that it leaves individuals exposed to reclassification risk. Reclassification risk arises because the health conditions of individuals evolve over time, while a typical health insurance contract only lasts for one year. A change in the health status can lead to a significant change in the health insurance premium. We study how costly this reclassification risk is for the welfare of consumers. More specifically, we use a general equilibrium model to quantify the implications of introducing guaranteed renewable contracts into the economy calibrated to replicate the key features of the health insurance system in the U.S. Guaranteed renewable contracts are private insurance contracts that can provide protection against reclassification risk even in the absence of consumer commitment or government intervention. We find that though guaranteed renewable contracts provide a good insurance against reclassification risk, the welfare effects from introducing this type of contracts are small. In other words, the presence of reclassification risk does not impose large welfare losses on consumers. This happens because some institutional features in the current U.S. system substitute for the missing explicit contracts that insure reclassification risk. In particular, a good protection against reclassification risk is provided through employer-sponsored health insurance and government means-tested transfers.
    Keywords: health insurance; reclassification risk; dynamic insurance; guaranteed renewable contracts; general equilibrium
    JEL: D52 D58 D91 G22 I11
    Date: 2011–12–12
  27. By: Taskin, Temel
    Abstract: In this paper, we incorporate home production into a quantitative model of unemployment and show that realistic levels of home production have a significant impact on the optimal unemployment insurance rate. Motivated by recently documented empirical facts, we augment an incomplete markets model of unemployment with a home production technology, which allows unemployed workers to use their extra non-market time as partial insurance against the drop in income due to unemployment. In the benchmark model, we find that the optimal replacement rate in the presence of home production is roughly 40% of wages, which is 40% lower than the no home production model’s optimal replacement rate of 65%. The 40% optimal rate is also close to the estimated rate in practice. The fact that home production makes a significant difference in the optimal unemployment insurance rate is robust to a variety of parameterizations and alternative model environments.
    Keywords: Unemployment insurance; home production; incomplete markets; self-insurance
    JEL: D13 J65 E21
    Date: 2011–08–01
  28. By: Ellen R. McGrattan; Edward C. Prescott
    Abstract: A problem facing the United States and many other countries is how to finance retirement consumption as the number of their workers per retiree falls. The problem with a savings for retirement systems is that there is a shortage of good savings opportunities given the nature of most current tax systems and governments’ limited ability to honor the debt it issues. We find that eliminating capital income taxes will greatly increase saving opportunities and make a savings-for-retirement system feasible with only modest amount of government debt. The switch from a system close to the current U.S. retirement system, which relies heavily on taxing workers’ incomes and making lump-sum transfers to retirees, to one without income taxes will increase the welfare of all birth-year cohorts alive today and particularly the welfare of the yet unborn cohorts. The equilibrium paths for the current and alternative policies are computed.
    Date: 2011
  29. By: Francesco Lancia; Alessia Russo
    Abstract: This paper focuses on a two-period OLG economy with public imperfect observability over the intergenerational cooperative dimension. Individual endowment is at free disposal and perfectly observable. In this environment we study how a new mechanism, we call Self-Commitment-Institution (SCI), outperforms personal and community enforcement in achieving higher ex-ante e¢ ciency. Social norms with and without SCI are characterized. If social norms with SCI are implemented, agents might freely dispose of their endowment. As long as they reduce their marginal gain from deviation in terms of current utility, they also credibly self-commit on intergenerational cooperation. Under quite general conditions we .nd that, even if individual strategies are still characterized by behavioral uncertainty, the introduction of SCI relaxes the inclination toward opportunistic behavior and sustains higher e¢ ciency compared to social norms without SCI. We quantify the value of SCI and investigate the role of memory with di¤erent social norms. Finally, applications on intergenerational public good games and transfer games with productive SCI are provided
    Keywords: Cooperation; Free disposal; Imperfect public monitoring; Memory; Overlapping generation game; Self-Commitment Institution;
    JEL: C70 D70 H40
    Date: 2011–11
  30. By: Paul Beaudry; Deokwoo Nam; Jian Wang
    Abstract: This paper provides new evidence in support of the idea that bouts of optimism and pessimism drive much of US business cycles. In particular, we begin by using sign-restriction based identification schemes to isolate innovations in optimism or pessimism and we document the extent to which such episodes explain macroeconomic fluctuations. We then examine the link between these identified mood shocks and subsequent developments in fundamentals using alternative identification schemes (i.e., variants of the maximum forecast error variance approach).> ; We find that there is a very close link between the two, suggesting that agents' feelings of optimism and pessimism are at least partially rational as total factor productivity (TFP) is observed to rise 8–10 quarters after an initial bout of optimism. While this later finding is consistent with some previous findings in the news shock literature, we cannot rule out that such episodes reflect self-fulfilling beliefs. Overall, we argue that mood swings account for over 50 percent of business-cycle fluctuations in hours and output.
    Keywords: Macroeconomics
    Date: 2011
  31. By: Kunieda, Takuma; Shibata, Akihisa
    Abstract: We identify countries that establish collateral-based lending systems with a small-open-economy version of Nobuhiro Kiyotaki and John Moore’s (1997) model. We find that 47 countries in 1980s and 48 countries in 1990s out of 98 countries establish collateral-based lending systems. We also investigate the origin of collateral-based lending systems and find that if a country offers good legal protection for lenders, then a collateral-based lending system is more likely to be embedded in that country.
    Keywords: Credit constraints; Collateral-based lending; Legal protection of lenders; Kiyotaki-Moore model
    JEL: E51 F41 K10 E10
    Date: 2011–09–29

This nep-dge issue is ©2011 by Christian Zimmermann. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.