nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2012‒02‒27
twenty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Optimal Monetary Policy and Stock-Prices Dynamics in a Non-Ricardian DSGE Model By Salvatore Nistico'
  2. Search and endogenous growth: when Romer meets Lagos and Wright By Chu, Angus C.; Lai, Ching-Chong; Liao, Chih-Hsing
  3. The effects of monetary policy shocks in credit and labor markets with search and matching frictions By Giuseppe Ciccarone; Francesco Giuli; Danilo Liberati
  4. Increasing life expectancy and optimal retirement:does population aging necessarily undermine economic prosperity? By Klaus Prettner; David Canning
  5. Labour Market and Fiscal Policy By Slim Bridji and Matthieu Charpe
  6. Do Ak models really lack transitional dynamics? By Yoseph Yilma Getachew
  7. Financial market frictions in a model of the euro area By Giovanni Lombardo; Peter McAdam
  8. A Matching Model of Endogenous Growth and Underground Firms By Gaetano Lisi; Maurizio Pugno
  9. Monetary Policy and Stock-Price Dynamics in a DSGE Framework By Salvatore Nisticò
  10. The Conundrum of Recovery Policies: Growth or Jobs? By Elias Dinopoulos; Wolf-Heimo Grieben; Fuat Sener
  11. Welfare Improving Taxation on Savings in a Growth Model By Xin Long; Alessandra Pelloni
  12. Can the Mortensen-Pissarides Model Match the Housing Market Facts? By Gaetano Lisi
  13. Optimal Unemployment Insurance for Older Workers By Jean-Olivier Hairault; François Langot; Sébastien Ménard; Thepthida Sopraseuth
  14. Learning generates Long Memory By Chevillon, Guillaume; Mavroeidis, Sophocles
  15. Analysing the Effects of Fiscal Policy Shocks in the South African Economy By Charl Jooste; Guangling "Dave" Liu; Ruthira Naraidoo
  16. The Economics of Pensions. Remarks on Growth, Distribution and Class Con ict. By Codrina Rada
  17. Default Risk on Government Bonds, Deflation, and Inflation By Oguro, Kazumasa; Sato, Motohiro
  18. Fiscal Policy in a Financial Crisis: Standard Policy vs. Bank Rescue Measure By Robert Kollmann; Werner Roeger; Jan in'tVeld
  19. Existence and Uniqueness of Perturbation Solutions to DSGE Models By Hong Lan; Alexander Meyer-Gohde
  20. Transitions in the German labor market: Structure and crisis By Krause, Michael U.; Uhlig, Harald
  21. Existence and Uniqueness of a Fixed Point for the Bellman Operator in Deterministic Dynamic Programming By Takashi Kamihigashi

  1. By: Salvatore Nistico' (University of Rome La Sapienza and LUISS Guido Carli University)
    Abstract: In a DSGE model with non-ricardian agents, a' la Blanchard-Yaari, stock-price fluctuations affect the dynamics of aggregate consumption through wealth effects. This wealth effects can be characterized as an additional dynamic distortion with respect to the social planner allocation, related to the cross sectional consumption dispersion that the decentralized allocation implies. By exploiting the specific cross-sectional distribution that the model implies for individual financial wealth, this paper derives the welfare criterion consistent with this economy, and shows that it features an additional target besides output-gap and price stability: financial stability. The ultimate implication is that price stability is no longer necessarily optimal, even absent cost push shocks. Given the quadratic form of the welfare criterion, some fluctuations in output and inflation will be optimal as long as they reduce the volatility of financial wealth.
    Keywords: Monetary Policy, DSGE Models, Stock Prices, Wealth Effects.
    JEL: E12 E44 E52
    Date: 2011
  2. By: Chu, Angus C.; Lai, Ching-Chong; Liao, Chih-Hsing
    Abstract: In this note, we develop a search-based monetary growth model to analyze the growth and welfare effects of inflation. We introduce endogenous growth via capital externality into a two-sector search model and compare the effects of inflation to those from a standard cash-in-advance (CIA) growth model. We …find two important differences between the two approaches. First, while the growth effect of inflation operates solely through endogenous labor supply in the CIA model, the growth effect of inflation operates through an additional consumption effect in the decentralized market in the search model. Second, we quantitatively evaluate the welfare cost of inflation and fi…nd that the search model exhibits a larger (smaller) welfare gain than the CIA model when we decrease the growth rate of money supply to achieve the Friedman rule (zero inflation). These contrasting results are due to a non-linearity in welfare as a function of inflation in the search model.
    Keywords: economic growth; inflation; monetary policy
    JEL: O42 O41 E41
    Date: 2012–02
  3. By: Giuseppe Ciccarone; Francesco Giuli; Danilo Liberati
    Abstract: By introducing search and matching frictions in both the labor and the credit markets into a cash in advance New Keynesian DSGE model, we provide a novel explanation of the incomplete pass-through from policy rates to loan rates. We show that this phenomenon is ineradicable if banks possess some power in the bargaining over the loan rate of interest, if the cost of posting job vacancies is positive and if firms and bank sustain costs when searching for lines of credit and when posting credit vacancies, respectively. We also show that the presence of credit market frictions moderates the reactions of output and wages to a monetary shock, and that the transmission of monetary policy shocks to output and inflation is more relevant than suggested by the recent literature.
    Keywords: interest rate pass-through,search and matching, credit market frictions.
    JEL: E43 E13 E24 E44
    Date: 2012–01
  4. By: Klaus Prettner (Harvard Center for Population and Development Studies); David Canning (Harvard School of Public Health)
    Abstract: In this paper we analyze the eects of changes in longevity and the pace of technological progress on interest rates, savings behaviour and optimal retirement decisions. In so doing we embed the dynamic optimization problem of choosing a life-cycle consumption path and the retirement age into a general equilibrium setting. Thereby we assume that technology evolves exogenously and the production side of the economy can be described by means of a neoclassical production function. Our results show that (i) the aggregate capital to consumption ratio increases and interest rates decrease in response to increases in longevity; (ii) the response of the optimal retirement age to increases in longevity is ambiguous. However, for reasonable parameter values the optimal retirement age increases in longevity; (iii) the aggregate capital to consumption ratio decreases and interest rates increase in response to faster technological progress; (iv) the response of the optimal retirement age to faster technological progress is ambiguous. However, for reasonable parameter values the optimal retirement age increases in the pace of technological improvements.
    Keywords: endogenous retirement, life-cycle savings, population aging, technological progress, economic prosperity
    Date: 2012–02
  5. By: Slim Bridji and Matthieu Charpe (ILO, International Labour Organization, Geneva)
    Abstract: This paper discusses fiscal policy using a DSGE model with search and matching in the labour market. Fiscal policy is effective mainly via its impact through the labour market. Although public intervention tends to crowd out private consumption, public spending also improves the matching between unemployed workers and job vacancies. The mechanism modelled in this paper shares similarity with Baxter & King (1993) and Leeper et al. (2010). The model produces positive fiscal multipliers on impact and in the short term and consistently reproduces the reaction to a spending shock of the main labour market variables such as wages,employment or labour market tightness. These results are similar with that of Monacelli et al. (2010) except that the transmission channel does not depend on the downward adjustment of the reservation wage of workers. The size of the fiscal multiplier increases with the elasticity of matching to spending and is also negatively related with the steady state spending to GDP ratio in the presence of diminishing marginal returns on spending. For large value of the multiplier, there is a crowding in of consumption and investment. Lastly, this model produces output multipliers larger than 1 in the presence of nominal price rigidities.
    Keywords: Fiscal policy, search, matching
    JEL: E24 E32 E62
    Date: 2012–02–16
  6. By: Yoseph Yilma Getachew (Durham Business School)
    Abstract: Contrary to a popular belief, the most popular Ak growth models display transitional dynamics once the representative agent and complete markets assumptions are overturned. The class of models is identified with diminishing-returns at individual but constant-returns at aggregate due to externality effects. Under incomplete markets, the former implies that dynasties with a lower levels of initial capital grow faster. This is picked up by the aggregate economy that passes through a long transitional period before it converges to its balanced growth path. During the transition period, aggregate consumption and output grow at the same rate but higher than that of capital.
    Keywords: Ak model, inequality dynamics, heterogeneous households, incomplete capital market
    JEL: D3 E1 O4
    Date: 2012–02–06
  7. By: Giovanni Lombardo (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Peter McAdam (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: We build a model of the euro area incorporating financial market frictions at the level of firms and households. Entrepreneurs borrow from financial intermediaries in order to purchase business capital, in the spirit of the "financial accelerator" literature. We also introduce two types of households that differ in their degree of time preference. All households have preferences for housing services. The impatient households are faced with a collateral constraint that is a function of the value of their housing stock. Our aim is to provide a unified framework for policy analysis that emphasizes financial market frictions alongside the more traditional model channels. The model is estimated by Bayesian methods using euro area aggregate data and model properties are illustrated with simulation and conditional variance and historical shock decomposition. JEL Classification: C11, C32, E32, E37.
    Keywords: Financial Frictions, euro area, DSGE modeling, Bayesian estimation, simulation, decompositions.
    Date: 2012–02
  8. By: Gaetano Lisi; Maurizio Pugno
    Abstract: A matching model will explain both unemployment and economic growth by considering the underground sector and human capital. Three problems can thus be simultaneously accounted for: (i) the persistence of the underground sector, (ii) the ambiguous relationships between underground employment and unemployment, and (iii) between growth and unemployment. Key assumptions are that entrepreneurial ability is heterogeneous, skill accumulation determines productivity growth, job-seekers choose whether to invest in education. The conclusions are that the least able entrepreneurs, whose number is endogenous, set up underground firms, employ unskilled labour, and do not contribute to growth. If the monitoring rate is sufficiently low, underground employment alleviates unemployment, but the economy grows at lower rates.
    Keywords: Matching models, endogenous growth, underground economy, entrepreneurship, unemployment.
    JEL: E26 J6 J24 L26
    Date: 2012–01–03
  9. By: Salvatore Nisticò (Università degli Studi di Roma “La Sapienza" and LUISS Guido Carli)
    Abstract: This paper analyzes the role of stock prices in driving Monetary Policy for price stability in a Non-Ricardian DSGE model. It shows that the dynamics of the interest rate consistent with price stability requires a response to stock-price changes that depends on the shock driving them: a supply shock (e.g. productivity) does not require an additional, dedicated response relative to the standard Representative-Agent framework, while a demand shock does. Moreover, we show that implementing the exible-price allocation by means of an interest-rate rule that reacts to deviations of the stock-price level from the exible-price equilibrium incurs risks of endogenous instability that are the higher the less profitable on average equity shares. On the other hand, reacting to the stock-price growth rate is risk-free from the perspective of equilibrium determinacy, and can be beneficial from an overall real stability perspective.
    Keywords: Monetary Policy, DSGE Models, Stock Prices, Wealth Effects.
    JEL: E12 E44 E52
    Date: 2012–02–10
  10. By: Elias Dinopoulos (University of Florida, Department of Economics, Gainesville, USA); Wolf-Heimo Grieben (Department of Economics, University of Konstanz, Germany); Fuat Sener (Department of Economics, Union College, Schenectady, New York, USA)
    Abstract: This paper adopts a Neo-Schumpeterian approach to macroeconomics, by proposing a model which includes fully-endogenous growth, involuntary search-based unemployment, and financial frictions. The model analyzes the effects of several recovery policies used by governments to fight unemployment or/and enhance growth. Employment protection legislation reduces growth and unemployment. Policies that reduce the cost of job vacancies decrease unemployment and raise growth. Industrial policies in the form of production subsidies to young small firms, production taxes to adult large firms, and R&D subsidies increase growth and unemployment. Policies that reduce financial frictions accelerate growth but exert an ambiguous effect on unemployment.
    Keywords: fully- endogenous growth, Schumpeterian unemployment, financial frictions, recovery policies, vacancy creation
    JEL: J63 O31
    Date: 2012–02–13
  11. By: Xin Long (Faculty of Economics, University of Rome "Tor Vergata"); Alessandra Pelloni (Faculty of Economics, University of Rome "Tor Vergata")
    Abstract: We consider the optimal factor income taxation in a standard R&D model with technical change represented by an increase in the variety of intermediate goods. Redistributing the tax burden from labor to capital will increase the employment rate in equilibrium. This has opposite e¤ects on two distortions in the model, one due to monopoly power, the second to the incomplete appropriability of the benefits of inventions. Their relative momentum determines the sign of the welfare effect. We show that, for parameter values consistent with available estimates, the optimal tax rate on capital will be sizable.
    Keywords: Capital Income Taxes, R&D, Growth Effect, Welfare Effect
    JEL: E62 H21 O41
    Date: 2012–01–27
  12. By: Gaetano Lisi
    Abstract: This paper examines whether the Mortensen-Pissarides matching model can account for the housing markets facts, most of all the empirical anomaly known as ‘price dispersion’. Our main finding is that the model can account for the three basic facts of housing market, without any restrictive assumption and in a very simple framework.
    Keywords: House prices, time-on-the-market, housing price dispersion, bargaining power, search and matching frictions.
    JEL: R0 R31 R21 D40 D83
    Date: 2012–01–01
  13. By: Jean-Olivier Hairault (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon Sorbonne, IZA - Institute for the Study of Labor); François Langot (IZA - Institute for the Study of Labor, GAINS-TEPP - Université du Mans, CEPREMAP - Centre pour la recherche économique et ses applications); Sébastien Ménard (GAINS - Université du Maine); Thepthida Sopraseuth (CEPREMAP - Centre pour la recherche économique et ses applications, GAINS-TEPP - Université du Maine)
    Abstract: This paper studies the optimal unemployment insurance for older workers in a repeated principal-agent model, where the search intensity of risk-averse workers (the agents) is not observed by the risk-neutral insurance agency (the principal). When unemployment benefits are the only available tool, the insurance agency is not able to induce older workers to search for a job. This is because of the short time-horizon of workers close to retirement. We propose to introduce a pension tax dependent on the length of the unemployment spell. We show that this device performs better than a wage tax after re-employment. First, it makes jobs more attractive, as they are free of tax. Second, because re-employment will be short-lived, a pension tax is a more powerful incentive than a wage tax, and provides more substantial fiscal gains to the agency. Finally, a pension tax allows those workers near retirement who still do not exercise job search to smooth their consumption during their unemployment spell, as if they could borrow against their future pension.
    Date: 2012–02–13
  14. By: Chevillon, Guillaume (ESSEC Business School); Mavroeidis, Sophocles (University of Oxford)
    Abstract: We consider a prototypical representative-agent forward-looking model, and study the low frequency variability of the data when the agent's beliefs about the model are updated through linear learning algorithms. We nd that learning in this context can generate strong persistence. The degree of persistence depends on the weights agents place on past observations when they update their beliefs, and on the magnitude of the feedback from expectations to the endogenous variable. When the learning algorithm is recursive least squares, long memory arises when the coefficient on expectations is sufficiently large. In algorithms with discounting, long memory provides a very good approximation to the low-frequency variability of the data. Hence long memory arises endogenously, due to the self-referential nature of the model, without any persistence in the exogenous shocks. This is distinctly dierent from the case of rational expectations, where the memory of the endogenous variable is determined exogenously. Finally, this property of learning is used to shed light on some well-known empirical puzzles.
    Keywords: Learning; Long Memory; Persistence; Present-Value Models
    Date: 2011–11–24
  15. By: Charl Jooste (Department of Economics, University of Pretoria); Guangling "Dave" Liu (Department of Economics, University of Stellenbosch); Ruthira Naraidoo (Department of Economics, University of Pretoria)
    Abstract: This paper is the first one to analyse the effect of aggregate government spending and taxes on output for South Africa using three types of a calibrated DSGE model and more data driven models such as a structural vector error correction (SVEC) model and a time-varying parameter VAR (TVP-VAR) to capture possible asymmetries and time variation of fiscal impulses. The impulse responses indicate first, that increases in government expenditure have a positive impact, albeit (at times) less than unity, on GDP in the short run; second, over the long run, the impact of government expenditure on GDP is insignificant; and third, increases in taxes decreases GDP over the short run, while having negligible effects over longer horizons.
    Keywords: rule-of-thumb consumers, fiscal multiplier, government spending, TVP-VAR, SVECM
    JEL: C54 D58 E32 E62 H31
    Date: 2012–02
  16. By: Codrina Rada
    Keywords: E24; E12; G23; H55; JEL Classification: This paper compares fully-funded (FF) and pay-as-you-go (paygo) pension plans in a Keynesian framework for an economy with overlapping generations and excess capacity. The model addresses both short/mediumrun equilibria and steady-states. Income distribution and class con ict, two crucial aspects of the political economy of pensions, become multidimensional. In a fully-funded economy class con ict between capitalists and labor gets diused in the short-run by retirees' own interest to maintain a high prot share. In the long-run capitalists recognize that they can control their (net) share of prots by controlling employment and therefore the number of future retirees through capital accumulation. An extension of the model can show that scal policy is not always helpful in a fully-funded economy. A pay-as-you-go economy maintains a closer resemblance to the classical story of class con ict over income distribution. This is because workers and retirees have their interests aligned with the wage share. In this case scal policy through spending can be eective without creating a debt problem.
    Date: 2012
  17. By: Oguro, Kazumasa; Sato, Motohiro
    Abstract: This paper analyzes the impact of deflation and inflation on the real interest rates of GBs using an overlapping generations model with the relationship between the real interest rate of GBs and the fiscal consolidation rule. We find that deflation may lower the real interest rate of GBs to the same level of public debt to capital, even if the fiscal consolidation rule is the same, as opposed to the conventional view that the real interest rate of GBs is determined independent of deflation if the Fisher equation holds. Our results are consistent with how the real interest rates of Japanese GBs react in periods of deflation. This paper also addresses the impact of fiscal inflation (i.e., monetizing all parts of the GB’s default using monetary policy). We calculate the expected fiscal inflation when the default rate in the event of fiscal consolidation is raised. The fiscal inflation may be extremely high if the extent of the required tax increase in fiscal consolidation is low. Initial inflation accelerates the expected fiscal inflation, but initial deflation suppresses it.
    Keywords: Overlapping generations model, real interest rate, fiscal consolidation rule, default risk, fiscal inflation
    JEL: E17 H30 H5 H60 E62 H63
    Date: 2012–02
  18. By: Robert Kollmann; Werner Roeger; Jan in'tVeld
    Abstract: A key dimension of fiscal policy during the financial crisis was massive government support for the banking system. The macroeconomic effects of that support have, so far, received little attention in the literature. This paper fills this gap, using a quantitative dynamic model with a banking sector. Our results suggest that state aid for banks may have a strong positive effect on real activity. Bank state aid multipliers are in the same range as conventional fiscal spending multipliers. Support for banks has a positive effect on investment, while a rise in government purchases crowds out investment.
    Keywords: state support for banks; financial crisis; financial stimulus; real activity
    JEL: E62 E63 G21 G28 H25
    Date: 2012–02
  19. By: Hong Lan; Alexander Meyer-Gohde
    Abstract: We prove that standard regularity and saddle stability assumptions for linear approximations are sufficient to guarantee the existence of a unique solution for all undetermined coefficients of nonlinear perturbations of arbitrary order to discrete time DSGE models. We derive the perturbation using a matrix calculus that preserves linear algebraic structures to arbitrary orders of derivatives, enabling the direct application of theorems from matrix analysis to prove our main result. As a consequence, we provide insight into several invertibility assumptions from linear solution methods, prove that the local solution is independent of terms first order in the perturbation parameter, and relax the assumptions needed for the local existence theorem of perturbation solutions.
    Keywords: Perturbation, matrix calculus, DSGE, solution methods, Bézout theorem; Sylvester equations
    JEL: C61 C63 E17
    Date: 2012–02
  20. By: Krause, Michael U.; Uhlig, Harald
    Abstract: Since the so-called Hartz IV reforms around 2005 and during the global crisis of 2008/2009, the German labor market featured mainly declining unemployment rates. We develop a search and matching model with heterogeneous skills to explore the role of structural and cyclical policies for this performance. Calibrating unemployment benefits to approximate legislation before and after the reforms, we find a large reduction in unemployment and its duration, with the transition concluding after about three years. During the crisis, the extended use of short-time labor subsidies that prevent jobs from being destroyed is likely to have prevented strong increases in unemployment. --
    Keywords: German Hartz IV reforms,search and matching,unemployment benefits,labor subsidies
    JEL: E24 E32 J64
    Date: 2011
  21. By: Takashi Kamihigashi (Research Institute for Economics and Business Administration, Kobe University, Nada-ku, Kobe, Japan)
    Abstract: We study existence and uniqueness of a xed point for the Bellman operator in deterministic dynamic programming. Without any topological assumption, we show that the Bellman operator has a unique xed point in a restricted domain, that this xed point is the value function, and that the value function can be computed by value iteration.
    Keywords: Dynamic programming, Bellman operator, value function, xed point.
    JEL: C61
    Date: 2012–02

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