nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2012‒03‒21
thirty-six papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Bayesian estimation of DSGE models By Pablo A. Guerrón-Quintana; James M. Nason
  2. DSGE model-based forecasting By Marco Del Negro; Frank Schorfheide
  3. Home production and Social Security reform By Michael Dotsey; Wenli Li; Fang Yang
  4. A DSGE Model with Housing in the Cointegrated VAR Framework By Bjørnar Karlsen Kivedal
  5. Estimating the Size of the Underground Economy: A DSGE Approach By R. Orsi; D. Raggi; F. Turino
  6. Balance-Sheet Shocks and Recapitalizations By Fabian Valencia; Damiano Sandri
  7. Ambiguous Business Cycles By Cosmin Ilut; Martin Schneider
  8. Fat-Tail Distributions and Business-Cycle Models By Guido Ascariy; Giorgio Fagiolo; Andrea Roventini
  9. Can the Mortensen-Pissarides Model Match the Housing Market Facts ? By Gaetano Lisi
  10. On the Desirability of Taxing Capital Income in Optimal Social Insurance By Bas Jacobs; Dirk Schindler
  11. Lifetime labor supply and human capital investment By Rodolfo E. Manuelli; Ananth Seshadri; Yongseok Shin
  12. Is increased price flexibility stabilizing? Redux By Saroj Bhattarai; Gauti Eggertsson; Raphael Schoenle
  13. The Forecasting Performance of an Estimated Medium Run Model By Tobias Kitlinski; Torsten Schmidt
  14. Privately optimal contracts and suboptimal outcomes in a model of agency costs By Charles T. Carlstrom; Timothy S. Fuerst; Matthias Paustian
  15. Capital, finance, and trade collapse By Yang Jiao; Yi Wen
  16. Entry dynamics as a solution to the puzzling behaviour of real marginal costs in the Ghironi-Melitz model By Alberto Felettigh
  17. Posterior Predictive Analysis for Evaluating DSGE Models By Jon Faust; Abhishek Gupta
  18. Fiscal Policy and the Real Exchange Rate By Santanu Chatterjee; Azer Mursagulov
  19. A Life Cycle Model of Health and Retirement: The Case of Swedish Pension Reform By Laun, Tobias; Wallenius, Johanna
  20. European Taxes in a Laboratory By Matus Senaj; Milan Vyskrabka
  21. On the Welfare Costs of Business-Cycle Fluctuations and Economic-Growth Variation in the 20th Century By Guillén, Osmani Teixeira de Carvalho; Issler, João Victor; Franco-Neto, Afonso Arinos de Mello
  22. Like Father, Like Son: Inheriting and Bequeathing By Lars Kunze
  23. Non-Keynesian Effects of Fiscal Consolidation: An Analysis with an Estimated DSGE Model for the Hungarian Economy By Szilárd Benk; Zoltán M. Jakab
  24. Asset bubbles, economic growth, and a self-fulfilling financial crisis: a dynamic general equilibrium model of infinitely lived heterogeneous agents By Kunieda, Takuma; Shibata, Akihisa
  25. Optimal target criteria for stabilization policy By Marc P. Giannoni; Michael Woodford
  26. Analizando la determinación de impuesto a la renta y sus efectos sobre el crecimiento de la economía boliviana By Valdivia, Daney; Loayza, Lilian
  27. Understanding booms and busts in housing markets By Craig Burnside; Martin Eichenbaum; Sergio Rebelo
  28. Habit formation heterogeneity: Implications for aggregate asset pricing By Eduard Dubin; Olesya V. Grishchenko; Vasily Kartashov
  29. Slow convergence in economies with firm heterogeneity By Erzo G.J. Luttmer
  30. The Macroeconomics of Microfinance By Francisco J. Buera; Joseph P. Kaboski; Yongseok Shin
  31. Moral hazard, investment, and firm dynamics By Hengjie Ai; Rui Li
  32. The Trade Comovement Puzzle and the Margins of International Trade By Wei Liao; Ana Maria Santacreu
  33. Optimal Lifecycle Fertility in a Barro Becker Economy By Pierre Pestieau; Grégory Ponthière
  34. Financial globalization, inequality, and the raising of public debt By Marina Azzimonti; Eva de Francisco; Vincenzo Quadrini
  35. Human capital portfolios By Pedro Silos; Eric Smith
  36. The labor productivity puzzle By Ellen R. McGrattan; Edward C. Prescott

  1. By: Pablo A. Guerrón-Quintana; James M. Nason
    Abstract: We survey Bayesian methods for estimating dynamic stochastic general equilibrium (DSGE) models in this article. We focus on New Keynesian (NK)DSGE models because of the interest shown in this class of models by economists in academic and policy-making institutions. This interest stems from the ability of this class of DSGE model to transmit real, nominal, and fiscal and monetary policy shocks into endogenous fluctuations at business cycle frequencies. Intuition about these propagation mechanisms is developed by reviewing the structure of a canonical NKDSGE model. Estimation and evaluation of the NKDSGE model rests on being able to detrend its optimality and equilibrium conditions, to construct a linear approximation of the model, to solve for its linear approximate decision rules, and to map from this solution into a state space model to generate Kalman filter projections. The likelihood of the linear approximate NKDSGE model is based on these projections. The projections and likelihood are useful inputs into the Metropolis-Hastings Markov chain Monte Carlo simulator that we employ to produce Bayesian estimates of the NKDSGE model. We discuss an algorithm that implements this simulator. This algorithm involves choosing priors of the NKDSGE model parameters and fixing initial conditions to start the simulator. The output of the simulator is posterior estimates of two NKDSGE models, which are summarized and compared to results in the existing literature. Given the posterior distributions, the NKDSGE models are evaluated with tools that determine which is most favored by the data. We also give a short history of DSGE model estimation as well as pointing to issues that are at the frontier of this research.
    Keywords: Bayesian statistical decision theory ; Markov processes ; Keynesian economics
    Date: 2012
  2. By: Marco Del Negro; Frank Schorfheide
    Abstract: Dynamic stochastic general equilibrium (DSGE) models use modern macroeconomic theory to explain and predict comovements of aggregate time series over the business cycle and to perform policy analysis. We explain how to use DSGE models for all three purposes—forecasting, story telling, and policy experiments—and review their forecasting record. We also provide our own real-time assessment of the forecasting performance of the Smets and Wouters (2007) model data up to 2011, compare it with Blue Chip and Greenbook forecasts, and show how it changes as we augment the standard set of observables with external information from surveys (nowcasts, interest rate forecasts, and expectations for long-run inflation and output growth). We explore methods of generating forecasts in the presence of a zero-lower-bound constraint on nominal interest rates and conditional on counterfactual interest rate paths. Finally, we perform a postmortem of DSGE model forecasts of the Great Recession and show that forecasts from a version of the Smets-Wouters model augmented by financial frictions, and using spreads as an observable, compare well with Blue Chip forecasts.
    Keywords: Stochastic analysis ; Equilibrium (Economics) ; Time-series analysis ; Econometric models ; Monetary policy ; Economic forecasting ; Recessions
    Date: 2012
  3. By: Michael Dotsey; Wenli Li; Fang Yang
    Abstract: This paper incorporates home production into a dynamic general equilibrium model of overlapping generations with endogenous retirement to study Social Security reforms. As such, the model differentiates both consumption goods and labor effort according to their respective roles in home production and market activities. Using a calibrated model, we find that eliminating the current pay-as-you-go Social Security system has important implications for both labor supply and consumption decisions and that these decisions are influenced by the presence of a home production technology. Comparing our benchmark economy to one with differentiated goods but no home production, we find that eliminating Social Security benefits generates larger welfare gains in the presence of home production. This result is due to the self insurance aspects generated by the presence of home production. Comparing our economy to a one-good economy without home production, we show that the welfare gains of eliminating Social Security are magnified even further. These policy analyses suggest the importance of modeling home production and distinguishing between both time use and consumption goods depending on whether they are involved in market or home production.
    Keywords: Housing ; Social security ; Labor supply
    Date: 2012
  4. By: Bjørnar Karlsen Kivedal (Department of Economics, Norwegian University of Science and Technology)
    Abstract: In order to empirically investigate the assumptions underlying a theoretical dynamic stochastic general equilibrium (DSGE) model, the long-run and the short-run structure of the model may be imposed in the framework given by a cointegrated vector autoregression (CVAR) model. By following the method outlined in Juselius and Franchi (2007), I use the CVAR model to investigate the restrictions underlying the DSGE model in Iacoviello (2005), which is a monetary business cycle model that includes housing in order to include eects from the nancial accelerator. This yields a common trends representation of the data subject to the theoretical constraints of the DSGE model which can be used to calculate the impulse responses for dierent shocks. These impulse responses are then compared to the impulse responses presented in Iacoviello (2005). The main nding is that the results given by the estimated CVAR model do not correspond well to the restrictions of the DSGE model. This is shown both by testing the cointegrating relationships implied by the long-run relations, and the response to shocks in the period for which the model is estimated. Imposing theoretical restrictions pertaining to the DSGE model in Iacoviello (2005) on his estimated VAR model yields dierent impulse responses from various shocks which change some of the main ndings of the model. Particularly, imposing long-run homogeneity between housing prices and output and imposing the Fisher relationship which is assumed in the theoretical model seems to yield results which is opposite of what the nancial accelerator, which is one of the key motivations behind the model in Iacoviello (2005), suggests. The non-stationarity of inflation and the nominal interest rate may be important reasons for this, together with the non-acceptance of the imposed long-run hypotheses.
    Date: 2012–03–03
  5. By: R. Orsi; D. Raggi; F. Turino
    Abstract: We study a new approach to estimating the underground economy that is based on a dynamic and stochastic general equilibrium (DSGE) framework. In particular, we generalize an otherwise standard two-sector DSGE model by introducing explicitly underground production and irregular market sectors. In this setup, firms can choose to produce goods for the regular market as well as for the underground sector, and households can evade taxes by reallocating their worked hours from the regular to the irregular labor market. The firms can be discovered evading with a given probability and forced to pay a penalty surcharge. Empirical evidence based on Italian data stresses that this phenomenon is relevant in Italy because the estimated size of the underground economy is approximately 22% of the GDP, which is 3 percentage points larger than the number reported in the official statistics. Counterfactual analysis suggests that an increase in the probability of being discovered and in the penalty surcharge, along with a moderate tax reduction, causes a sensitive reduction in the size of the underground economy and a positive stimulus to the official economy that jointly increases the total fiscal revenues.
    JEL: E65 O41 O52
    Date: 2012–03
  6. By: Fabian Valencia; Damiano Sandri
    Abstract: We develop a dynamic stochastic general equilibrium model with financial frictions on both financial intermediaries and goods-producing firms. In this context, due to high leverage of financial intermediaries, balance sheet disruptions in the financial sector are particularly detrimental for aggregate output. We show that the welfare gains from recapitalizing the financial sector in response to large but rare net worth losses are as large as those from eliminating business cycle fluctuations. We also find that these gains are increasing in the size of the net worth loss, are larger when recapitalization funds are raised from the household rather than the real sector, and may increase with a reduction in financial intermediaries idiosyncratic risk.
    Date: 2012–03–05
  7. By: Cosmin Ilut; Martin Schneider
    Abstract: This paper considers business cycle models with agents who dislike both risk and ambiguity (Knightian uncertainty). Ambiguity aversion is described by recursive multiple priors preferences that capture agents' lack of confidence in probability assessments. While modeling changes in risk typically requires higher-order approximations, changes in ambiguity in our models work like changes in conditional means. Our models thus allow for uncertainty shocks but can still be solved and estimated using first-order approximations. In our estimated medium-scale DSGE model, a loss of confidence about productivity works like 'unrealized' bad news. Time-varying confidence emerges as a major source of business cycle fluctuations.
    JEL: E32
    Date: 2012–03
  8. By: Guido Ascariy; Giorgio Fagiolo; Andrea Roventini
    Abstract: Recent empirical findings suggest that macroeconomic variables are seldom normally distributed. For example, the distributions of aggregate output growth-rate time series of many OECD countries are well approximated by symmetric exponential-power (EP) densities, with Laplace fat tails. In this work, we assess whether Real Business Cycle (RBC) and standard medium-scale New-Keynesian (NK) models are able to replicate this statistical regularity. We simulate both models drawing Gaussian- vs Laplace-distributed shocks and we explore the statistical properties of simulated time series. Our results cast doubts on whether RBC and NK models are able to provide a satisfactory representation of the transmission mechanisms linking exogenous shocks to macroeconomic dynamics.
    Keywords: Growth-Rate Distributions, Normality, Fat Tails, Time Series, Exponential-Power Distributions, Laplace Distributions, DSGE Models, RBC Models
    JEL: C1 E3
    Date: 2012
  9. By: Gaetano Lisi (University of Cassino - Creativity and Motivations (CreaM) Economic Center)
    Abstract: This paper examines whether the baseline Mortensen-Pissarides matching model can account for the housing market facts, namely, the existence of price dispersion, the positive correlation between housing price and trading volume, and between housing price and time-on-the-market. Our main finding is that the model can account for these three basic facts of the housing market, thus showing that the Mortensen-Pissarides framework can be seen as the benchmark macroeconomic model not only for the labour market but for any market with frictions.
    Keywords: housing price dispersion; time-on-the-market; trading volume; search and matching process.
    Date: 2012–02–26
  10. By: Bas Jacobs (Erasmus School of Economics, Erasmus University Rotterdam, The Netherlands); Dirk Schindler (Department of Economics, University of Konstanz, Germany)
    Abstract: This paper analyzes optimal linear taxes on labor income and savings in a two-period life cycle model with ex ante identical households, endogenous leisure demands in both periods, and general processes of skill shocks over the life cycle. We demonstrate that the Atkinson-Stiglitz theorem breaks down under risk. Capital taxes are employed besides labor income taxes for two distinct reasons: i) capital taxes reduce labor supply distortions on second-period labor supply, since second-period labor supply and saving are substitutes, ii) capital taxes insure first-period income risk, although this benefit is partially off-set because first-period labor supply and saving are complements. Our results imply that (retirement) saving should not be actuarially fair.
    Keywords: Optimal Capital Taxation, Risk, Atkinson-Stiglitz theorem
    JEL: H21 D80
    Date: 2012–01–23
  11. By: Rodolfo E. Manuelli; Ananth Seshadri; Yongseok Shin
    Abstract: We develop a model of retirement and human capital investment to study the effects of tax and retirement policies. Workers choose the supply of raw labor (career length) and also the human capital embodied in their labor. Our model explains a significant fraction of the US-Europe difference in schooling and retirement. The model predicts that reforms of the European retirement policies modeled after the US can deliver 15–35 percent gains in per-worker output in the long run. Increased human capital investment in and out of school accounts for most of the gains, with relatively small changes in career length.
    Keywords: Human capital ; Labor supply ; Retirement
    Date: 2012
  12. By: Saroj Bhattarai; Gauti Eggertsson; Raphael Schoenle
    Abstract: We study the implications of increased price flexibility on aggregate output volatility in a dynamic stochastic general equilibrium (DSGE) model. First, using a simplified version of the model, we show analytically that the results depend on the shocks driving the economy and the systematic response of monetary policy to inflation: More flexible prices amplify the effect of demand shocks on output if interest rates do not respond strongly to inflation, while higher flexibility amplifies the effect of supply shocks on output if interest rates are very responsive to inflation. Next, we estimate a medium-scale DSGE model using post-WWII U.S. data and Bayesian methods and, conditional on the estimates of structural parameters and shocks, ask: Would the U.S. economy have been more or less stable had prices been more flexible than historically? Our main finding is that increased price flexibility would have been destabilizing for output and employment.
    Keywords: Prices ; Productivity ; Equilibrium (Economics) ; Monetary policy ; Inflation (Finance)
    Date: 2012
  13. By: Tobias Kitlinski; Torsten Schmidt
    Abstract: In recent times DSGE models came more and more into the focus of forecasters and showed promising forecast performances for the short term. We contribute to the existing literature by analyzing the forecast power of a DSGE model including endogenous growth for the medium run. Instead of only calibrating the model we apply a mixture of calibrating and estimating using Bayesian estimation methods. As forecasting benchmarks we take the Smets-Wouters model (2007) and a VAR model. The evaluation of the forecast errors shows that the Medium-Term model outperforms the Smets-Wouters model with respect to some key macroeconomic variables in the medium run. Compared to the VAR model the Medium-Term model forecast performance is competitive. These results show that the forecast ability of DSGE models is also valid for the medium term.
    Keywords: Bayesian analysis; DSGE model; medium run; forecasting
    JEL: C32 C52 E32 E37
    Date: 2011–12
  14. By: Charles T. Carlstrom; Timothy S. Fuerst; Matthias Paustian
    Abstract: This paper derives the privately optimal lending contract in the celebrated fi nancial accelerator model of Bernanke, Gertler and Gilchrist (1999). The privately optimal contract includes indexation to the aggregate return on capital and household consumption. Although privately optimal, this contract is not welfare maximizing as it exacerbates fluctuations in real activity. The household’s desire to hedge business cycle risk, leads, via the fi nancial contract, to greater business cycle risk. The welfare cost of the privately optimal contract (when compared to the planner outcome) is quite large. A countercyclical tax on lender profi ts comes close to achieving the planner outcome
    Keywords: Contracts ; Financial markets
    Date: 2012
  15. By: Yang Jiao; Yi Wen
    Abstract: This paper proposes a model of international trade with capital accumulation and financial intermediation. This is achieved by embedding the Melitz (2003) model into an incomplete-markets neoclassical framework with an endogenous credit market. The model preserves the analytical tractability of the original Melitz model despite non-trivial distribution of firms’ net worth and capital stocks. We use the model to examine the differential effects of financial and non-financial shocks on aggregate output and international trade flows. The model predicts that trade volume declines far more sharply and significantly than that of output (with an elasticity larger than 3) under financial shocks than under non-financial shocks. The prediction is consistent with the stylized fact that most countries that experienced major financial crises had significantly larger and sharper contraction in exports than aggregate output (as is also true during the recent financial crisis). In the long run, however, a deeper financial market is a great source of "comparative advantage"— it raises not only the level of aggregate productivity but also the ratio of trade volume to domestic output.>
    Keywords: Financial crises ; Credit ; International trade
    Date: 2012
  16. By: Alberto Felettigh (Bank of Italy)
    Abstract: The work of Ghironi and Melitz (2005) is at the frontier of international real business cycle (IRBC) models with heterogeneous firms. In their model, the dynamic behaviour of real marginal costs is puzzling: a positive technology shock hitting the home country makes it permanently less cost-effective than the foreign economy. Wages grow more than profits during booms and the labour share in GDP is counterfactually procyclical. Entry by new firms is crucial in delivering this result. It is sufficient to posit that technology improvements are more efficacious in manufacturing than in the "production of new firms" for the labour share and real marginal costs to become countercyclical, consistently with empirical evidence. Once I introduce tradable capital goods and endogenous labour supply, the two models are on average equally good in replicating the empirical moments typically considered in the IRBC literature.
    Keywords: international real business cycles, firm heterogeneity, firm entry dynamics, real marginal costs, labour share
    JEL: F12 F41
    Date: 2012–02
  17. By: Jon Faust; Abhishek Gupta
    Abstract: While dynamic stochastic general equilibrium (DSGE) models for monetary policy analysis have come a long way, there is considerable difference of opinion over the role these models should play in the policy process. The paper develops three main points about assessing the value of these models. First, we document that DSGE models continue to have aspects of crude approximation and omission. This motivates the need for tools to reveal the strengths and weaknesses of the models--both to direct development efforts and to inform how best to use the current flawed models. Second, posterior predictive analysis provides a useful and economical tool for finding and communicating strengths and weaknesses. In particular, we adapt a form of discrepancy analysis as proposed by Gelman, et al. (1996). Third, we provide a nonstandard defense of posterior predictive analysis in the DSGE context against long-standing objections. We use the iconic Smets-Wouters model for illustrative purposes, showing a number of heretofore unrecognized properties that may be important from a policymaking perspective.
    JEL: C52 E1 E32 E37
    Date: 2012–03
  18. By: Santanu Chatterjee; Azer Mursagulov
    Abstract: Government spending on infrastructure has recently increased sharply in many emerging-market economies. This paper examines the mechanism through which public infrastructure spending affects the dynamics of the real exchange rate. Using a two-sector dependent open economy model with intersectoral adjustment costs, we show that government spending generates a non-monotonic U-shaped adjustment path for the real exchange rate with sharp intertemporal trade-offs. The effect of government spending on the real exchange rate depends critically on (i) the composition of public spending, (ii) the underlying financing policy, (iii) the intensity of private capital in production, and (iv) the relative productivity of public infrastructure. In deriving these results, the model also identifies conditions under which the predictions of the neoclassical open economy model can be reconciled with empirical regularities, namely the intertemporal relationship between government spending, private consumption, and the real exchange rate.
    Keywords: Fiscal policy , Government expenditures , Infrastructure , Public investment , Real effective exchange rates , Resource allocation ,
    Date: 2012–02–16
  19. By: Laun, Tobias (Dept. of Economics, Stockholm School of Economics); Wallenius, Johanna (Dept. of Economics, Stockholm School of Economics)
    Abstract: In this paper we develop a life cycle model of labor supply and retirement to study the interactions between health and the labor supply behavior of older workers, in particular disability insurance and pension claiming. In our framework, individuals choose when to stop working and, given eligibility criteria, when/if to apply for disability and pension benefits. Individuals care about their health and can partially insure against health shocks by investing in health. We use the model to study the labor supply implications of the recent Swedish pension reform. We find that the new pension system creates big incentives for the continued employment of older workers. In particular, the model predicts an increase in the average retirement age of more than two years.
    Keywords: life cycle; retirement; pension reform; disability insurance; health
    JEL: E24 J22 J26
    Date: 2012–03–06
  20. By: Matus Senaj (National Bank of Slovakia, Research Departmen); Milan Vyskrabka (National Bank of Slovakia, Monetary Policy Department)
    Abstract: Labour tax rates are considerably heterogeneous across European countries. In this paper, we investigate the effects of a policy experiment in which the tax rates levied on labour are harmonised in the member countries of the euro area. Using a four-country DSGE model, we find that shifts in domestic tax rates are the main driver of the total outcome of the policy change while spillover effects are rather limited in the long run. Countries that decrease their total tax wedge boost their economies while countries that increase their tax wedge lose a proportion of output. The adjustment process is rather complicated: a country which gains in the long run may temporarily go through a period of dampened economic activity. The adjustment process is complicated somewhat by the fact that a country which gains in the long run may temporarily go through a period of dampened economic activity. In terms of volatility, the euro area with its homogenous labour tax system may be better prepared to face common area-wide shocks. On the other hand, shocks originating outside the euro area may increase the volatility of euro area output under the homogenous tax regime.
    Keywords: tax reform, DSGE model, euro area
    JEL: D58 H20
    Date: 2011–12
  21. By: Guillén, Osmani Teixeira de Carvalho; Issler, João Victor; Franco-Neto, Afonso Arinos de Mello
    Abstract: Lucas (1987) has shown a surprising result in business-cycle research: the welfare cost ofbusiness cycles are very small. Our paper has several original contributions. First, in computingwelfare costs, we propose a novel setup that separates the effects of uncertainty stemming frombusiness-cycle fluctuations and economic-growth variation. Second, we extend the sample from which to compute the moments of consumption: the whole of the literature chose primarily to work with post-WWII data. For this period, actual consumption is already a result of counter-cyclical policies, and is potentially smoother than what it otherwise have been in their absence. So, we employ also pre-WWII data. Third, we take an econometric approach and compute explicitly the asymptotic standard deviation of welfare costs using the Delta Method. Estimates of welfare costs show major differences for the pre-WWII and the post-WWII era. They can reach up to 15 times for reasonable parameter values -β=0.985, and ∅=5. For example, in the pre-WWII period (1901-1941), welfare cost estimates are 0.31% of consumption if we consider only permanent shocks and 0.61% of consumption if we consider only transitory shocks. In comparison, the post-WWII era is much quieter: welfare costs of economic growth are 0.11% and welfare costs of business cycles are 0.037% - the latter being very close to the estimate in Lucas (0.040%). Estimates of marginal welfare costs are roughly twice the size of the total welfare costs. For the pre-WWII era, marginal welfare costs of economic-growth and business- cycle fluctuations are respectively 0.63% and 1.17% of per-capita consumption. The same figures for the post-WWII era are, respectively, 0.21% and 0.07% of per-capita consumption.
    Date: 2012–02–28
  22. By: Lars Kunze
    Abstract: Empirical evidence suggests that parents who have themselves inherited from their own parents are more likely to leave an estate to their children even after controlling for income, wealth and education. This implies an indirect reciprocal behavior between three generations by transmitting the attitude towards bequeathing from one generation to the next. We incorporate such an intergenerational chain into an overlapping generations model and show that the economy might be characterized by multiple steady states involving poverty traps. Individuals will not leave bequests unless per capita income levels exceed a threshold level. In such a situation, an unfunded social security security programme may help to overcome poverty by providing additional old age income out of which to bequeath.
    Keywords: Capital accumulation; indirect reciprocity; overlapping generations; unfunded social security
    JEL: D64 D91 H55
    Date: 2012–02
  23. By: Szilárd Benk; Zoltán M. Jakab
    Abstract: Using an estimated DSGE model for Hungary, the paper identifies the possible non-Keynesian channels through which a fiscal consolidation may manifest as expansionary. Simulations show that fiscal consolidation policies are typically contractionary. Nevertheless, taking into account some specific features of the Hungarian economy, there is a possibility that expansionary effects arise. These effects may take the form of a drop in interest rate risk premium or favourable balance sheet effects through the appreciation of the currency. However, the credibility of fiscal consolidation is key in achieving positive output effects. A non-credible consolidation is unlikely to expand output, regardless of the assumptions regarding the specific features of the economy, and regardless of the composition of a consolidation package.<P>Les effets non-Keynésiens de l'assainissement budgétaire : une analyse avec un modèle DSGE estimé pour l'économie hongroise<BR>À partir d’un modèle d’équilibre général dynamique et stochastique (DSGE) estimé pour la Hongrie, ce papier identifie les canaux non-Keynésiens susceptibles de donner un caractère expansionniste à un assainissement budgétaire. Les simulations montrent que les politiques d’ajustement budgétaire se traduisent généralement par une contraction de l’activité. Toutefois, compte tenu de certaines caractéristiques propres à l’économie hongroise, il est probable que des effets expansionnistes surviennent. Ces effets peuvent prendre la forme d’une baisse de la prime de risque de taux d’intérêt ou d’effets de bilan favorables du fait d’une appréciation du taux de change. Cela étant, la crédibilité de l’assainissement budgétaire est indispensable pour obtenir des effets positifs sur la production. Un ajustement non crédible a peu de chances de produire de tels effets, quelles que soient les hypothèses retenues à propos des caractéristiques de l’économie et quelle que soit la composition du programme d’assainissement.
    Keywords: taxation, government expenditure, fiscal consolidation, DSGE model, non-Keynesian effects, fiscalité, assainissement budgétaire, modèle DSGE, effets non-Keynésiens, dépense publique
    JEL: E27 E62 H30 H50
    Date: 2012–03–09
  24. By: Kunieda, Takuma; Shibata, Akihisa
    Abstract: We develop a dynamic general equilibrium growth model with infinitely lived heterogeneous agents to describe a self-fulfilling financial crisis accompanied by an asset bubble burst as a rational expectations equilibrium. Because of financial market imperfections, asset bubbles appear under mild parameter conditions even though we assume infinitely lived agents. Although these bubbles have both a crowd-in liquidity effect and a crowd-out effect on investment, the former effect always dominates the latter. Thus, a self-fulfilling financial crisis accompanied by an asset bubble burst results in an economic recession. This phenomenon is consistent with empirical observations on financial crises in the existing literature. In addition, we present an effective government policy to avoid self-fulfilling financial crises.
    Keywords: Crowd-in effect of bubbles; Financial market imperfections; Sunspots; Self-fulfilling financial crisis; Economic growth
    JEL: E44
    Date: 2012–03–13
  25. By: Marc P. Giannoni; Michael Woodford
    Abstract: This paper considers a general class of nonlinear rational-expectations models in which policymakers seek to maximize an objective function that may be household expected utility. We show how to derive a target criterion that is 1) consistent with the model’s structural equations, 2) strong enough to imply a unique equilibrium, and 3) optimal, in the sense that a commitment to adjust the policy instrument at all dates so as to satisfy the target criterion maximizes the objective function. The proposed optimal target criterion is a linear equation that must be satisfied by the projected paths of certain economically relevant “target variables.” It takes the same form at all times and generally involves only a small number of target variables, regardless of the size and complexity of the model. While the projected path of the economy requires information about its current state, the target criterion itself can be stated without reference to a complete description of the state of the world. We illustrate the application of the method to a nonlinear DSGE model with staggered price setting, in which the objective of policy is to maximize household expected utility.
    Keywords: Rational expectations (Economic theory) ; Econometric models ; Households - Economic aspects
    Date: 2012
  26. By: Valdivia, Daney; Loayza, Lilian
    Abstract: We compute the optimal income tax using the Quarterly Employment Survey 2010 and the model proposed by Kaplow (2008). The collection of optimal income taxes excludes 92% of people and it’s applied in the three stages; results show that 17% of income tax is optimal. The “optimal tax” is applied in a modified version of the model proposed by Valdivia and Montenegro (2008) in order to evaluate the redistribution effectiveness of consumption and its effects on economic growth. Results show that rule-of-thumb consumption raise 10.7% with a sacrifice of 4% of ricardian households and an increase of total consumption of 0.63% and economic growth, in the medium term, of 0.3% over its natural level. In the same way, fiscal spending raise and we can see positive effects on factor markets (employment and capital raises). Finally, according to the results showed we can see that welfare should be better because the introduction of the income tax causes intra and intergenerational redistribution across households.
    Keywords: income tax; dynamic stochastic general equilibrium model
    JEL: H21 E32
    Date: 2012–01–24
  27. By: Craig Burnside; Martin Eichenbaum; Sergio Rebelo
    Abstract: Some booms in housing prices are followed by busts. Others are not. In either case it is difficult to find observable fundamentals that are correlated with price movements. We develop a model consistent with these observations. Real estate agents have heterogeneous expectations about long-run fundamentals but change their views because of "social dynamics." Agents meet randomly with one another. Those with tighter priors are more likely to convert others to their beliefs. The model generates a "fad": The fraction of the population with a particular view rises and then falls. Depending on which agent is correct about fundamentals, these fads generate boom-busts or protracted booms.
    Date: 2012
  28. By: Eduard Dubin; Olesya V. Grishchenko; Vasily Kartashov
    Abstract: We study the asset pricing implications of a general equilibrium Lucas endowment economy inhabited by two agents with habit formation preferences. Preferences are modeled either as internal or external habits. We allow for agents' heterogeneity in relative risk aversion and habit strength. We explicitly compute aggregate prices, such as equity premium, equity volatility, Sharpe ratio, interest rate volatility, and asset holdings for both types of preferences. Equilibrium quantities are computed using a recently developed algorithm of Dumas and Lyasoff (2011), which is refined to capture time nonseparability induced by habit. We obtain that internal habits provide for a considerable improvement in obtaining aggregate asset pricing quantities consistent with historically observed magnitudes as opposed to ``catching up with Joneses" preferences.
    Date: 2012
  29. By: Erzo G.J. Luttmer
    Abstract: This paper presents a simple formula that relates the tail index of the firm size distribution to the aggregate speed with which an economy converges to its balanced growth path. The fact that there are so many firms in the right tail implies that aggregate shocks that permanently destroy employment among incumbent firms, rather than cause these firms to scale back temporarily, are followed by slow recoveries. This is true despite the existence of many rapidly growing firms.
    Date: 2012
  30. By: Francisco J. Buera; Joseph P. Kaboski; Yongseok Shin
    Abstract: We provide a quantitative evaluation of the aggregate and distributional impact of microfinance or credit programs targeted toward small businesses. We find that the redistributive impact of microfinance is stronger in general equilibrium than in partial equilibrium, but the impact on aggregate output and capital is smaller in general equilibrium. Aggregate total factor productivity (TFP) increases with microfinance in general equilibrium but decreases in partial equilibrium. When general equilibrium effects are accounted for, scaling up the microfinance program will have only a small impact on per-capita income, because the increase in TFP is counterbalanced by lower capital accumulation resulting from the redistribution of income from high-savers to low-savers. Nevertheless, the vast majority of the population will be positively affected by microfinance through the increase in equilibrium wages.
    JEL: D91 D92 E44 O11
    Date: 2012–03
  31. By: Hengjie Ai; Rui Li
    Abstract: We present a dynamic general equilibrium model with heterogeneous firms. Owners of firms delegate investment decisions to managers, whose consumption and investment decisions are private information. We solve the optimal contracts and characterize the implied general equilibrium. Our calibrated model has implications on the cross-sectional distribution and time-series dynamics of firms' investment, managers' compensation, and dividend payout policies. Risk sharing requires that managers' equity shares decrease with firm sizes. That, in turn, implies it is harder to prevent private benefit in larger firms, where managers have a lower equity stake under the optimal contract. Consequently, small firms invest more, pay less dividends, and grow faster than large firms. Despite the heterogeneity in firms' decision rules and the failure of Gibrat's law, we show that the size distribution of firms in our model resembles a power law distribution with a slope coefficient about 1.06, as in the data.
    Date: 2012
  32. By: Wei Liao (Hong Kong Institute for Monetary Research); Ana Maria Santacreu (INSEAD and Hong Kong Institute for Monetary Research)
    Abstract: Countries that trade more with each other tend to have more correlated business cycles. Yet, traditional international business cycle models predict a much weaker link between trade and business cycle comovement. We propose that the international diffusion of technology through trade in varieties may be driving the observed comovement by increasing the correlation of total factor productivity (TFP). Our hypothesis is that business cycles should be more correlated between countries that trade a wider variety of goods. We find empirical support for this hypothesis. After decomposing trade into its extensive and intensive margins, we find that the extensive margin explains most of the trade-TFP and trade-output comovement. This result is striking because the extensive margin accounts for only a third of total trade. We then develop a three-country model of technology innovation and international diffusion through trade, in which TFP correlation increases with trade in varieties. A numerical exercise shows that the proposed mechanism increases business cycle synchronization relative to traditional models. Impulse responses to a TFP shock in one country reveal a strong positive effect on the output of its trading partner. Finally, our model implies a trade-output coefficient that is 40% of that observed in the data and 5 times higher than that predicted by standard models.
    Date: 2012–02
  33. By: Pierre Pestieau (CREPP - Center of Research in Public Economics and Population Economics - Université de Liège, PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - Ecole des Ponts ParisTech - Ecole Normale Supérieure de Paris - ENS Paris - INRA, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, CORE - Center of Operation Research and Econometrics [Louvain] - Université Catholique de Louvain, CEPR - Center for Economic Policy Research - CEPR); Grégory Ponthière (PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - Ecole des Ponts ParisTech - Ecole Normale Supérieure de Paris - ENS Paris - INRA, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: Parenthood postponement is a key demographic trend of the last three decades. In order to rationalize that stylized fact, we extend the canonical model by Barro and Becker (1989) to include two - instead of one reproduction periods. We examine how the cost structure of early and late children in terms of time and goods a¤ects the optimal fertility timing. Then, focusing a stationary equilibrium with stationary population, we provide two alternative explanations for the observed postponement of births: (1) a fall of the direct cost of late children (thanks to medical advances); (2) a rise in hourly productivity, which increases the (relative) opportunity costs of early children in comparison to late children.
    Keywords: Fertility ; Birth Timing ; Population ; Dynastic Altruism ; OLG Model
    Date: 2012–03
  34. By: Marina Azzimonti; Eva de Francisco; Vincenzo Quadrini
    Abstract: During the last three decades, the stock of government debt has increased in most developed countries. During the same period, we also observe a significant liberalization of international financial markets and an increase in income inequality in several industrialized countries. In this paper we propose a multicountry political economy model with incomplete markets and endogenous government borrowing and show that governments choose higher levels of public debt when financial markets become internationally integrated and inequality increases. We also conduct an empirical analysis using OECD data and find that the predictions of the theoretical model are supported by the empirical results.
    Keywords: Debts, Public
    Date: 2012
  35. By: Pedro Silos; Eric Smith
    Abstract: This paper assesses the trade-off between acquiring specialized skills targeted for a particular occupation and acquiring a package of skills that diversifies risk across occupations. Individual-level data on college credits across subjects and labor-market dynamics reveal that diversification generates higher income growth for individuals who switch occupations whereas specialization benefits those who stick with one type of job. A human capital portfolio choice problem featuring skills, abilities, and uncertain labor outcomes replicates this general pattern and generate a sizable amount of inequality. Policy experiments illustrate that forced specialization generates lower average income growth and lower turnover, but also lower inequality.
    Date: 2012
  36. By: Ellen R. McGrattan; Edward C. Prescott
    Abstract: Prior to the mid-1980s, labor productivity growth was a useful barometer of the U.S. economy’s performance: it was low during economic recessions and high during expansions. Since then, labor productivity has become significantly less procyclical. In the recent recession of 2008–2009, labor productivity actually rose as GDP plummeted. These facts have motivated the development of new business cycle theories because the conventional view is that they are inconsistent with existing business cycle theory. In this paper, we analyze recent events with existing theory and find that the labor productivity puzzle is much less of a puzzle than previously thought. In light of these findings, we argue that policy agendas arising from new untested theories should be disregarded.
    Date: 2012

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