nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2012‒04‒17
23 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Firm Entry, Endogenous Markups and the Dynamics of the Labor Share By Andrea Colciago; Lorenza Rossi
  2. International Capital Flows with Limited Commitment and Incomplete Markets By Jurgen von Hagen; Haiping Zhang
  3. The natural rate of interest in a small open economy By Fernando de Holanda Barbosa
  4. A Macroeconomic Analysis of Energy Subsidies in a Small Open Economy: The Case of Egypt By Gerhard Glomm; Juergen Jung
  5. Endogenous time preference: evidence from Australian households' behav iour By Dutta, Dilip; Yang, Yibai
  6. Asymmetric information in credit markets, bank leverage cycles and macroeconomic dynamics By Ansgar Rannenberg
  7. Investment for Patience in an Endogenous Growth Model By Taketo Kawagishi
  8. Initial reforms and dynamics of transition By Ariane TICHIT MINISCLOUX; Solenne TANGUY
  9. A model of waste control and abatement capital: Permanent versus temporary environmental policies By Travaglini, Giuseppe; Saltari, Enrico
  10. Does habit formation always increase the agents' desire to smooth consumption? By Emmanuelle Augeraud-Veron; Mauro Bambi
  11. Unemployment accounts By Setty, Ofer
  12. Fiscal rules and the sovereign default premium By Juan Carlos Hatchondo; Leonardo Martinez; Francisco Roch
  13. The financial accelerator and monetary policy rules By Günes Kamber; Christoph Thoenissen
  14. Stock Market Bubbles and Unemployment By Jianjun Miao; PENGFEI WANG; Lifang Xu
  15. Does Financial Development Cause Higher Firm Volatility and Lower Aggregate Volatility? By Shalini Mitra
  16. An Evaluation of the Revenue side as a source of fiscal consolidation in high debt economies By Banerjee, Ritwik
  17. Immigration, Human Capital and the Welfare of Natives By Eberhard, Juan
  18. Banking Bubbles and Financial Crisis By Jianjun Miao; PENGFEI WANG
  19. Capital Controls with International Reserve Accumulation: Can this Be Optimal ? By Philippe Bacchetta; Kenza Benhima; Yannick Kalantzis
  20. Informative Advertising in Directed Search By Gomis-Porqueras, Pedro; Julien, Benoit; Chengsi, Wang
  21. Job Search Costs and Incentives By Andriy Zapechelnyuk; Ro'i Zultan
  22. A Regional Model of Endogenous Growth with Creative Destruction By Steven Bond-Smith
  23. Searching on a Deadline By S. Nuray Akin; Brennan C. Platt

  1. By: Andrea Colciago (Department of Economics, University of Milano Bicocca); Lorenza Rossi (Department of Economics and Quantitative Methods, University of Pavia)
    Abstract: Recent U.S. evidence suggests that the response of the labor share to a productivity shock is characterized by countercyclicality and overshooting. These findings cannot be easily reconciled with existing business cycle models. We extend the standard model of search and matching in the labor market by considering strategic interactions among an endogenous number of producers. This leads to countercyclical price markups. While Nash bargaining is sufficient to capture the labor share countercyclicality, we show that countercyclical markups are key to address the overshooting.
    Keywords: Endogenous Market Structures, Oligopolistic Competition, Firms' Entry, Search and Matching Frictions, Labor Share Overshooting.
    JEL: E24 E32 L11
    Date: 2012–03
  2. By: Jurgen von Hagen (University of Bonn, Indiana University and CEPR); Haiping Zhang (School of Economics, Singapore Management University)
    Abstract: Recent literature has proposed two alternative types of financial frictions, i.e., limited commitment and incomplete markets, to explain the patterns of international capital flows between developed and developing countries observed in the past two decades. This paper integrates both types of frictions into a two-country overlapping-generations framework to facilitate a direct comparison of their effects. In our model, limited commitment distorts the investment made by agents with different productivity, which creates a wedge between the interest rates on equity capital vs. credit capital; while incomplete markets distort the investment among projects with different riskiness, which creates a wedge between the risk-free rate and the mean rate of return to risky capital. We show that the two approaches are observationally equivalent with respect to their implications for international capital flows, production efficiency, and aggregate output.
    Keywords: E44, F41
    Date: 2012–01
  3. By: Fernando de Holanda Barbosa (FGV)
    Abstract: The goal of this paper is to show that the natural rate of interest in a small open economy, with access to the world capital markets, is equal to the international real rate of interest. We show this property by using the infinitely-lived overlapping generations model and we use this model to analyze both fixed and flexible exchange rate regimes.
    Keywords: small open economy; natural rate of interest; complete and incomplete asset markets
    JEL: F41
    Date: 2011
  4. By: Gerhard Glomm (Indiana University); Juergen Jung (Towson University)
    Abstract: We construct a dynamic general equilibrium model to analyze the effects of large energy subsidies in a small open economy. The model pays special attention to domestic energy production and consumption, trade in energy at world market prices, as well as private and public sector production including the provision of public infrastructure. The model is calibrated to data from Egypt and then used to study policy reforms such as reductions in energy subsidies with corresponding reductions in consumption taxes, labor taxes, capital taxes, or increases in infrastructure investment. We calculate the new steady states, the transition paths to the new steady state and the size of the associated welfare losses or gains. In response to a 15 percent cut in energy subsidies, GDP may fall as less energy is used in production. Excess energy is exported and capital imports are reduced. Welfare in consumption equivalent terms can rise by up to 0.6 percent of GDP. Gains in output can be realized only if the government re-invests into infrastructure.
    Date: 2012–04
  5. By: Dutta, Dilip; Yang, Yibai
    Abstract: Recently, the focus has been increasingly on the importance of endogenous time preference and its varying degrees of marginal impatience. Two types of marginal impatience can change the representative household's endogenous discount function: increasing (Koopmans-Uzawa type) and decreasing (Becker-Mulligan type), which are induced by current consumption and the investment on future-oriented capital, respectively. By modifying the endogenous discount factor in a small-open-economy RBC model, the equilibrium levels of the turnover in future-oriented capital and current consumption are obtained in a reduced form, which overcomes the non- stationarity problem. The relation between current consumption and the turnover in future-oriented capital is consistent with the empirical evidence from Australia.
    Keywords: Endogenous time preference; Stationarity; Real business cycles; Marginal impatience; Future-oriented capital
    Date: 2012–03
  6. By: Ansgar Rannenberg (Deutsche Bundesbank, Economics Department)
    Abstract: The paper adds a moral hazard problem between banks and depositors as in Gertler and Karadi (2011) to a DSGE model with a costly state verification problem between entrepreneurs and banks as in Bernanke, Gertler and Girlchrist (1999, BGG). This modification amplifies the response of the external finance premium and the overall economy to monetary policy and productivity shocks. It allows the model to match the volatility and correlation with output of the external finance premium, bank leverage, entrepreneurial leverage and other variables in US data better than a BGG-type model. A reasonably calibrated simulation of a bank balance sheet shock produces a downturn of a magnitude similar to the "Great Recession".
    Keywords: Financial accelerator, bank leverage, DSGE model
    JEL: E44 G21
    Date: 2012–04
  7. By: Taketo Kawagishi (Kyoto University)
    Abstract: This paper explores a one-sector AK model in which time preference depends on private investment in future-oriented resources along the lines of Becker and Mulligan (1997). Assuming that time preference is also affected by the social level of such investment and that of consumption, we show that multiple balanced growth path (BGP henceforth) equilibria can exist, and provide the conditions for multiple BGP equilibria. Furthermore, we clarify that the equilibrium path is indeterminate in the high-growth BGP equilibrium, while it is determinate in the low-growth BGP equilibrium. We also discuss the effect of a subsidy policy to private investment in future-oriented resources on an endogenous growth rate.
    Keywords: One-sector AK model; Endogenous time preference; Multiple balanced growth path equilibria; Subsidy policy
    JEL: E32 H23 O40
    Date: 2012–04
  8. By: Ariane TICHIT MINISCLOUX (Centre d'Etudes et de Recherches sur le Développement International); Solenne TANGUY
    Abstract: This article analyses the impact on the labor market of the transition from a state-controlled economy towards a market economy. We consider a dynamic matching-model with a declining and an emerging competitive sector. We show that there are two opposite strategies in the move towards a market economy: a massive decrease in employment or a small decrease in employment in the non-competitive sector. We find that the transition is achieved faster with a big reduction in state employment than with a small one. Surprisingly, the end of transition is also characterized by lower unemployment when there are massive layoffs - because in the short run, the high unemployment implied by the massive decrease makes job creation in the competitive sector more profitable. In fact, this seems to have been the way chosen by most of the CEECs.
    Keywords: Unemployment, Matching models, transitional economies
    Date: 2012
  9. By: Travaglini, Giuseppe; Saltari, Enrico
    Abstract: In this paper we investigate the effects of introducing explicitly abatement capital in a welfare function which depends on waste stock and consumption. Consumption is assumed to produce an undesiderable residue. Society can control waste accumulation using abatement capital. We focus on two issues: the intertemporal relationship between abatement investment and waste emission, and the effects of permanent and temporary environmental policies on the long-run equilibrium of the economic-ecological system. We get three main results. First, for a society the problems of waste control and abatement investment are very interrelated. Any change in investment affects waste emission and consumption, but not always in a predictable manner. Second, we show that the adoption of either temporary subsidies or taxes do not change the long-run properties of the economy. It is not just current subsidies or taxes, but their entire path over time that affects accumulation of waste and capital. Third, we get that environmental policies may have ambiguous effects: in response to subsidies or taxes a society might accumulate less abatement capital than desidered, allowing the stock of waste to rise in the long run.
    Keywords: Abatement investment; waste accumulation; dynamic optimization; environmental policy
    JEL: L51 E22 H23
    Date: 2012–03
  10. By: Emmanuelle Augeraud-Veron; Mauro Bambi
    Abstract: In the literature, habit formation has been often introduced to enhance the agents' desire to smooth consumption over time. This characteristic was found particularly useful in solving the equity premium puzzle and in matching several stylized facts in growth, and business cycles theory as, for example, the high persistence in the U.S. output volatility. In this paper we propose a definition of habit formation, which is ``general'' relative to the assumptions on the intensity, persistence, and lag structure, and we unveil two mechanisms which point to the opposite direction: habits may reduce the desire of smoothing consumption over time and then may potentially decrease the power of a model in explaining the previously mentioned facts. More precisely, we propose a complete taxonomy of the rich dynamics which may emerge in an AK model with external addictive habits for all the feasible combinations of the intensity, persistence and lag structure characterizing their formation and we point out to the region in the parameters' space coherent with less smoothing in consumption. An economic explanation of these mechanisms is suggested and the robustness of our results in the case of internal habits verified. Finally and crucially habit formation always reduces the desire of consumption smoothing once the model is calibrated to match the average U.S. output and utility growth rates observed in the data.
    Keywords: Habit formation; endogenous fluctuations, delayed functional differential equations.
    JEL: E00 E30 O40
    Date: 2012–04
  11. By: Setty, Ofer
    Abstract: Unemployment Accounts (UA) are mandatory individual saving accounts that can be used by governments as an alternative to the Unemployment Insurance (UI) system. I study a two tier UA-UI system where the unemployed withdraw from their unemployment account until it is exhausted and then receive unemployment benefits. The hybrid policy provides insurance to workers more efficiently than a traditional UI because it provides government benefits selectively. Using a structural model calibrated to the US economy, I find that relative to a two tier UI system the hybrid policy leads to a welfare gain of 0.9%.
    Keywords: Unemployment Accounts; Unemployment Insurance; Job-search; Moral hazard; Mechanism Design; Optimal Policy;
    JEL: E24 J65 J64 E61
    Date: 2012–04–12
  12. By: Juan Carlos Hatchondo; Leonardo Martinez; Francisco Roch
    Abstract: We find the optimal target values for fiscal rules and measure their aggregate effects using a model of sovereign default. We calibrate the model to an economy that pays a significant sovereign default premium when the government is not constrained by fiscal rules. For different levels of the default premium, we find that a government with a debt of 38 percent of trend income (typical in the case studied here) chooses to commit to a debt ceiling of 30 percent of trend income that starts being enforced four years after its announcement. This rule generates expectations of lower future indebtedness, and thus it allows the government to borrow at interest rates significantly lower than the ones it pays without a rule. We also study the case in which the government conducts a voluntary debt restructuring to capture the capital gains from the increase in its debt market value implied by the existence of a fiscal rule. In this case, the government is found to choose instead a debt ceiling of 25 percent of trend income that starts being enforced less than two years after its announcement. After the imposition of the debt ceiling, lower debt levels allow the government to implement a less procyclical fiscal policy that reduces consumption volatility. However, the government prefers a procyclical debt ceiling that implies a larger reduction of the default probability at the expense of a higher consumption volatility.
    Date: 2012
  13. By: Günes Kamber; Christoph Thoenissen (Reserve Bank of New Zealand)
    Abstract: The ability of financial frictions to amplify the output response of monetary policy, as in the financial accelerator model of Bernanke et al (1999), is analysed for a wider class of policy rules where the policy interest rate responds to both inflation and the output gap. When policy makers respond to the output gap as well as inflation, the standard financial accelerator model reacts less to an interest rate shock than does a comparable model without an operational financial accelerator mechanism. In recessions, when firm-specific volatility rises, financial acceleration due to financial frictions is further reduced, even under pure inflation targeting.
    JEL: E32 E52
    Date: 2012–02
  14. By: Jianjun Miao (Department of Economics, Boston University, CEMA, Central University of Finance and Economics, and AFR, Zhejiang University); PENGFEI WANG (Department of Economics, Hong Kong University of Science and Technology, ClearWater Bay, Hong Kong.); Lifang Xu (Department of Economics, Hong Kong University of Science and Technology, ClearWater Bay, Hong Kong.)
    Abstract: This paper introduces endogenous credit constraints in a search model of unemployment. These constraints generate multiple equilibria supported by self-fulfilling beliefs. A stock market bubble exists through a positive feedback loop mechanism. The collapse of the bubble tightens the credit constraints, causing firms to reduce investment and hirings. Unemployed workers are hard to find jobs generating high and persistent unemployment.
    Keywords: stock market bubbles, unemployment, self-fulfilling beliefs, credit constraints, multiple equilibria
    JEL: E24 E44 J64
    Date: 2012–01
  15. By: Shalini Mitra (University of Connecticut)
    Abstract: The period before the financial crisis was characterized by unprecedented calm in the U.S. and other developed countries. Volatility of aggregate output growth declined in the U.S. beginning in the early 1980's until the fall of 2007 (the phenomenon has been widely called the Great Moderation). Meanwhile micro level evidence suggests increasing volatility at the firm level over the last 60 years including the period of the Great Moderation. I conduct a quantitative analysis of the role played by financial development in the divergence of firm and aggregate volatilities. In a DSGE setting based on Kiyotaki and Moore (1997) type borrowing constraints I show that financial development is associated with increasing firm growth volatility and declining aggregate volatility. The reason for the divergence is a decline in correlation of the firm with the aggregate as financial development occurs. Classification-JEL: D21, D58, E27, E32
    Keywords: Great Moderation, Firm-Level Volatility, Borrowing Constraints, Heterogenous Firms, Business Cycle
    Date: 2012–03
  16. By: Banerjee, Ritwik
    Abstract: Unsustainable levels of debt for some European economies is causing enormous strain in the Euro area. How to tide over the debt crisis seems to be the most important objective the European policy makers are currently facing. We use a dynamic general equilibrium closed economy model to compute the dynamic Laffer Curves for Portugal, Ireland, Greece and Spain for different class of taxes. We conclude that there exists scope for considerable revenue generation by raising certain class of taxes. Thus revenue generation, along with fiscal consolidation holds key for debt reduction.
    Keywords: fiscal consolidation; dynamic laffer curve; tax revenue; fiscal policy
    JEL: E62 E61 O52
    Date: 2012–04–07
  17. By: Eberhard, Juan
    Abstract: I analyze the effect of an unexpected influx of immigrants on the price of skill and hence on the earnings, human capital accumulation and educational attainment of native workers. In order to study these effects, I develop a general equilibrium model with heterogeneous workers who differ in their level of skill and in their ability to learn new skills. These workers accumulate human capital optimally using information about the current and future market price of skill to guide their decisions. To assess the impact of immigration, I compare simulated earnings in the presence of immigration with a series of counterfactual experiments. My findings suggest that immigration has a small negative direct effect on earnings, but a positive and relatively large impact indirectly through human capital accumulation and educational attainment. This latter mechanism explains 60% of the variations in earnings caused by immigration.
    Keywords: Human Capital; Immigration; Heterogeneous Agents
    JEL: D31 E24 J61
    Date: 2012–03
  18. By: Jianjun Miao (Department of Economics, Boston University, CEMA, Central University of Finance and Economics, and AFR, Zhejiang University); PENGFEI WANG (Department of Economics, Hong Kong University of Science and Technology, ClearWater Bay, Hong Kong.)
    Abstract: This paper develops a macroeconomic model with a banking sector in which banks face endogenous borrowing constraints. There is no uncertainty about economic fundamentals. Banking bubbles can emerge through a positive feedback loop mechanism. Changes in household confidence can cause the collapse of bubbles, resulting in a financial crisis. Credit policy can mitigate economic downturns but also incur an efficiency loss. Bank capital requirements can prevent the formation of banking bubbles by limiting leverage. But a too restrictive requirement leads to less lending and hence less production.
    Keywords: Banking Bubble, Multiple Equilibria, Financial Crisis, Self-ful?lling Prophecy, Credit Policy, Capital Requirements, Borrowing Constraints
    JEL: E2 E44 G01 G20
    Date: 2012–01
  19. By: Philippe Bacchetta; Kenza Benhima; Yannick Kalantzis
    Abstract: Motivated by the Chinese experience, we analyze a semi-open economy where the central bank has access to international capital markets, but the private sector has not. This enables the central bank to choose an interest rate different from the international rate. We examine the optimal policy of the central bank by modelling it as a Ramsey planner who can choose the level of domestic public debt and of international reserves. The central bank can improve savings opportunities of credit-constrained consumers modelled as in Woodford (1990). We find that in a steady state it is optimal for the central bank to replicate the open economy, i.e., to issue debt financed by the accumulation of reserves so that the domestic interest rate equals the foreign rate. When the economy is in transition, however, a rapidly growing economy has a higher welfare without capital mobility and the optimal interest rate differs from the international rate. We argue that the domestic interest rate should be temporarily above the international rate. We also find that capital controls can still help reach the first best when the planner has more fiscal instruments.
    Keywords: reserve accumulation; capital controls; Ramsey planner; credit constraints
    JEL: E58 F36 F41
    Date: 2011–12
  20. By: Gomis-Porqueras, Pedro; Julien, Benoit; Chengsi, Wang
    Abstract: We consider a directed search environment where capacity constrained sellers reach uncoordinated buyers through costly advertising while buyers observed all prices probabilistically. We show that: (i) the equilibrium advertising intensity has an inverted U-shape in market tightness, (ii) the equilibrium advertising intensity is higher under an auction mechanism than under posted pricing, and (iii) the equilibrium price and measure of informed buyers may {be positively correlated} even in large markets.
    Keywords: costly advertising; directed search; imperfect observability; sales mechanism
    JEL: M37 J64 D83
    Date: 2012–04–10
  21. By: Andriy Zapechelnyuk (Queen Mary, University of London); Ro'i Zultan (Ben-Gurion University of the Negev)
    Abstract: The costs of searching for a job vacancy are typically associated with friction that deters or delays employment of potentially productive individuals. We demonstrate that in a labor market with moral hazard where effort is noncontractible, job search costs play a positive role, whose effect may outweigh the negative implications. As workers are provided incentives to exert effort by the threat of losing their job and having to search for a new vacancy, a reduction in job search costs leads to fewer employees willing to exert effort. The overall lower productivity will make more individuals and firms opting to stay out of the labor market, resulting in lower employment and decreased welfare. Eventually, a reduction of jobs search costs below a certain level results in collapse of the labor market.
    Keywords: : Job search, Moral hazard, Labor market, Unemployment insurance
    JEL: D83 J64 J65
    Date: 2012–04
  22. By: Steven Bond-Smith (University of Waikato)
    Abstract: We examine endogenous growth through vertical innovations in a two region model with partial regional and varietal knowledge spillovers. This paper extends the growth literature by adding a regional endogenous growth model with improvements in product quality, instead of a product variety engine for growth, where we account for partial knowledge spillovers in R&D. Starting with the quality ladders endogenous growth model we add traditional goods production by unskilled workers, location as a factor in R&D spillovers, migration of knowledge workers and vary the freeness of trade. Production of each manufactured variety is contestable through vertical innovation based on available knowledge and as a result, firms choose a location to maximise the productivity of R&D, maintain their niche monopoly and minimise transport costs. With contestability, knowledge spillovers provide for additional growth and the partial nature of spillovers causes an additional clustering effect encouraging agglomeration. Growth is highest when there is full agglomeration in one location, as knowledge spillovers are greater with manufacturing concentration. Agglomerated locations are reliant on local inter-varietal knowledge spillovers for growth while peripheral locations rely on trade and regional knowledge spillovers. In the long run, locations experience equal growth rates. If a location becomes agglomerated, it has higher long-run wages and higher growth rates during the transition to the long run. The model offers policy implications for lagging economies to improve inter-regional knowledge spillovers while agglomerated economies should be more concerned with business interaction within the region. Policies which reduce barriers to migration will increase long run growth rates by accelerating the transition to agglomeration.
    Keywords: endogenous growth; new economic geography; innovation; knowledge spillovers; agglomeration; quality ladders; creative destruction
    JEL: O41 R10
    Date: 2012–04–07
  23. By: S. Nuray Akin (Department of Economics, University of Miami); Brennan C. Platt (Department of Economics, Brigham Young University)
    Abstract: We analyze an equilibrium search model where the buyer seeks to purchase a good before a deadline. The buyer's reservation price rises continuously as the deadline approaches. A seller cannot observe a potential buyer's remaining time until deadline, and hence posts a price that weighs the probability of sale versus the profit once sold. The model has a unique equilibrium, which can take exactly one of two forms. In a late equilibrium, buyers initially forgo any purchases, only accepting some offers as the deadline draws near. In an early equilibrium, buyers are willing to accept some offers even as they enter the market. Equilibrium price dynamics are determined by the concentration of buyers near their deadline, as well as their urgency of completing the transaction before their deadline.
    Keywords: Multiple treatments; Equilibrium search, deadline, reservation prices, price posting
    JEL: D40 D83
    Date: 2011

This nep-dge issue is ©2012 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.