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

  2. Monetary Policies and Nigerian Economy:Simulations from Dynamic Stochastic General Equilibrium(DSGE)Model By Nwaobi, Godwin
  3. Accounting for the Great Recession in the UK: Real Business Cycles and Financial Frictions By Jagjit S. Chadha; James Warren
  4. A Pitfall with DSGE-Based, Estimated, Government Spending Multipliers By Fève, Patrick; Matheron, Julien; Sahuc, Jean-Guillaume
  5. A Theory of Optimal Capital Taxation By Thomas Piketty; Emmanuel Saez
  6. Assessing DSGE Models with Capital Accumulation and Indeterminacy By Vadim Khramov
  7. Initial reforms and dynamics of transition By Ariane Tichit Miniscloux; Solenne Tanguy
  8. The Laffer Curve in an Incomplete-Markets Economy By Fève, Patrick; Matheron, Julien; Sahuc, Jean-Guillaume
  9. Dynamic analysis of reductions in public debt in an endogenous growth model with public capital By Noritaka Maebayashi; Takeo Hori; Koichi Futagami
  10. Job matching, family gap and fertility choice By Chang, Chia-Ying; Laing, Derek; Wang, Ping
  11. When banking systems meet currencies By Chang, Chia-Ying
  12. Monetary Policy in Low Income Countries in the Face of the Global Crisis: The Case of Zambia By Jaromir Benes; Alfredo Baldini; Mai Dao; Rafael Portillo; Andrew Berg
  13. Educational Signaling, Credit Constraints and Inequality Dynamics By Marcello D'Amato; Dilip Mookherjee
  14. Reserves, Liquidity and Money: An Assessment of Balance sheet Policies By Jagjit S. Chadha; Luisa Corrado; Jack Meaning
  15. Fiscal policy and the great recession in the Euro area By Günter Coenen; Roland Straub; Mathias Trabandt
  16. New entries and economic growth By Chang, Chia-Ying; Hansen, Vera
  17. Distressed sales and liquidity in OTC markets By Selcuk, Cemil
  18. The role of market frictions on the price differential: A search-theoretical approach By Chang, Chia-Ying
  19. Gift Exchange versus Monetary Exchange: Theory and Evidence By John Duffy
  20. Intellectual property rights, technical progress and the volatility of economic growth By Chu, Angus C.; Leung, Charles Ka Yui; TANG, C. H. Edward
  21. Government spending, corruption and economic growth By d'Agostino, Giorgio; Dunne, Paul J.; Pieroni, Luca

  1. By: Mertens, Jean-Francois (CORE, Universite Catholique de Louvain); Rubinchik, Anna (Department of Economics, University of Haifa)
    Abstract: For an overlapping generations economy with varying life-cycle productivity, non-stationary endowments, continuous time starting at infinity (hence allowing for full anticipation), constant-returns-to-scale production and ces utility we fully characterise equilibria where output is higher than investment, which is strictly positive. Net assets (aggregate savings minus the value of the capital stock) are constant in any equilibrium, and, for balanced growth equilibria (BGE, defined for an economy with stationary endowments), net assets are non-zero only in the golden rule equilibrium, in accord with Gale 1973. The number of BGE is finite. Their parity, however, depends on the life-cycle productivity, in particular, on the relation between the intertemporal elasticity of substitution, the minimal working age and the minimal tax age.
    Keywords: Infinite Economies, Overlapping Generations, Exogenous Growth
    JEL: D50
    Date: 2012–03–05
  2. By: Nwaobi, Godwin
    Abstract: Traditionally, the task of monetary management is usually performed by the monetary authority on behalf of government. However, a key challenge in monetary management is how to deal with uncertainty. Thus, the relevant policy questions must include how best the available instruments of monetary policy be deployed in shock prone mature stabilizers. Therefore, the basic thrust of this paper is to evaluate monetary policy - tradeoffs using a dynamic stochastic general equilibrium(DSGE)model estimated on data for Nigeria.
    Keywords: dynamic; stochastic; general; equilibrium; dsge; nigeria; monetary management; shocks; var; monetary policy; fiscal policy; exchange rate; central bank
    JEL: D50 C68 C63 C50 E58
    Date: 2012–04–17
  3. By: Jagjit S. Chadha; James Warren
    Abstract: Using the business cycle accounting (BCA) framework pioneered by Chari, Kehoe and McGratten (2006) we examine the 2008-09 recession in the UK. There has been much commentary on the financial causes of this recession, which we might have expected to shock the equation governing the intertemporal rate of substitution in consumption. However, the recession appears to have been mostly driven by shocks to the efficiency wedge in total production, rather than the intertemporal consumption, labour or spending wedge. From an expenditure perspective this result is consistent with the observed large falls in both consumption and investment during the recession. To assess this result we also simulate artificial data from a DSGE model in which asset price shocks dominate and find no strong role for the intertemporal consumption wedge using the BCA method. This result does not imply that financial frictions did not matter for the recent recession but that such frictions do not necessarily impact only on the intertemporal rate of substitution in consumption.
    Keywords: Business Cycle Accounting; Major Recessions; TFP; Financial Frictions
    JEL: E31 E40 E51
    Date: 2012–04
  4. By: Fève, Patrick; Matheron, Julien; Sahuc, Jean-Guillaume
    Abstract: This paper examines issues related to the estimation of the government spending multiplier (GSM) in a Dynamic Stochastic General Equilibrium context. We stress a potential source of bias in the GSM arising from the combination of Edgeworth complementarity/substitutability between private consumption and government expenditures and endogenous government expenditures. Due to crossequation restrictions, omitting the endogenous component of government policy at the estimation stage would lead an econometrician to underestimate the degree of Edgeworth complementarity and, consequently, the long-run GSM. An estimated version of our model with US postwar data shows that this bias matters quantitatively. The results prove to be robust to a number of perturbations.
    Keywords: , , , , , , , Government spending rules, DSGE models, Edgeworth complementarity/substitutability, Multiplier
    JEL: C32 E32 E62
    Date: 2012–04
  5. By: Thomas Piketty; Emmanuel Saez
    Abstract: This paper develops a realistic, tractable theoretical model that can be used to investigate socially-optimal capital taxation. We present a dynamic model of savings and bequests with heterogeneous random tastes for bequests to children and for wealth per se. We derive formulas for optimal tax rates on capitalized inheritance expressed in terms of estimable parameters and social preferences. Under our model assumptions, the long-run optimal tax rate increases with the aggregate steady-state flow of inheritances to output, decreases with the elasticity of bequests to the net-of-tax rate, and decreases with the strength of preferences for leaving bequests. For realistic parameters of our model, the optimal tax rate on capitalized inheritance would be as high as 50%-60%–or even higher for top wealth holders–if the social objective is meritocratic (i.e., the social planner puts higher welfare weights on those receiving little inheritance) and if capital is highly concentrated (as it is in the real world). In contrast to the Atkinson-Stiglitz result, the optimal tax on bequest remains positive in our model even with optimal labor taxation because inequality is two-dimensional: with inheritances, labor income is no longer the unique determinant of lifetime resources. In contrast to Chamley-Judd, the optimal tax on capital is positive in our model because we have finite long run elasticities of inheritance to tax rates. Finally, we discuss how adding capital market imperfections and uninsurable shocks to rates of return to our optimal tax model leads to shifting one-off inheritance taxation toward lifetime capital taxation, and can account for the actual structure and mix of inheritance and capital taxation.
    JEL: H21
    Date: 2012–04
  6. By: Vadim Khramov
    Abstract: The simulated results of this paper show that New Keynesian DSGE models with capital accumulation can generate substantial persistencies in the dynamics of the main economic variables, due to the stock nature of capital. Empirical estimates on U.S. data from 1960:I to 2008:I show the response of monetary policy to inflation was almost twice lower than traditionally considered, as capital accumulation creates an additional channel of influence through real interest rates in the production sector. Versions of the model with indeterminacy empirically outperform determinate versions. This paper allows for the reconsideration of previous findings and has significant monetary policy implications.
    Keywords: Capital accumulation , Economic models , Monetary policy ,
    Date: 2012–03–21
  7. By: Ariane Tichit Miniscloux (CERDI - Centre d'études et de recherches sur le developpement international - CNRS : UMR6587 - Université d'Auvergne - Clermont-Ferrand I); Solenne Tanguy (CREG - Centre de recherche en économie de Grenoble - Université Pierre Mendès-France - Grenoble II : EA4625)
    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: 2012–04–13
  8. By: Fève, Patrick; Matheron, Julien; Sahuc, Jean-Guillaume
    Abstract: This paper is a quantitative investigation into the characteristics of the Laffer curve in a neoclassical growth model with incomplete markets and heterogeneous, liquidity-constrained agents. We show that the shape of the Laffer curves related to taxes on labor, capital and consumption dramatically changes depending on which of transfers or government debt are adjusted to make the government budget constraint hold. When transfers are adjusted, the Laffer curve has the traditional shape. However, when debt is adjusted, the Laffer curve looks like a horizontal S, in which case fiscal revenues can be associated with up to three diferent levels of taxation. This finding occurs because the tax rates change non monotonically with public debt when markets are incomplete.
    Keywords: , , , , , , , Laffer Curve, Incomplete Markets, Labor Supply, Precautionary Savings, Public Debt
    JEL: E6 H6
    Date: 2012–04
  9. By: Noritaka Maebayashi (Graduate School of Economics, Osaka University); Takeo Hori (College of Economics, Aoyama Gakuin University); Koichi Futagami (Graduate School of Economics, Osaka University)
    Abstract: We construct an endogenous growth model with productive public capital and government debt when government debt is adjusted to the target level. We examine how reducing public debt in an economy with a large public debt affects the transition of the economy and welfare. We find that the government faces the following trade off when reducing its debt. In the short run, public investment is reduced to decrease the debt and this has a negative effect on welfare. However, as the interest payments on the debt decrease, public investment begins to increase. Eventually, the government can increase the amount of public investment by more than before. This has a positive effect on welfare, implying that reducing the debt is welfare improving. Furthermore, we find that the adjustment speed of reductions in debt affects welfare crucially. The relationships between the welfare gains and the adjustment speed are U-shaped in many cases. However, they are decreasing monotonically when the tax rate is low and the initial debt?GDP ratio is sufficiently large.
    Keywords: Reductions in public debt, Debt policy rule, Public capital, Endogenous Growth
    JEL: E62 H54 H63
    Date: 2012–04
  10. By: Chang, Chia-Ying; Laing, Derek; Wang, Ping
    Abstract: This paper concentrates on the role of job matching frictions in influencing the interactions between fertility choice and wage offers and show that job market frictions are a crucial factor in wage differentials among female workers. The goals of this paper are to examine how the home-stay alternative and asymmetric market frictions in‡uence this wage differential and whether the well documented negative correlation between fertility choice and female earnings still holds in the face of life-cycle choices. To address these questions, we develop a search-theoretic model that incorporates fertility and job decisions and assume that the workers with children face a lower job matching rate and a higher job quitting rate relative to the rates faced by the workers without children. As a result, we find that a wider wage differential is associated with more asymmetric market frictions and that the wage differential has a positive effect from output differential, a positive scale effect from the output of mothers and a negative effect from the utility from staying home. The wage differential is positively correlated with both fertility and home-stay rates and negatively correlated with market thickness and matching technology. Furthermore, by having both fertility and home-stay choices endogenously determined, we can show that a tighter market will enhance the fertility rate and the home-stay rate and a better job matching technology would not only increase the home-stay rate but decrease the fertility rate. In general equilibrium, the effects of both market tightness and the matching technology on the wage differential are indeterminate. These results indicate that the home-stay choice actually gives workers with children not only an alternative but also the power to negotiate higher wages. This shrinks the wage differential. Finally, the result that a higher fertility rate enlarges the wage differential also implies a negative relationship between the fertility rate and the earnings of workers with children. This result is consistent with standard empirical findings.
    Keywords: job search, female labor participation, fertility choice,
    Date: 2012–03–19
  11. By: Chang, Chia-Ying
    Abstract: In this paper, we examine the link of investment portfolio decisions of households and investment on international capital flows. I extend Bencivenga and Smith (1991)’s overlapping generation model to an open economy and combine with capital market imperfections in Kiyotake and Moore (1997) to address how the portfolio decisions of one countrty might affect that of the other country. In this general equilibrium framework with flexible exchange rate, I find that the investment portfolio deicisions of households are crucial for the directions of capital inflows. In other words, the portfolio decision of individuals in one country is crucial for the deposit and loan rate, which would affect where the capital inflows from the foreign investors.
    Keywords: international capital markets, capital flows, portfolio decisions, financial intermediaries,
    Date: 2012–03–16
  12. By: Jaromir Benes; Alfredo Baldini; Mai Dao; Rafael Portillo; Andrew Berg
    Abstract: We develop a DSGE model with a banking sector to analyze the impact of the financial crisis on Zambia and the role of the monetary policy response. We view the crisis as a combination of three related shocks: a worsening in the terms of the trade, an increase in the country’s risk premium, and a decrease in the risk appetite of local banks. We characterize monetary policy as "stop and go": initially tight, subsequently loose. Simulations of the model broadly match the path of the economy during this period. We find that the initial policy response contributed to the domestic impact of the crisis by further tightening financial conditions. We study the factors driving the "stop" part of policy and derive policy implications for central banks in low-income countries.
    Date: 2012–04–05
  13. By: Marcello D'Amato (Università di Salerno, and CSEF); Dilip Mookherjee (Boston University)
    Abstract: We present a dynamic OLG model of educational signaling, inequality and mobility with missing credit markets. Agents are characterized by two sources of unobserved heterogeneity: ability and parental income, consistent with empirical evidence on returns to schooling. Both quantity and quality of human capital evolve endogenously. The model generates a Kuznets inverted-U pattern in skill premia similar to historical US and UK experience. In the first (resp. later) phase the skill premium rises (falls), social returns to education exceed (falls below) private returns: under-investment owing to financial imperfections dominate (are dominated by) over-investment owing to signaling distortions. There always exist Pareto-improving policy interventions reallocating education between poor and rich children. JEL Classification:
    Date: 2012–04–11
  14. By: Jagjit S. Chadha; Luisa Corrado; Jack Meaning
    Abstract: The financial crisis and its aftermath has stimulated a vigorous debate on the use of macro-prudential instruments for both regulating the banking system and for providing additional tools for monetary policy makers. The widespread adoption of non-conventional monetary policies has provided some evidence on the efficacy of liquidity and asset purchases for offsetting the lower zero bound. Central banks have thus been reminded as to the effectiveness of extended open market operations as a supplementary tool of monetary policy. These tools are essentially fiscal instruments, as they issue central bank liabilities backed by fiscal transfers. And so having written these tools into the fiscal budget constraint, we can examine the consequences of these operations within the context of a micro-founded macroeconomic model of banking and money. We can mimic the responses of the Federal Reserve balance sheet to the crisis. Specifically, we examine the role of reserves for bond and capital swaps in stabilising the economy and also the impact of changing the composition of the central bank balance sheet. We find that such policies can significantly enhance the ability of the central bank to stabilise the economy. This is because balance sheet operations supply (remove) liquidity to a financial market that is otherwise short (long) of liquidity and hence allows other .nancial spreads to move less violently over the cycle to compensate.
    Keywords: non-conventional monetary interest on reserves; monetary and fiscal policy instruments; Basel III
    JEL: E31 E40 E51
    Date: 2012–04
  15. By: Günter Coenen (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Roland Straub (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Mathias Trabandt (Board of Governors of the Federal Reserve System, Division of International Finance, 20th Street and Constitution Avenue N.W, Washington, DC 20551, USA.)
    Abstract: How much did fiscal policy contribute to euro area real GDP growth during the Great Recession? We estimate that discretionary fiscal measures have increased annualized quarterly real GDP growth during the crisis by up to 1.6 percentage points. We obtain our result by using an extended version of the European Central Bank’s New Area- Wide Model with a rich specification of the fiscal sector. A detailed modeling of the fiscal sector and the incorporation of as many as eight fiscal time series appear pivotal for our result. JEL Classification: C11, E32, E62.
    Keywords: Fiscal policy, DSGE modelling, Bayesian inference, euro area.
    Date: 2012–03
  16. By: Chang, Chia-Ying; Hansen, Vera
    Abstract: The main goal of this paper is to construct a theoretical model that provides an explanation for the relationship between growth and new entry that is consistent with empirical evidence. The model is a four sector endogenous growth model in which there is a technologically advanced and a technologically laggard consumption goods which are imperfect substitutes. The production of each good requires its own stock of human capital and physical capital. The accumulation of physical capital and human capital in each industry is modelled by a Cobb-Douglas production function. The main result of the model is that new entries have a positive effect on the fraction of the existing stock of human capital devoted to the accumulation of human capital in both the advanced and laggard sectors. However, this effect is stronger in the advanced sectors than in the laggard sectors. This result is consistent with empirical evidence.
    Keywords: new entry, growth, advanced, laggard, technology,
    Date: 2012–03–19
  17. By: Selcuk, Cemil
    Abstract: We present a stylized model of the over-the-counter (OTC) markets in the tradition of Duffie, Gârleanu, and Pedersen 2005 with three distinctive features: (i) Buyers' willingness to pay is private information. (ii) Dividends depend on the state of the macro economy. (iii) Sellers become financially distressed if they cannot sell for too long. Unlike the existing body of work in this literature the probability of trade is endogenous, which in turn opens the door to many interesting results, such as liquidation sales, predation and boom and bust cycles.
    Keywords: fire sales; predation; liquidity; boom and bust cycles
    JEL: D80 G10
    Date: 2012–04–01
  18. By: Chang, Chia-Ying
    Abstract: To shed light on how market frictions and the waiting time of imitators affect prices and how effective research subsidy and patent protection affect the price differential, this paper adopts a direct search-theoretical approach to capture the searching behaviors of consumers and producers in the innovative and imitative markets. As a result, this model shows that the price differential with endogenous market frictions would react to the change of quality the least. A shorter durability would result in a wider price differential in the model without the extra state for imitators than in the model with the extra state. While a research subsidy shrinks the price differential, and improve consumers’ flow values, the patent protection widens the price differential, hurts imitators’ profits and may not improve the consumers’ flow values. The innovators could take the advantage of the effects of durability on price differential by inventing products which might influence the durability of the products currently hold by the consumers. This finding might provide an explanation on why the latest versions of computer products are invented less likely convertible to older versions of Windows or associated software.
    Keywords: market frictions, price differential, direct search, innovation, imitation,
    Date: 2012–03–16
  19. By: John Duffy
    Abstract: This paper reports findings from an experiment that implements the Lagos-Wright (2005) model of monetary exchange. We find that subjects generally avoid the autarkic equilibrium of that model and make trading decisions consistent with the model`s monetary equilibrium. Aliprantis, Camera and Puzzello (ACP, 2007) show that providing periodic access to centralized markets as in the Lagos and Wright framework may facilitate the sustainability of social norms of gift exchange, thus rendering money inessential in decentralized exchange. We also explore this hypothesis by replacing the centralized market of the Lagos-Wright model with a version of the centralized market of ACP`s model. We find that the essentiality of money is not threatened by the presence of centralized meetings. Indeed, the efficiency of allocations is significantly higher in the environment with money than without money, suggesting that money plays a role as an efficiency enhancing coordination device.
    Date: 2011–11
  20. By: Chu, Angus C.; Leung, Charles Ka Yui; TANG, C. H. Edward
    Abstract: In this note, we analyze the effects of intellectual property rights on the volatility of economic growth. Our analysis is motivated by the observation that the strengthening of patent protection and the increase in R&D in the US coincide with a reduction in growth volatility beginning in the mid 1980’s. To analyze this phenomenon, we develop an R&D-based growth model with aggregate uncertainty in the innovation process and apply the model to ask whether increasing patent strength and R&D can lead to a significant reduction in growth volatility. We find a small but non-negligible effect that explains no less than 10% of the observed reduction in growth volatility in the US.
    Keywords: Economic growth; Intellectual property rights; Growth volatility
    JEL: E32 O34 O33
    Date: 2012–04
  21. By: d'Agostino, Giorgio; Dunne, Paul J.; Pieroni, Luca
    Abstract: This paper considers the effects of corruption and government spending on economic growth. It starts from an endogenous growth model and extends it to account for the detrimental effects of corruption on the potentially productive components of government spending, namely military and investment spending. The resulting model is estimated on a sample of African countries and the results show, first, that the growth rate is strongly influenced by the interaction between corruption and military burden, with the interaction between corruption and government investment expenditure having a weaker effect. Second, allowing for the cyclical economic fluctuations in specific countries leaves the estimated elasticities close to those of the full sample. Third, there are significant conditioning variables that need to be taken into account, namely the form of government, political instability and natural resource endowment. These illustrate the cross country heterogeneity when accounting for quantitative direct and indirect effects of key variables on economic growth. Overall, these findings suggest important policy implications.
    Keywords: corruption; military spending; development economics; panel data; Africa
    JEL: D73 H5 O57
    Date: 2012–04–15

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