nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2012‒06‒05
eighteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Ambiguous Business Cycles By Cosmin Ilut; Martin Schneider
  2. Jobs in a recession By Pascal Michaillat
  3. Time-consistent fiscal policy under heterogeneity: Conflicting or common interests? By Angelopoulos, Konstantinos; Malley, James; Philippopoulos, Apostolis
  4. The impact of fiscal consolidation on economic growth. An illustration for the Spanish economy based on a general equilibrium model By Pablo Hernández de Cos; Carlos Thomas
  5. Unions in a Frictional Labor Market By Leena Rudanko; Per Krusell
  6. On the welfare impacts of an immigration amnesty By Joël MACHADO
  7. On Identification of Bayesian DSGE Models By Koop, Gary; Pesaran, M. Hashem; Smith, Ron P.
  8. Realised and Optimal Monetary Policy Rules in an Estimated Markov-Switching DSGE Model of the United Kingdom By Chen, Xiaoshan; MacDonald, Ronald
  9. Neutral technology shocks and employment dynamics: results based on an RBC identification scheme By Mumtaz, Haroon; Zanetti, Francesco
  10. Optimal labor-income tax volatility with credit frictions. By Abo-Zaid, Salem
  11. News, Credit Spreads and Default Costs: An expectations-driven interpretation of the recent boom-bust cycle in the U.S. By Christopher M. Gunn; Alok Johri
  12. Adaptation, Anticipation-Bias and Optimal Income Taxation By Aronsson, Thomas; Schöb, Ronnie
  13. Global analysis and indeterminacy in a two-sector growth model with human capital By Antoci, Angelo; Galeotti, Marcello; Russu, Paolo
  14. Commitment-Flexibility Trade-Off and Withdrawal Penalties By Attila Ambrus; Georgy Egorov
  15. The Contribution of Housing to the Dynamics of Inequalities By Modibo Sidibé
  16. Optimal exploitation of a renewable resource with capital limitations. By Asle Gauteplass and Anders Skonhoft
  17. Mandatory pension savings, private savings, homeownership, and financial stability By Asgeir Danielsson
  18. Government spending, corruption and economic growth By G. d'Agostino; J.P Dunne; L. Pieroni

  1. 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.
    Date: 2012
  2. By: Pascal Michaillat
    Abstract: This article is based on a paper that models unemployment as the result of matching frictions and job rationing. Job rationing is a shortage of jobs arising naturally in an economic equilibrium from the combination of some wage rigidity and diminishing marginal returns to labor. During recessions, job rationing is acute, driving the rise in unemployment, whereas matching frictions contribute little to unemployment. Intuitively, in recessions jobs are lacking, the labor market is slack, recruiting is easy and inexpensive, so matching frictions do not matter much. In a calibrated model, cyclical fluctuations in the composition of unemployment are quantitatively large.
    Keywords: Unemployment, matching frictions, job rationing
    JEL: E24 E32 J64
    Date: 2012–05
  3. By: Angelopoulos, Konstantinos; Malley, James; Philippopoulos, Apostolis
    Abstract: This paper studies the aggregate and distributional implications of Markov-perfect tax-spending policy in a neoclassical growth model with capitalists and workers. Focusing on the long run, our main fi ndings are: (i) it is optimal for a benevolent government, which cares equally about its citizens, to tax capital heavily and to subsidise labour; (ii) a Pareto improving means to reduce ine¢ ciently high capital taxation under discretion is for the government to place greater weight on the welfare of capitalists; (iii) capitalists and workers preferences, regarding the optimal amount of "capitalist bias", are not aligned implying a conflict of interests.
    Keywords: Optimal fi scal policy, Markov-perfect equilibrium, heterogeneous agents,
    Date: 2011
  4. By: Pablo Hernández de Cos (Banco de España); Carlos Thomas (Banco de España)
    Abstract: This study illustrates the effects of different fiscal consolidation measures on economic activity through simulations performed with a general equilibrium model calibrated to the Spanish economy. Overall, our results show that fiscal consolidation has short-run costs but sizable long-run benefits in terms of growth. Regarding the short-run costs, their magnitude depends crucially on the presence of confidence effects due to the consolidation process, which tend to reduce the value of fiscal multipliers
    Keywords: Fiscal consolidation, general equilibrium, fiscal multipliers, confidence effects
    JEL: E62 C68
    Date: 2012–05
  5. By: Leena Rudanko (Department of Economics, Boston University, and NBER); Per Krusell (Stockholm University, CEPR, and NBER)
    Abstract: We analyze a labor market with search and matching frictions where wage setting is controlled by a monopoly union. We take a benevolent view of the union in assuming it to care equally about employed and unemployed workers and we assume, moreover, that it is fully rational, thus taking job creation into account when making its wage demands. Under these assumptions, if the union is also able to fully commit to future wages it generates an efficient level of long-run unemployment. However, in the short run, it uses its market power to collect surpluses from firms with existing matches by raising current wages above the efficient level. These elements give rise to a time inconsistency. Without commitment, and in a Markov-perfect equilibrium, not only is unemployment well above its efficient level, but the union wage also exhibits endogenous real stickiness which amplifies the responses of vacancy creation and unemployment to shocks. We consider extensions to partial unionization and collective bargaining between a labor union and an employers’ association.
    Keywords: Labor unions, frictional labor markets, time-inconsistency
    JEL: E02 E24 J51 J64
    Date: 2012–01
  6. By: Joël MACHADO (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES))
    Abstract: This paper aims to assess the effects of an immigration amnesty on agents' welfare by using a simple two-period overlapping generations model. Given that illegal immigrants play a role in the economy even before being regularized, an amnesty differs from new immigration. In the presence of labor market discrimination, capital holders are harmed as the acquisition of legal status increases the wage bill that they pay. The net fiscal effect strongly depends on the discrimination that illegal workers face ex ante. A calibration of the model on Germany and the United Kingdom highlights overall limited economic consequences of amnesty which can be contrasted to the effects of deportation and new legal immigration. In particular, when public welfare expenditures are low, amnesty and new immigration can increase native's welfare in the long run while deportation might harm less-educated agents.
    Keywords: illegal immigration, amnesty, regularization, discrimination
    JEL: F29 J61 J79
    Date: 2012–05–09
  7. By: Koop, Gary; Pesaran, M. Hashem; Smith, Ron P.
    Abstract: In recent years there has been increasing concern about the identification of parameters in dynamic stochastic general equilibrium (DSGE) models. Given the structure of DSGE models it may be difficult to determine whether a parameter is identified. For the researcher using Bayesian methods, a lack of identification may not be evident since the posterior of a parameter of interest may differ from its prior even if the parameter is unidentified. We show that this can even be the case even if the priors assumed on the structural parameters are independent. We suggest two Bayesian identification indicators that do not suffer from this difficulty and are relatively easy to compute. The first applies to DSGE models where the parameters can be partitioned into those that are known to be identified and the rest where it is not known whether they are identified. In such cases the marginal posterior of an unidentified parameter will equal the posterior expectation of the prior for that parameter conditional on the identified parameters. The second indicator is more generally applicable and considers the rate at which the posterior precision gets updated as the sample size (T) is increased. For identified parameters the posterior precision rises with T, whilst for an unidentified parameter its posterior precision may be updated but its rate of update will be slower than T. This result assumes that the identified parameters are pT-consistent, but similar differential rates of updates for identified and unidentified parameters can be established in the case of super consistent estimators. These results are illustrated by means of simple DSGE models.
    Keywords: Bayesian identifi cation, DSGE models, posterior updating, New Keynesian Phillips Curve,
    Date: 2011
  8. By: Chen, Xiaoshan; MacDonald, Ronald
    Abstract: This paper investigates underlying changes in the UK economy over the past thirtyfive years using a small open economy DSGE model. Using Bayesian analysis, we find UK monetary policy, nominal price rigidity and exogenous shocks, are all subject to regime shifting. A model incorporating these changes is used to estimate the realised monetary policy and derive the optimal monetary policy for the UK. This allows us to assess the effectiveness of the realised policy in terms of stabilising economic fluctuations, and, in turn, provide an indication of whether there is room for monetary authorities to further improve their policies.
    Keywords: Markov-switching, Bayesian analysis, DSGE models,
    Date: 2011
  9. By: Mumtaz, Haroon (Bank of England); Zanetti, Francesco (Bank of England)
    Abstract: This paper studies the dynamic response of labour input to neutral technology shocks. It uses a standard real business cycle model enriched with labour market search and matching frictions and investment-specific technological progress that enables a new, agnostic, identification scheme based on sign restrictions on an SVAR. The estimation supports an increase of labour input in response to neutral technology shocks. This finding is robust across different perturbations of the SVAR model. The model is extended to allow for time-varying volatility of shocks and the identification scheme is used to investigate the importance of neutral and investment-specific technology shocks to explain the reduced volatility of US macroeconomic variables over the past two decades. Neutral technology shocks are found to be more important than investment-specific technology shocks.
    Date: 2012–05–18
  10. By: Abo-Zaid, Salem
    Abstract: This paper studies the optimality of labor tax smoothing in a simple model with credit frictions. Firms’ borrowing to pay their wage payments in advance is constrained by the value of their collateral at the beginning of the period. The labor tax and the shadow value on the credit constraint lead to a (static) wedge between the marginal product of labor and the marginal rate of substitution between labor and consumption. This paper suggests that while the notion of “wedge smoothing” is carried over to this environment, it is achieved only through a volatile labor-income tax rate. As the shadow value on the financing constraint varies over the business cycle, tax volatility is needed in order to counteract this variation and thus allow for “wedge smoothing”. In particular, the optimal labor-income tax rate is lower when the credit market is more tightened and higher when the credit market is less tightened. Therefore, when firms are more credit-constrained and the demand for labor is reduced, optimal fiscal policy calls for boosting labor supply by lowering the labor-income tax rate.
    Keywords: Labor tax smoothing; Credit frictions; Borrowing constraints
    JEL: E62 H21 E44
    Date: 2012–05–11
  11. By: Christopher M. Gunn; Alok Johri
    Abstract: The years leading up to the "great recession" were a time of rapid innovation in the financial industry. This period also saw a fall in credit spreads and a boom in liquidity and asset prices that accompanied the boom in real activity, especially investment. In this paper we argue that these were not unrelated phenomena. The adoption of new financial products and practices led to a fall in the expected costs of default which in turn engendered the flood of liquidity in the financial sector, lowered interest rate spreads and facilitated the boom in asset prices and economic activity. When the events of 2007-2009 led to a re-evaluation of the effectiveness of these new products, agents revised their expectations regarding the actual efficiency gains available to the financial sector and this led to a withdrawal of liquidity from the financial system, a reversal in credit spreads and asset prices and a bust in real activity. We treat the efficiency of the financial sector as an exogenous process governing bankruptcy (monitoring) costs facing intermediaries in a costly state verification framework and study the impact of "news shocks" regarding this process. Following the expectations driven business cycle literature, we model the boom and bust cycle in terms of an expected future fall in bankruptcy costs which are eventually not realized. The build up in liquidity and economic activity in expectation of these efficiency gains is then abruptly reversed when agent's hopes are dashed. The model generates counter-cyclical movements in the spread between lending rates and the risk-free rate which are driven purely by expectations, even in the absence of any exogenous movement in intermediation costs as well as an endogenous rise and fall in asset prices and leverage.
    Keywords: expectations-driven business cycles, intermediation shocks, credit shocks, financial intermediation, financial innovation, news shocks, business cycles, costly state verification, leverage, financial accelerator
    JEL: E3
    Date: 2012–05
  12. By: Aronsson, Thomas (Department of Economics, Umeå University); Schöb, Ronnie (School of Business and Economics)
    Abstract: Adaptation is omnipresent but people systematically fail to correctly anticipate the degree to which they adapt. This leads individuals to make inefficient intertemporal decisions. This paper concerns optimal income taxation to correct for such anticipation-biases in a framework where consumers adapt to earlier consumption levels through a habit-formation process. The analysis is based on a general equilibrium OLG model with endogenous labor supply and savings where each consumer lives for three periods. Our results show how a paternalistic government may correct for the effects of anticipation-bias through a combination of time-variant marginal labor income taxes and savings subsidies. Furthermore, the optimal policy mix remains the same, irrespective of whether consumers commit to their original life-time plan for work hours and savings decided upon in the first period of life or re-optimize later on when realizing the failure to adapt.
    Keywords: Optimal taxation; adaptation; habit-formation; anticipation-bias; paternalism
    JEL: D03 D61 D91 H21
    Date: 2012–05–23
  13. By: Antoci, Angelo; Galeotti, Marcello; Russu, Paolo
    Abstract: The purpose of the present paper is to highlight some features of global dynamics of the two-sector growth model with accumulation of human and physical capital analyzed by Brito, P. and Venditti, A. (2010). In particular, we explore two cases where the Brito-Venditti system admits two balanced growth paths each of them corresponding, after a change of variables, to an equilibrium point of a 3-dimensional system. In the former one, the two stationary states have, respectively, a 2-dimensional and a 1-dimensional stable manifold (i.e. they are, in the Brito-Venditti terminology, locally indeterminate of order 2 and determinate, respectively). In the latter case, instead, the stable manifolds of the two equilibria have, respectively, dimension two and three (i.e. they are locally indeterminate of order 2 and 3). In both cases we prove the possible existence of points P such that in any neighborhood of P lying on the plane corresponding to a fixed value of the state variable there exist points Q whose positive trajectories tend to either equilibrium point. Moreover we show examples where the 2-dimensional stable manifold of the order 2 locally indeterminate equilibrium, in the former case, and the basin of the attracting equilibrium, in the latter case, are proven to be both unbounded.
    Keywords: global and local indeterminacy; two-sector model; endogenous growth; poverty trap; global analysis
    JEL: O41 O10 E24 C02 D90 C61
    Date: 2012–05
  14. By: Attila Ambrus; Georgy Egorov
    Abstract: Withdrawal penalties are common features of time deposit contracts offered by commercial banks, as well as individual retirement accounts and employer-sponsored plans. Moreover, there is a significant amount of early withdrawals from these accounts, despite the associated penalties, and empirical evidence shows that liquidity shocks of depositors are a major driving force of this. Using the consumption-savings model proposed by Amador, Werning and Angeletos in their 2006 Econometrica paper (henceforth AWA), in which individuals face the trade-off between flexibility and commitment, we show that withdrawal penalties can be part of the optimal contract, despite involving money-burning from an ex ante perspective. For the case of two states (which we interpret as “normal times” and a “negative liquidity shock”), we provide a full characterization of the optimal contract, and show that within the parameter region where the first best is unattainable, the likelihood that withdrawal penalties are part of the optimal contract is decreasing in the probability of a negative liquidity shock, increasing in the severity of the shock, and it is nonmonotonic in the magnitude of present bias. We also show that contracts with the same qualitative feature (withdrawal penalties for high types) arise in continuous state spaces, too. Our conclusions differ from AWA because the analysis in the latter implicitly assumes that the optimal contract is interior (the amount withdrawn from the savings account is strictly positive in each period in every state). We show that for any utility function consistent with their framework there is an open set of parameter values for which the optimal contract is a corner solution, inducing money burning in some states.
    Keywords: Commitment, flexibility, self-control, money-burning
    JEL: D23 D82 D86
    Date: 2012
  15. By: Modibo Sidibé (Université de Lyon, Lyon, F-69007, France ; CNRS, GATE Lyon St Etienne,F-69130 Ecully, France)
    Abstract: This paper proposes a unified framework for the analysis of inequalities. In contrast to the former literature on inequalities, housing is included as a major determinant of individual saving behavior. Disparities across locations affect individual outcomes in both labor and education markets. In a Bewley-Huggett-Aiyagari type model where several frictions are represented, the model allows for segmentation between homeowners and renters in the housing market, imperfection in the capital market and residential mobility over the life-cycle. Moreover, individual location is assumed to affect labor productivity, wealth accumulation via the dynamics of housing prices and the human capital acquisition process of the next generation. The dynamics of prices combined to bequest motive provide the perfect framework to understand the tenure choice of individuals. Furthermore, the fixity of housing supply in each neighborhood combined with borrowing constraints prevent some households from living in their preferred area, which leads to segregation. Using this general framework, the paper contributes to the understanding of the complex relationships between labor, housing and education markets. Finally, several experiments aimed at decreasing the level of inequalities at the individual and location level are provided.
    Keywords: Heterogeneous Agents, Inequalities, Wealth distribution, Housing
    JEL: E24 I30 R23
    Date: 2012
  16. By: Asle Gauteplass and Anders Skonhoft (Department of Economics, Norwegian University of Science and Technology)
    Abstract: A model of interaction between a renewable natural resource with capital limitations, as exemplified by the optimal investment problem of sheep farming in a Nordic context, is analyzed. The model builds on existing studies from the fisheries literature, but the important difference is that while capital is related to harvesting effort in the fisheries, capital attributes to production capacity to keep the animal stock during the winter in our farm model. The paper provides several results where both optimal steady states and the optimal approach paths are characterized analytically. The results are further supported by a numerical example.
    Date: 2012–05–30
  17. By: Asgeir Danielsson
    Abstract: This paper contributes to the discussion of effects of mandatory pension savings and house price risk on aggregate household savings, homeownership, and risks in lending to homeowners. The analysis is theoretical and based on the life-cycle hypothesis. It is shown that mandatory pension savings based on defined benefits will increase risk in lending to homeowners. Households that remain homeowners will increase their personal savings while those that prefer renting will decrease their savings as renters take on less risk from house price volatility than homeowners. The relative size of the two effects on savings depends on households‘ preferences over homeownership and renting. The assets of the mandatory pension funds in Iceland are among the highest in the world. This country also scores very high in homeownership with around 80% of households living in own homes. For these reasons data on the Icelandic pension system and on homeownership in this country provide a convenient background for discussion of the theoretical issues.
    Date: 2012–05
  18. By: G. d'Agostino; J.P Dunne (SALDRU, School of Economics, University of Cape Town); L. Pieroni
    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: O57 H5 D73
    Date: 2012

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