nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2012‒06‒13
seventeen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Optimal Fiscal Devaluation By Langot, François; Patureau, Lise; Sopraseuth, Thepthida
  2. Neighborhood dynamics and the distribution of opportunity By Dionissi Aliprantis; Daniel Carroll
  3. Hedging against the government: a solution to the home asset bias puzzle By Tiago C. Berriel; Saroj Bhattarai
  4. Health Investment over the Life-Cycle By Timothy Halliday; Hui He; Hao Zhang
  5. Policy regimes, policy shifts, and U.S. business cycles By Saroj Bhattarai; Jae Won Lee; Woong Yong Park
  6. Longevity, life-cycle behavior and pension reform By Haan, Peter; Prowse, Victoria
  7. Bridging DSGE models and the raw data By Fabio Canova
  8. A DSGE model with Endogenous Term Structure By M. Falagiarda; M. Marzo
  9. A simple model of price dispersion By Alexander Chudik
  10. Beliefs incentives and economic growth By Jellal , Mohamed
  11. Macroeconomics with Financial Frictions: A Survey By Markus K. Brunnermeier; Thomas M. Eisenbach; Yuliy Sannikov
  12. The Financing of a Public Utility By Eric Smith; Martin Shubik
  13. Stable Marriages and Search Frictions By Stephan Lauermann; Georg Nöldeke
  14. A mechanism for booms and busts in housing prices By Hillebrand, Marten; Kikuchi, Tomoo
  15. Are predictable improvements in TFP contractionary or expansionary? implications from sectoral TFP By Deokwoo Nam; Jian Wang
  16. Trade and growth in an unequal global economy By Andreas Kohler
  17. Measuring Convergence using Dynamic Equilibrium Models: Evidence from Chinese Provinces By Lei Pan; Olaf Posch; Michel van der Wel

  1. By: Langot, François; Patureau, Lise; Sopraseuth, Thepthida
    Abstract: We study fiscal devaluation in a small-open economy with labor market search frictions. Our analysis shows the key role of both dimensions in shaping the optimal tax scheme. By reducing labor market distortions, the tax reform is welfare-improving. Yet, as it makes imports more expensive, fiscal devaluation lowers the agents’ purchasing power, which is welfare-reducing. These contrasting effects give rise to an optimal tax scheme. Besides, transition matters. If the economy is better off in the long run, the required transitional saving effort increases the cost of the reform, thereby calling for a moderate magnitude of fiscal devaluation.
    Keywords: fiscal devaluation; consumption tax; payroll tax; labor market search; small open economy; Dynamic General Equilibrium model
    JEL: E27 E62 H21 J38
    Date: 2012–04
  2. By: Dionissi Aliprantis; Daniel Carroll
    Abstract: This paper uses an overlapping-generations dynamic general equilibrium model of residential sorting and intergenerational human capital accumulation to investigate effects of neighborhood externalities. In the model, households choose where to live and how much to invest toward the production of their child’s human capital. The return on the parent’s investment is determined in part by the child’s ability and in part by an externality from the average human capital in their neighborhood. We use the model to test a prominent hypothesis about the concentration of poverty within racially-segregated neighborhoods (Wilson 1987). We first impose segregation on a model with two neighborhoods and match the model steady state to income and housing data from Chicago in 1960. Next, we lift the restriction on moving and compute the new steady state and corresponding transition path. The transition implied by the model qualitatively supports Wilson’s hypothesis: high-income residents of the low-average-human-capital neighborhood move out, reducing the returns to investment in their old neighborhood. Sorting increases citywide human capital, but it also produces congestion in the high-income neighborhood, increasing the average cost of housing. As a result, average welfare decreases by 2.2 percent of steady state consumption, and the loss is greatest for those initially in the low-income neighborhood.
    Keywords: Housing policy ; Population ; Wealth ; Equilibrium (Economics) - Mathematical models ; Human capital
    Date: 2012
  3. By: Tiago C. Berriel; Saroj Bhattarai
    Abstract: This paper explains two puzzling facts: international nominal bonds and equity portfolios are biased domestically. In our two-country model, holding domestic government nominal debt provides a hedge against shocks to bond returns and the impact on taxes they induce. For this result, only two features are essential: some nominal risk and taxes falling only on domestic agents. A third feature explains why agents choose to hold primarily domestic equity: government spending falls on domestic goods. Then, an increase in government spending raises the returns on domestic equity, providing a hedge against the subsequent increase in taxes. These conclusions are robust to a wide range of preference parameter values and the incompleteness of financial markets. A calibrated version of the model predicts asset holdings that quantitatively match the data.
    Date: 2012
  4. By: Timothy Halliday (Department of Economics, University of Hawaii at Manoa); Hui He (Department of Economics, University of Hawaii at Manoa); Hao Zhang (Department of Economics, University of Hawaii at Manoa)
    Abstract: We quantify what drives the rise in medical expenditures over the life- cycle. Three motives are considered. First, health delivers a flow of utility each period (the consumption motive). Second, better health enables people to allocate more time to productive or pleasurable activities (the investment motive). Third, better health improves survival prospects (the survival mo- tive). We calibrate an overlapping generations model with endogenous health accumulation to match key economic targets and then we gauge its perfor- mance by comparing key age-pro?les from the model to their counterparts in the data. We ?nd that the investment motive is more important than the consumption motive until about age 50. After that, the rise in medical ex- penditures is primarily driven by the value of health as a consumption good. The survival motive is quantitatively less important when compared to the other two motives. Finally, with our calibrated model, we conduct a series of counter-factual experiments to investigate how modi?cations to social security, government-run health insurance, and longevity impact the life-cycle behavior of medical expenditures as well as the aggregate medical expenditures-GDP ratio.
    Keywords: Health Investment Motive, Medical Expenditure, life Cycle
    JEL: E21 I12
    Date: 2012–06–01
  5. By: Saroj Bhattarai; Jae Won Lee; Woong Yong Park
    Abstract: Using an estimated DSGE model that features monetary and fiscal policy interactions and allows for equilibrium indeterminacy, we find that a passive monetary and passive fiscal policy regime prevailed in the pre-Volcker period while an active monetary and passive fiscal policy regime prevailed post-Volcker. Since both monetary and fiscal policies were passive pre-Volcker, there was equilibrium indeterminacy which resulted in substantially different transmission mechanisms of policy as compared to conventional models: unanticipated increases in interest rates increased inflation and output while unanticipated increases in lump-sum taxes decreased inflation and output. Unanticipated shifts in monetary and fiscal policies however, played no substantial role in explaining the variation of inflation and output at any horizon in either of the time periods. Pre-Volcker, in sharp contrast to post- Volcker, we find that a time-varying inflation target does not explain low-frequency movements in inflation. A combination of shocks account for the dynamics of output, inflation, and government debt, with the relative importance of a particular shock quite different in the two time-periods due to changes in the systematic responses of policy. Finally, in a counterfactual exercise, we show that had the monetary policy regime of the post-Volcker era been in place pre-Volcker, inflation volatility would have been lower by 34% and the rise of inflation in the 1970s would not have occurred.
    Date: 2012
  6. By: Haan, Peter; Prowse, Victoria
    Abstract: How can public pension systems be reformed to ensure fiscal stability in the face of increasing life expectancy? To address this pressing open question in public finance, we use micro data to estimate a structural life-cycle model of individuals' employment, retirement and consumption decisions. Our modeling approach allows life expectancy and the nature of the public pension system to influence the decisions of forward-looking individuals planning for retirement. We calculate that, in the case of Germany, an increase of 4.34 years in the full pensionable age or a cut of 37.7% in the per-year value of public pension benefits would offset the fiscal consequences of the 6.4 year increase in age 65 life expectancy anticipated to occur over the next 40 years. Of these two approaches to coping with the fiscal impact of improving longevity, increasing the full pensionable age generates the largest responses in labor supply and retirement behavior.
    Keywords: Life Expectancy; Public Pension Reform; Retirement; Employment; Life-cycle Models; Consumption; Tax and Transfer System
    JEL: D91 J22 J64 J26 J11
    Date: 2012–06–06
  7. By: Fabio Canova
    Abstract: A method to estimate DSGE models using the raw data is proposed. The approach links the observables to the model counterparts via a flexible specification which does not require the model-based component to be solely located at business cycle frequencies, allows the non model-based component to take various time series patterns, and permits model misspecification. Applying standard data transformations induce biases in structural estimates and distortions in the policy conclusions. The proposed approach recovers important model-based features in selected experimental designs. Two widely discussed issues are used to illustrate its practical use.
    Keywords: DSGE models, Filters, Structural estimation, Business cycles
    JEL: E3 C3
    Date: 2012–05
  8. By: M. Falagiarda; M. Marzo
    Abstract: In this paper, we propose a DSGE model with the term structure of interest rates drawing on the framework introduced by Andrés et al. (2004) and Marzo et al. (2008). In particular, we reproduce segmentation in financial markets by introducing bonds of different maturities and bond adjustment costs non-zero at the steady state, introducing a structural liquidity frictions among bonds with different maturities: agents are assumed to pay a cost whenever they trade bonds. As a result, the model is able to generate a non-zero demand for bonds of different maturities, which become imperfect substitutes, due to differential liquidity conditions. The main properties of the model are analysed through both simulation and estimation exercises. The importance of the results are twofold. On one hand, the calibrated model is able to replicate the stylized facts regarding the yield curve and the term premium in the US over the period 1987:3-2011:3, without compromising its ability to match macro dynamics. On the other hand, the estimation, besides providing an empirical support to the theoretical setting, highlights the potentialities of the model to analyze the term premium in a microfounded macro framework. The results match very closely the behavior of actual yields, reflecting the recent activity of the Fed on longer maturities bonds.
    JEL: C5 E32 E37 E43 E44
    Date: 2012–06
  9. By: Alexander Chudik
    Abstract: This article considers a simple stock-flow matching model with fully informed market participants. Unlike in the standard matching literature, prices are assumed to be set ex-ante. When sellers pre-commit themselves to sell their products at an advertised price, the unique equilibrium is characterized by price dispersion due to the idiosyncratic match payoffs (in a marketplace with full information). This provides new insights into the price dispersion literature, where price dispersion is commonly assumed to be generated by a costly search of uninformed buyers.
    Date: 2012
  10. By: Jellal , Mohamed
    Abstract: We integrate a general social norm function which associates status to accumulation of capital and consumption into a simple model of endogenous growth. We show that societies which place a greater weight on capital as opposed to consumption will experience fast growth.Our results are consistent with those obtained by Baumol(1990) in the context of entrepreneurship and by Fershtman and Weiss (1991
    Keywords: Beliefs ; social incentives; social status; growth
    JEL: Z1 D9 O43 Z13
    Date: 2012
  11. By: Markus K. Brunnermeier; Thomas M. Eisenbach; Yuliy Sannikov
    Abstract: This article surveys the macroeconomic implications of financial frictions. Financial frictions lead to persistence and when combined with illiquidity to non-linear amplification effects. Risk is endogenous and liquidity spirals cause financial instability. Increasing margins further restrict leverage and exacerbate downturns. A demand for liquid assets and a role for money emerges. The market outcome is generically not even constrained efficient and the issuance of government debt can lead to a Pareto improvement. While financial institutions can mitigate frictions, they introduce additional fragility and through their erratic money creation harm price stability.
    JEL: A23 E1 E3 E4 E5 G01 G1 G2
    Date: 2012–05
  12. By: Eric Smith (Santa Fe Institute); Martin Shubik (Cowles Foundation, Yale University)
    Abstract: The interaction of capital stock with overlapping generations is investigated where the time structures of human capital and other physical capital does not match. We consider the economies with either gold or fiat as the outside money and consider the financing problems that appear in the financing of capital stock. The complexity of the underlying physical structure combined with concern for efficiency and equity help to determine the financial structure.
    Keywords: Capital stock, Time scales, Fiat, Gold, Joint product
    JEL: C73 D24 E22 E41
    Date: 2012–06
  13. By: Stephan Lauermann; Georg Nöldeke (University of Basel)
    Keywords: Marriage Market, Stable Matchings, Random Matchings, Serarch Frictions
    JEL: C78 D83
    Date: 2012
  14. By: Hillebrand, Marten; Kikuchi, Tomoo
    Abstract: We study an exchange economy with overlapping generations of consumers who derive utility from consuming a non-durable commodity and housing. A banking sector offers loans to finance housing. We provide a complete characterization of the equilibrium dynamics which alternates between an expansive regime where housing prices increase and banks expand loans and a contractive regime associated with decreasing housing values and shrinking credit volume. Regime switches occur even under small but persistent income changes giving rise to large and recurrent booms and busts in housing prices not reflecting changes in fundamentals. --
    Keywords: OLG,Housing prices,Credit volume,Boom-bust scenarios,Regime switching
    JEL: C62 E32 G21
    Date: 2012
  15. By: Deokwoo Nam; Jian Wang
    Abstract: We document in the US data: (1) The dominant predictable component of investment-sector TFP is its long-run movements, and a favorable shock to predictable changes in investmentsector TFP induces a broad economic boom that leads actual increases in investment-sector TFP by almost two years, and (2) predictable changes in consumption-sector TFP occur mainly at short forecast horizons, and a favorable shock to such predictable changes leads to immediate reductions in hours worked, investment, and output as well as an immediate rise in consumption-sector TFP. We argue that these documented differences in the responses to shocks to predictable sectoral TFP changes can reconcile the seemingly contradictory findings in Beaudry and Portier (2006) and Barsky and Sims (2011), whose analyses are based on aggregate TFP measures. In addition, we find that shocks to predictable changes in investment-sector TFP account for 50% of business cycle fluctuations in consumption, hours, investment, and output, while shocks to predictable changes in consumption-sector TFP explain only a small fraction of business cycle fluctuations of these aggregate variables.
    Date: 2012
  16. By: Andreas Kohler
    Abstract: This paper studies the patterns of trade and the incentives to innovate in an unequal global economy. We introduce non-homothetic preferences in a general-equilibrium model of endogenous growth and international trade between two countries, and argue that the effects of market integration on the consequent trade patterns and the incentives to innovate depend on the degree of income inequality across countries. We find that if inequality across countries is low, the extensive margin of trade between countries is high whereas the world growth rate is low. The introduction of non-homothetic preferences rises a number of interesting questions that are not an issue in the standard model. For example, we discuss the design of intellectual property rights, in particular national vs. international exhaustion of patents, and argue that households in poor and rich countries might not see eye to eye depending on how poor households weigh future losses in consumption against present gains. Furthermore, we address the welfare consequences of a trade liberalization, and show that households in the poor country might loose relative to households in the rich country if trade costs fall from a high to a sufficiently low level.
    Keywords: Growth, inequality, international trade
    JEL: D30 O30 F10
    Date: 2012–06
  17. By: Lei Pan (Wageningen University); Olaf Posch (Aarhus University and CREATES); Michel van der Wel (Erasmus University Rotterdam and CREATES)
    Abstract: We propose a model to study economic convergence in the tradition of neoclassical growth theory. We employ a novel stochastic set-up of the Solow (1956) model with shocks to both capital and labor. Our novel approach identifies the speed of convergence directly from estimating the parameters which determine equilibrium dynamics. The inference on the structural parameters is done using a maximum-likelihood approach. We estimate our model using growth and population data for China’s provinces from 1978 to 2010. We report heterogeneity in the speed of convergence both across provinces and time. The Eastern provinces show a higher tendency of convergence, while there is no evidence of convergence for the Central and Western provinces. We find empirical evidence that the speed of convergence decreases over time for most provinces.
    Keywords: Economic convergence, Dynamic stochastic equilibrium models, Solow model, Structural estimation
    JEL: C13 E32 O40
    Date: 2012–05–30

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