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on Dynamic General Equilibrium |
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Issue of 2012‒07‒01
eighteen papers chosen by Christian Zimmermann Federal Reserve Bank of St. Louis |
| By: | Gunes Kamber; Christie Smith; Christoph Thoenissen |
| Abstract: | Various papers have identified shocks to investment as major drivers of output, investment, hours, and interest rates. These investment shocks have been linked to financial frictions because financial markets are instrumental in transforming consumption goods into installed capital. However, the importance of investment shocks is not robust once we explicitly account for a simple financial friction. We estimate a medium scale dynamic stochastic general equilibrium model with collateral constraints. When entrepreneurs are subject to binding collateral constraints, a reduction in the value of installed capital reduces the value of collateral and thus the amount an entrepreneur can borrow. As a result, aggregate consumption no longer co-moves with GDP and the response of investment to a positive investment shock is attenuated. In the model with collateral constraints, the role of risk premium shocks in the business cycle increases markedly, whereas investment shocks have a much diminished role. |
| Keywords: | DSGE model, financial frictions, risk premium shocks, investment specific technology shocks, Bayesian estimation |
| JEL: | C11 E22 E32 E44 |
| Date: | 2012–06–08 |
| URL: | http://d.repec.org/n?u=RePEc:san:cdmawp:1206&r=dge |
| By: | Enzo A. Cerletti (CEMFI, Centro de Estudios Monetarios y Financieros); Josep Pijoan-Mas (CEMFI, Centro de Estudios Monetarios y Financieros) |
| Abstract: | In this paper we study the transmission of income shocks into nondurable consumption in the presence of durable goods. We use a standard a life-cycle model with two goods to characterize the interaction of durability of goods, durability of shocks, and borrowing constraints as determinants of shock transmission. We show that borrowing constraints lead to a substitution between durable and non-durable goods upon arrival of an unexpected income change. This substitution biases the conventional measures of insurance based on the response of non-durable consumption to income changes. The sign of this bias depends critically on the persistence of the shock. We show that households have less insurance against transitory shocks and more insurance against permanent shocks than commonly measured. We calibrate the model economy to the US in order to measure the size of this bias. |
| Keywords: | Consumption insurance, durable goods, incomplete markets, borrowing constraints, persistence of income shocks. |
| JEL: | E21 D91 D12 |
| Date: | 2012–05 |
| URL: | http://d.repec.org/n?u=RePEc:cmf:wpaper:wp2012_1206&r=dge |
| By: | Mimir, Yasin; Sunel, Enes; Taskin, Temel |
| Abstract: | This paper conducts a quantitative investigation of the role of reserve requirements as a macroprudential policy tool. We build a monetary DSGE model with a banking sector in which (i) an agency problem between households and banks leads to endogenous capital constraints for banks in obtaining funds from households, (ii) banks are subject to time-varying reserve requirements that countercyclically respond to expected credit growth, (iii) households face cash-in-advance constraints, requiring them to hold real balances, and (iv) standard productivity and money growth shocks are two sources of aggregate uncertainty. We calibrate the model to the Turkish economy which is representative of using reserve requirements as a macroprudential policy tool recently. We also consider the impact of financial shocks that affect the net worth of financial intermediaries. We find that (i) the time-varying required reserve ratio rule countervails the negative effects of the financial accelerator mechanism triggered by adverse macroeconomic and financial shocks, (ii) in response to TFP and money growth shocks, countercyclical reserves policy reduces the volatilities of key real macroeconomic and financial variables compared to fixed reserves policy over the business cycle, and (iii) a time-varying reserve requirement policy is welfare superior to a fixed reserve requirement policy. The credit policy is most effective when the economy is hit by a financial shock. Time-varying required reserves policy reduces the intertemporal distortions created by the credit spreads at expense of generating higher inflation volatility, indicating an interesting trade-off between price stability and financial stability. |
| Keywords: | Banking sector; time-varying reserve requirements; macroeconomic and financial shocks |
| JEL: | E51 E44 G28 G21 |
| Date: | 2012–06–22 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:39613&r=dge |
| By: | Rafael Repullo (CEMFI, Centro de Estudios Monetarios y Financieros); Javier Suarez (CEMFI, Centro de Estudios Monetarios y Financieros) |
| Abstract: | We develop and calibrate a dynamic equilibrium model of relationship lending in which banks are unable to access the equity markets every period and the business cycle is a Markov process that determines loans’ probabilities of default. Banks anticipate that shocks to their earnings and the possible variation of capital requirements over the cycle can impair their future lending capacity and, as a precaution, hold capital buffers. We compare the relative performance of several capital regulation regimes, including one that maximizes a measure of social welfare. We show that Basel II is significantly more procyclical than Basel I, but makes banks safer. For this reason, it dominates Basel I in terms of welfare except for small social costs of bank failure. We also show that for high values of this cost, Basel III points in the right direction, with higher but less cyclically-varying capital requirements. |
| Keywords: | Banking regulation, Basel capital requirements, Capital market frictions, Credit rationing, Loan defaults, Relationship banking, Social cost of bank failure. |
| JEL: | G21 G28 E44 |
| Date: | 2012–02 |
| URL: | http://d.repec.org/n?u=RePEc:cmf:wpaper:wp2012_1202&r=dge |
| By: | Tatiana Damjanovic; Vladislav Damjanovic; Charles Nolan |
| Abstract: | A stylized macroeconomic model is developed with an indebted, heterogeneous Investment Banking Sector funded by borrowing from a retail banking sector. The government guarantees retail deposits. Investment banks choose how risky their activities should be. We compared the benefits of separated vs. universal banking modelled as a vertical integration of the retail and investment banks. The incidence of banking default is considered under different constellations of shocks and degrees of competitiveness. The benefits of universal banking rise in the volatility of idiosyncratic shocks to trading strategies and are positive even for very bad common shocks, even though government bailouts, which are costly, are larger compared to the case of separated banking entities. The welfare assessment of the structure of banks may depend crucially on the kinds of shock hitting the economy as well as on the efficiency of government intervention. |
| Keywords: | Risk in DSGE models, investment banking, financial intermediation, separating commercial and investment banking, competition and risk, moral hazard in banking, prudential regulation, systematic vs. idiosyncratic risks. |
| JEL: | E13 E44 G11 G24 G28 |
| Date: | 2012–01–17 |
| URL: | http://d.repec.org/n?u=RePEc:san:cdmawp:1205&r=dge |
| By: | Giacomo Ponzetto; Ugo Troiano |
| Abstract: | Countries with greater social capital have higher economic growth. We show that social capital is also highly positively correlated across countries with government expenditure on education. We develop an infinite-horizon model of public spending and endogenous stochastic growth that explains both facts through frictions in political agency when voters have imperfect information. In our model, the government provides services that yield immediate utility, and investment that raises future productivity. Voters are more likely to observe public services, so politicians have electoral incentives to underprovide public investment. Social capital increases voters' awareness of all government activity. As a consequence, both politicians' incentives and their selection improve. In the dynamic equilibrium, both the amount and the efficiency of public investment increase, permanently raising the growth rate. |
| Keywords: | Social Capital, Government Expenditures, Economic Growth, Public Investment, Elections, Imperfect Information |
| JEL: | D72 D83 H50 H54 O43 Z13 |
| Date: | 2012–02 |
| URL: | http://d.repec.org/n?u=RePEc:upf:upfgen:1307&r=dge |
| By: | Angelo Antoci (Università degli Studi di Sassari); Marcello Galeotti (Università degli Studi di Firenze,); Paolo Russu (Università degli Studi di Sassari) |
| 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 and Venditti, which is a specification of the model proposed by Mulligan and Sala-i-Martin. In particular, our analysis focuses on the context in which 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, and proves 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. This implies that equilibrium selection in Brito Venditti system may depend on expectations of economic agents rather than on the history of the economy. That is, economies with identical technologies and preferences, starting from the same initial values of the state variables (history), may follow rather different equilibrium trajectories according to the economic agents' choices of the initial values of the jumping variables (expectations). Moreover we prove that the basins of attraction (two or three dimensional) of locally indeterminate equilibrium points may be very large, as they may extend up to the boundary of the system phase space. |
| Keywords: | global and local indeterminacy; two-sector model; endogenous growth; poverty trap; global analysis |
| JEL: | C62 E32 O41 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:frz:wpaper:wp2012_14.rdf&r=dge |
| By: | Kaushik Mitra; George W. Evans; Seppo Honkapohja |
| Abstract: | Using the standard real business cycle model with lump-sum taxes, we analyze the impact of fiscal policy when agents form expectations using adaptive learning rather than rational expectations (RE). The output multipliers for government purchases are significantly higher under learning, and fall within empirical bounds reported in the literature (in sharp contrast to the implausibly low values under RE). Effectiveness of fiscal policy is demonstrated during times of economic stress like the recent Great Recession. Finally it is shown how learning can lead to dynamics empirically documented during episodes of "fiscal consolidations." |
| Keywords: | Government Purchases, Expectations, Output Multiplier, Fiscal Consolidation, Taxation. |
| JEL: | E62 D84 E21 E43 |
| Date: | 2012–01–17 |
| URL: | http://d.repec.org/n?u=RePEc:san:cdmawp:1202&r=dge |
| By: | Moen, Espen R. (Norwegian Business School (BI)); Yashiv, Eran (Tel Aviv University) |
| Abstract: | This paper studies the value of firms and their hiring and firing decisions in an environment where the productivity of the workers depends on how well they match with their co-workers and the firm acts as a coordinating device. Match quality derives from a production technology whereby workers are randomly located on the Salop circle, and depends negatively on the distance between the workers. It is shown that a worker's contribution in a given firm changes over time in a nontrivial way as co-workers are replaced with new workers. The paper derives optimal hiring and replacement policies, including an optimal stopping rule, and characterizes the resulting equilibrium in terms of employment, wages and distribution of firm values. The paper stresses the role of horizontal differences in worker productivity, as opposed to vertical, assortative matching issues. Simulations of the model show the dynamics of worker replacement policy, the resulting firm value and age distributions, and the connections between them. |
| Keywords: | firm value, complementarity, worker value, Salop circle, hiring, firing, match quality, optimal stopping |
| JEL: | E23 J62 J63 |
| Date: | 2012–06 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp6657&r=dge |
| By: | John Taylor (Stanford University); John Cogan (Stanford University); Volker Wieland (Goethe University Frankfurt); Maik Wolters (Goethe University Frankfurt) |
| Abstract: | In the aftermath of the global financial crisis and great recession, many countries face substantial deficits and growing debts. In the United States, federal government outlays as a ratio to GDP rose substantially from about 19.5 percent before the crisis to over 24 percent after the crisis. In this paper we consider a fiscal consolidation strategy that brings the budget to balance by gradually reducing this spending ratio over time to the level that prevailed prior to the crisis. A crucial issue is the impact of such a consolidation strategy on the economy. We use structural macroeconomic models to estimate this impact. We consider two types of dynamic stochastic general equilibrium models: a neoclassical growth model and more complicated models with price and wage rigidities and adjustment costs. We separate out the impact of reductions in government purchases and transfers, and we allow for a reduction in both distortionary taxes and government debt relative to the baseline of no consolidation. According to the initial model simulations GDP rises in the short run upon announcement and implementation of this fiscal consolidation strategy and remains higher than the baseline in the long run. Creation Date: 2012-06 Revision Date: |
| URL: | http://d.repec.org/n?u=RePEc:sip:dpaper:11-015&r=dge |
| By: | Margolis, David Naum (World Bank); Navarro, Lucas (Universidad Alberto Hurtado); Robalino, David A. (World Bank) |
| Abstract: | This paper analyses the potential impacts of introducing unemployment insurance (UI) in middle income countries using the case of Malaysia, which today does not have such a system. The analysis is based on a job search model with unemployment and three employment sectors: formal and informal wage employment, and self employment. The parameters of the model are estimated to replicate the structure of the labor market in Malaysia in 2009 and the distribution of earnings for informal, formal and self employed workers. The results suggest that unemployment insurance would have only a modest negative effect on unemployment if benefits are not overly generous. The main effect would be a reallocation of labor from wage into self employment while increasing average wages in the formal and informal sectors. |
| Keywords: | unemployment insurance, informal sector, self employment, job search |
| JEL: | J64 J65 O17 J23 J31 J21 J62 |
| Date: | 2012–06 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp6660&r=dge |
| By: | George W. Evans; Seppo Honkapohja; Thomas Sargent; Noah Williams |
| Abstract: | Agents have two forecasting models, one consistent with the unique rational expectations equilibrium, another that assumes a time-varying parameter structure. When agents use Bayesian updating to choose between models in a self-referential system, we find that learning dynamics lead to selection of one of the two models. However, there are parameter regions for which the non-rational forecasting model is selected in the long-run. A key structural parameter governing outcomes measures the degree of expectations feedback in Muth's model of price determination. |
| Keywords: | Learning dynamics, Bayesian model averaging, grain of truth, self-referential systems. |
| JEL: | D83 D84 C52 C11 |
| Date: | 2012–01–25 |
| URL: | http://d.repec.org/n?u=RePEc:san:cdmawp:1203&r=dge |
| By: | Hajime Tomura |
| Abstract: | This paper presents a model of an over-the-counter bond market in which bond dealers and cash investors arrange repurchase agreements (repos) endogenously. If cash investors buy bonds to store their cash, then they suffer an endogenous bond-liquidation cost because they must sell their bonds before the scheduled times of their cash payments. This cost provides incentive for both dealers and cash investors to arrange repos with endogenous margins. As part of multiple equilibria, the bond-liquidation cost also gives rise to another equilibrium in which cash investors stop transacting with dealers all at once. Credit market interventions block this equilibrium. |
| Keywords: | Financial markets; Financial stability; Payment; clearing; and settlement systems |
| JEL: | G24 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:12-17&r=dge |
| By: | Jordi Galí; Frank Smets; Rafael Wouters |
| Abstract: | An analysis of the performance of GDP, employment and other labor market variables following the troughs in postwar U.S. business cycles points to much slower recoveries in the three most recent episodes, but does not reveal any significant change over time in the relation between GDP and employment. This leads us to characterize the last three episodes as slow recoveries, as opposed to jobless recoveries. We use the estimated New Keynesian model in Galí-Smets- Wouters (2011) to provide a structural interpretation for the slower recoveries since the early nineties. |
| Keywords: | jobless recoveries, U.S. business cycle, estimated DSGE models, Okun's law. |
| JEL: | E32 |
| Date: | 2012–05 |
| URL: | http://d.repec.org/n?u=RePEc:upf:upfgen:1317&r=dge |
| By: | Daron Acemoglu; Martin Kaae Jensen |
| Abstract: | We consider infinite horizon economies populated by a continuum of agents who are subject to idiosyncratic shocks. This framework contains models of saving and capital accumulation with incomplete markets in the spirit of works by Bewley, Aiyagari, and Huggett, and models of entry, exit and industry dynamics in the spirit of Hopenhayn's work as special cases. Robust and easy-to-apply comparative statics results are established with respect to exogenous parameters as well as various kinds of changes in the Markov processes governing the law of motion of the idiosyncratic shocks. These results complement the existing literature which uses simulations and numerical analysis to study this class of models and are illustrated using a number of examples. |
| JEL: | C61 D90 E21 |
| Date: | 2012–06 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:18178&r=dge |
| By: | William Branch; George W. Evans; Bruce McGough |
| Abstract: | Incorporating adaptive learning into macroeconomics requires assumptions about how agents incorporate their forecasts into their decision-making. We develop a theory of bounded rationality that we call finite-horizon learning. This approach generalizes the two existing benchmarks in the literature: Euler-equation learning, which assumes that consumption decisions are made to satisfy the one-step-ahead perceived Euler equation, and infinite-horizon learning, in which consumption today is determined optimally from an infinite-horizon optimization problem with given beliefs. In our approach, agents hold a finite forecasting/planning horizon. We find for the Ramsey model that the unique rational expectations equilibrium is E-stable at all horizons. However, transitional dynamics can differ significantly depending upon the horizon. |
| Keywords: | Planning horizon, bounded rationality, dynamic optimization, adaptive learning, Ramsey model. |
| JEL: | D83 D84 D91 E32 |
| Date: | 2012–01–25 |
| URL: | http://d.repec.org/n?u=RePEc:san:cdmawp:1204&r=dge |
| By: | Susanto Basu; Luigi Pascali; Fabio Schiantarelli; Luis Serven |
| Abstract: | We show that the welfare of a representative consumer can be related to observable aggregate data. To a first order, the change in welfare is summarized by (the present value of) the Solow productivity residual and by the growth rate of the capital stock per capita. We also show that productivity and the capital stock suffice to calculate differences in welfare across countries, with both variables computed as log level deviations from a reference country. These results hold for arbitrary production technology, regardless of the degree of product market competition, and apply to open economies as well if TFP is constructed using absorption rather than GDP as the measure of output. They require that TFP be constructed using prices and quantities as perceived by consumers. Thus, factor shares need to be calculated using after-tax wages and rental rates, and will typically sum to less than one. We apply these results to calculate welfare gaps and growth rates in a sample of developed countries for which high-quality TFP and capital data are available. We find that under realistic scenarios the United Kingdom and Spain had the highest growth rates of welfare over our sample period of 1985-2005, but the United States had the highest level of welfare. |
| Keywords: | Productivity, Welfare, TFP, Solow Residual. |
| JEL: | D24 D90 E20 O47 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:upf:upfgen:1312&r=dge |
| By: | Emin Dinlersoz; Jeremy Greenwood |
| Abstract: | Union membership displayed an inverted U-shaped pattern over the 20th century, while the distribution of income sketched a U. A model of unions is developed to analyze these phenomena. There is a distribution of firms in the economy. Firms hire capital, plus skilled and unskilled labor. Unionization is a costly process. A union decides how many firms to organize and its members’ wage rate. Simulation of the developed model establishes that skilled-biased technological change, which affects the productivity of skilled labor relative to unskilled labor, can potentially explain the above facts. Statistical analysis suggests that skill-biased technological change is an important factor in de-unionization. |
| Keywords: | CES,economic,research,micro,data,microdata, Computers, Distribution of Income, Flexible Manufacturing, Mass Production, Numerically Controlled Machines, Panel-Data Regression Analysis, Relative Price of New Equipment, Skill-Biased Technological Change, Simulation Analysis, Union Coverage, Union Membership, Deunionization |
| JEL: | J51 J24 L23 L11 L16 O14 O33 |
| Date: | 2012–06 |
| URL: | http://d.repec.org/n?u=RePEc:cen:wpaper:12-12&r=dge |