nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2012‒07‒08
twenty-two papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Underground labor, search frictions and macroeconomic fluctuations By Giuseppe Ciccarone; Francesco Giuli; Enrico Marchetti
  2. Financial frictions and the role of investment specific technology shocks in the business cycle By Gunes Kamber; Christie Smith; Christoph Thoenissen
  3. International equity and bond positions in a DSGE model with variety risk in consumption By Hamano Masashige
  4. Financial intermediaries, credit Shocks and business cycles By Mimir, Yasin
  5. Financial market frictions in a model of the euro area By Giovanni Lombardo; Peter McAdam
  6. Optimal Capital Income Taxation with Means-tested Benefits By Cagri Seda Kumru; John Piggott
  7. Transitional Dynamics of Disinflation in a Small Open Economy with Heterogeneous Agents By Sunel, Enes
  8. A Stationary Markov Equilibrium in an OLG Model By Zhixiang Zhang; Heng-fu Zou
  9. The Friedman rule in a model with nonlinear taxation and income misreporting By Gahvari, Firouz; Micheletto, Luca
  10. Trade Wedges, Inventories, and International Business Cycles By George Alessandria; Joseph Kaboski; Virgiliu Midrigan
  11. Journey into the unknown? Economic consequences of factor market integration under increasing returns to scale By Schäfer, Andreas; Steger, Thomas
  12. Assortative matching through signals By Poeschel, Friedrich
  13. Interbank Market and Macroprudential Tools in a DSGE Model By Carrera, Cesar; Vega, Hugo
  14. Status-seeking and economic growth: the Barro model revisited. By Thi Kim Cuong Pham
  15. Determinants of credit to households in a life-cycle model By Michal Rubaszek; Dobromil Serwa
  16. Moment Condition Models in Empirical Economics. By [no author]
  17. Interest Rate Rules, Endogenous Cycles, and Chaotic Dynamics in Open Economies By Luis-Felipe Zanna; Marco Airaudo
  18. Public Investment, Growth, and Debt Sustainability: Putting Together the Pieces By Edward F. Buffie; Rafael Portillo; Luis-Felipe Zanna; Catherine A. Pattillo; Andrew Berg
  19. Innovative and absorptive capacity effects of education in a small open economy By Brita Bye and Taran Fæhn
  20. Fiscal policy and the great recession in the Euro area By Günter Coenen; Roland Straub; Mathias Trabandt
  21. The Volatility Trap: Precautionary Saving, Investment, and Aggregate Risk By Fuad Hasanov; Reda Cherif
  22. Sur les Causes et les Effets en Macro-Economie : les Contributions de Sargent et Sims,Prix Nobel d'Economie 2011 By Collard, Fabrice; Fève, Patrick

  1. By: Giuseppe Ciccarone; Francesco Giuli; Enrico Marchetti
    Abstract: We study the e¤ects of underground activities on labour market dynamics in a RBC model with search frictions in the labor market, bargained wage and quadratic hiring costs. Underground activities, which allow agents to (partially) evade taxes, are modelled through a moonlighting production scheme where both regular and underground labor use the same capital equipment inside the firm. Calibrating the model on the U.S. economy, we show that a higher relative size of underground production implies lower average employment and a lower job finding rate, together with higher volatility of employment and lower volatilities of hours worked and wages of regular labor services. The theoretical explanation we provide is that a higher level of the underground activity increases the ratio of the flow contribution of non-working to the flow contribution of a worker to a labour match.
    Keywords: underground activities, tax evasion, search and matching, real business cycle
    JEL: E32 E26 J64
    Date: 2012–06
  2. 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.
    JEL: C11 E22 E32 E44
    Date: 2012–06
  3. By: Hamano Masashige (University of Luxembourg CREA)
    Abstract: This paper analyzes equity and bond positions in a two-country DSGE model where the number of varieties, i.e. extensive margin is endogenously determined. Households take care about not only the price of goods but also the variety of goods they consume. The welfare-based real exchange rate fluctuations matter in inter- national consumption risk sharing. We investigate analytically and numerically the implication of "variety risk" induced by fluctuations in extensive margins. In nu- merical computation of zero-order steady state portfolios, we employ the Devereux and Sutherland method. We show that, with variety risk, home biased equity posi- tions are further amplified compared to those obtained with the standard model in the literature. The result is shown to be robust with or without firm heterogeneity in marginal costs of production.
    Keywords: real exchange rate, home biased equity puzzle, firm entry, firm heterogeneity
    JEL: F12 F41 F43
    Date: 2012
  4. By: Mimir, Yasin
    Abstract: This paper conducts a quantitative analysis of the role of financial shocks and credit frictions affecting the banking sector in driving U.S. business cycles. I first document three key business cycle stylized facts of aggregate financial variables in the U.S. banking sector: (i) Bank credit, deposits and loan spread are less volatile than output, while net worth and leverage ratio are more volatile, (ii) bank credit and net worth are procyclical, while deposits, leverage ratio and loan spread are countercyclical, and (iii) financial variables lead the output fluctuations by one to three quarters. I then present an equilibrium business cycle model with a financial sector, featuring a moral hazard problem between banks and its depositors, which leads to endogenous capital constraints for banks in obtaining funds from households. The model incorporates empirically-disciplined shocks to bank net worth (i.e. "financial shocks") that alter the ability of banks to borrow and to extend credit to non-financial businesses. I show that the benchmark model is able to deliver most of the above stylized facts. Financial shocks and credit frictions in banking sector are important not only for explaining the dynamics of financial variables but also for the dynamics of standard macroeconomic variables. Financial shocks play a major role in driving real fluctuations due to their impact on the tightness of bank capital constraint and the credit spread.
    Keywords: Banks; Financial Fluctuations; Credit Frictions; Bank Equity; Real Fluctuations
    JEL: E32 E44 E10 E20
    Date: 2012–05
  5. By: Giovanni Lombardo (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Peter McAdam (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: We build a model of the euro area incorporating financial market frictions at the level of firms and households. Entrepreneurs borrow from financial intermediaries in order to purchase business capital, in the spirit of the "financial accelerator" literature. We also introduce two types of households that differ in their degree of time preference. All households have preferences for housing services. The impatient households are faced with a collateral constraint that is a function of the value of their housing stock. Our aim is to provide a unified framework for policy analysis that emphasizes financial market frictions alongside the more traditional model channels. The model is estimated by Bayesian methods using euro area aggregate data and model properties are illustrated with simulation and conditional variance and historical shock decomposition. JEL Classification: C11, C32, E32, E37.
    Keywords: Financial Frictions, euro area, DSGE modeling, Bayesian estimation, simulation, decompositions.
    Date: 2012–02
  6. By: Cagri Seda Kumru; John Piggott
    Abstract: This paper studies the interaction between capital income taxation and a means tested age pension in the context of an overlapping generations model, calibrated to the UK economy. Recent literature has suggested a rehabilitation of capital income taxation (Conesa et al. (2009)), predicated on the idea that capital is a complement with retirement leisure. This leads naturally to the conjecture that a publicly funded age pension contingent upon holdings of capital or capital income may have a similar effect. We formalize this using a stochastic OLG model with multiple individuals differentiated by labour productivity and pension entitlement. Our preliminary findings suggest that a means tested pension has effects similar to capital income taxation in a life-cycle context.
    JEL: E21 E62 H55
    Date: 2012–06
  7. By: Sunel, Enes
    Abstract: This study investigates quantitative properties of the transitional dynamics produced by gradual disinflation in a small open economy inhabited by heterogeneous consumers. The main exercise is to feed the empirically observed declining path for inflation into the calibrated model and account for its macroeconomic, distributional and welfare effects under alternative fiscal arrangements. The results show that (i) when uniform transfers are endogenous, gradual decline in the inflation rate from 14.25% to 2.25% increases aggregate welfare by 0.28%. (ii) When wasteful spending is endogenous, aggregate welfare increases by 0.53%. These welfare effects are substantially different from those implied by steady state comparisons. This is because when transition is accounted for, fiscal variables do not jump to their low inflation steady state levels immediately.
    Keywords: Small open economy; incomplete markets; welfare effects of inflation
    JEL: D31 E52 F41
    Date: 2012–06–26
  8. By: Zhixiang Zhang (CEMA, Central University of Finance and Economics); Heng-fu Zou (CEMA, Central University of Finance and Economics)
    Abstract: This paper provides suffcient conditions on the technology and preferences, under which the optimal savings-consumption policy is unique, and a stationary Markov equilibrium exists for an overlapping generation economy. Comparing with Wang (1993), our conditions on the uniqueness of optimal policy function are more general, and our conditions on the existence of equilibria depend on the exogenous parameters in the model instead of on endogenous variables.
    Date: 2012–02–08
  9. By: Gahvari, Firouz (Department of Economics); Micheletto, Luca (Uppsala Center for Fiscal Studies)
    Abstract: This paper develops an overlapping-generations model with money-in-the-utilityfunction and heterogeneous agents in terms of earning ability. It shows that in the presence of income misreporting the Friedman rule is in general violated. The result holds even though the government taxes reported incomes nonlinearly and agents have preferences that are separable between labor supply and other goods including real money balances.
    Keywords: Monetary policy; scal policy; redistribution; Friedman rule; income misreporting; overlapping generations; second best
    JEL: E52 H21
    Date: 2012–06–27
  10. By: George Alessandria; Joseph Kaboski; Virgiliu Midrigan
    Abstract: The large, persistent fluctuations in international trade that can not be explained in standard models by changes in expenditures and relative prices are often attributed to trade wedges. We show that these trade wedges can reflect the decisions of importers to change their inventory holdings. We find that a two-country model of international business cycles with an inventory management decision can generate trade flows and wedges consistent with the data. Moreover, matching trade flows alters the international transmission of business cycles. Specifically, real net exports become countercyclical and consumption is less correlated across countries than in standard models. We also show that ignoring inventories as a source of trade wedges substantially overstates the role of trade wedges in business cycle fluctuations.
    JEL: F41 F44
    Date: 2012–06
  11. By: Schäfer, Andreas; Steger, Thomas
    Abstract: What are the dynamic consequences of comprehensive integration shocks? The answer to this question appears all but trivial. We set up a dynamic macroeconomic model of a small open economy where both capital and labor are mobile and there are increasing returns to scale at the aggregate level. The model features multiple equilibria as well as (local and global) indeterminacy. Hence, expectations matter for resulting equilibrium dynamics. Despite its simplicity, the model creates a rich set of plausible implications. Our analysis contributes to a better understanding of the interaction between expectations and fundamentals in models with indeterminacy. The model is applied to replicate two striking empirical characteristics of macroeconomic development in East Germany since 1991. --
    Keywords: Increasing returns to scale,Capital mobility,Migration,Multiple equilibria,Indeterminacy,History vs. expectations
    JEL: D90 F20 O10
    Date: 2012
  12. By: Poeschel, Friedrich (Institut für Arbeitsmarkt- und Berufsforschung (IAB), Nürnberg [Institute for Employment Research, Nuremberg, Germany])
    Abstract: "The matching of likes is a frequently observed phenomenon. However, for such assortative matching to arise in a search model, often implausibly strong conditions are required. This paper shows that, once signals are introduced, a search model can generate even perfect assortative matching under weak conditions: supermodularity of the match production function is a necessary and sufficient condition. It simultaneously drives sorting and functions as a single-crossing property ensuring that agents choose truthful signals. The information thereby transmitted allows agents to avoid all unnecessary costs of random search, which creates in effect an almost frictionless environment. Hence the unique separating equilibrium in the model achieves nearly unconstrained efficiency despite frictions." (Author's abstract, IAB-Doku) ((en))
    Keywords: Arbeitsuche, Produktionsfunktion, Suchverfahren, Strukturierung, ökonomische Theorie
    JEL: J64 D83 C78
    Date: 2012–06–29
  13. By: Carrera, Cesar (Banco Central de Reserva del Perú); Vega, Hugo (Banco Central de Reserva del Perú; London School of Economics)
    Abstract: The interbank market helps regulate liquidity in the banking sector. Banks with outstanding resources usually lend to banks that are in needs of liquidity. Regulating the interbank market may actually benefit the policy stance of monetary policy. Introducing an interbank market in a general equilibrium model may allow better identification of the final effects of non-conventional policy tools such as reserve requirements. We introduce an interbank market in which there are two types of private banks and a central bank that has the ability to issue money into a DSGE model. Then, we use the model to analyse the effects of changes to reserve requirements (a macroprudential tool), while the central bank follows a Taylor rule to set the policy interest rate. We find that changes to reserve requirements have similar effects to interest rate hikes and that both monetary policy tools can be used jointly in order to avoid big swings in the policy rate (that could have an undesired effect on private expectations) or a zero bound (i.e. liquidity trap scenarios).
    Keywords: reserve requirements, collateral, banks, interbank market, DSGE
    JEL: E31 O42
    Date: 2012–06
  14. By: Thi Kim Cuong Pham
    Abstract: This paper reexamines the Barro growth model taking into account status-seeking behavior. Agents care about both consumption and social status, which is determined by their relative consumption in society. Public capital as production input is financed by income tax or lumpsum tax. We discuss different measures to reach the optimal growth and optimal welfare in a decentralized economy and find that under some parameter conditions, there are some government sizes for which the decentralized growth is optimal, and this result does not require corrective taxation policy. We also find the superiority of income tax versus lump-sum tax from the point of view of optimal growth in a decentralized economy and of social welfare. Besides, we propose corrective tax programs with constant capital tax or subsidy and time-varying consumption tax that enable an economy to reach the first-best optimal growth. The extension to a congestion model modifies somewhat the results. We discuss conditions under which the first-best or the secondbest optimal growth is attained in a decentralized economy.
    Keywords: Corrective tax, endogenous growth, public expenditure, relative consumption, status-seeking.
    JEL: D90 H21 H50 O41
    Date: 2012
  15. By: Michal Rubaszek (National Bank of Poland, 00-919 Warszawa, ul. Świętokrzyska 11/21, Poland and Warsaw School of Economics.); Dobromil Serwa (National Bank of Poland, 00-919 Warszawa, ul. Świętokrzyska 11/21, Poland and Warsaw School of Economics.)
    Abstract: This paper applies a life-cycle model with individual income uncertainty to investigate the determinants of credit to households. We show that the value of household credit to GDP ratio depends on (i) the lending-deposit interest rate spread, (ii) individual income uncertainty, (iii) individual productivity persistence, and (iv) the generosity of the pension system. Subsequently, we provide empirical evidence for the predictions of the theoretical model on the basis of data for OECD and EU countries. JEL Classification: E21, E43, E51.
    Keywords: Household credit, life cycle economies, banking sector.
    Date: 2012–02
  16. By: [no author]
    Abstract: In the first chapter of this dissertation, we approach the estimation of dynamic stochastic general equilibrium models through a moments-based estimator, the empirical likelihood. We try to show that this inference process can be a valid alternative to maximum likelihood. The empirical likelihood estimator only requires knowledge about the moments of the data generating process of the model. In this context, we exploit the fact that these economies can be formulated as a set of moment conditions to infer on their parameters through this technique. For illustrational purposes, we consider the standard real business cycle model with a constant relative risk adverse utility function and indivisible labour, driven by a normal technology shock. In the second chapter, we explore further aspects of the estimation of dynamic stochastic general equilibrium models using the empirical likelihood family of estimators. In particular, we propose possible ways of tackling the main problems identified in the first chapter. These problems resume to: (i) the possible existence of dependence between the random variables; (ii) the definition of moment conditions in the dynamic stochastic general equilibrium models setup; (iii) the alternatives to the data generation process used in the first chapter. In the third chapter, we investigate the short run effects of macroeconomic and fiscal volatility on the decision of the policy maker on how much to consume and how much to invest. To that end, we analyse a panel of 10 EU countries during 1991-2007. Our results suggest that increases in the volatility of regularly collected and cyclical revenues such as the VAT and income taxes tend to tilt the expenditure composition in favour of public investment. In contrast, increases in the volatility of ad hoc -type of taxes such as capital taxes tend to favour public consumption spending, albeit only a little.
    Date: 2012
  17. By: Luis-Felipe Zanna; Marco Airaudo
    Abstract: We present an extensive analysis of the consequences for global equilibrium determinacy in flexible-price open economies of implementing active interest rate rules, i.e., monetary rules where the nominal interest rate responds more than proportionally to inflation. We show that conditions under which these rules generate aggregate instability by inducing liquidity traps, endogenous cycles, and chaotic dynamics depend on specific characteristics of open economies. In particular, rules that respond to expected future inflation are more prone to induce endogenous cyclical and chaotic dynamics the more open the economy to trade.
    Keywords: Business cycles , Economic models , Flexible pricing policy , Interest rates , International trade , Monetary policy , Real effective exchange rates ,
    Date: 2012–05–11
  18. By: Edward F. Buffie; Rafael Portillo; Luis-Felipe Zanna; Catherine A. Pattillo; Andrew Berg
    Abstract: We develop a model to study the macroeconomic effects of public investment surges in low-income countries, making explicit: (i) the investment-growth linkages; (ii) public external and domestic debt accumulation; (iii) the fiscal policy reactions necessary to ensure debt-sustainability; and (iv) the macroeconomic adjustment required to ensure internal and external balance. Well-executed high-yielding public investment programs can substantially raise output and consumption and be self-financing in the long run. However, even if the long run looks good, transition problems can be formidable when concessional financing does not cover the full cost of the investment program. Covering the resulting gap with tax increases or spending cuts requires sharp macroeconomic adjustments, crowding out private investment and consumption and delaying the growth benefits of public investment. Covering the gap with domestic borrowing market is not helpful either: higher domestic rates increase the financing challenge and private investment and consumption are still crowded out. Supplementing with external commercial borrowing, on the other hand, can smooth these difficult adjustments, reconciling the scaling up with feasibility constraints on increases in tax rates. But the strategy may be also risky. With poor execution, sluggish fiscal policy reactions, or persistent negative exogenous shocks, this strategy can easily lead to unsustainable public debt dynamics. Front-loaded investment programs and weak structural conditions (such as low returns to public capital and poor execution of investments) make the fiscal adjustment more challenging and the risks greater.
    Date: 2012–06–05
  19. By: Brita Bye and Taran Fæhn (Statistics Norway)
    Abstract: Evidence points to relatively low supply elasticities for workers skilled for research and development (R&D), which can hamper innovation and growth. Increasing the supply of R&D skills will expand an economy's innovative capacity. A simultaneous effect of increased education, which is particularly important for small, open economies, is to raise final goods producers’ capacity to absorb cross-border knowledge spillovers. In a calibrated endogenous growth model for Norway, we find that increasing the share of highly educated workers has pronounced absorptive capacity effects that partially crowd out R&D-based innovation. Both innovative and absorptive capacity expansions contribute to higher growth and welfare.
    Keywords: Absorptive capacity; Computable general equilibrium model; Endogenous growth; Human capital; Innovation; Research and Development
    JEL: O30 O41
    Date: 2012–06
  20. 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
  21. By: Fuad Hasanov; Reda Cherif
    Abstract: We study the effects of permanent and temporary income shocks on precautionary saving and investment in a "store-or-sow" model of growth. High volatility of permanent shocks results in high precautionary saving in the safe asset and low investment, or a "volatility trap." Namely, big savers invest relatively little. In contrast, low volatility of permanent shocks leads to low precautionary saving and high or low investment, depending on the volatility of temporary shocks. Empirical evidence shows a nonlinear relationship between investment and saving and that investment is a hump-shaped function of the volatility of permanent shocks, as predicted by the model.
    Keywords: Economic growth , Economic models , External shocks , Investment , Savings ,
    Date: 2012–05–23
  22. By: Collard, Fabrice (Université de Berne); Fève, Patrick (TSE (GREMAQ, IUF, IDEI et Banque de France))
    Abstract: Cet article présente les contributions originelles et essentielles de T. Sargent et C. Sims à la modélisation macro-économétrique. Après avoir exposé leur critique de la modélisation existante, cet article s'attache à préciser l'originalité de leurs approches respectives. La présentation de leurs travaux insiste ensuite sur les différentes voies de rapprochement de ces deux types des modélisations.
    Keywords: , , , , , , , Anticipations Rationnelles, Modèles Dynamiques, Identifications, Chocs Structurels
    JEL: C1 C2 C3 E2 E3 E4
    Date: 2012–05

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