nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2012‒07‒23
38 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Countercyclical Markups and News-Driven Business Cycles By Oscar Pavlov; Mark Weder
  2. Capital destruction, jobless recoveries, and the discipline device role of unemployment By Marianna Riggi
  3. News about Aggregate Demand and the Business Cycle By Jang-Ting Guo; Anca-Ioana Sirbu; Mark Weder
  4. Durable Goods, Borrowing Constraints and Consumption Insurance By Cerletti, Enzo; Pijoan-Mas, Josep
  5. Trade wedges, inventories, and international business cycles By George Alessandria; Joseph Kaboski; Virgiliu Midrigan
  6. Indeterminacy in a dynamic small open economy with international migration By Parello, Carmelo Pierpaolo
  7. Frequency of trade and the deterrminacy of equilibrium in economies of overlapping generations By Hippolyte D'Albis; Emmanuelle Augeraud-Véron
  8. Business cycle fluctuations and learning-by-doing externalities in a one-sector model By Hippolyte D'Albis; Emmanuelle Augeraud-Véron; Alain Venditti
  9. Liquidity, Assets and Business Cycles By Shouyong Shi
  10. Unions in a Frictional Labor Market By Per Krusell; Leena Rudanko
  11. Financial frictions and fluctuations in volatility By Cristina Arellano; Yan Bai; Patrick J. Kehoe
  12. A Theory of Countercyclical Government-Consumption Multiplier By Michaillat, Pascal
  13. Taking Trends Seriously in DSGE Models: An Application to the Dutch Economy By Pierre Lafourcade; Joris de Wind
  14. Testing macroeconomic models by indirect inference on unfiltered data By Meenagh, David; Minford, Patrick; Wickens, Michael R.
  15. How Useful are DSGE Macroeconomic Models for Forecasting? By Wickens, Michael R.
  16. Engines of growth: Education and innovation By Stadler, Manfred
  17. Education, Life Expectancy and Family Bargaining: The Ben-Porath Effect Revisited By Laura Leker; Grégory Ponthière
  18. Fairness, Search Frictions, and Offshoring By Devashish Mitra; Priya Ranjan
  19. On ABCs (and Ds) of VAR representations of DSGE models By Massimo Franchi; Paolo Paruolo
  20. Global Banks and Crisis Transmission By Kalemli-Ozcan, Sebnem; Papaioannou, Elias; Perri, Fabrizio
  21. A Numerical Evaluation on a Sustainable Size of Primary Deficit in Japan By Real Arai; Junji Ueda
  22. Testing DSGE models by Indirect inference and other methods: some Monte Carlo experiments By Le, Vo Phuong Mai; Meenagh, David; Minford, Patrick; Wickens, Michael R.
  23. The Modeling of Expectations in Empirical DSGE Models: a Survey By Fabio Milani
  24. Dynamic Competitive Economies with Complete Markets and Collateral Constraints By GOTTARDI, Piero; KUBLER, Felix
  25. Fiscal Consolidation Strategy By Cogan, John F.; Taylor, John B.; Wieland, Volker; Wolters, Maik H
  26. What causes banking crises? An empirical investigation By Le, Vo Phuong Mai; Meenagh, David; Minford, Patrick
  27. On the Welfare Costs of Business-Cycle Fluctuations and Economic-Growth Variation in the 20th Century By Osmani Teixeira de Carvalho Guillény; João Victor Isslerz; Afonso Arinos de Mello Franco-Neto
  28. Market and Non-Market Monetary Policy Tools in a Calibrated DSGE Model for Mainland China By Chen, Qianying; Funke, Michael; Paetz, Michael
  29. Private Uncertainty and Multiplicity. By Gaballo, G.
  30. Learning-by-Doing and Its Implications for Economic Growth and International Trade By Mao, Zi-Ying
  31. Foreclosure delay and U.S. unemployment By Kyle F. Herkenhoff; Lee Ohanian
  32. Asset Pricing with Heterogeneous Investors and Portfolio Constraints By Georgy Chabakauri
  33. Ergodic Invariant Distributions for Non-optimal Dynamic Economics By Manuel S. Santos; Adrian Peralta-Alva
  34. Do Low Interest Rates Sow the Seeds of Financial Crises? By Simona E. Cociuba; Malik Shukayev; Alexander Ueberfeldt
  35. A Century of Human Capital and Hours By Diego Restuccia; Guillaume Vandenbroucke
  36. Banks’ reactions to Basel-III By Paolo Angelini; Andrea Gerali
  37. U.S. monetary policy: a view from macro theory By William T. Gavin; Benjamin D. Keen
  38. Fiscal devaluations in EMU By J.E. Bosca; Rafael Domenech; J. Ferri

  1. By: Oscar Pavlov (School of Economics, University of Adelaide); Mark Weder (School of Economics, University of Adelaide)
    Abstract: The standard one-sector real business cycle model is unable to generate expectations-driven fluctuations. The addition of countercyclical markups and modest investment adjustment costs offers an easy fix to this conundrum. The simulated model generates quantitatively realistic business cycles with news shocks accounting for over half of the variance of technology shocks.
    Keywords: expectations-driven business cycles, markups
    JEL: E32
    Date: 2012–01
  2. By: Marianna Riggi (Bank of Italy)
    Abstract: I consider an economy growing along the balanced growth path that is hit by an adverse shock to its capital accumulation process. The model integrates efficiency wages due to imperfect monitoring of the quality of labour in a search and matching framework with methods of dynamic general equilibrium analysis. I show that, depending on the firms' abilities to assess workers' performance, the discipline device role of unemployment may account for sharp declines in employment and jobless recoveries driven by exceptional increases in the work effort of employees. The model also explains why rigid real wages may prevail in equilibrium: the large movements in unemployment are indeed associated with real wage rigidity, which is generated endogenously by efficiency wages.
    Keywords: jobless recoveries, efficiency wages, productivity, capital depreciation, real wage rigidities.
    JEL: E24 E32
    Date: 2012–07
  3. By: Jang-Ting Guo (Department of Economics, University of California-Riverside); Anca-Ioana Sirbu (Department of Economics, University of California-Riverside); Mark Weder (School of Economics, University of Adelaide)
    Abstract: We show that a one-sector real business cycle model with variable capital utilization and mild increasing returns-to-scale is able to generate qualitatively as well as quantitatively realistic aggregate fluctuations driven by news shocks to future consumption demand. In sharp contrast to many studies in the existing expectations-driven business cycle literature, our results do not rely on non-separable preferences or investment adjustment costs.
    Keywords: News Shocks; Aggregate Demand; Business Cycles
    JEL: E32
    Date: 2012–01
  4. By: Cerletti, Enzo; Pijoan-Mas, Josep
    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: Borrowing Constraints; Consumption Insurance; Durable Goods; Incomplete Markets; Persistence of Income Shocks
    JEL: D12 D91 E21
    Date: 2012–07
  5. By: George Alessandria; Joseph Kaboski; Virgiliu Midrigan
    Abstract: The large, persistent fluctuations in international trade that cannot 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.
    Keywords: Exports ; Trade
    Date: 2012
  6. By: Parello, Carmelo Pierpaolo
    Abstract: This paper presents a dynamic small open economy version of the standard neoclassical exogenous growth model with international migration. It considers both the case of perfect world capital markets and the case of imperfect capital markets and shows that local indeterminacy always arises independently of the capital market regime. To study the dynamic implications of migration on domestic consumption, current account and capital accumulation, we simulate the model numerically by distinguishing three different scenarios depending on whether the initial immigration ratio is larger, equal or smaller than its steady-state value. In the case of perfect world capital markets, we find that migration has only a temporary impact on capital accumulation, but a permanent impact on domestic consumption and foreign debt. Instead, in the case of imperfect world capital markets, we find that migration has only temporary impacts on all the main macroeconomic variables.
    Keywords: Small Open Economy; Indeterminacy; International Migration; Capital Adjustment Costs; First best
    JEL: F22 O41 C61 F43 C62
    Date: 2012–07–07
  7. By: Hippolyte D'Albis (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon Sorbonne); Emmanuelle Augeraud-Véron (MIA - Mathématiques, Image et Applications - Université de La Rochelle : EA3165)
    Abstract: In a recent article, Demichelis and Polemarchakis (2007) highlighted the role played by the frequency of trade on the degree of indeterminacy of equilibrium in economies of overlapping generations. Assuming that time has a finite starting point and extends into the infinite future, they prove that the degree of indeterminacy increases with the number of periods in the life-span of individuals, which is assumed to be certain. We show that this result does not hold when individual longevity is uncertain. We build a discrete time model that uniformly converges to a standard continuous time overlapping-generation model when the frequency of trade is infinite. Deriving the equilibrium prices, we demonstrate that the degree of indeterminacy is independent of the frequency of trade and is always equal to one.
    Keywords: Overlapping generations, perpetual youth model, determinacy, continuous time, discrete time.
    Date: 2012–06
  8. By: Hippolyte D'Albis (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon Sorbonne); Emmanuelle Augeraud-Véron (MIA - Mathématiques, Image et Applications - Université de La Rochelle : EA3165); Alain Venditti (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille II - Université Paul Cézanne - Aix-Marseille III - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - CNRS : UMR6579, EDHEC Business School - Département Comptabilité, Droit, Finance et Economie)
    Abstract: We consider a one-sector Ramsey-type growth model with inelastic labor and learning-by-doing externalities based on cumulative gross investment (cumulative production of capital goods), which is assumed, in accordance with Arrow [4], to be a better index of experience than the average capital stock. We prove that a slight memory effect characterizing the learning-by-doing process is enough to generate business cycle fluctuations through a Hopf bifurcation leading to stable periodic orbits. This is obtained for reasonable parameter values, notably for both the amount of externalities and the elasticity of intertemporal substitution. Hence, contrary to all the results available in the literature on aggregate models, we show that endogenous fluctuations are compatible with a low (in actual fact, zero) wage elasticity of the labor supply.
    Keywords: One-sector infinite-horizon model, learning-by-doing externalities, inelastic labor, business cycle fluctuations, Hopf bifurcation, local determinacy.
    Date: 2012–03
  9. By: Shouyong Shi
    Abstract: I construct a tractable model to evaluate the liquidity shock hypothesis that exogenous shocks to equity market liquidity are an important cause of the business cycle. After calibrating the model, I find that a large and persistent negative liquidity shock can generate large drops in investment, employment and output. Contrary to the hypothesis, however, a negative liquidity shock generates an equity price boom. This counterfactual response of equity price is robust, provided that a negative liquidity shock tightens firms' financing constraint on investment. Also, I demonstrate that the same counterfactual response of equity price arises when there is a financial shock to a firm's collateral constraint on borrowing. For equity price to fall as it typically does in a recession, the negative liquidity/financial shock must be accompanied or caused by other changes that relax firms' financing constraint on investment. I discuss some candidates of these concurrent changes.
    Keywords: Liquidity; Assets; Business cycles; Collateral
    JEL: E32 E5 G1
    Date: 2012–07–03
  10. By: Per Krusell; Leena Rudanko
    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, assuming it to care equally about employed and unemployed workers, to treat identical workers in identical jobs the same, as well as to be fully rational, taking job creation into account when making its wage demands. Under these assumptions, if the union is able to fully commit to future wages, it achieves an efficient level of long-run unemployment. In the short run, however, the union raises current wages above the efficient level, in order to appropriate surpluses from firms with existing matches. The union wage policy is thus time-inconsistent. 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 leads to increased volatility in the labor market. We consider extensions to partial unionization and collective bargaining between the union and an employers’ association.
    JEL: E02 E24 J51 J64
    Date: 2012–07
  11. By: Cristina Arellano; Yan Bai; Patrick J. Kehoe
    Abstract: During the recent U.S. financial crisis, the large decline in economic activity and credit was accompanied by a large increase in the dispersion of growth rates across firms. However, even though aggregate labor and output fell sharply during this period, labor productivity did not. These features motivate us to build a model in which increased volatility at the firm level generates a downturn but has little effect on labor productivity. In the model, hiring inputs is risky because financial frictions limit firms' ability to insure against shocks that occur between the time of production and the receipt of revenues. Hence, an increase in idiosyncratic volatility induces firms to reduce their inputs to reduce such risk. We find that our model can generate about 67% of the decline in output of the Great Recession of 2007–2009.
    Keywords: Recessions ; Credit
    Date: 2012
  12. By: Michaillat, Pascal
    Abstract: This paper proposes a dynamic stochastic general equilibrium model in which the government-consumption multiplier doubles when unemployment rises from 5% to 8%. Theoretically, such countercyclicality arises because of a nonlinearity, namely, that labor supply is convex in a labor market tightness-employment diagram. In the model, as government consumption increases, public employment rises, stimulating labor demand. Equilibrium tightness increases, which reduces private employment and partially offsets the increase in public employment. Since labor supply is convex, the increase in tightness is small in recessions but large in expansions. Hence, government consumption reduces unemployment much more in recessions than in expansions.
    Keywords: business cycle; multiplier; unemployment
    JEL: E24 E32 E62
    Date: 2012–07
  13. By: Pierre Lafourcade; Joris de Wind
    Abstract: We construct a new-Keynesian DSGE model tailored to the Netherlands and interpret it as a multivariate unobserved components model. We identify three major stochastic trends in the data—trends in general-purpose technology, investment-specific technology, and labor supply—and model them formally in our theoretical set-up. Our trend-cycle decomposition captures the data’s co-integrating properties without which long-run analysis—whether scenario analysis or forecasting—would likely be misspecified. In particular, this approach appears to produce better-behaved posteriors for parameters along decision margins where traditional modeling imposes highly persistent but temporary shocks. The existence of permanent and temporary disturbances along the same margin broadens the scope for counterfactuals. Specifically, differences in short-run responses to the two types of shocks reflect smoothing motives and discounted valuation effects reminiscent of the Permanent Income Hypothesis.
    JEL: C54 E27 E37 E47
    Date: 2012–07
  14. By: Meenagh, David; Minford, Patrick; Wickens, Michael R.
    Abstract: We extend the method of indirect inference testing to data that is not filtered and so may be non-stationary. We apply the method to an open economy real businss cycle model on UK data. We review the method using a Monte Carlo experiment and find that it performs accurately and has good power.
    Keywords: Bootstrap; DSGE; indirect inference; Monte Carlo; VECM
    JEL: C12 C32 C52 E1
    Date: 2012–07
  15. By: Wickens, Michael R.
    Abstract: We find that forecasts from DSGE models are not more accurate than either times series models or official forecasts, but neither are they any worse. We also find that all three types of forecast failed to predict the recession that started in 2007 and continued to forecast poorly even after the recession was known to have begun. We investigate why these results occur by examining the structure of the solution of DSGE models and compare this with pure time series models. We show that the main factor is the dynamic structure of DSGE models. Their backward-looking dynamics gives them a similar forecasting structure to time series models and their forward-looking dynamics, which consists of expected values of future exogenous variables, is difficult to forecast accurately. As a result we suggest that DSGE models should not be tested through their forecasting ability.
    Keywords: DSGE models; Forecasting; VAR models
    JEL: C5 E1
    Date: 2012–07
  16. By: Stadler, Manfred
    Abstract: The paper presents a dynamic general-equilibrium model of education, quality and variety innovation, and scale-invariant growth. We consider endogenous humancapital accumulation in an educational sector and quality and variety innovation in two separate R&D sectors. In the balanced growth equilibrium education and innovation appear as in-line engines of growth and government can accelerate growth by subsidizing education or by enhancing the effectiveness of the educational sector. --
    Keywords: education,quality and variety innovation,scale-invariant growth
    JEL: O2 O3
    Date: 2012
  17. By: Laura Leker (PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - Ecole des Ponts ParisTech - Ecole Normale Supérieure de Paris - ENS Paris - INRA, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Grégory Ponthière (PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - Ecole des Ponts ParisTech - Ecole Normale Supérieure de Paris - ENS Paris - INRA, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: Following Ben-Porath (1967), the influence of life expectancy on education has attracted much attention. Whereas existing growth models rely on an education decision made either by the child or by his parent, we revisit the Ben-Porath effect when the education is the outcome of a bargaining between the parent and the child. We develop a three-period OLG model with human capital accumulation and endogenous life expectancy, and show that, as a result of the unequal life horizons faced by parents and children, the Ben-Porath effect depends on the distribution of bargaining power within the family, which in turn affects the long-run dynamics of the economy. Using data on 17 OECD countries (1940-1980), we show that the introduction of intergenerational bargaining on education helps to rationalize the observed education patterns across countries.
    Keywords: Education ; Life Expectancy ; Family Bargaining ; OLG Model
    Date: 2012–07
  18. By: Devashish Mitra (Department of Economics, Syracuse University); Priya Ranjan (Department of Economics, University of California-Irvine)
    Abstract: Fairness considerations within the firm are introduced into the determination of wages in a two factor Pissarides-style model of search unemployment to study its implications for the unemployment rates of unskilled and skilled workers in both the closed economy case and when the economy can offshore some inputs. While the effect of a fair-wage constraint on unskilled workers takes the form of an increase in their wage and unemployment, we also Önd interesting effects on skilled workers in a closed economy. The skilled wage and skilled unemployment move in directions opposite to each other, with the actual direction of their movement depending on the elasticity of substitution between skilled and unskilled labor. The impact of offshoring of the services of unskilled labor on the unemployment of unskilled workers is stronger in the presence of fairness considerations than in the case when search frictions are the only source of unemployment. Finally, offshoring insulates the skilled labor market outcomes from fairness concerns that are present in a closed economy.
    Keywords: Fair wages; Unemployment; Overhiring effect, offshoring
    JEL: F16 F40 E24 J64
    Date: 2012–03
  19. By: Massimo Franchi ("Sapienza" Universita' di Roma); Paolo Paruolo (Universita' dell'Insubria)
    Abstract: This paper shows that the poor man's invertibility condition in Fernandez-Villaverde et al. (2007) is, in general, sufficient but not necessary for fundamentalness; that is, a violation of this condition does not necessarily imply the impossibility of recovering the structural shocks of a DSGE via a VAR. The permanent income model in Fernandez-Villaverde et al. (2007) is used to illustrate this fact. A necessary and sufficient condition for fundamentalness is formulated and its relations with the poor man's invertibility condition are discussed.
    Keywords: DSGE; VAR; invertibility; non-fundamentalness.
    Date: 2012–07
  20. By: Kalemli-Ozcan, Sebnem; Papaioannou, Elias; Perri, Fabrizio
    Abstract: We study the effect of financial integration on the transmission of international business cycles. In a sample of 20 developed countries between 1978 and 2009 we find that, in periods without financial crises, increases in bilateral financial linkages are associated with more divergent output cycles. This relation is significantly weaker during financial turmoil periods, suggesting that financial crises induce co-movement among more financially integrated countries. We also show that countries with stronger, direct and indirect, financial ties to the U.S. experienced more synchronized cycles with the U.S. during the recent 2007-2009 crisis. We then interpret these findings using a simple general equilibrium model of international business cycles with banks and shocks to banking activity. The model suggests that the change in the relation between integration and synchronization can be driven by changes in the nature of shocks hitting the world economy, and that shocks to global banks played an important role in triggering and spreading the 2007-2009 crisis.
    Keywords: co-movement; crisis; financial integration; international business cycles
    JEL: E32 F15 F36
    Date: 2012–07
  21. By: Real Arai (Graduate School of Social Sciences, Hiroshima University); Junji Ueda (Policy Research Institute, the Ministry of Finance, Japan)
    Abstract: We investigate how large a size of primary deficit to GDP ratio the Japan's government can sustain. For this investigation, we construct an overlapping generations model, in which multi-generational households live and the government maintains a constant ratio of primary deficit to GDP. We numerically show that the primary deficit cannot be sustained unless the rate of economic growth is unrealistically high, which is more than five percent according to our settings. Our result implies that Japan's government needs to achieve a positive primary balance in the long-run in order to avoid the divergence of the public debt to GDP ratio.
    Keywords: fiscal sustainability, public debt, primary deficit, economic growth
    JEL: E62 H62 H63 H68
    Date: 2012–06
  22. By: Le, Vo Phuong Mai; Meenagh, David; Minford, Patrick; Wickens, Michael R.
    Abstract: Using Monte Carlo experiments, we examine the performance of Indirect Inference tests of DSGE models, usually versions of the Smets-Wouters New Keynesian model of the US postwar period. We compare these with tests based on direct inference (using the Likelihood Ratio), and on the Del Negro-Schorfheide DSGE-VAR weight. We find that the power of all three tests is substantial so that a false model will tend to be rejected by all three; but that the power of the indirect inference tests are by far the greatest, necessitating re-estimation by indirect inference to ensure that the model is tested in its fullest sense.
    Keywords: Bootstrap; DSGE; DSGE-VAR weight; indirect inference; likelihood ratio; New Classical; New Keynesian; Wald statistic
    JEL: C12 C32 C52 E1
    Date: 2012–07
  23. By: Fabio Milani (Department of Economics, University of California-Irvine)
    Abstract: A recent notable development in the empirical macroeconomics literature has been the rapid growth of papers that build structural models, which include a number of frictions and shocks, and which are confronted with the data using sophisticated full-information econometric approaches, often using Bayesian methods. A widespread assumption in these estimated models, as in most of the macroeconomic literature in general, is that economic agents' expectations are formed according to the Rational Expectations Hypothesis (REH). Various alternative ways to model the formation of expectations have, however, emerged: some are simple refinements that maintain the REH, but change the information structure along different dimensions, while others imply more significant departures from rational expectations. I review here the modeling of the expectation formation process and discuss related econometric issues in current structural macroeconomic models. The discussion includes benchmark models assuming rational expectations, extensions based on allowing for sunspots, news, sticky information, as well as models that abandon the REH to use learning, heuristics, or subjective expectations.
    Keywords: Expectations formation; DSGE models; Rational expectations; Adaptive learning; Survey expectations; New Bayesian macroeconometrics
    JEL: C52 D84 E32 E50 E60
    Date: 2012–06
  24. By: GOTTARDI, Piero; KUBLER, Felix
    Abstract: In this paper we examine the competitive equilibria of a dynamic stochastic economy with complete markets and collateral constraints. We show that, provided both the set of asset payoffs and collateral levels are sufficiently rich, the equilibrium allocations with sequential trades and collateral constraints are equivalent to those obtained in Arrow-Debreu markets subject to a series of appropriate limited pledgeability constraints. We provide sufficient conditions for equilibria to be Pareto efficient and show that when collateral is scarce equilibria are also often constrained inefficient, in the sense that imposing tighter borrowing restrictions can make everybody in the economy better off. We derive sufficient conditions for the existence of Markov equilibria and show that they typically have finite support when there are two agents' types. The model is then tractable and its equilibria can be computed with arbitrary accuracy. We carry outon this basis a quantitative assessment of the risk sharing and efficiency properties ofequilibria.
    Date: 2012
  25. By: Cogan, John F.; Taylor, John B.; Wieland, Volker; Wolters, Maik H
    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.
    Keywords: budget deficit; fiscal consolidation strategy; fiscal policy; government debt; U.S. budget
    JEL: E27 E62 H30 H63
    Date: 2012–07
  26. By: Le, Vo Phuong Mai; Meenagh, David; Minford, Patrick
    Abstract: We add the Bernanke-Gertler-Gilchrist model to a modified version of the Smets-Wouters model of the US in order to explore the causes of the banking crisis. We test the model against the data on HP-detrended data and reestimate it by indirect inference; the resulting model passes the Wald test on output, inflation and interest rates. We then extract the model's implied residuals on US unfiltered data since 1984 to replicate how the model predicts the crisis. The main banking shock tracks the unfolding `sub-prime' shock, which appears to have been authored mainly by US government intervention. This shock worsens the banking crisis but `traditional' shocks explain the bulk of the crisis; the non-stationarity of the productivity shock plays a key role. Crises occur when there is a `run' of bad shocks; based on this sample they occur on average once every 40 years and when they occur around half are accompanied by financial crisis. Financial shocks on their own, even when extreme, do not cause crises --- provided the government acts swiftly to counteract such a shock as happened in this sample.
    Keywords: Banking; Bootstrap; Crisis; DSGE
    JEL: C32 C52 E1
    Date: 2012–07
  27. By: Osmani Teixeira de Carvalho Guillény; João Victor Isslerz; Afonso Arinos de Mello Franco-Neto
    Abstract: Lucas(1987) has shown a surprising result in business-cycle research: the welfare cost of business cycles are very small. Our paper has several original contributions. First, in computing welfare costs, we propose a novel setup that separates the effects of uncertainty stemming from business-cycle fluctuations and economic-growth variation. Second, we extend the sample from which to compute the moments of consumption: the whole of the literature chose primarily to work with post-WWII data. For this period, actual consumption is already a result of counter-cyclical policies, and is potentially smoother than what it otherwise have been in their absence. So, we employ also pre-WWII data. Third, we take an econometric approach and compute explicitly the asymptotic standard deviation of welfare costs using the Delta Method. Estimates of welfare costs show major differences for the pre-WWII and the post-WWII era. They can reach up to 15 times for reasonable parameter values -- ß=0.985, and f=5. For example, in the pre-WWII period (1901-1941), welfare cost estimates are 0.31% of consumption if we consider only permanent shocks and 0.61% of consumption if we consider only transitory shocks. In comparison, the post-WWII era is much quieter: welfare costs of economic growth are 0.11% and welfare costs of business cycles are 0.037% -- the latter being very close to the estimate in Lucas (0.040%). Estimates of marginal welfare costs are roughly twice the size of the total welfare costs. For the pre-WWII era, marginal welfare costs of economic-growth and business-cycle fluctuations are respectively 0.63% and 1.17% of per-capita consumption. The same figures for the post-WWII era are, respectively, 0.21% and 0.07% of per-capita consumption.
    Date: 2012–07
  28. By: Chen, Qianying (BOFIT); Funke, Michael (BOFIT); Paetz, Michael (BOFIT)
    Abstract: Monetary policy in mainland China differs from conventional central banking in several respects. The central bank regulates retail lending and deposit rates, influences the credit supply via window guidance, and, in recent years has even used the required reserve ratio as a tool for fine-tuning monetary policy. This paper develops a New Keynesian DSGE model to captures China’s unconventional monetary policy toolkit. We find that credit quotas are important as the interest-rate corridor distorts the efficient reactions of the economy. Moreover, for China’s central bankers the choice of a particular monetary policy tool or a the appropriate combination of instruments depends on the source of the shock.
    Keywords: DSGE models; monetary policy; China; macroprudential policy
    JEL: E42 E52 E58
    Date: 2012–07–13
  29. By: Gaballo, G.
    Abstract: This paper provides the conditions under which small enough private uncertainty on an aggregate endogenous state of the economy can invalidate uniqueness of the equilibrium. The main result is presented in a fully microfounded macroeconomic model where agents learn from arising prices. The findings apply to a broad class of static signal extraction problems where both fundamental correlation and pay-off externalities jointly contribute to a multiplicity of equilibria. The cases where only one of these two determinants is sufficient for a multiplicity are also isolated and discussed.
    Keywords: dispersed information, coordination of expectations, second-order beliefs.
    JEL: D82 D83 E3
    Date: 2012
  30. By: Mao, Zi-Ying
    Abstract: This paper extends the learning-by-doing model of Alwyn Young (1991), which assumes bounded learning-by-doing in each industry and knowledge spillovers, from two perspectives. First, it introduces physical capital as another factor of production in addition to labor. Second, it takes into account capital accumulation and population growth. This extended model is then used to study the dynamic effects of learning-by-doing in both autarky and two-country free trade situations. The main findings are: 1. Learning-by-doing is the source of sustainable growth in the long-run; 2. In both autarky and free trade situations, an increase in population growth rate or saving rate expedites both the growth rate of Real GDP per capita and technical progress in the long-run; 3. Compared with the autarky situation, under free trade the LDC experiences slower growth rate of per-capita output and slower technical progress, while the situation in DC is just the opposite. In addition, the effects of free trade on intertemporal welfare as well as the implications of a change in population growth rate or saving rate are also discussed based on the conclusions in Young (1991).
    Keywords: Learning-by-Doing; Human Capital; Technical Progress; Intertemporal Welfare; Sustainable Growth; Free Trade
    JEL: O41 O39 F1 O4 O3 F19
    Date: 2012–06–22
  31. By: Kyle F. Herkenhoff; Lee Ohanian
    Abstract: Through a purely positive lens, we study and document the growing trend of mortgagors who skip mortgage payments as an extra source of "informal" unemployment insurance during the 2007 recession and the subsequent recovery. In a dynamic model, we capture this behavior by treating both delinquency and foreclosure not as one period events, but rather as protracted and potentially reversible episodes that influence job search behavior and wage acceptance decisions. With a relatively conservative parameterization, we find that the observed foreclosure delays increase the unemployment rate by an additional 1/3%-1/2% and increase the stock of delinquent loans by 8%-12%. When interpreted as an implicit line of credit, those that use their mortgage as “informal" unemployment insurance borrow at a real rate of at least 18%.>
    Keywords: Foreclosure ; Unemployment
    Date: 2012
  32. By: Georgy Chabakauri
    Abstract: We study dynamic general equilibrium in one-tree and two-trees Lucas economies with one consumption good and two CRRA investors with heterogeneous risk aversions and portfolio constraints. We provide a tractable characterization of equilibrium without relying on the assumption of logarithmic constrained investors, popular in the literature, under which wealthconsumption ratios of these investors are unaffected by constraints. In one-tree economy we focus on the impact of limited stock market participation and margin constraints on market prices of risk, interest rates, stock return volatilities and price-dividend ratios. We demonstrate conditions under which constraints increase or decrease these equilibrium processes, and generate dynamic patterns consistent with empirical findings. In a two-trees economy we demonstrate that investor heterogeneity gives rise to large countercyclical excess stock return correlations, but margin constraints significantly reduce them by restricting the leverage in the economy, and give rise to rich saddle-type patterns. We also derive a new closed-form consumption CAPM that captures the impact of constraints on stock risk premia.
    Date: 2012–07
  33. By: Manuel S. Santos (Department of Economics, University of Miami); Adrian Peralta-Alva (Research Department, Federal Reserve Bank of Saint Louis)
    Abstract: In this paper we are concerned with the simulation of non-optimal dynamic economies. The equilibrium laws of motion of these economies cannot be characterized by the methods of dynamic programming and may not be described by continuous policy functions. We prove existence of an invariant distribution for the equilibrium law of motion, and establish some convergence and accuracy properties for the simulated moments. We obtain these results without resorting to artificial randomizations of the equilibrium correspondence or discretizations of the state space.
    Keywords: Markov Equilibrium; Invariant Distribution; Computed Solution; Simulated Moments
    JEL: C63 E60
    Date: 2012–07–08
  34. By: Simona E. Cociuba (University of Western Ontario); Malik Shukayev (Bank of Canada); Alexander Ueberfeldt (Bank of Canada)
    Abstract: A view advanced in the aftermath of the late-2000s financial crisis is that lower than optimal interest rates lead to excessive risk taking by financial intermediaries. We evaluate this view in a quantitative dynamic model where interest rate policy affects risk taking by changing the amount of safe bonds available as collateral for repo transactions. Given properly priced collateral, lower than optimal interest rates reduce risk taking. However, if intermediaries can augment their collateral by issuing assets whose risk is underestimated by rating agencies, lower than optimal interest rates contribute to excessive risk taking and amplify the severity of recessions.
    Keywords: financial intermediation; risk taking; optimal interest rate policy; capital regulation
    JEL: E44 E52 G28 D53
    Date: 2012
  35. By: Diego Restuccia; Guillaume Vandenbroucke
    Abstract: An average person born in the United States in the second half of the nineteenth century completed 7 years of schooling and spent 58 hours a week working in the market. By contrast, an average person born at the end of the twentieth century completed 14 years of schooling and spent 40 hours a week working. In the span of 100 years, completed years of schooling doubled and working hours decreased by 30 percent. What explains these trends? We consider a model of human capital and labor supply to quantitatively assess the contribution of exogenous variations in productivity (wage) and life expectancy in accounting for the secular trends in educational attainment and hours of work. We find that the observed increase in wages and life expectancy account for 80 percent of the increase in years of schooling and 88 percent of the reduction in hours of work. Rising wages alone account for 75 percent of the increase in schooling and almost all the decrease in hours in the model, whereas rising life expectancy alone accounts for 25 percent of the increase in schooling and almost none of the decrease in hours of work. In addition, we show that the mechanism emphasized in the model is consistent with other trends at a more disaggregate level such as the reduction in the racial gap in schooling and the decrease in the cross-sectional dispersion in hours.
    Keywords: Schooling, hours of work, productivity, life expectancy, trends, United States
    JEL: E1 I25 J11 O4
    Date: 2012–07–09
  36. By: Paolo Angelini (Bank of Italy); Andrea Gerali (Bank of Italy)
    Abstract: We use a dynamic general equilibrium model of the euro area to study banks’ possible responses to the stricter capital requirements called for by the Basel III reform package. We show that the effects on output depend, inter alia, on the strategy banks adopt in response to the reform, and that banks tend to prefer some strategies over others. Specifically, an increase in loan spreads minimizes banks’ costs and induces the sharpest contraction in real activity and investment, in the immediate as well as long term. A recapitalization, or restrictions on dividends, have more modest effects on output, but are less likely to be preferred by banks. We also find that the undesired macroeconomic effects of the reform during the transition phase are significantly mitigated if the reform is announced well ahead of its actual implementation – as was done for the Basel III package.
    Keywords: Basel III, capital requirements, macroprudential policy, banks.
    JEL: E44 E58 E61
    Date: 2012–07
  37. By: William T. Gavin; Benjamin D. Keen
    Abstract: We use a dynamic stochastic general equilibrium model to address two questions about U.S. monetary policy: 1) Can monetary policy elevate output when it is below potential? and 2) Is the zero lower bound a trap? The model answer to the first question is yes it can, but the effect is only temporary and probably not welfare enhancing. The answer to the second question is more complicated becasue it depends on policy. It also depends on whether it is the inflation rate or the real interest rate that will adjust over the longer run if the policy rate is held near zero for an extended period. We use the Fisher equation to analyze possible outcomes for situtations where the central bank has promised to keep the interest rate near zero for an extended period.
    Keywords: Monetary policy ; Econometric models
    Date: 2012
  38. By: J.E. Bosca; Rafael Domenech; J. Ferri
    Abstract: We use a small open economy general equilibrium model to analyse the effects of a fiscal devaluation in EMU. The model has been calibrated for the Spanish economy, that is a good example of the advantages of a change in the tax mix, given that its tax system shows a positive bias in the ratio of social security contributions over consumption taxes. The preliminary empirical evidence for European countries shows that this bias was negatively correlated with the current account balance in the expansionary years previous to the 2009 crisis, where many EMU members accumulated large external imbalances. Our simulations results point to positive significant effects of a fiscal devaluation on GDP and employment similar to the ones that could be obtained with a exchange rate devaluation. However, although the effects in terms of GDP and employment are similar, the composition effects of fiscal and nominal devaluations are not alike. In both cases, there is an improvement in net exports, but the effects on domestic and external demand are quite different.
    Keywords: tax mix, fiscal devaluation, nominal devaluation
    JEL: E62 E47 F31
    Date: 2012–06

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