nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2012‒07‒29
sixteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. International Business Cycles and Financial Frictions By Wen Yao
  2. Trend shocks and the countercyclical U.S. current account By Amdur, David; Ersal Kiziler, Eylem
  3. Dynamic Tax Competition under Asymmetric Productivity of Public Capital By Hiroki Tanaka; Masahiro Hidaka
  4. Asset Prices and Monetary Policy – A sticky-dispersed information model By Marta Areosa; Waldyr Areosa
  5. On ABCs (and Ds) of VAR representations of DSGE models By Massimo Franchi; Paolo Paruolo
  6. Really Uncertain Business Cycles By Nicholas Bloom; Max Floetotto; Nir Jaimovich; Itay Saporta-Eksten; Stephen J. Terry
  7. Trade in Intermediate Inputs and Business Cycle Comovement By Robert C. Johnson
  8. Adaptation, Anticipation-bias and optimal income taxation By Aronsson, Thomas; Schöb, Ronnie
  9. Campbell and Cochrane meet Melino and Yang: reverse engineering the surplus ratio in a Mehra-Prescott economy By Jim Dolmas
  10. Estimating equilibrium effects of job search assistance By Gautier, Pieter A; Muller, Paul; Rosholm, Michael; Svarer, Michael; van der Klaauw, Bas
  11. Bargaining, Aggregate Demand and Employment By Charpe, Matthieu; Kühn, Stefan
  12. Foreign Aid, External Debt and Governance By Qayyum, Unbreen; Musleh ud, Din; Haider, Adnan
  13. Aggregate Reallocation Shocks and the Dynamics of Occupational Mobility and Wage Inequality By Jacob Wong
  14. Optimal disclosure policy and undue diligence By David Andolfatto; Aleksander Berentsen; Christopher Waller
  15. Mismatch, On-the-job Training, and Unemployment By Frédéric Gavrel; Jean-Pascal Guironnet; Isabelle Lebon
  16. What do sticky and flexible prices tell us? By Millard, Stephen; O'Grady, Tom

  1. By: Wen Yao
    Abstract: This paper builds a two-country DSGE model to study the quantitative impact of financial frictions on business cycle co-movements when investors have foreign asset exposure. The investor in each country holds capital in both countries and faces a leverage constraint on her debt. I show quantitatively that financial frictions along with foreign asset exposure give rise to a multiplier effect that amplifies the transmission of shocks between countries. The key mechanism is that a negative shock in the home country reduces the wealth of investors in both countries, which tightens their leverage constraints, leading to a fall in investment, consumption, and hours worked in the foreign country. Compared to the existing literature, which tends to produce either negative or positive but small cross-country correlations, this model produces positive and sizable correlations that are consistent with the data. The model can account for most of the investment, employment and consumption correlations and predicts more than half of the output correlation. In addition, the model shows that, consistent with empirical findings, when investors have more foreign asset exposure to the other country, the output correlation between the two countries increases.
    Keywords: Business fluctuations and cycles; International financial markets; International topics
    JEL: E30 F42 F44
    Date: 2012
  2. By: Amdur, David; Ersal Kiziler, Eylem
    Abstract: From 1960-2009, the U.S. current account balance has tended to decline during expansions and improve in recessions. We argue that trend shocks to productivity can help explain the countercyclical U.S. current account. Our framework is a two-country, two-good real business cycle (RBC) model in which cross-border asset trade is limited to an international bond. We identify trend and transitory shocks to U.S. productivity using generalized method of moments (GMM) estimation. The specification that best matches the data assigns a large role to trend shocks. The estimated model generates a countercyclical current account without excessive consumption volatility.
    Keywords: Current account; trend shocks; business cycles; open economy macroeconomics; DSGE models; GMM estimation
    JEL: E32 F32 F41 E21
    Date: 2012–01
  3. By: Hiroki Tanaka; Masahiro Hidaka
    Abstract: We here expand the static tax competition models in symmetric small regions, which were indicated by Zodrow and Mieszkowski (1986) and Wilson (1986), to a dynamic tax competition model in large regions, taking consideration of the regional asymmetry of productivity of public capital and the existence of capital accumulation. The aim of this paper is to verify how the taxation policy affects asymmetric equilibrium based on a simulation analysis using an overlapping generations model in two regions. It is assumed that the public capital as a public input is formed on the basis of the capital tax of local governments and the lump-sum tax of the central government. As demonstrated in related literature, the optimal capital tax rate should become zero when the lump-sum tax is imposed only on older generations, however, the optimal tax rate may become positive when it is imposed proportionally on younger and older generations. In the asymmetric equilibrium, several cooperative solutions can possibly exist which can achieve a higher welfare standard than the actualized cooperative solution either in Region1 or 2. JEL classification Ôºö H21; H42; H71; H77; R13; R53 Keywords Ôºö Tax competition, Capital taxation, Capital accumulation, Public inputs, Infrastructure
    Date: 2011–09
  4. By: Marta Areosa; Waldyr Areosa
    Abstract: We present a DSGE model with heterogeneously informed agents and two investment opportunities – stocks and bonds – to study the interaction between monetary policy and asset prices. The information is both sticky, as in Mankiw e Reis (2002), and dispersed, as in Morris e Shin (2002). This framework allows us to (i) show that variations in stock market wealth affect consumption, (ii) demonstrate that a central bank can prevent the creation of boom-bust episodes in the economy, (iii) determine the moment of a bust occurrence and (iv) study the impulse responses to dividend and informational shocks.
    Date: 2012–07
  5. By: Massimo Franchi (University of Rome "La Sapienza", Italy); Paolo Paruolo (University of Insubria, Italy)
    Abstract: This paper shows that the poor man's invertibility condition in Fernández-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 Fernández-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.
    Date: 2012–07
  6. By: Nicholas Bloom; Max Floetotto; Nir Jaimovich; Itay Saporta-Eksten; Stephen J. Terry
    Abstract: We propose uncertainty shocks as a new shock that drives business cycles. First, we demonstrate that microeconomic uncertainty is robustly countercyclical, rising sharply during recessions, particularly during the Great Recession of 2007-2009. Second, we quantify the impact of time-varying uncertainty on the economy in a dynamic stochastic general equilibrium model with heterogeneous firms. We find that reasonably calibrated uncertainty shocks can explain drops and rebounds in GDP of around 3%. Moreover, we show that increased uncertainty alters the relative impact of government policies, making them initially less effective and then subsequently more effective.
    JEL: E3
    Date: 2012–07
  7. By: Robert C. Johnson
    Abstract: Do cross-border input linkages transmit shocks and synchronize business cycles across countries? I integrate input trade into a dynamic many country, multi-sector model and calibrate the model to match observed bilateral input-output linkages. With estimated productivity shocks, the model generates an aggregate trade-comovement correlation 30-40% as large as in data, and 50-75% as large for the goods producing sector. With independent shocks, the model accounts for one-quarter of the trade-comovement relationship for gross output of goods. However, shocks transmitted through input linkages do not synchronize value added. And contrary to conventional wisdom, input complementarity does not amplify value added comovement.
    JEL: F1 F4
    Date: 2012–07
  8. By: Aronsson, Thomas; Schöb, Ronnie
    Abstract: Adaptation is omnipresent but people systematically fail to correctly anticipate the degree to which they adapt. This leads individuals to make inefficient intertemporal decisions. This paper concerns optimal income taxation to correct for such anticipation-biases in a framework where consumers adapt to earlier consumption levels through a habit-formation process. The analysis is based on a general equilibrium OLG model with endogenous labor supply and savings where each consumer lives for three periods. Our results show how a paternalistic government may correct for the effects of anticipation-bias through a combination of time-variant marginal labor income taxes and savings subsidies. Furthermore, the optimal policy mix remains the same, irrespective of whether consumers commit to their original life-time plan for work hours and savings decided upon in the first period of life or re-optimize later on when realizing the failure to adapt. --
    Keywords: optimal taxation,adaptation,habit-formation,anticipation-bias,paternalism
    JEL: D03 D61 D91 H21
    Date: 2012
  9. By: Jim Dolmas
    Abstract: The habit model of Campbell and Cochrane (1999) specifies a process for the 'surplus ratio'-the excess of consumption over habit, relative to consumption-rather than an evolution for the habit stock. It's not immediately apparent if their formulation can be accommodated within the Markov chain framework of Mehra and Prescott (1985). This note illustrates one way to create a Campbell and Cochrane-like model within the Mehra-Prescott framework. A consequence is that we can perform another sort of reverse-engineering exercize-we can calibrate the resulting model to match the stochastic discount factor derived in the Mehra-Prescott framework by Melino and Yang (2003). The Melino-Yang SDF, combined with Mehra and Prescott's consumption process, yields asset returns that exactly match the first and second moments of the data, as estimated by Mehra and Prescott.> ; A byproduct of the exercize is an equivalent (in terms of SDFs) representation of Campbell-Cochrane preferences as a state-dependent version of standard time-additively-separable, constant relative risk aversion preferences. When calibrated to exactly match the asset return data, both the utility discount factor and the coefficient of relative risk aversion vary with the Markov state. Not surprisingly, our Campbell-Cochrane preferences are equivalent to a state-dependent representation with strongly countercyclical risk aversion. Less expected is the equivalent utility discount factor-it is uniformly greater than one, and countercyclical. In their analysis, Melino and Yang ruled out state-dependent specifications where the utility discount factor exceeds one. Our model gives one plausible rationalization for such a specification.
    Keywords: Financial markets ; Asset pricing
    Date: 2012
  10. By: Gautier, Pieter A; Muller, Paul; Rosholm, Michael; Svarer, Michael; van der Klaauw, Bas
    Abstract: Randomized experiments provide policy relevant treatment effects if there are no spillovers between participants and nonparticipants. We show that this assumption is violated for a Danish activation program for unemployed workers. Using a difference-in-difference model we show that the nonparticipants in the experiment regions find jobs slower after the introduction of the activation program (relative to workers in other regions). We then estimate an equilibrium search model. This model shows that a large scale role out of the activation program decreases welfare, while a standard partial microeconometric cost-benefit analysis would conclude the opposite.
    Keywords: externalities; indirect inference; job search; policy-relevant treatment effects; randomized experiment
    JEL: C21 E24 J64
    Date: 2012–07
  11. By: Charpe, Matthieu; Kühn, Stefan
    Abstract: This paper depicts the negative impact of a falling labour share caused by reduced bargaining power of workers on aggregate demand and employment. Contrary to standard New Keynesian models, the presence of consumers not participating in financial markets (rule of thumb consumers) causes an immediate negative response of output and employment, which is amplified when the economy faces a lower bound on the nominal interest rate. Additionally, the paper shows that by supporting consumption demand, minimum wages might enhance output and employment.
    Keywords: Labour share; search and matching; aggregate demand; household heterogeneity
    JEL: E32 E24 E21
    Date: 2012–07–19
  12. By: Qayyum, Unbreen; Musleh ud, Din; Haider, Adnan
    Abstract: This paper presents a theoretical model for governance. Specifically, the Ramsey-Cass-Koopman's growth model has been extended by incorporating governance in an open economy framework. Steady-state and short run analysis show that external debt and foreign aid do not affect the growth rate of consumption but have level impact on consumption. Foreign aid and governance encourage the economic growth but external debt creates a burden on the economy. Both Investment and saving are independent of external debt and thus the current account surplus. Foreign aid does not affect investment directly but it has a direct positive impact on the savings in the economy. Therefore, it is argued that improvements in the quality of governance will stimulate the output and consumption rapidly and it acts like a catalyst.
    Keywords: External Debt; Foreign Aid; Governance; Ramsey-Cass-Koopman Model
    JEL: E02 F35 F34 F43 E20
    Date: 2012–07–25
  13. By: Jacob Wong (School of Economics, University of Adelaide)
    Abstract: This paper presents a dynamic model of structural unemployment and occupational choice in which an economy is subjected to aggregate reallocation shocks. Reallocation shocks, which change the relative labour productivity across occupations, drive variation in the distribution of workers across occupations. The wage paid to workers in a given occupation depends on its labour productivity and the number of workers employed in that occupation. Workers who wish to switch occupations in order to obtain higher wages face a fixed cost to retrain and, in addition, it is more costly to switch to occupations requiring vastly different skills relative to those of the worker's current occupation. Thus workers may prefer to remain unemployed in occupations suering through relatively low productivity states. Between the late-1970s and the mid-2000s the U.S. economy featured an episode during which occupational mobility rose along with an increase in wage inequality both in the top and bottom halves of the wage distribution. This was followed by an episode during which occupational mobility fell, while a rise in inequality in the top half of the wage distribution was accompanied by a fall in inequality in the bottom half. The model can produce episodes with properties similar to that of the U.S. experience and thus offers a theory of why these episodes occur.
    Keywords: Occupational Mobility, Wage Inequality
    JEL: E24 E32 J24 J31 J62
    Date: 2012–07
  14. By: David Andolfatto; Aleksander Berentsen; Christopher Waller
    Abstract: While both public and private financial agencies supply asset markets with large quantities of information, they do not necessarily disclose all asset-related information to the general public. This observation leads us to ask what principles might govern the optimal disclosure policy for an asset manager or financial regulator. To investigate this question, we study the properties of a dynamic economy endowed with a risky asset, and with individuals that lack commitment. Information relating to future asset returns is available to society at zero cost. Legislation dictates whether this information is to be made public or not. Given the nature of our environment, nondisclosure is generally desirable. This result is overturned, however, when individuals are able to access hidden information - what we call undue diligence - at sufficiently low cost. Information disclosure is desirable, in other words, only in the event that individuals can easily discover it for themselves.
    Keywords: Monetary policy, liquidity, financial markets
    JEL: E52 E58 E59
    Date: 2011–11
  15. By: Frédéric Gavrel (UFR de sciences économiques et de gestion, Université de Caen Basse-Normandie, CREM-CNRS, UMR 6211); Jean-Pascal Guironnet (UFR de sciences économiques et de gestion, Université de Caen Basse-Normandie, CREM-CNRS, UMR 6211); Isabelle Lebon (UFR de sciences économiques et de gestion, Université de Caen Basse-Normandie, CREM-CNRS, UMR 6211)
    Abstract: In this paper, training, which is seen as a way to reduce the mismatch between workers and jobs, takes place on the job. We show that a general rise in unemployment lowers the probability of on-the-job training by reducing the mismatch. We then close the model by assuming free-entry and study its social efficiency properties. Private educational choices are socially optimal, but job creation is too high under the Hosios condition. Using French data on regional unemployment, we estimate a probit model of the training decision and find that on-the-job training is significantly less probable in regions with high unemployment.
    Keywords: On-the-job training; Mismatch, Equilibrium unemployment, Market efficiency
    JEL: H21 J24 J64
    Date: 2012–06
  16. By: Millard, Stephen (Bank of England); O'Grady, Tom (Massachusetts Institute of Technology)
    Abstract: In this paper, we investigate the information content of prices in relatively sticky-price sectors versus relatively flexible-price sectors. We first present some empirical evidence that relatively flexible prices react more to deviations of output from trend than stickier prices and that sticky prices can tell us about firms’ inflation expectations. We then develop a simple DSGE model with a sticky-price sector and a flexible-price sector and use this model to show that these empirical results are exactly what you would actually expect to see, given standard economic theory. Taken together, the results of this paper suggest that calculations of ‘flexible-price’ inflation could, potentially, be used to provide monetary policy makers with a steer on the output gap, which is notoriously hard to measure, and that calculations of ‘sticky-price’ inflation could, potentially, be used to provide monetary policy makers with a steer on the medium-term inflation expectations of price-setters.
    Keywords: Flexible-price inflation; sticky-price inflation; heterogeneous price-setting
    JEL: B30 B40
    Date: 2012–07–20

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