nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2012‒09‒09
24 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Adult Longevity and Growth Takeoff By Daishin Yasui
  2. Optimal Taxation in a Limited Commitment Economy By Yena Park
  3. Business Cycle Dependent Unemployment Benefits with Wealth Heterogeneity and Precautionary Savings By Mark Strøm Kristoffersen
  4. Targeting the Poor: A Macroeconomic Analysis of Cash Transfer Programs By Eduardo Zilberman; Tiago Berriel
  5. A DSGE model for a SOE with systematic interest and foreign exchange policy in which policymakers exploit the risk premium for stabilization purposes By Escudé, Guillermo J.
  6. Henry George Theorem in a Dynamic Framework without Accumulation of Public Goods By Masamichi Kawano
  7. Time constraints, saving and old age By Davoine, Thomas
  8. Analysis of Numerical Errors By Manuel S. Santos; Adrian Peralta-Alva
  9. Transmission of fiscal policy shocks into Romania's economy By Serbanoiu, Georgian Valentin
  10. Monetary policy and endogenous market structure in a schumpeterian economy By Angus C. , Chu; Lei, Ji
  11. LOLA 2.0: Luxembourg OverLapping generation model for policy Analysis By Luca Marchiori; Olivier Pierrard
  12. Capital Adequacy and the Bank Lending Channel: Macroeconomic Implications By Shaw, Ming-fu; Chang, Juin-jen; Chen, Hung-Ju
  13. Public Infrastructures, Production Organizations, and Economic Development By Kohei Daido; Ken Tabata
  14. A Matching Model on the Use of Immigrant Social Networks and Referral Hiring By Monica I. Garcia-Perez
  15. Housing Dynamics over the Business Cycle By Kydland, Finn; Rupert, Peter; Sustek, Roman
  16. Revisiting wage, earnings, and hours profiles By Rupert, Peter; Zanella, Giulio
  17. Deconstructing Growth - A Business Cycle Accounting Approach with application to BRICs By Suparna Chakraborty; Keisuke Otsu
  18. R&D Subsidies, International Knowledge Dispersion, and Fully Endogenous Productivity Growth By Colin Davis; Ken-ichi Hashimoto
  19. The Genesis of the Golden Age - Accounting for the Rise in Health and Leisure By Carl-Johan Dalgaard; Holger Strulik
  20. Financial Globalization, Inequality, and the Raising of Public Debt By Azzimonti, Marina; de Francisco, Eva; Quadrini, Vincenzo
  21. Wages and Informality in Developing Countries By Costas Meghir; Renata Narita; Jean-Marc Robin
  22. The Determinants of Long-Run Inequality By Andrea Canidio
  23. Use Less, Pay More: Can Climate Policy Address the Unfortunate Event for Being Poor? By Lucas Bretschger; Nujin Suphaphiphat
  24. On the Smoothness of Value Functions By Bruno Strulovici; Martin Szydlowski

  1. By: Daishin Yasui (Graduate School of Economics, Kobe University)
    Abstract: This paper develops an overlapping generations model in which agents make educational and fertility decisions under life-cycle considerations, and retirement from work is distinguished from death. This model sheds light on a novel mechanism that links life expectancy, retirement, education, fertility, and growth. Gains in adult longevity induce agents to save more for retirement, reduce fertility, invest in education, and achieve sustained growth. Even if the length of working life is shortened by early retirement, this mechanism works as long as adult longevity increases sufficiently. Our model replicates the stylized facts of the transition from stagnation to growth in terms of longevity, time in retirement, fertility, education, and income, as well as reconciles the theory that gains in life expectancy trigger a growth takeoff by increasing education with the observation that the length of working life is not substantially prolonged because of retirement. This study provides a framework for considering the joint determination of education, fertility, and retirement.
    Keywords: Fertility; Growth; Human capital; Life expectancy; Retirement
    JEL: J13 O11
    Date: 2012–08
  2. By: Yena Park (Department of Economics, University of Pennsylvania)
    Abstract: This paper studies optimal Ramsey taxation when risk sharing in private insurance markets is imperfect due to limited enforcement. In a limited commitment economy, there are externalities associated with capital and labor because individuals do not take into account that their labor and saving decisions affect aggregate supply, wages and thus the value of autarky. Due to these externalities, the Ramsey government has an additional goal, which is to internalize the externalities of labor and capital to improve risk sharing, in addition to its usual goal - minimizing distortions when financing government expenditures. These two goals drive capital and labor taxes in opposite directions. By balancing these conflicting goals, the steady-state optimal capital income taxes are levied only to remove the negative externality of the capital, and optimal labor income taxes are set to meet the budgetary needs of the government in the long run, despite positive externalities of labor.
    Keywords: Ramsey Taxation, Limited Enforcement
    JEL: D52 E62 H21 H23
    Date: 2012–08–28
  3. By: Mark Strøm Kristoffersen (Department of Economics and Business, Aarhus University, Denmark)
    Abstract: In the wake of the financial and economic crisis the discussion about social insurance and optimal stabilization policies has re-blossomed. This paper adds to the literature by studying the effects of a business cycle dependent level of unemployment benefits in a model with labor market matching, wealth heterogeneity, precautionary savings, and aggregate fluctuations in productivity. The results are ambiguous: both procyclical and countercyclical unemployment benefi?ts can increase welfare relative to business cy- cle invariant benefits. Procyclical benefits are beneficial due to countercyclicality of the distortionary effect (on job creation) from providing unemployment insurance, whereas countercyclical benefits facilitate consumption smoothing.
    Keywords: Unemployment insurance, business cycles, wealth heterogeneity, precautionary savings
    JEL: E32 H3 J65
    Date: 2012–08–30
  4. By: Eduardo Zilberman (Department of Economics PUC-Rio); Tiago Berriel (EPGe/FGV)
    Abstract: This paper introduces cash transfers targeting the poor in an incomplete marketsmodel with heterogeneous agents facing idiosyncratic risk. These transfers change the degree of insurance in the economy and affect precautionary motives asymmetrically,leading the poorest households to decrease savings proportionally more than their richer counterparts. In a model economy calibrated to Brazil, once the cash transfer program is adopted, wealth inequality and social welfare increase, poverty decreases,while employment and income inequality remain about the same. Imperfect access to financial markets is important for these results, whereas whether the program is funded with lump sum or distortive taxes is not.
    Date: 2012–08
  5. By: Escudé, Guillermo J.
    Abstract: This paper builds a DSGE model for a small open economy (SOE) in which the central bank systematically intervenes both the domestic currency bond and the FX markets using two policy rules: a Taylor-type rule and a second rule in which the operational target is the rate of nominal currency depreciation. For this, the instruments used by the central bank (bonds and international reserves) must be included in the model, as well as the institutional arrangements that determine the total amount of resources the central bank can use. The corner regimes in which only one of the policy rules is used are particular cases of the model. The model is calibrated and implemented in Dynare for 1) simple policy rules, 2) optimal simple policy rules, and 3) optimal policy under commitment. Numerical losses are obtained for ad-hoc loss functions for different sets of central bank preferences (styles). The results show that the losses are systematically lower when both policy rules are used simultaneously, and much lower for the usual preferences (in which only inflation and/or output stabilization matter). It is shown that this result is basically due to the central bank's enhanced ability, when it uses the two policy rules, to influence capital flows through the effects of its actions on the endogenous risk premium in the (risk-adjusted) interest parity equation. --
    Keywords: DSGE models,small open economy,exchange rate policy,optimal policy
    JEL: D58 F41 O24
    Date: 2012
  6. By: Masamichi Kawano (School of Economics, Kwansei Gakuin University)
    Abstract: The Henry George Theorem, which is originally established in a static model, asserts that the cost of public good provision should be equal to the total revenue of the land rent to achieve the optimal size of population of each region. This paper examines this theorem in a dynamic framework of overlapping generations model, assuming that the government maximizes the sum of the utilities of the generations of finite periods. We show that the optimal path converges to the stationary state, however, it does not stay on it. We derive that the theorem is valid only in the stationary state, and no longer valid along the optimal path.
    Keywords: Henry George theorem, local public good, overlapping generations model
    JEL: R51 F11
    Date: 2012–08
  7. By: Davoine, Thomas
    Abstract: Abstract I take seriously the hypothesis that the wealthy lack time to consume to explain empirical evidence on old age asset decumulation and rich savings rates. Basic life-cycle theory predicts that households run down their assets toward the end of their life but evidence shows they do it at a very low rate. Under homothetic preferences, this theory also predicts that rich and poor save at the same rate, inconsistent with empirical evidence. Other existing models are also inconsistent with both evidence at the same time. Integrating a Becker home production model in Ramsey growth theory, I show that time constraints can explain the evidence on savings rate and asset decumulation, as well as some other evidence difficult to rationalize.
    Keywords: Time constraints, home production, neoclassical growth theory, savings rate, old age asset decumulation
    JEL: E21 D9 J14 J22
    Date: 2012–08
  8. By: Manuel S. Santos (Department of Economics, University of Miami); Adrian Peralta-Alva (Research Department, Federal Reserve Bank of Saint Louis)
    Abstract: This paper provides a general framework for the quantitative analysis of stochastic dynamic models. We review convergence properties of some numerical algorithms and available methods to bound approximation errors. We then address convergence and accuracy properties of the simulated moments. Our purpose is to provide an asymptotic theory for the computation, simulation-based estimation, and testing of dynamic economies. The theoretical analysis is complemented with several illustrative examples. We study both optimal and non-optimal economies. Optimal economies generate smooth laws of motion defining Markov equilibria, and can be approximated by recursive methods with contractive properties. Non-optimal economies, however, lack existence of continuous Markov equilibria, and need to be computed by other algorithms with weaker approximation properties.
    Keywords: Stochastic Dynamic Model, Markov Equilibrium, Numerical Solution, Approximation Error, Accuracy, Simulation-Based Estimation, Consistency
    JEL: C63 C60
    Date: 2012–08–19
  9. By: Serbanoiu, Georgian Valentin
    Abstract: In this paper I use a medium scale open economy DSGE model developed by Baksa, Benk and Jakab (2010) for the Hungarian economy. This model provides a notable degree of disaggregation both on the government revenue and expenditure side, being able to capture the shocks that come from fiscal policy decisions. My contributions can be summed up in the following three actions. First of all, I estimated the model for the Romanian economy, using Bayesian techniques. Secondly, I determined the parameters of fiscal feedback rules in order to establish if the automatic stabilizers work properly. And thirdly, I tried to analyze the impulse response functions in order to assess the effects of different fiscal policy measures on the most important macroeconomic variables.
    Keywords: DSGE model; Bayesian estimation; Fiscal policy; Procyclicality of fiscal policy; Impulse response functions; Fiscal feedback rules; Fiscal deficit; Government debt;
    JEL: E62 C68 H50 H30 C15 G28 E61 C11
    Date: 2012–06–28
  10. By: Angus C. , Chu; Lei, Ji
    Abstract: In this study, we develop a monetary Schumpeterian growth model with endogenous market structure (EMS) to explore the effects of monetary policy on the number of firms, …firm size, economic growth and social welfare. EMS leads to richer implications and different results from previous studies in which market structure is exogenous. In the short run, a higher nominal interest rate leads to lower growth rates of innovation, output and consumption and also smaller …rm size due to a reduction in labor supply. In the long run, an increase in the nominal interest rate reduces the equilibrium number of …firms but has no effect on economic growth and fi…rm size because of a scale-invariant property of the model as a result of entry and exit of fi…rms. Although monetary policy has no long-run effect on economic growth, an increase in the nominal interest rate permanently reduces the levels of output, consumption and employment. Taking into account transition dynamics, we …nd that social welfare is decreasing in the nominal interest rate. Given that a zero nominal interest rate maximizes welfare, Friedman rule is optimal in this economy.
    Keywords: monetary policy; economic growth; R&D; endogenous market structure
    JEL: O30 O40 E41
    Date: 2012–08–27
  11. By: Luca Marchiori; Olivier Pierrard
    Abstract: Beyond cyclical movements, it may be helpful to understand how structural forces or policies shape an economy in the longer term. With such remote horizons, it is crucial to base analysis on an appropriate tool. In this paper, we build an overlapping generation structure with New Open Economy Macroeconomics and labour market frictions à la Diamond-Mortensen-Pissarides. The main novelty over LOLA 1.0 is the integration of current account and exchange rate dynamics according to the New Open Economy Macroeconomics approach. We calibrate themodel on Luxembourg data. Byway of illustration, we study the interactions between expected demographic changes, labour market dynamics and public finance, and we look at the recently proposed policy responses.
    Keywords: Overlapping generations, Long-run projections, Imbalances, Luxembourg
    JEL: D91 E24 E62 F41 J11
    Date: 2012–07
  12. By: Shaw, Ming-fu; Chang, Juin-jen; Chen, Hung-Ju
    Abstract: This paper develops an analytically tractable dynamic general-equilibrium model with a banking system to examine the macroeconomic implications of capital adequacy requirements. In contrast to the hypothesis of a credit crunch, we find that increasing the strength of bank capital requirements does not necessarily reduce the equilibrium quantity of loans, provided that banks have the option to respond to the capital requirements by accumulating more equity instead of cutting back on lending. Accordingly, we show that there is an inverted-U-shaped relationship between CAR and capital accumulation (and consumption). Furthermore, the optimal capital adequacy ratio for social-welfare maximization is lower than that for capital-accumulation maximization. In accordance with general empirical findings, the capital- accumulation maximizing capital adequacy ratio is procyclical with respect to economic conditions. We also find that monetary policy affects the real macroeconomic activities via the so-called bank lending channel, but the effectiveness of monetary policy is weakened by bank capital requirements.
    Keywords: Banking capital regulation; bank lending channel; the loan-deposit rate
    JEL: E5 O4
    Date: 2012–09–05
  13. By: Kohei Daido (School of Economics, Kwansei Gakuin University); Ken Tabata (School of Economics, Kwansei Gakuin University)
    Abstract: We develop a political economy model of growth to examine economic development led by the interactions between an economic decision concerning a firm’s production technology (CRS vs IRS technology) and a political decision concerning public infrastructures. We show that multiple equilibrium growth paths occur due to differences in expectations regarding the quality of public infrastructures. These multiple paths illustrate why economies with poor initial conditions can catch up to and, furthermore, overtake economies with better initial conditions. Our result could explain the experiences of some East Asian countries where co-evolutions of public infrastructures and industrial transformations spurred economic development.
    Keywords: Public Infrastructure, Political Economy, Production Organization, Overlapping Generations Model
    JEL: H5 O1 O4
    Date: 2012–08
  14. By: Monica I. Garcia-Perez (Department of Economics, St. Cloud State University)
    Abstract: Using a simple search model, with urn-ball derived matching function, this paper investigates the effect of firm owner’s and coworkers’ nativity on hiring patterns and wages. In the model, social networks reduce search frictions and wages are derived endogenously as a function of the efficiency of the social ties of current employees. As a result, individuals with more efficient connections tend to receive higher wages and lower unemployment rate. However, because this efficiency depends on matching with same-type owners and coworkers, there is also a differential effect among workers’ wages in the same firm. This analysis highlights the potential importance of social connections and social capital for understanding employment opportunities and wage differentials between these groups.
    Keywords: immigration; search models; social networks; wage differential; hiring process.
    JEL: J15 J21 J31 J61 R23
    Date: 2012
  15. By: Kydland, Finn; Rupert, Peter; Sustek, Roman
    Abstract: Over the U.S. business cycle, fluctuations in residential investment are well known to systematically lead GDP. These dynamics are documented here to be specific to the U.S. and Canada. In other developed economies residential investment is broadly coincident with GDP. Nonresidential investment has the opposite dynamics, being coincident with or lagging GDP. These observations are in sharp contrast with the properties of nearly all business cycle models with disaggregated investment. Including mortgages and interest rate dynamics aligns the theory more closely with U.S. observations. Longer time to build in housing construction makes residential investment coincident with output.
    Keywords: Economics, General, Economics, Other, residential investment, nonresidential investment, business cycle, mortgages, time to build
    Date: 2012–08–01
  16. By: Rupert, Peter; Zanella, Giulio
    Abstract: We document empirical life cycle profiles of wages, earnings, and hours of work for pay from the Panel Study of Income Dynamics, following the same workers for up to four decades along the intensive margin of labor supply. For six of the eight cohorts we analyze the wage profile does not decline with age, while the earnings profile always does. The discrepancy is explained by a sharp drop of the hours profile beginning shortly after age 50, when many workers start a smooth transition into retirement by working progressively fewer hours. This pattern is not an artifact of staggered abrupt retirement, and is robust to attrition- and selection correction (i.e., to taking into account that the composition of our sample, for a given cohort, changes over time). We explore the nontrivial restrictions on dynamic models of the aggregate economy that this evidence suggests, and we provide numerical profiles that can be readily used in quantitative macroeconomic analysis.
    Keywords: Economics, General, Economics, Other, International Economics, life cycle, wage profile, labor supply, intensive margin human capital, preretirement
    Date: 2012–08–29
  17. By: Suparna Chakraborty; Keisuke Otsu
    Abstract: What are the economic mechanisms that account for sudden growth spurts? Are these mechanisms similar across episodes? Focusing on the economic resurgence of the BRICs over the last decade, we employ the Business Cycle Accounting methodology developed by Chari, Kehoe and McGrattan (2007) to address these questions. Our results highlight that while efficiency wedges do contribute in a large part to growth, especially in Brazil and Russia, there is an increasing importance of investment wedge especially in the late 2000s, noted in China and India. The results are typically related to the stages of development with Brazil and Russia coming off a crisis to grow in the 2000s, while India and China were already on a stable growth path. Our conclusions are robust to alternative methodological extensions where we allow shocks to the trend component of efficiency as opposed to traditional shocks to the cyclical component, as well as to standard modifications where we allow for investment adjustment costs. Relating improvements in wedges to institutional and financial reforms, we find that financial development and improvements in effective governance in BRICs are consistent with improvements in investment and efficiency wedges that led to growth.
    Keywords: BRIC; business cycle accounting; efficiency; market frictions; trend shocks; investment adjustment costs
    JEL: E32
    Date: 2012–08
  18. By: Colin Davis (The Institute for the Liberal Arts, Doshisha University); Ken-ichi Hashimoto (Graduate School of Economics, Kobe University)
    Abstract: This paper develops a two country model to investigate the effects of national R&D subsidies on aggregate product variety and endogenous productivity growth without scale effects. In particular, monopolistically competitive firms invest in process innovation with the aim of lowering production costs. With imperfect knowledge dispersion, the larger of the two countries has a larger share of firms and a greater level of productivity. The higher concentration of relatively productive firms increases the size of knowledge flows between firms, leading to an increase in firm-level employment in innovation. As a result, an economy with asymmetric countries produces a faster rate of growth than one with countries of similar size. The larger scale of firm-level innovation activity reduces market entry, however, and overall product variety falls. Using this framework, we find that a national R&D subsidy has a positive effect on the industry share, relative productivity, and wage rate of the implementing country. Moreover, if the smaller country introduces an R&D subsidy, overall product variety rises but the rate of productivity growth falls. Alternatively, if the larger country introduces an R&D subsidy, the rate of productivity growth rises, but overall product variety may rise or fall. Finally, we briefly consider the effects of a national R&D subsidy on national and world welfare levels.
    Keywords: R&D Subsidy, Knowledge Dispersion, Productivity Growth, Scale Effect
    JEL: F43 O30 O40
    Date: 2012–08
  19. By: Carl-Johan Dalgaard (Department of Economics, University of Copenhagen); Holger Strulik (University of Goettingen, Department of Economics)
    Abstract: We develop a life cycle model featuring an optimal retirement decision in the presence of physiological aging. In modeling the aging process we draw on recent advances within the fields of biology and medicine. In the model individuals decide on optimal consumption during life, the age of retirement, and (via health investments) the timing of their death. Accordingly, "years in retirement" is fully endogenously determined. Using the model we can account for the evolution of age of retirement and longevity across cohorts born between 1850 and 1940 in the US. Our analysis indicates that 2/3 of the observed increase in longevity can be accounted for by wage growth, whereas the driver behind the observed rising age of retirement appears to have been technological change in health care. Both technology and income contribute to the rise in years in retirement, but the contribution from income is slightly greater.
    Keywords: Aging, Longevity, Retirement, Health, Health Technology
    JEL: D91 I15 J17 J26
    Date: 2012–08
  20. By: Azzimonti, Marina; de Francisco, Eva; Quadrini, Vincenzo
    Abstract: During the last three decades, the stock of government debt has increased in most developed countries. During the same period, we also observe a significant liberalization of international financial markets and an increase in income inequality in several industrialized countries. In this paper we propose a multicountry political economy model with incomplete markets and endogenous government borrowing and show that governments choose higher levels of public debt when financial markets become internationally integrated and inequality increases. We also conduct an empirical analysis using OECD data and find that the predictions of the theoretical model are supported by the empirical results.
    Keywords: Financial integration; Government debt; Income inequality
    JEL: E60 F59
    Date: 2012–09
  21. By: Costas Meghir; Renata Narita; Jean-Marc Robin
    Abstract: It is often argued that informal labor markets in developing countries promote growth by reducing the impact of regulation. On the other hand informality may reduce the amount of social protection offered to workers. We extend the wage-posting framework of Burdett and Mortensen (1998) to allow heterogeneous firms to decide whether to locate in the formal or the informal sector, as well as set wages. Workers engage in both off the job and on the job search. We estimate the model using Brazilian micro data and evaluate the labor market and welfare effects of policies towards informality.
    JEL: J24 J3 J42 J6 O17
    Date: 2012–08
  22. By: Andrea Canidio
    Abstract: I explore the effect of skill-biased technological change on long-run inequality using a theoretical model where the supply of skilled and unskilled workers, the cost of education, and credit rationing are endogenous. I show that the existence of unequal steady states does not depend on the degree of technological skill bias, but on the credit market, the cost of education, altruism, and the overall growth rate of the economy. However, when unequal steady states exist, economies with a higher technological skill bias have a greater long-run inequality. Therefore, skill-bias technological change is a second-order determinant of long-run inequality: a higher technological skill bias is associated with greater long-run inequality only if long-run inequality exists; the existence of long-run inequality does not depend on skill bias.
    Date: 2012–03–20
  23. By: Lucas Bretschger (ETH Zurich, Switzerland); Nujin Suphaphiphat (ETH Zurich, Switzerland)
    Abstract: The paper develops a two-region endogenous growth model with climate change affecting the countries' capital stocks negatively. We compare two different policies aimed at supporting less developed countries: climate mitigation by rich countries, which diminishes the increase in stock pollution and hence capital depreciation, and income transfers in the tradition of development aid. Under a mild set of assumptions we find that active climate policies are more efficient for rich economies and also, remarkably, better for poor countries than additional development aid. The main reason is the difference between the two policies with respect to their effects on economic growth. The results are robust with respect to possible model extensions.
    Keywords: Climate policy; development aid; endogenous growth; stock pollution
    JEL: O10 Q52 Q54
    Date: 2012–08
  24. By: Bruno Strulovici; Martin Szydlowski
    Abstract: In dynamic models driven by diffusion processes, the smoothness of the value function plays a crucial role for characterizing properties of the solution. However, available methods to ensure such smoothness have limited applicability in economics, and economists have often relied on either model-specific arguments or explicit solutions. In this paper, we prove that the value function for the optimal control of any time-homogeneous, one-dimensional diffusion is twice continuously differentiable, under Lipschitz, growth, and non-vanishing volatility conditions. Under similar conditions, the value function of any optimal stopping problem is continuously diferentiable. For the first problem, we provide sufficient conditions for the existence of an optimal control. The optimal control is Markovian and constructed from the Bellman equation. We also establish an envelope theorem for parameterized optimal stopping problems. Several applications are discussed, including growth, dynamic contracting, and experimentation models. JEL Code: C61, D9, D83, D86, E20, G11
    Keywords: Stochastic Control, Super Contact, Smooth Pasting, Value Function
    Date: 2012–08–23

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