nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2012‒10‒20
twenty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Financial intermediation, investment dynamics and business cycle fluctuations By Andrea Ajello
  2. Markups and Entry in a DSGE Model By Cavallari, Lilia
  3. Data Revisions in the Estimation of DSGE Models By Casares, Miguel; Vázquez Pérez, Jesús
  4. Optimal capital taxation with idiosyncratic investment risk By Vasia Panousi; Catarina Reis
  5. Fat-Tail Distributions and Business-Cycle Models By Guido Ascari; Giorgio Fagiolo; Andrea Roventini
  6. Barro-Becker with Credit Frictions By Cordoba, Juan Carlos; Ripoll, Marla
  7. Sovereign Defaults and Banking Crises By Cesar Sosa-Padilla
  8. Income Taxation in a Life Cycle Model with Human Capital By Michael P. Keane
  9. Endogenous risk in a DSGE model with capital-constrained financial intermediaries By Hans Dewachter; Raf Wouters
  10. A macroeconomic model with a financial sector By Markus K. Brunnermeier; Yuliy Sannikov
  11. Wages and informality in developing countries. By Costas Meghir; Renata Narita; Jean-Marc Robin
  12. Macroeconomic Policy in DSGE and Agent-Based Models By Giorgio Fagiolo; Andrea Roventini
  13. Financing constraints, firm dynamics, and international trade By Stephane Verani; Till Gross
  14. Structural and Cyclical Forces in the Labor Market During the Great Recession: Cross-Country Evidence By Sala, Luca; Söderström, Ulf; Trigari, Antonella
  15. Declining Predation during Development: a Feedback Process By Bethencourt, Carlos; Perera-Tallo, Fernando
  16. Stochastic Optimal Growth with Risky Labor Supply By Yiyong Cai; Takashi Kamihigashi; John Stachurski
  17. Saving and learning: Theory and evidence from saving for child's college By Zhu, Junyi
  18. Consumption Inequality and Family Labor Supply By Blundell, Richard; Pistaferri, Luigi; Saporta-Eksten, Itay
  19. The Evolution of Education: A Macroeconomic Analysis By Diego Restuccia; Guillaume Vandenbroucke
  20. Financial reforms and capital flows: Insights from general equilibrium By Alberto Martin; Jaume Ventura
  21. Technical Appendix to "Productivity and Misallocation During a Crisis: Evidence from the Chilean Crisis of 1982" By Ezra Oberfield

  1. By: Andrea Ajello
    Abstract: I use micro data to quantify key features of U.S. firm financing. In particular, I establish that a substantial 35% of firms' investment is funded using financial markets. I then construct a dynamic equilibrium model that matches these features and fit the model to business cycle data using Bayesian methods. In the model, stylized banks enable trades of financial assets, directing funds towards investment opportunities, and charge an intermediation spread to cover their costs. According to the model estimation, exogenous shocks to the intermediation spread explain 35% of GDP and 60% of investment volatility.
    Date: 2012
  2. By: Cavallari, Lilia
    Abstract: This paper provides a DSGE model with firm entry. Simulations show that the model matches the synchronization of markups and entry observed in the data while at the same time reproducing empirically plausible moments for key macroeconomic variables. Sticky prices are essential for these results.
    Keywords: endogenous entry; firm dynamics; monopolistic competition; market power; markups
    JEL: E32 E37
    Date: 2012–10–08
  3. By: Casares, Miguel; Vázquez Pérez, Jesús
    Abstract: Revisions of US macroeconomic data are not white-noise. They are persistent, correlated with real-time data, and with high variability (around 80% of volatility observed in US real-time data). Their business cycle effects are examined in an estimated DSGE model extended with both real-time and final data. After implementing a Bayesian estimation approach, the role of both habit formation and price indexation fall significantly in the extended model. The results show how revision shocks of both output and inflation are expansionary because they occur when real-time published data are too low and the Fed reacts by cutting interest rates. Consumption revisions, by contrast, are countercyclical as consumption habits mirror the observed reduction in real-time consumption. In turn, revisions of the three variables explain 9.3% of changes of output in its long-run variance decomposition.
    Keywords: DSGE models, data revisions, business cycles
    JEL: C32 E30
    Date: 2012
  4. By: Vasia Panousi; Catarina Reis
    Abstract: We examine the optimal taxation of capital in a Ramsey setting of a general-equilibrium heterogeneous-agent economy with uninsurable idiosyncratic investment or capital-income risk. We prove that the ex ante optimal tax, evaluated at steady state, maximizes human wealth, namely the present discounted value of agents' income from sources that are not subject to capital risk. Furthermore, when the amount of idiosyncratic risk in the economy is higher than a minimum lower bound, the optimal tax is positive and it is precisely the tax that maximizes the economy-wide aggregates, such as the capital stock and output. By contrast, when the amount of risk is exogenously very low, the social planner finds it optimal to increase social risk taking by subsidizing investment in capital.
    Date: 2012
  5. By: Guido Ascari (Università di Pavia); Giorgio Fagiolo (Sant'Anna School of Advanced Studies, Pisa); Andrea Roventini (Department of Economics (University of Verona))
    Abstract: Recent empirical findings suggest that macroeconomic variables are seldom normally distributed. For example, the distributions of aggregate output growth-rate time series of many OECD countries are well approximated by symmetric exponential-power (EP) densities, with Laplace fat tails. In this work, we assess whether Real Business Cycle (RBC) and standard medium-scale New-Keynesian (NK) models are able to replicate this statistical regularity. We simulate both models drawing Gaussian- vs Laplace-distributed shocks and we explore the statistical properties of simulated time series. Our results cast doubts on whether RBC and NK models are able to provide a satisfactory representation of the transmission mechanisms linking exogenous shocks to macroeconomic dynamics.
    Keywords: Growth-Rate Distributions, Normality, Fat Tails, Time Series, Exponential-Power Distributions, Laplace Distributions, DSGE Models, RBC Model
    JEL: C1 E3
    Date: 2012–01
  6. By: Cordoba, Juan Carlos; Ripoll, Marla
    Abstract: The Barro-Becker model of fertility has three controversial predictions: (i) fertility and schooling are independent of family income; (ii) children are a net financial burden to society; and (iii) individual consumption is negatively associated to individual income. We show that introducing credit frictions into the model helps overturn these predictions. In particular, a negative relationship between fertility and individual wage income can be obtained when the intertemporal elasticity of substitution is larger than one. The credit constrained model can also explain the quantity-quality trade-off: individuals with higher wage income choose more schooling and fewer children.
    Keywords: Fertility; credit frictions; parental altruism; elasticity of intertemporal substitution
    JEL: D J
    Date: 2012–10–05
  7. By: Cesar Sosa-Padilla
    Abstract: Episodes of sovereign default feature three key empirical regularities in connection with the banking systems of the countries where they occur: (i) sovereign defaults and banking crises tend to happen together, (ii) commercial banks have substantial holdings of government debt, and (iii) sovereign defaults result in major contractions in bank credit and production. This paper provides a rationale for these phenomena by extending the traditional sovereign default framework to incorporate bankers that lend to both the government and the corporate sector. When these bankers are highly exposed to government debt a default triggers a banking crisis which leads to a corporate credit collapse and subsequently to an output decline. When calibrated to Argentina's 2001 default episode the model produces default on equilibrium with a frequency in line with actual default frequencies, and when it happens credit experiences a sharp contraction which generates an output drop similar in magnitude to the one observed in the data. Moreover, the model also matches several moments of the cyclical dynamics of macroeconomic aggregates.
    Keywords: sovereign default, banking crisis, credit crunch, optimal fiscal policy, Markov perfect equilibrium, endogenous cost of default, domestic Debt.
    JEL: F34 E62
    Date: 2012–09
  8. By: Michael P. Keane (Nuffield College, University of Oxford)
    Abstract: I examine the effect of labor income taxation in life-cycle models where work experience builds human capital. In this case, the wage no longer equals the opportunity cost of time – which is, instead, the wage plus returns to work experience. This has a number of interesting consequences. First, the data appear consistent with much larger labor supply elasticities than most prior work suggests. Second, again contrary to conventional wisdom, permanent tax changes can have larger effects on current labor supply than temporary tax changes. Third, human capital amplifies the labor supply response to permanent tax changes in the long-run, as a permanent tax reduces the rate of human capital accumulation (reducing worker productivity). Fourth, for plausible parameter values, welfare losses from proportional income taxation are likely to be much larger than conventional wisdom suggests.
    Date: 2012–10–15
  9. By: Hans Dewachter (National Bank of Belgium, Research Department; University of Leuven); Raf Wouters (National Bank of Belgium, Research Department)
    Abstract: This paper proposes a perturbation-based approach to implement the idea of endogenous financial risk in a standard DSGE macro-model. Recent papers, such as Mendoza (2010), Brunnermeier and Sannikov (2012) and He and Krishnamurthy (2012), that have stimulated the research field on endogenous risk in a macroeconomic context, are based on sophisticated solution methods that are not easily applicable in larger models. We propose an approximation method that allows us to capture some of the basic insights of this literature in a standard macro-model. We are able to identify an important risk-channel that derives from the risk aversion of constrained intermediaries and that contributes significantly to the overall financial and macro volatility. With this procedure, we obtain a consistent and computationally-efficient modelling device that can be used for integrating financial stability concerns within the traditional monetary policy analysis.
    Date: 2012–10
  10. By: Markus K. Brunnermeier (Department of Economics, Princeton University); Yuliy Sannikov (Department of Economics, Princeton University)
    Abstract: This paper studies the full equilibrium dynamics of an economy with financial frictions. Due to highly non-linear amplification effects, the economy is prone to instability and occasionally enters volatile episodes. Risk is endogenous and asset price correlations are high in down turns. In an environment of low exogenous risk experts assume higher leverage making the system more prone to systemic volatility spikes - a volatility paradox. Securitization and derivatives contracts leads to better sharing of exogenous risk but to higher endogenous systemic risk. Financial experts may impose a negative externality on each other and the economy by not maintaining adequate capital cushion.
    Date: 2012–10
  11. By: Costas Meghir (Institute for Fiscal Studies and Yale University); Renata Narita; Jean-Marc Robin (Institute for Fiscal Studies and Sciences Po)
    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.
    Keywords: Wages, informality, developing countries
    Date: 2012–09
  12. By: Giorgio Fagiolo (Sant'Anna School of Advanced Studies, Pisa); Andrea Roventini (Department of Economics (University of Verona))
    Abstract: The Great Recession seems to be a natural experiment for macroeconomics showing the inadequacy of the predominant theoretical framework — the New Neoclassical Synthesis — grounded on the DSGE model. In this paper, we present a critical discussion of the theoretical, empirical and political-economy pitfalls of the DSGE-based approach to policy analysis. We suggest that a more fruitful research avenue to pursue is to explore alternative theoretical paradigms, which can escape the strong theoretical requirements of neoclassical models (e.g., equilibrium, rationality, representative agent, etc.). We briefly introduce one of the most successful alternative research projects – known in the literature as agent-based computational economics (ACE) – and we present the way it has been applied to policy analysis issues. We then provide a survey of agent-based models addressing macroeconomic policy issues. Finally, we conclude by discussing the methodological status of ACE, as well as the (many) problems it raises.
    Keywords: Economic Policy, Monetary and Fiscal Policies, New Neoclassical Synthesis, New Keynesian Models, DSGE Models, Agent-Based Computational Economics, Agent- Based Models, Great Recession, Crisis
    JEL: B41 B50 E32 E52
    Date: 2012–02
  13. By: Stephane Verani; Till Gross
    Abstract: There is growing empirical support for the conjecture that access to credit is an important determinant of firms' export decisions. We study a multi-country general equilibrium economy in which entrepreneurs and lenders engage in long-term credit relationships. Financial constraints arise in consequence of financials contracts that are optimal given information asymmetry. Consistent with empirical regularities, as firm age and size increase, the model implies decreasing mean and variance of fi rm growth and increasing fi rm survival. Exporters are larger, their survival in international markets increases with the time spent exporting, and the sales of older exporters are larger and more stable.
    Date: 2012
  14. By: Sala, Luca; Söderström, Ulf; Trigari, Antonella
    Abstract: We use an estimated monetary business cycle model with search and matching frictions in the labor market and nominal price and wage rigidities to study four countries (the U.S., the U.K., Sweden, and Germany) during the financial crisis and the Great Recession. We estimate the model over the period prior to the financial crisis and use the model to interpret movements in GDP, unemployment, vacancies, and wages in the period from 2007 until 2011. We show that contractionary financial factors and reduced efficiency in labor market matching were largely responsible for the experience in the U.S. Financial factors were also important in the U.K., but less so in Sweden and Germany. Reduced matching efficiency was considerably less important in the U.K. and Sweden than in the U.S., but matching efficiency improved in Germany, helping to keep unemployment low. A counterfactual experiment suggests that unemployment in Germany would have been substantially higher if the German labor market had been more similar to that in the U.S.
    Keywords: Business cycles; Financial crisis; Labor market matching
    JEL: E24 E32
    Date: 2012–10
  15. By: Bethencourt, Carlos; Perera-Tallo, Fernando
    Abstract: Empirical evidence suggests that poorer countries have larger portions of predation. We formulate a neoclassical growth model in which agents devote time either to produce or predate. When the elasticity of substitution between labor and capital is lower than one, the labor share rises with capital, reducing the incentive to predate and increasing the incentive to produce throughout the transition. Consequently, a feedback process between capital accumulation and predation arises which ampli¯es income di®erences generated by di®erences in productivity. Thus, this paper helps understand why di®erences among countries have remained stable and the key role that institutions play in development.
    Keywords: Predation; Labor share; Development
    JEL: O41 O43
    Date: 2012–10–10
  16. By: Yiyong Cai; Takashi Kamihigashi; John Stachurski
    Abstract: Production takes time, and labor supply and profit maximization decisions that relate to current production are typically made before all shocks affecting that production have been realized. In this paper we re-examine the problem of stochastic optimal growth with aggregate risk where the timing of the model conforms to this information structure. We provide a set of conditions under which the economy has a unique, nontrivial and stable stationary distribution. In addition, we verify key optimality properties in the presence of unbounded shocks and rewards, and provide the sample path laws necessary for consistent estimation and simulation.
    JEL: C61 C62 O41
    Date: 2012–10
  17. By: Zhu, Junyi
    Abstract: This paper analyzes the main uncertainty of college saving - the child's ability - in the context of the saving with learning model. The first section develops a dynamic model combining asset accumulation and learning to explain the parents' forward-looking saving behavior when they are confronted with the real option of college choice due to uncertainty of their child's ability. The model infers that, with enough time spent learning, information can improve parents' welfare. This can be accomplished by improving the allocation of the consumption to accommodate the burden of college cost given both asset status and the child's true ability. Next, I test the implications of the model from the Panel Study of Income Dynamics/Child Development Supplement & Transition into Adulthood (PSID/CDS & TA) (1997-2005) in the second section. This empirical study investigates college saving behavior when learning is present. Data suggest pessimistic and/or rich parents might reduce the level of college saving, which confirms the interaction of wealth and learning effects predicted by this model. The result also supports the state dependence of parents' college expectations and diminishing persistence over time due to learning. Finally, a number of policy improvements on ESA (Education Saving Account) are proposed to encourage parents to learn about their childs ability. --
    Keywords: education saving,search,learning,intertemporal consumption,real option,dynamic panel
    JEL: D83 D91 C23 I22
    Date: 2012
  18. By: Blundell, Richard (University College London); Pistaferri, Luigi (Stanford University); Saporta-Eksten, Itay (Stanford University)
    Abstract: In this paper we examine the link between wage inequality and consumption inequality using a life cycle model that incorporates household consumption and family labor supply decisions. We derive analytical expressions based on approximations for the dynamics of consumption, hours, and earnings of two earners in the presence of correlated wage shocks, non-separability and asset accumulation decisions. We show how the model can be estimated and identified using panel data for hours, earnings, assets and consumption. We focus on the importance of family labour supply as an insurance mechanism to wage shocks and find strong evidence of smoothing of male's and female's permanent shocks to wages. Once family labor supply, assets and taxes are properly accounted for, there is little evidence of additional insurance.
    Keywords: consumption, labor supply, earnings, inequality
    JEL: J22
    Date: 2012–10
  19. By: Diego Restuccia; Guillaume Vandenbroucke
    Abstract: Between 1940 and 2000 there has been a substantial increase of educational attainment in the United States. What caused this trend? We develop a model of human capital accumulation that features a non-degenerate distribution of educational attainment in the population. We use this framework to assess the quantitative contribution of technological progress and changes in life expectancy in explaining the evolution of educational attainment. The model implies an increase in average years of schooling of 24 percent which is the increase observed in the data. We find that technological variables and in particular skill-biased technical change represent the most important factors in accounting for the increase in educational attainment. The strong response of schooling to changes in income is informative about the potential role of educational policy and the impact of other trends affecting lifetime income.
    Keywords: educational attainment, schooling, skill-biased technical progress, human capital.
    JEL: E1 O3 O4
    Date: 2012–10–06
  20. By: Alberto Martin; Jaume Ventura
    Abstract: As a result of debt enforcement problems, many high-productivity firms in emerging economies are unable to pledge enough future profits to their creditors and this constrains the financing they can raise. Many have argued that, by relaxing these credit constraints, reforms that strengthen enforcement institutions would increase capital flows to emerging economies. This argument is based on a partial equilibrium intuition though, which does not take into account the origin of any additional resources that flow to high-productivity firms after the reforms. We show that some of these resources do not come from abroad, but instead from domestic low-productivity firms that are driven out of business as a result of the reforms. Indeed, the resources released by these low-productivity firms could exceed those absorbed by high-productivity ones so that capital flows to emerging economies might actually decrease following successful reforms. This result provides a new perspective on some recent patterns of capital flows in industrial and emerging economies.
    Keywords: capital flows, financial reforms, productivity, economic growth, financial globalization
    JEL: F34 F36 G15 O19 O43
    Date: 2012–09
  21. By: Ezra Oberfield (Federal Reserve Bank of Chicago)
    Abstract: Technical appendix for the Review of Economic Dynamics article
    Date: 2012–12

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