nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2012‒10‒27
25 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Practical tools for policy analysis in DSGE models with missing channels By Dario Caldara; Richard Harrison; Anna Lipinska
  3. Land-Price Dynamics and Macroeconomic Fluctuations By pengfei Wang; Tao Zha; Zheng Liu
  4. Housing and Liquidity By Yu Zhu; Randall Wright; Chao He
  5. Fiscal policy in contemporary DSGE models By Virginia Queijo von Heideken; Ferre De Graeve
  6. Hours and Employment in the Cross-Section and Over the Cycle By Sun-Bin Kim; Richard Rogerson; Yongsung Chang
  7. Income Inequality, Mobility, and the Accumulation of Capital. The role of Heterogeneous Labor Productivity. By Cecilia García-Peñalosa; Stephen J. Turnovsky
  8. Liquidity Constraints of the Middle Class By Jeffrey Campbell; Zvi Hercowitz
  9. Life-Cycle Portfolio Choice with Liquid and Illiquid Financial Assets By Claudio Campanale; Carolina Fugazza; Francisco Gomes
  10. The Effects of Credit Subsidies on Development By Antonio Antunes; Tiago Cavalcanti; Anne Villamil
  11. Aging, labour market dynamics and fiscal imbalances By Luca Marchiori; Olivier Pierrard; Henri R. Sneessens
  12. Embodied learning by investing and speed of convergence By Ronald Wendner; Christian Groth
  13. Efficiency in a Search and Matching Economy with a Competitive Informal Sector By Charlot, Olivier; Malherbet, Franck; Ulus, Mustafa
  14. Consumption Inequality and Family Labor Supply By Blundell, Richard William; Pistaferri, Luigi; Saporta-Eksten, Itay
  15. Optimal policy for macro-financial stability By Gianluca Benigno; Huigang Chen; Christopher Otrok; Alessandro Rebucci; Eric R. Young
  16. Social Capital as an Engine of Growth. Multisectoral Modelling and Implications By Youyou Baende Bofota; Raouf Boucekkine; Alain Pholo Bala
  17. Optimal Sovereign Default By Adam, Klaus; Grill, Michael
  18. Financial Risk Capacity By Saki Bigio
  19. Household Search or Individual Search: Does It Matter? Evidence from Lifetime Inequality Estimates By Flabbi, Luca; Mabli, James
  20. The Viability of a Voting System that Allocates Parliamentary Seats According to Life Expectancy: An analysis using OLG models By Oguro, Kazumasa; Ishida, Ryo
  21. Is the GDP Growth Rate in NIPA a Welfare Measure? By Jorge Durán; Omar Licandro
  22. Labour Market Performance Effects of Discrimination and Loss of Skill By Larsen, Birthe; Waisman, Gisela
  23. Trade and Synchronization in a Multi Country Economy By Paulo Santos Monteiro; Luciana Juvenal
  24. Why doesn’t technology flow from rich to poor countries? By Harold L. Cole; Jeremy Greenwood; Juan M. Sánchez
  25. The dynamics of public investment under persistent electoral advantag By Marina Azzimonti

  1. By: Dario Caldara; Richard Harrison; Anna Lipinska
    Abstract: In this paper we analyze the propagation of shocks originating in sectors that are not present in a baseline dynamic stochastic general equilibrium (DSGE) model. Specifically, we proxy the missing sector through a small set of factors, that feed into the structural shocks of the DSGE model to create correlated disturbances. We estimate the factor structure by matching impulse responses of the augmented DSGE model to those generated by an auxiliary model. We apply this methodology to track the effects of oil shocks and housing demand shocks in models without energy and housing sectors.
    Date: 2012
  2. By: Lilia Cavallari (Università degli Studi di Roma Tre)
    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: E31 E32 E52
    Date: 2012
  3. By: pengfei Wang (Hong Kong University of Science and Technology); Tao Zha (Federal Reserve Bank of Atlanta); Zheng Liu (Federal Reserve Bank of San Francisco)
    Abstract: We argue that positive co-movements between land prices and business investment are a driving force behind the broad impact of land-price dynamics on the macroeconomy. We develop an economic mechanism that captures the co-movements by incorporating two key features into a DSGE model: We introduce land as a collateral asset in firms' credit constraints and we identify a shock that drives most of the observed fluctuations in land prices. Our estimates imply that these two features combine to generate an empirically important mechanism that amplifies and propagates macroeconomic fluctuations through the joint dynamics of land prices and business investment.
    Date: 2012
  4. By: Yu Zhu (Wisconsin); Randall Wright (U Wisconsin); Chao He (University of Wisconsin-Madison)
    Abstract: We study economies where houses, in addition to providing utility as shelter, may also facilitate credit transactions, since home equity can be used as collateral. We document there were big increases in home-equity-backed consumption loans coinciding with the start of the house price boom, and suggest an explanation. When it can be used as collateral, housing can bear a liquidity premium. Since liquidity is endogenous, even when fundamentals are constant and agents fully rational house prices can display complicated equilibrium paths resembling bubbles. Our framework is tractable, with exogenous or with endogenous supply, yet captures several salient features of housing markets. The effects of monetary policy are also discussed.
    Date: 2012
  5. By: Virginia Queijo von Heideken (Sveriges Riksbank); Ferre De Graeve (Sveriges Riksbank)
    Abstract: The role of fiscal policy in DSGE models has long been ignored. Recent evidence from reduced-form VARs (Sims (2011)), event-studies (Leeper et al. (2012)) and structural models (Fernández-Vilaverde et al. (2012)) shows that information about fiscal variables can add to macroeconomic models. To strongly convey the point that DSGE models should take fiscal policy seriously, we show that even without any information on fiscal variables standard contemporary DSGE models map historical fluctuations to fiscal policy. We estimate a version of the Smets-Wouters model and show that the model interprets changes in long-term interest rates, unrelated to current short rates, as news about fiscal policy through the effect it may have on future inflation. This interpretation is exactly the one Sims (2011) and Leeper and Walker (2012) argue for.
    Date: 2012
  6. By: Sun-Bin Kim (Yonsei University); Richard Rogerson (Princeton University); Yongsung Chang (University of Rochester / Yonsei Univ.)
    Abstract: We develop a heterogeneous-agent general equilibrium model that incorporates both intensive and extensive margins of labor supply. A nonconvexity in the mapping between time devoted to work and labor services distinguishes between extensive and intensive margins. We consider calibrated versions of this model that differ in the value of a key preference parameter for labor supply and the extent of heterogeneity. The model is able to capture the key features of the empirical hours worked distribution, including how individuals transit within this distribution. We then study how the various specifications influence labor supply responses to temporary shocks and permanent tax changes, with a particular focus on the intensive and extensive margin elasticities in response to these changes. A key finding is that these two elasticities are jointly determined and cannot be thought of as two independent properties of aggregate labor supply.
    Date: 2012
  7. By: Cecilia García-Peñalosa (Aix-Marseille Université); Stephen J. Turnovsky (University of Washington, Seattle)
    Abstract: We examine the determinants of income inequality and mobility in a Ramsey model with elastic labor supply. Individuals differ both in their initial capital endowment and productive ability (labor endowment). With two sources of heterogeneity, initially poorer agents may catch up with the income and wealth of initial richer ones, implying that the Ramsey model is compatible with rich distributional dynamics. We show that the elasticity of the labor supply plays a key role in the extent of mobility in the economy. Capital-rich individuals supply less labor while ability-rich agents tend to work more. The more elastic the labor supply is, the stronger these effects tend to be and hence the greater the degree of income mobility is.
    Keywords: Inequality, Income mobility, Endogenous labour supply, Transitional dynamics.
    JEL: D31 O41
    Date: 2012–04
  8. By: Jeffrey Campbell (Federal Reserve Bank of Chicago); Zvi Hercowitz (Tel Aviv University)
    Abstract: Consumption of households with liquid financial assets responds much more to transitory income shocks than the permanent-income hypothesis predicts. That is, middle class households act as if they face liquidity constraints. This paper addresses this puzzling observation with a model of impatient households that face a large recurring expenditure. In spite of impatience, they save as this expenditure draws near. We call such saving made in preparation for a foreseeable event "term saving". Under precautionary saving, good luck drives wealth accumulation, so a high asset level implies an abundance of liquidity. With term saving, assets indicate an impending need for funds and a shortage of liquidity. The borrowing constraint will bind at the time of the expenditure. This separates planning up to that time from the rest of the household's lifetime and thereby shortens its effective horizon. Intertemporal substitution over such a limited period generates strong consumption responses to temporary income changes. As the expenditure approaches, the effective horizon shortens further as the household accumulates assets. Hence, households with more assets have larger consumption responses. We compare a calibrated version of a model that embodies both term saving and precautionary saving motives with observed consumption responses to the 2001 U.S. tax rebate. The model replicates these observations well and also generates "excess smoothness" of aggregate consumption.
    Date: 2012
  9. By: Claudio Campanale; Carolina Fugazza; Francisco Gomes
    Abstract: Traditionally quantitative models that have studied households' port- folio choice have focused exclusively on the different risk properties of alternative financial assets. In the present paper we take a different ap- proach and assume that assets also differ in their liquidity. We construct a model where agents face uninsurable idiosyncratic shocks to labor earn- ings. Earnings are paid in the form of a liquid asset that is needed to buy consumption goods. A second, risky asset, called stock is also available, however a fixed transaction cost is needed to buy or sell this asset. When the transaction cost is calibrated to match the observed infrequency in households' trading, the model generates patterns of portfolio stock allo- cations over age and wealth that are constant or moderately increasing, thus more in line with the empirical evidence compared to conventional models.
    Keywords: household portfolio choice, self-insurance, cash-in-advance, transaction cost.
    JEL: G11 D91 H55
    Date: 2012
  10. By: Antonio Antunes; Tiago Cavalcanti; Anne Villamil
    Abstract: Under credit market imperfections, the marginal productivity of capital will not necessarily be equalized, resulting in misallocation and lower output. Preferential interest rate policies are often used to remedy the problem. This paper constructs a general equilibrium model with heterogeneous agents, imperfect enforcement and costly intermediation. Occupational choice and firm size are determined endogenously by an agent's type (ability and net wealth) and credit market frictions. The credit program subsidizes the interest rate on loans and requires a fixed application cost, which might be null, in the form of bureaucracy and regulations. First, we find that the interest credit subsidy policy has no significant effect on output, but it can have negative effects on wages and government finances. The program is largely a transfer from households to a small group of entrepreneurs with minor aggregate effects. We include a transition analysis. Second, we provide quantitative estimates of the effects of reducing the frictions directly. When comparing differences in U.S. output per capita in baseline and simulations with counterfactually high frictions such as those observed in Brazil, intermediation costs and enforcement.
    Date: 2012
  11. By: Luca Marchiori (Banque centrale du Luxembourg); Olivier Pierrard (Banque centrale du Luxembourg); Henri R. Sneessens (Université du Luxembourg, IZA and Universite catholique de Louvain)
    Abstract: Population aging is a phenomenon common to all regions in the developed world, forcing most governments to implement structural reforms in order to avoid the development of fiscal imbalances. In Luxembourg, large inflows of – young – foreign workers generate an apparently sound public pension system, although no major structural reform has been implemented yet. In this paper, we study the interactions between demographic changes, labour market dynamics and public finance, by building an overlapping generations structure with New Open Macroeconomics and labour market frictions à la Diamond- Mortensen-Pissarides. We calibrate the model on Luxembourg data and we show that foreign labour inflows are a palliative but not a long term solution to the fiscal consequences of aging, and that only deep – and unpopular – fiscal reforms could solve the expected deficit problem. We also show that without foreign trade, foreign labour inflows would increase the domestic unemployment rate. This underlines the need to combine in a single framework the NOEM and the search and matching approaches.
    Keywords: Overlapping Generations, Aging, Fiscal Imbalances
    JEL: D91 E24 E62 F41 J11
    Date: 2012
  12. By: Ronald Wendner (Karl-Franzens University of Graz); Christian Groth (University of Copenhagen)
    Abstract: Based on a dynamic general equilibrium model we study how the composition of technical progress, along three dimensions, aects transitional dynamics, with an emphasis on the speed of convergence. The three dimensions are, rst, the degree to which technical change is embodied, second, the extent to which an endogenous source, learning, drives productivity advances, and, third, the extent to which the vehicle of learning is gross investment rather than net investment. The analysis shows that the speed of convergence, both ultimately and in a nite distance from the steady state, depends strongly and negatively on the importance of learning in the growth engine and on gross investment being the vehicle of learning rather than net investment. In contrast to a presumption implied by \old growth theory", a rising degree of embodiment in the wake of the computer revolution is not likely to raise the speed of convergence when learning by investing is the driving force of productivity increases.
    Keywords: Transitional dynamics, Speed of convergence, Learning by investing, Embodied technological progress, Decomposable dynamics
    JEL: D91 E21 O41
    Date: 2012–10
  13. By: Charlot, Olivier (University of Cergy-Pontoise); Malherbet, Franck (University of Rouen); Ulus, Mustafa (Galatasaray University)
    Abstract: We consider a dual labor market with a frictional formal sector and a competitive informal sector. We show that the size of the informal sector is generally too large compared to the optimal allocation of the workers. It follows that our results give a rationale to informality-reducing policies.
    Keywords: search and matching models, informality, efficiency
    JEL: E24 E26 J60 L16 O1
    Date: 2012–10
  14. By: Blundell, Richard William; Pistaferri, Luigi; Saporta-Eksten, Itay
    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 identifi…ed using panel data for hours, earnings, assets and consumption. We focus on the importance of family labor supply as an insurance mechanism to wage shocks and fi…nd 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 their is little evidence of additional insurance.
    Keywords: Consumption; Inequality; Labor Supply
    JEL: E21 J22
    Date: 2012–10
  15. By: Gianluca Benigno; Huigang Chen; Christopher Otrok; Alessandro Rebucci; Eric R. Young
    Abstract: In this paper we study whether policy makers should wait to intervene until a financial crisis strikes or rather act in a preemptive manner. We study this question in a relatively simple dynamic stochastic general equilibrium model in which crises are endogenous events induced by the presence of an occasionally binding borrowing constraint as in Mendoza (2010). First, we show that the same set of taxes that replicates the constrained social planner allocation could be used optimally by a Ramsey planner to achieve the first best unconstrained equilibrium: in both cases without any precautionary intervention. Second, we show that the extent to which policymakers should intervene in a preemptive manner depends critically on the set of policy tools available and what these instruments can achieve when a crisis strikes. For example, in the context of our model, we find that, if the policy tools is constrained so that the first best cannot be achieved and the policy maker has access to only one tax instrument, it is always desirable to intervene before the crisis regardless of the instrument used. If however the policy maker has access to two instruments, it is optimal to act only during crisis times. Third and finally, we propose a computational algorithm to solve Markov-Perfect optimal policy for problems in which the policy function is not differentiable.
    Keywords: Monetary policy ; Financial stability
    Date: 2012
  16. By: Youyou Baende Bofota (Université Catholique de Louvain (UCL), Ires); Raouf Boucekkine (Aix-Marseille Université, Greqam and UCL, Ires-Core); Alain Pholo Bala (University of Johannesburg)
    Abstract: We propose a multisector endogenous growth model incorporating social capital. Social capital only serves as input in the production of human capital and it involves a cost in terms of the final good. We show that in contrast to existing alternative specifications, this setting assures that social capital enhances productivity gains by playing the role of a timing belt driving the transmission and propagation of all productivity shocks throughout society whatever the sectoral origin of the shocks. Further econometric work is conducted in order to estimate the contribution of social capital to human capital formation. We find that depending on the measure of social capital considered, the elasticity of human capital to social capital varies from 6% to 10%. Finally we investigate the short-term dynamics and imbalance effect properties of the models depending on the value of this elasticity (taking the Lucas-Uzawa model as a limit case). In particular, it’s shown that when the substitutability of social capital to human capital increases, the economy is better equipped to surmount initial imbalances as individuals may allocate more working time in the final goods sector without impeding economic growth.
    Keywords: social capital, human capital, economic growth, imbalance effects.
    JEL: C61 E20 E22 E24 O41
    Date: 2012–03–12
  17. By: Adam, Klaus; Grill, Michael
    Abstract: When is it optimal for a government to default on its legal repayment obligations? We answer this question for a small open economy with domestic production risk in which the government optimally fi…nances itself by issuing non-contingent debt. We show that Ramsey optimal policies occasionally deviate from the legal repayment obligation and repay debt only partially, even if such deviations give rise to signi…cant ‘default costs’. Optimal default improves the international diversi…cation of domestic output risk, increases the efficiency of domestic investment and - for a wide range of default costs - signi…cantly increase welfare relative to a situation where default is simply ruled out from Ramsey optimal plans. We show analytically that default is optimal following adverse shocks to domestic output, especially for very negative international wealth positions. A quantitative analysis reveals that for empirically plausible wealth levels, default is optimal only in response to disaster-like shocks to domestic output, and that default can be Ramsey optimal even if the net foreign asset position is positive.
    Keywords: incomplete markets; optimal default; Ramsey optimal fiscal policy
    JEL: E62 F34
    Date: 2012–10
  18. By: Saki Bigio (New York University)
    Abstract: Financial crises appear to persist if banks fail to be recapitalized quickly after large losses. I explain this impediment through a model where banks provide intermediation services in asset markets with informational asymmetries. Intermediation is risky because banks take positions over assets under disadvantageous information. Large losses reduce bank net worth and, therefore, the capacity to bear further losses. Losing this capacity leads to reductions in intermediation volumes that exacerbate adverse selection. Adverse selection, in turn, lowers bank prots which explains the failure to attract new equity. These financial crises are characterized by a depression in economic growth that is overcome only as banks slowly strengthen by retaining earnings. The model is calibrated and used to analyze several policy interventions.
    Date: 2012
  19. By: Flabbi, Luca (Georgetown University); Mabli, James (Mathematica Policy Research)
    Abstract: Search Models of the labor market are widespread and influential but they usually ignore that labor market decisions are frequently taken at the household level. We fill this gap by developing and estimating an household search model with on-the-job search and labor supply. We build on previous work (Dey and Flinn (2008) and Guler, Guvenen and Violante (2011)) to propose a novel identification strategy of the risk aversion parameters and a specification test. We find that ignoring the household as unit of decision-making has relevant empirical consequences. In estimation, the individual search specification implies gender wage offers differentials 200% larger than the household search specification. In the application, the individual search specification implies gender differentials in lifetime utility inequality 74% larger. The results of our policy experiments emphasize the importance of looking at lifetime utility inequality measures as opposed to simply cross-sectional wage inequality measures.
    Keywords: household search, inequality, structural estimation
    JEL: J64 D63 C63
    Date: 2012–10
  20. By: Oguro, Kazumasa; Ishida, Ryo
    Abstract: This paper constructs an overlapping generations model in order to demonstrate low political intervention and interaction in the working and retired generations affect the allocation rate in future growth-stimulating public investment and the public pension. It also analyzes the possibility of moving to a voting system that allocates parliamentary seats according to life expectancy. The presented results suggest the following three main findings. Firstly, the voting system is important when population demographics change. Declining birthrates and an aging population may shorten the temporal perspective for policymaking over time. Any theoretical transition from the current voting system to a voting system that allocates parliamentary seats according to life expectancy would thus lengthen the temporal perspective for policymaking, potentially increasing the public investment rate and improving the utilities of the working and future generations. Secondly, when age-based voting turnout disparity is high, the shift from the current voting system to one based on life expectancy and region or life expectancy and age is possible. Thirdly, if both transitions from the current system are possible, moving to the latter would offer greater possibility for increasing the utilities of the working generation and future generations than moving to the former.
    Keywords: Public investment, Public pension, OLG model, Generational-based constituency bloc, Demeny voting system, Life expectancy
    JEL: D90 H50 H60 J18 O20
    Date: 2012–10
  21. By: Jorge Durán; Omar Licandro
    Abstract: The permanent decline of equipment prices relative to nondurable consumption prices rendered fixed-base quantity indexes obsolete, because of the well-known substitution bias. National Income and Product Accounts (NIPA) responded by switching to a flexible-base quantity index to measure GDP growth. We argue this is a welfare measure of output growth. In a two-sector endogenous growth model, we use the Bellman equation to explicitly represent preferences on consumption and investment, we apply a Fisher-Shell true quantity index to this utility representation and show it is equal to the Divisia index, well approximated by the flexible-base quantity index used by NIPA.
    Keywords: growth measurement, quantity indexes, embodied technical progress, NIPA
    JEL: C43 D91 O41 O47
    Date: 2012–05
  22. By: Larsen, Birthe (Department of Economics, Copenhagen Business School); Waisman, Gisela (Stockholm University)
    Abstract: We examine the impact of discrimination on labour market performance when workers are subject to a risk of losing skills during the experience of unemployment. Within a search and matching model, we show that all natives and immigrants are affected by discrimination. Discrimination in one sector has positive spillovers, inducing employment increases in the other sector. <p>Discrimination may induce immigrants to train more or less than natives, depending on the sector where it is present. <p>Welfare tends to be most negatively affected by discrimination among high- productivity workers.
    Keywords: discrimination; unemployment; search and matching; wages
    JEL: J15 J31 J61 J64 J71
    Date: 2012–10–15
  23. By: Paulo Santos Monteiro (University of Warwick); Luciana Juvenal (Federal Reserve Bank of St Louis)
    Abstract: Substantial evidence suggests that countries with stronger trade linkages have more synchronized business cycles. The standard international business cycle framework cannot replicate this finding, uncovering the trade-comovement puzzle. We show that under certain macro-level conditions but irrespective of the micro-level assumptions concerning trade the puzzle arises because trade fails to substantially increase the correlation between each country's import penetration ratio and the trade partner's technology shock. Within a large class of trade models, there are three channels through which bilateral trade may increase business cycle synchronization. Specifically, increased bilateral trade may (i) raise the correlation between each country's technology shocks, (ii) raise the correlation between each country's share of expenditure on domestic goods, and (iii) raise the response of the domestic import penetration ratio to foreign technology shocks. Empirical evidence strongly supports the first and second channels. We show that the trade-comovement puzzle can be resolved if productivity shocks are more correlated between country-pairs that trade more.
    Date: 2012
  24. By: Harold L. Cole; Jeremy Greenwood; Juan M. Sánchez
    Abstract: What determines the technology that a country adopts? While there could be many factors, the efficiency of the country’s financial system may play a significant role. To address this question, a dynamic contract model is embedded into a general equilibrium setting with competitive interme- diation. The ability of an intermediary to monitor and control the cash flows of a firm plays an important role in a firm’s decision to adopt a technology. Can such a theory help to explain the differences in total factor productivity and establishment-size distributions across India, Mexico, and the U.S.? Applied analysis suggests that answer is yes.
    Keywords: Cash flow ; Economic development ; Technology - Economic aspects ; India ; Mexico
    Date: 2012
  25. By: Marina Azzimonti (FRB of Philadelphia)
    Abstract: This paper studies the effects of asymmetries in re-election probabilities across parties on public policy and its subsequent propagation to the economy. The struggle between groups that disagree on targeted transfers results in governments being endogenously short-sighted: Systematic underinvestment in infrastructure and overspending on public goods arise, beyond what is observed in symmetric environments. Because the party enjoying an electoral advantage is less short-sighted, it devotes a larger proportion of revenues to productive investment. Hence, political turnover induces economic fluctuations in an otherwise deterministic environment. I characterize analytically the long-run distribution of allocations, and show that output increases with electoral advantage, despite the fact that governments expand. Volatility is non-monotonic in electoral advantage and is an additional source of inefficiency. Using panel data from US States I confirm these findings, and show that there is an inverted U-shape relation between the volatility of public policy and electoral advantage.
    Date: 2012

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