nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2012‒11‒11
forty-two papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Self-fulfilling credit cycles By Costas Azariadis; Leo Kaas
  2. Demographic Patterns and Household Saving in China By Steven Lugauer; Nelson Mark
  3. Job Search, Human Capital and Wage Inequality By Carrillo-Tudela, Carlos
  4. Liquidity, Innovation and Growth By Aleksander Berentsen; Mariana Rojas Breu; Shouyong Shi
  5. Markov-perfect optimal fiscal policy : the case of unbalanced budgets By Salvador Ortigueira; Joana Pereira; Paul Pichler
  6. Housing and the Macroeconomy: The Role of Bailout Guarantees for Government Sponsored Enterprises By Dirk Krueger
  7. Real effects of money growth and optimal rate of inflation in a cash-in-advance economy with labor-market frictions By Wang, Ping; Xie, Danyang
  8. Financial market heterogeneity: Implications for the EMU By Gareis, Johannes; Mayer, Eric
  9. Understanding Booms and Busts in Housing Markets By Sergio Rebelo; Martin Eichenbaum; Craig Burnside
  10. Labor disruption costs and real wages cyclicality By Cervini-Plá, María; Silva, José I.; López-Villavicencio, Antonia
  11. Endogenous credit limits with small default costs By Costas Azariadis; Leo Kaas
  12. A two-sector model of endogenous growth with leisure externalities By Costas Azariadis; Been-Lon Chen; Chia-Hui Lu; Yin-Chi Wang
  13. The optimal inflation target in an economy with limited enforcement By Gaetano Antinolfi; Costas Azariadis; James Bullard
  14. The Supply of Skills in the Labor Force and Aggregate Output Volatility By Steven Lugauer
  15. Estimating a dynamic equilibrium model of firm location choices in an urban economy By Jeffrey Brinkman; Daniele Coen-Pirani; Holger Sieg
  16. News, Non-Invertibility, and Structural VARs By Eric R. Sims
  17. The forward guidance puzzle By Marco Del Negro; Marc Giannoni; Christina Patterson
  18. Gauging the effects of fiscal stimulus packages in the euro area By Günter Coenen; Roland Straub; Mathias Trabandt
  19. Formal vs. Informal Default in Consumer Credit By Xavier Mateos-Planas; David Benjamin
  20. Consumption Dynamics During the Great Recession By Joseph Vavra; David Berger
  21. Early and Late Human Capital Investments, Borrowing Constraints, and the Family By Lance Lochner; Elizabeth Caucutt
  22. Debt-Deflation versus the Liquidity Trap : The Dilemma of Nonconventional Monetary Policy. By Gaël Giraud; Antonin Pottier
  24. Capital misallocation and aggregate factor productivity By Costas Azariadis; Leo Kaas
  25. Skill-Biased Technical Change and the Cost of Higher Education By John Bailey Jones; Fang Yang
  26. Tax Reform and Coordination in a Currency Union By Benjamin Carton
  27. Bankruptcy and delinquency in a model of unsecured debt By Kartik Athreya; Juan M. Sánchez; Xuan S. Tam; Eric R. Young
  28. Monetary policy and fiscal stimulus with the zero lower bound and financial frictions By Rossana MEROLA
  29. Immigration Conflicts By Junko Doi; Laixun Zhao
  30. Tax Evasion and Public Expenditures on Tax Collection Services in an Endogenous Growth Model By Sifis Kafkalas; Pantelis Kalaitzidakis; Vangelis Tzouvelekas
  31. Information acquisition and financial intermediation By Nina Boyarchenko
  32. Man-bites-dog business cycles By Kristoffer Nimark
  33. Endogeneous Risk in Monopolistic Competition By Vladislav Damjanovic
  34. Macroeconomic effects of Federal Reserve forward guidance By Jeffrey R. Campbell; Charles Evans; Jonas D. M. Fisher; Alejandro Justiniano
  35. Generalizing the Taylor Principle: New Comment. By Barthélemy, J.; Marx, M.
  36. Technical Appendix to "Politico-Economic Inequality and the Comovement of Government Purchases" By Ruediger Bachmann; Jinhui Bai
  37. Models of government expenditure multipliers By Sebastian Dyrda; Jose-Victor Rios-Rull
  38. Trade Costs, Innovation, and the Gains from Trade By Jeff Thurk
  39. Financial Intermediation, International Risk Sharing, and Reserve Currencies By Matteo Maggiori
  40. Financially constrained arbitrage and cross-market contagion By Dimitri Vayanos; Denis Gromb
  41. Merging Simulation and Projection Approaches to Solve High-Dimensional Problems By Kenneth L. Judd; Lilia Maliar; Serguei Maliar
  42. Forecast Combination Based on Multiple Encompassing Tests in a Macroeconomic DSGE-VAR System By Costantini, Mauro; Gunter, Ulrich; Kunst, Robert M.

  1. By: Costas Azariadis; Leo Kaas
    Abstract: This paper argues that self-fulfilling beliefs in credit conditions can generate endoge- nously persistent business cycle dynamics. We develop a tractable dynamic general equi- librium model in which heterogeneous firms face idiosyncratic productivity shocks. Capital from less productive firms is lent to more productive ones in the form of credit secured by collateral and also as unsecured credit based on reputation. A dynamic complemen- tarity between current and future credit constraints permits uncorrelated sunspot shocks to trigger persistent aggregate fluctuations in debt, factor productivity and output. In a calibrated version we compare the features of sunspot cycles with those generated by shocks to economic fundamentals.
    Keywords: Credit ; Business cycles
    Date: 2012
  2. By: Steven Lugauer (Department of Economics, University of Notre Dame); Nelson Mark (Department of Economics, University of Notre Dame)
    Abstract: This paper studies how changing demographics can explain much of the evolution of China's household saving rate from 1955 to 2009. We undertake a quantitative investigation using an overlapping generations model in which agents live for 85 years. Agents begin to exercise decision making when they are 20. From age 20 to 63, they work. From age 20 to 49, they also provide for children. Dependent children's consumption enters into the parent's utility, and parents choose the consumption level of the young until they leave the household. Working agents transfer a portion of their labor income to their retired parents and save for their own retirement. Retirees live of of their accumulated assets and support from current workers. We present agents in the parameterized model with the future time-path of the demographics, interest rates and wages as given by the data and analyze their saving decisions. The simulated model accounts for nearly all the observed increase in the household saving rate from 1955 to 2009.
    Keywords: Saving Rate, Life-Cycle, China, Demographics, Overlapping Generations
    JEL: E2 J1
    Date: 2010–12
  3. By: Carrillo-Tudela, Carlos (University of Essex)
    Abstract: The objective of this paper is to construct and quantitatively assess an equilibrium search model with on-the-job search and general human capital accumulation. In the model workers enter the labour market with different abilities and firms differ in their productivities. Wages are dispersed because of search frictions and workers' productivity differentials. The model generates a simple (log) wage variance decomposition that is used to measure the importance of firm and worker productivity differentials, frictional wage dispersion and workers' sorting dynamics. I calibrate the model using a sample of young workers for the UK. I show that wage inequality among low skilled workers is mostly due to differences in their productivities. Among medium skilled workers frictional wage dispersion and sorting dynamics are, together, as important as workers' productivity differentials. Differences in firms' productivities are also an important source of wage inequality for both skill groups and account for a large share of frictional wage dispersion. Quantitatively the model is able to reproduce the observed cross-sectional wage distribution, the average wage-experience profile and the amount of frictional wage dispersion observed in the data as measured by the Mean-min ratio.
    Keywords: job search, human capital accumulation, wage dispersion, turnover
    JEL: J63 J64 J41 J42
    Date: 2012–10
  4. By: Aleksander Berentsen; Mariana Rojas Breu; Shouyong Shi
    Abstract: Many countries simultaneously suffer from high inflation, low growth and poorly developed financial sectors. In this paper, we integrate a microfounded model of money and finance into a model of endogenous growth to examine the effects of inflation on welfare, growth and the size of the financial sector. A novel feature is that the innovation sector is decentralized. Financial intermediaries arise endogenously to provide liquidity to this sector. Consistent with the data but in contrast to previous work, reducing inflation generates large growth gains. These large gains cannot be easily reproduced by imposing a cash-in-advance constraint in the innovation sector.
    Keywords: Inflation; Growth; Search; Innovation; Credit.
    JEL: E5 O42
    Date: 2012–11–04
  5. By: Salvador Ortigueira; Joana Pereira; Paul Pichler
    Abstract: We study optimal time-consistent fiscal policy in a neoclassical economy with endogenous government spending, physical capital and public debt. We show that a dynamic complementarity between the households’ consumption-savings decision and the government’s policy decision gives rise to a multiplicity of expectations-driven Markov-perfect equilibria. The long-run levels of taxes, government spending and debt are not uniquely pinned down by economic fundamentals, but are determined by expectations over current and future policies. Accordingly, economies with identical fundamentals may significantly differ in their levels of public indebtedness
    Keywords: Optimal fiscal policy, Markov-perfect equilibrium, Time-consistent policy, Expectation traps
    JEL: E61 E62 H21 H63
    Date: 2012–10
  6. By: Dirk Krueger (University of Pennsylvania)
    Abstract: This paper evaluates the macroeconomic and distributional effects of government bailout guarantees for Government Sponsored Enterprises (such as Fannie Mae and Freddy Mac) in the mortgage market. In order to do so we construct a model with heterogeneous, infinitely lived households and competitive housing and mortgage markets. Households have the option to default on their mortgages, with the consequence of having their homes foreclosed. We model the bailout guarantee as a government provided and tax-financed mortgage interest rate subsidy. We find that eliminating this subsidy leads to substantially lower equilibrium mortgage origination and increases aggregate welfare, but has little effect on foreclosure rates and housing investment. The interest rate subsidy is a regressive policy: eliminating it benefits low-income and low-asset households who did not own homes or had small mortgages, while lowering the welfare of high-income, high-asset households.
    Date: 2012
  7. By: Wang, Ping; Xie, Danyang
    Abstract: This paper studies the consequences of labor-market frictions for the real effects of steady inflation when cash is required for households' consumption purchases and firms' wage payments. Money growth may generate a positive real effect by encouraging vacancy creation and raising job matches. This may result in a positive optimal rate of inflation, particularly in an economy with moderate money injections to firms and with nonnegligible labor-market frictions in which wage bargains are not efficient. This main finding holds for a wide range of money injection schemes, with alternative cash constraints, and in a second-best world with pre-existing distortionary taxes.
    Keywords: Cash Constraints; Nonsuperneutrality of Money; the Friedman rule; Labor-Market Frictions
    JEL: O42 D90 E41
    Date: 2012–10–29
  8. By: Gareis, Johannes; Mayer, Eric
    Abstract: This paper evaluates business cycle and welfare effects of cross-country mortgage market heterogeneity for a monetary union. By employing a calibrated two-country New Keynesian DSGE model with collateral constraints tied to housing values, we show that a change in cross-country institutional characteristics of mortgage markets, such as the LTV ratio, is likely to be an important driver of an asymmetric development in housing markets and real economic activity of member states. Our welfare analysis suggests that the welfare of the home country where the reform is implemented increases substantially. In contrast, the rest of the EMU's welfare falls due to spillover effects with magnitude depending on the size of the home country. --
    Keywords: housing,LTV ratio,monetary union,cross-country heterogeneity
    JEL: E32 E44 F41
    Date: 2012
  9. By: Sergio Rebelo (Northwestern University); Martin Eichenbaum (Northwestern University); Craig Burnside (Duke University)
    Abstract: Some booms in housing prices are followed by busts. Others are not. In either case it is difficult to find observable fundamentals that are correlated with price movements. We develop a model consistent with these observations. Agents have heterogeneous expectations about long-run fundamentals but change their views because of "social dynamics." Agents meet randomly. Those with tighter priors are more likely to convert others to their beliefs. The model generates a "fad": the fraction of the population with a particular view rises and then falls. Depending on which agent is correct about fundamentals, these fads generate boom-busts or protracted booms.
    Date: 2012
  10. By: Cervini-Plá, María; Silva, José I.; López-Villavicencio, Antonia
    Abstract: In this paper, we propose a matching and search model with adjustment costs in the form of labor disruption charges that can generate counter-cyclical real wages. Empirically, we use a measure of wage cyclicality based on the generalized impulse response function of real wages to a shock in a cycle measure. We provide evidence that wages in the United States are counter-cyclical during the first few quarters. The calibration and simulated results of the model match remarkably well the counter-cyclicality obtained from our empirical model.
    Keywords: Labor disruption costs; real wages; matching frictions; wage cyclicality
    JEL: E32 E24 J63 J32
    Date: 2012–10–29
  11. By: Costas Azariadis; Leo Kaas
    Abstract: We analyze an exchange economy of unsecured credit where borrowers have the option to declare bankruptcy in which case they are temporarily excluded from financial markets. Endogenous credit limits are imposed that are just tight enough to prevent default. Economies with temporary exclusion differ from their permanent exclusion counterparts in two important properties. If households are extremely patient, then the first–best allocation is an equilibrium in the latter economies but not necessarily in the former. In addition, temporary exclusion permits multiple stationary equilibria, with both complete and with incomplete consumption smoothing.
    Keywords: Bankruptcy ; Credit
    Date: 2012
  12. By: Costas Azariadis; Been-Lon Chen; Chia-Hui Lu; Yin-Chi Wang
    Abstract: This paper considers the impact of leisure preference and leisure externalities on growth and labor supply in a Lucas [12] type model, as in Gómez [7], with a separable non-homothetic utility and the assumption that physical and human capital are both necessary inputs in both the goods and the education sectors. In spite of the non-concavities due to the leisure externality, the balanced growth path is always unique, which guarantees global stability for comparative-static exercises. We find that small differences in preferences toward leisure or in leisure externalities can generate substantial differences in hours worked and growth, which may play a significant role in explaining differences in growth paths between the US and Europe, in addition to the mechanisms uncovered in Prescott [16] relying on differing marginal tax rates on labor income. Our model indicates, however, that a higher preference for leisure or leisure externality implies less growth but also less education attainment, which seems counterfactual.
    Keywords: Labor supply ; Economic growth
    Date: 2012
  13. By: Gaetano Antinolfi; Costas Azariadis; James Bullard
    Abstract: We formulate the central bank’s problem of selecting an optimal long-run inflation rate as the choice of a distorting tax by a planner who wishes to maximize discounted stationary utility for a heterogeneous population of infinitely-lived households in an economy with constant aggregate income and public information. Households are segmented into cash agents, who store value in currency alone, and credit agents who have access to both currency and loans. The planner’s problem is equivalent to choosing inflation and nominal interest rates consistent with a resource constraint, and with an incentive constraint that ensures credit agents prefer the superior consumption- smoothing power of loans to that of currency. We show that the optimum inflation rate is positive, because inflation reduces the value of the outside option for credit agents and raises their debt limits.
    Keywords: Inflation targeting ; Deflation (Finance) ; Monetary policy
    Date: 2012
  14. By: Steven Lugauer (Department of Economics, University of Notre Dame)
    Abstract: The cyclical volatility of U.S. gross domestic product suddenly declined during the early 1980s and remained low for over 20 years. I develop a labor search model with worker heterogeneity and match-specific costs to show how an increase in the supply of high-skill workers can contribute to a decrease in aggregate output volatility. In the model, firms react to changes in the distribution of skills by creating jobs designed specifically for high-skill workers. The new worker-firm matches are more profitable and less likely to break apart due to productivity shocks. Aggregate output volatility falls because the labor market stabilizes on the extensive margin. In a simple calibration exercise, the labor market based mechanism generates a substantial portion of the observed changes in output volatility.
    Keywords: Business Cycles, Skill Supply, Demographics
    JEL: E32 J24
    Date: 2012–06
  15. By: Jeffrey Brinkman; Daniele Coen-Pirani; Holger Sieg
    Abstract: We develop a new dynamic general equilibrium model to explain firm entry, exit, and relocation decisions in an urban economy with multiple locations and agglomeration externalities. We characterize the stationary distribution of firms that arises in equilibrium. We estimate the parameters of the model using a method of moments estimator. Using unique panel data collected by Dun and Bradstreet, we find that our model fits the moments used in estimation as well as a set of moments that we use for model validation. Agglomeration externalities increase the productivity of firms by about 8 percent. Economic policies that subsidize firm relocations to the central business district increase agglomeration externalities in that area. They also increase economic welfare in the urban economy.
    Keywords: Externalities (Economics) ; Urban economics ; Equilibrium (Economics) ; Estimation theory
    Date: 2012
  16. By: Eric R. Sims (Department of Economics, University of Notre Dame)
    Abstract: A state space representation of a linearized DSGE model implies a VAR in terms of observable variables. The model is said be non-invertible if there exists no linear rotation of the VAR innovations which can recover the economic shocks. Non-invertibility arises when the observed variables fail to perfectly reveal the state variables of the model. The imperfect observation of the state drives a wedge between the VAR innovations and the deep shocks, potentially invalidating conclusions drawn from structural impulse response analysis in the VAR. The principal contribution of this paper is to show that non-invertibility should not be thought of as an ``either/or'' proposition even when a model has a non-invertibility, the wedge between VAR innovations and economic shocks may be small, and structural VARs may nonetheless perform reliably. As an increasingly popular example, so-called ``news shocks'' generate foresight about changes in future fundamentals such as productivity, taxes, or government spending and lead to an unassailable missing state variable problem and hence non-invertible VAR representatations. Simulation evidence from a medium scale DSGE model augmented with news shocks about future productivity reveals that structural VAR methods often perform well in practice, in spite of a known non-invertibility. Impulse responses obtained from VARs closely correspond to the theoretical responses from the model, and the estimated VAR responses are successful in discriminating between alternative, nested specifications of the underlying DSGE model. Since the non-invertibility problem is, at its core, one of missing information, conditioning on more information, for example through factor augmented VARs, is shown to either ameliorate oreliminate invertibility problems altogether.
    Keywords: DSGE, VAR, News shocks
    JEL: E C2
    Date: 2012–06
  17. By: Marco Del Negro; Marc Giannoni; Christina Patterson
    Abstract: With short-term interest rates at the zero lower bound, forward guidance has become a key tool for central bankers, and yet we know little about its effectiveness. Standard medium-scale DSGE models tend to grossly overestimate the impact of forward guidance on the macroeconomy—a phenomenon we call the “forward guidance puzzle.” We explain why this is the case and describe one approach to addressing this issue.
    Keywords: Banks and banking, Central ; Interest rates ; Federal Open Market Committee ; Stochastic analysis ; Equilibrium (Economics) ; Monetary policy
    Date: 2012
  18. By: Günter Coenen (European Central Bank); Roland Straub (European Central Bank); Mathias Trabandt (Board of Governors of the Federal Reserve System)
    Abstract: We seek to quantify the impact on euro area GDP of the European Economic Recovery Plan (EERP) enacted in response to the financial crisis of 2008-09. To do so, we estimate an extended version of the ECB’s New Area-Wide Model with a richly specified fiscal sector. The estimation results point to the existence of important complementarities between private and government consumption and, to a lesser extent, between private and public capital. We first examine the implied present-value multipliers for seven distinct fiscal instruments and show that the estimated complementarities result in fiscal multipliers larger than one for government consumption and investment. We highlight the importance of monetary accommodation for these findings. We then show that the EERP, if implemented as initially enacted, had a sizeable, although short-lived impact on euro area GDP. Since the EERP comprised both revenue and expenditurebased fiscal stimulus measures, the total multiplier is below unity. JEL Classification: C11, E32, E62
    Keywords: Fiscal policy, fiscal multiplier, European Economic Recovery Plan, DSGE modelling, Bayesian inference, euro area
    Date: 2012–10
  19. By: Xavier Mateos-Planas (Queen Mary University of London); David Benjamin (SUNY Buffalo)
    Abstract: This paper studies informal default in consumer credit as the start of a process of negotiation with the lender. We consider an economy with uninsurable individual risk where households in debt have also the option of declaring formal bankruptcy. In a calibrated version of the model, informal defaulters are notably wealthier, have lower income, and hold more debt than formal defaulters, an implication consistent with the evidence. Quick settlements are achieved often, with limited discounts. Protracted negotiations feature individuals disaving before they reach agreement or declare bankruptcy. Allowing for negotiations raises default rates but substantially improves welfare as it provides greater insurance opportunities. Thus lowering the cost of informal default, as opposed to that of formal default, raises welfare and dampens consumption volatility. A tighter exemption improves welfare as the bargaining option mitigates the adverse effect on insurance via formal bankruptcy. Attempts at limiting collection outside bankruptcy reduce the incidence of bankruptcy but lower overall welfare.
    Date: 2012
  20. By: Joseph Vavra (University of Chicago); David Berger (Yale University)
    Abstract: Business cycle models typically abstract from the distinction between durable and non-durable consumption. However, in the 2007 recession, durable expenditures fell by three times as much as GDP while non-durable expenditures fell by slightly less than GDP. We show that simple extensions of business cycle models (both with and without complete markets) that assume frictionless durable adjustment are no more successful at matching the behavior of consumption, as they imply a decline in durable expenditures that is too large and a decline in non-durable expenditures that is too small, relative to the recession. Motivated by micro evidence, we introduce fixed costs of durable adjustment into the incomplete markets model and show that the model is able to match the behavior of consumption in the most recent recession. Fixed costs dampen the volatility of durable expenditures and amplify the volatility of non-durable expenditures, as a large fraction of households hold wealth in illiquid durables. In addition, the model implies non-linear dynamics that are in line with time-series data: durable expenditures respond more strongly to shocks during booms than during recessions. Finally, we provide additional evidence that supports our model: using micro panel data we show that households with a large fraction of wealth in durables are less able to insure against income shocks.
    Date: 2012
  21. By: Lance Lochner (University of Western Ontario); Elizabeth Caucutt (University of Western Ontario)
    Abstract: This paper investigates the importance of family borrowing constraints in determining human capital investments in children at early and late ages. We begin by providing new empirical evidence that suggests binding borrowing constraints among at least some families with young children. Next, we develop an intergenerational model of lifecycle human capital accumulation to study the role of early versus late investments in children. We analytically show that when early and late investments are sufficiently complementary in the production of human capital, binding borrowing constraints during either period reduce both early and late investments. We use data from the Children of the NLSY, NLSY, and CPS to calibrate our dynastic model. Our calibrated steady state suggests that about 40% of young parents and 30% of old parents are borrowing constrained, while older children are unconstrained. We also find strong complementarity between early and late investments, suggesting that policies targeted to one stage of development tend to have similar effects on investment in the other stage. We use this calibrated model to study the effects of education subsidies, loans and transfers offered at different ages on early and late human capital investments and subsequent earnings in the short-run and long-run.
    Date: 2012
  22. By: Gaël Giraud (Centre d'Economie de la Sorbonne - Paris School of Economics); Antonin Pottier (CIRED)
    Abstract: This paper examines quantity-targeting monetary policy in a two-period economy with fiat money, endogenously incomplete markets of financial securities, durable goods and production. Short positions in financial assets and long-term loans are backed by collateral, the value of which depends on monetary policy. The decision to default is endogenous and depends on the relative value of the collateral to the loan. We show that Collateral Monetary Equilibria exist and prove there is also a refinement of the Quantity Theory of Money that turns out to be compatible with the long-run non-neutrality of money. Moreover, only three scenarios are compatible with the equilibrium condition : 1) either the economy enters a liquidity trap in the first period ; 2) or a credible ex-pansionary monetary policy accompanies the orderly functioning of markets at the cost of running an inflationary risk ; 3) else the money injected by the Central Bank increases the leverage of indebted investors, fueling a financial bubble whose bursting leads to debt-deflation in the next period with a non-zero probability. This dilemma of monetary policy highlights the default channel affecting trades and production, and provides a rigorous foundation to Fisher’s debt deflation theory as being distinct from Keynes’ liquidity trap.
    Keywords: Central Bank, liquidity trap, collateral, default, deflation, quantitative easing, debt-deflation.
    JEL: D50 E40 E44 E50 E52 E58 G38 H50
    Date: 2012–10
  23. By: MASTERS, ADRIAN; MUTHOO, ABHINAY (Department of Economics, University of Warwick)
    Abstract: This paper studies a dynamic model of a market such as a labour market in which firms post wages and search for workers but trade may occur at a negotiated wage procedure in markets characterized by match-specific heterogeneity. We study a model of a market in which, in each time period, agents on one side (e.g., sellers) choose whether or not to post a price before they encounter agents of the opposite type. After a pair of agents have encountered each other, their match-specific values from trading with each other are realized. If a price was not posted, then the terms of trade (and whether or not it occurs) are determined by bargaining. Otherwise, depending upon the agents’ match-specific trading values, trade occurs (if it does) either on the posted price or at a renegotiated price. We analyze the symmetric Markov subgame perfect equilibria of this market game, and address a variety of issues such as the impact of market frictions on the equilibrium proportion of trades that occur at a posted price rather than at a negotiated price.
    Keywords: Match-specific heterogeneity ; Ex-ante Price Posting ; Ex-Post Mutually Beneficial Renegotiation ; Markov Subgame Perfect Equilibrium.
    Date: 2012
  24. By: Costas Azariadis; Leo Kaas
    Abstract: We propose a sectoral–shift theory of aggregate factor productivity for a class of economies with AK technologies, limited loan enforcement, and a constant production possibilities frontier. Both the growth rate and TFP respond to random and persistent endogenous fluctuations in the sectoral distribution of physical capital which, in turn, responds to reversible exogenous shifts in relative sector productivities. Surplus capital from less productive sectors is lent to more productive ones in the form of secured collateral loans, as in Kiyotaki–Moore (1997), and also as unsecured reputational loans suggested in Bulow–Rogoff (1989). Endogenous debt limits slow down capital reallocation, preventing the equalization of risk–adjusted equity yields across sectors. Economy–wide factor productivity and the aggregate growth rate are both negatively correlated with the dispersion of sectoral rates of return, sectoral TFP and sectoral growth rates. We also find highly volatile limit cycles in economies with small amounts of collateral.
    Keywords: Productivity ; Economic growth
    Date: 2012
  25. By: John Bailey Jones; Fang Yang
    Abstract: We document the growth in higher education costs and tuition over the past 50 years. To explain these trends, we develop a general equilibrium model with skill- and sector-biased technical change. We assume that higher education suffers from Baumol's (1967) service sector disease, in that the quantity of labor and capital needed to educate a student is constant over time. Finding the model's parameters through a combination of calibration and estimation, we show that it can explain the rise in college costs between 1961 and 2009, along with the increase in college attainment and the increase in the relative earnings of college graduates. We finish by using the model to perform a number of numerical experiments.
    Date: 2012
  26. By: Benjamin Carton
    Abstract: We propose a two-country DSGE model to analyze short-term and long-term impact of a modification of consumption and labor tax rate in one country in a currency union. The model embodies the fact that firms differ in their pricing behavior after a VAT tax increase. Due to the common monetary policy, national tax policies have large spill-overs on the rest of the currency union. Furthermore, a fiscal devaluation is different from a nominal devaluation due to the common monetary policy.
    Keywords: Fiscal Policy;Monetary Policy;DSGE;Value Added Tax;Monetary Union
    JEL: C12
    Date: 2012–10
  27. By: Kartik Athreya; Juan M. Sánchez; Xuan S. Tam; Eric R. Young
    Abstract: Limited commitment for the repayment of consumer debt originates from two places: (i) formal bankruptcy laws granting a partial or complete legal removal of debts under certain circumstances, and (ii) informal default and renegotiation, “delinquency.” In the US, both channels are used routinely. The usefulness of each of these routes as a way out of debt depends on the costs and benefits available through the other: delinquency exposes a household to collections processes initiated by lenders, while formal bankruptcy appears to carry more visible consequences for future transactions, including restrictions to even secured forms of credit. This paper introduces a model of unsecured consumer credit markets in the presence of both bankruptcy and delinquency. A key feature of our model is to allow lenders to deal with debtors in delinquency by choosing the (implicit) interest rate on debt owed by delinquent borrowers to maximize the market value of these obligations. We show that these two options to default on unsecured debt indeed interact in important ways. We first show that households with a large amount of debt who have received negative income shocks prefer delinquency. As long as their income does not improve, they remain there. This behavior occurs as lenders’ optimal behavior is to offer write-offs to households in delinquency, but only when they have very low incomes. As income improves, lenders can extract more from the households that stay delinquent, so the households look to reorganize their financial situation by either repaying the debt or filing for bankruptcy. We also show that stricter control of delinquency, defined by a relatively high ability to garnish wages, increases the risk of bankruptcy and lowers equilibrium credit use, in line with cross-state comparisons in the U.S. From a normative perspective, such policies lower welfare, in part because they encourage excessive use of bankruptcy.
    Keywords: Debt ; Bankruptcy ; Finance, Personal
    Date: 2012
  28. By: Rossana MEROLA (OECD, Economics Department and Université Catholique de Louvain)
    Abstract: Recent developments in many industrialized countries have triggered a debate on whether monetary policy is effective when the nominal interest rate is close to zero. When the nominal interest rate hits its lower bound, the monetary authority is no longer in a position to pursue a policy of monetary easing by lowering nominal interest rates further. In this paper, I assess the implications of the zero lower bound in a DSGE model with financial frictions. The analysis shows that in a framework with financial frictions, when the interest rate is at the lower bound, the initial impact of a negative shock is amplified and the economy is more likely to plunge into a recession. I assess whether different macro policies, such as the management of expectations by the central bank or a counter-cyclical fiscal stimulus, may help recover the economy from the recession. I find that the monetary authority might alleviate the recession by targeting the price-level. Fiscal stimulus represents an alternative solution especially when the zero lower bound constraint becomes binding, as fiscal multipliers may become larger than one. In analyzing discretionary fiscal policy, this paper also focuses on two crucial aspects: the duration of the fiscal stimulus and the presence of implementation lags.
    Keywords: Optimal monetary policy, financial accelerator, lower bound on nominal interest rates, price-level targeting, fiscal stimulus
    JEL: E31 E44 E52 E58
    Date: 2012–10–30
  29. By: Junko Doi (Faculty of Economics, Kansai University, Japan); Laixun Zhao (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan)
    Abstract: Almost all existing literature assumes immigrants immediately assimilate in the receiving country. In contrast, the present paper considers the case of non-immidiate assimilation, and analyzes immigration conflicts in an overlapping generations dynamic system. We examine three types of conflicts that arise when immigrants come in: skill conflicts that affect the capital rental and also cause the wage gap to change between skilled and unskilled workers; intergenerational conflicts that lead to different impacts on the young and old generations; and distributional conflicts that affect each generation's life time utility unequally. The degree of substitution between natives and immigrants in production plays a key role. We also analyze the welfare composition in detail generation by generation, and provide policy recommendation for each case.
    Keywords: Immigration, Overlapping generations, Inequality
    JEL: F22
    Date: 2012–10
  30. By: Sifis Kafkalas (University of Crete); Pantelis Kalaitzidakis (Dept of Economics, University of Crete, Greece); Vangelis Tzouvelekas (Department of Economics, University of Crete, Greece)
    Abstract: This paper analyzes the relationship between tax evasion and the two main policy instruments affecting evasion rates, namely, the announced tax rate and the share of tax revenues allocated to tax monitoring mechanisms. For doing so, we adopt a simple one-sector endogenous growth model modified under tax evasion following Roubini and Sala-i-Martin (1993) analysis on income taxes and tax evasion. Our model confirms Barro�s (1990) theoretical finding stating that the optimal tax rate is equal to the elasticity of private capital. However, when tax evasion matters to the social welfare, the effective tax rate is lower than the output elasticity in line with Futagami et al., (1993) and Turnovsky (1997) theoretical results. Our model is then calibrated using data from 145 developed and developing countries for 2011. Simulation results suggest that both tax evasion and output growth are decreasing with the share of tax revenues allocated to monitoring expenses, while welfare maximizing policies imply an announced tax rate lower from the elasticity of public capital and a share of monitoring expenses around 6.0%.
    Keywords: tax evasion, tax monitoring, effective tax rate, social loss.
    JEL: H21 H26 H54
    Date: 2012–04–26
  31. By: Nina Boyarchenko
    Abstract: This paper considers the problem of information acquisition in an intermediated market, where the specialists have access to superior technology for acquiring information. These informational advantages of specialists relative to households lead to disagreement between the two groups, changing the shape of the intermediation-constrained region of the economy and increasing the frequency of periods when the intermediation constraint binds. Acquiring the additional information is, however, costly to the specialists, making them less likely to decrease their risky asset holdings when the intermediation constraint binds. I show that this behavior leads the equity capital constraint to bind more frequently, making asset prices in the economy more volatile. I find empirical evidence consistent with these predictions.
    Keywords: Information theory ; Information technology ; Technology - Economic aspects ; Assets (Accounting) ; Households - Economic aspects ; Intermediation (Finance)
    Date: 2012
  32. By: Kristoffer Nimark (CREI)
    Abstract: The newsworthiness of an event is partly determined by how unusual it is and this paper investigates the business cycle implications of this fact. We present a tractable model that features an information structure in which some types of signals are more likely to be observed after unusual events. Counterintuitively, more signals may then increase uncertainty. When embedded in a simple business cycle model, the proposed information structure can help us understand why we observe (i) large changes in macro economic aggregate variables without a correspondingly large change in underlying fundamentals (ii) persistent periods of high macroeconomic volatility and (iii) a positive correlation between absolute changes in macro variables and the cross-sectional dispersion of expectations as measured by survey data. These results are consequences of optimal updating by agents when the availability of some signals is positively correlated with tail-events. The model is estimated by likelihood based methods using raw survey data and a quarterly time series of total factor productivity along with standard aggregate time series. The estimated model suggests that there have been episodes in recent US history when the impact on output of innovations to productivity of a given magnitude were up to twice as large compared to normal times.
    Date: 2012
  33. By: Vladislav Damjanovic (Department of Economics, University of Exeter)
    Abstract: We consider a model of financial intermediation with a monopolistic competition market structure. A non-monotonic relationship between the risk measured as a probability of default and the degree of competition is established.
    Keywords: Competition and Risk, Risk in DSGE models, Bank competition; Bank failure, Default correlation, Risk-shifting effect, Margin effect.
    JEL: G21 G24 D43 E13 E43
    Date: 2012
  34. By: Jeffrey R. Campbell; Charles Evans; Jonas D. M. Fisher; Alejandro Justiniano
    Abstract: A large output gap accompanied by stable inflation close to its target calls for further monetary accommodation, but the zero lower bound on interest rates has robbed the Federal Open Market Committee (FOMC) of the usual tool for its provision. We examine how public statements of FOMC intentions—forward guidance—can substitute for lower rates at the zero bound. We distinguish between Odyssean forward guidance, which publicly commits the FOMC to a future action, and Delphic forward guidance, which merely forecasts macroeconomic performance and likely monetary policy actions. Others have shown how forward guidance that commits the central bank to keeping rates at zero for longer than conditions would otherwise warrant can provide monetary easing, if the public trusts it. ; We empirically characterize the responses of asset prices and private macroeconomic forecasts to FOMC forward guidance, both before and since the recent financial crisis. Our results show that the FOMC has extensive experience successfully telegraphing its intended adjustments to evolving conditions, so communication difficulties do not present an insurmountable barrier to Odyssean forward guidance. Using an estimated dynamic stochastic general equilibrium model, we investigate how pairing such guidance with bright-line rules for launching rate increases can mitigate risks to the Federal Reserve’s price stability mandate.
    Keywords: Macroeconomics - Econometric models ; Monetary policy ; Federal Reserve banks
    Date: 2012
  35. By: Barthélemy, J.; Marx, M.
    Abstract: In this paper, we provide determinacy conditions, i.e. conditions ensuring the existence and uniqueness of a bounded solution, in a purely forward-looking linear Markov switching rational expectations model. We thus settle the debate between Davig and Leeper (2007) and Farmer et al. (2010). The conditions derived by the former are valid in a subset of bounded solutions only depending on a finite number of past regimes, that we call Markovian. However, in the complete bounded solution space, the new determinacy conditions we derive are tighter. Nevertheless, when unique, the solution coincides with the Markovian solution of Davig and Leeper (2007). We finally illustrate our results in the standard new-Keynesian model studied by Davig and Leeper (2007) and Farmer et al. (2010).
    Keywords: Markov switching, DSGE, indeterminacy.
    JEL: E31 E43 E52
    Date: 2012
  36. By: Ruediger Bachmann (RTWH University Aachen); Jinhui Bai (Georgetown University)
    Abstract: Technical appendix for the Review of Economic Dynamics article that develops and alternative interpretation of the model.
    Date: 2012
  37. By: Sebastian Dyrda; Jose-Victor Rios-Rull
    Abstract: In this note, we demonstrate and analyze the inability of standard neoclassical models to generate accurate estimates of the fiscal multiplier (that is, the macroeconomic response to increased government spending). We then examine whether estimates can be improved by incorporating recently developed theory on demand-induced productivity increases into neoclassical models. We find that neoclassical models modified in this fashion produce considerably better estimates, but they remain unable to generate anything close to an accurate value of the fiscal multiplier.
    Date: 2012
  38. By: Jeff Thurk (University of Notre Dame)
    Abstract: We ask whether incorporating product quality differentiation has real effects on trade flows and welfare. We develop and calibrate a multi-country, general equilibrium model of international trade that includes endogenous product quality differentiation amongst heterogeneous firms. Separable transportation and ad valorem trade costs as in Hummels and Skiba (2004) creates a mechanism for product quality to have real effects. The model provides a framework to quantify the effects of quality dierentiation on trade flows and welfare in response to a trade liberalization. We find that this channel amplifies the effects of trade liberalization on welfare and exports by 46% and 34%, respectively. Roughly 80% of these effects are driven by liberalization of tariffs rather than transport or fixed export costs.
    Date: 2012
  39. By: Matteo Maggiori (UC Berkeley)
    Abstract: I provide a framework for understanding the global financial architecture as an equilibrium outcome of the risk sharing between countries with different levels of financial development. The country that has the most developed financial sector takes on a larger proportion of global fundamental and financial risk because its financial intermediaries are better able to deal with funding problems following negative shocks. This asymmetric risk sharing has real consequences. In good times, and in the long run, the more financially developed country consumes more, relative to other countries, and runs a trade deficit financed by the higher financial income that it earns as compensation for taking greater risk. During global crises, it suffers heavier capital losses than other countries, exacerbating its fall in consumption. This country's currency emerges as the world's reserve currency because it appreciates during crises and so provides a good hedge. The model is able to rationalize these facts, which characterize the role of the US as the key country in the global financial architecture.
    Date: 2012
  40. By: Dimitri Vayanos (London School of Economics); Denis Gromb (INSEAD)
    Abstract: We propose a continuous time infinite horizon equilibrium model of financial markets in which arbitrageurs have multiple valuable investment opportunities but face financial constraints. The investment opportunities, heterogeneous along different dimensions, are provided by pairs of similar assets trading at different prices in segmented markets. By exploiting these opportunities, arbitrageurs alleviate the segmentation of markets, providing liquidity to other investors by intermediating their trades. We characterize the arbitrageurs' optimal investment policy, and derive implications for market liquidity and asset prices. We show that liquidity is smallest, volatility is largest, correlations between asset pairs with uncorrelated fundamentals are largest, and correlations between asset pairs with highly correlated fundamentals are smallest for intermediate levels of arbitrageur wealth.
    Date: 2012
  41. By: Kenneth L. Judd; Lilia Maliar; Serguei Maliar
    Abstract: We introduce an algorithm for solving dynamic economic models that merges stochastic simulation and projection approaches: we use simulation to approximate the ergodic measure of the solution, we construct a fixed grid covering the support of the constructed ergodic measure, and we use projection techniques to accurately solve the model on that grid. The grid construction is the key novel piece of our analysis: we select an ε-distinguishable subset of simulated points that covers the support of the ergodic measure roughly uniformly. The proposed algorithm is tractable in problems with high dimensionality (hundreds of state variables) on a desktop computer. As an illustration, we solve one- and multicountry neoclassical growth models and a large-scale new Keynesian model with a zero lower bound on nominal interest rates.
    JEL: C61 C63
    Date: 2012–11
  42. By: Costantini, Mauro (Department of Economics and Finance, Brunel University London, United Kingdom); Gunter, Ulrich (Austrian National Bank, Vienna, Austria); Kunst, Robert M. (Department of Economics and Finance, Institute for Advanced Studies, Vienna, Austria and Department of Economics, University of Vienna, Austria)
    Abstract: We study the benefits of forecast combinations based on forecast-encompassing tests relative to uniformly weighted forecast averages across rival models. For a realistic simulation design, we generate multivariate time-series samples of size 40 to 200 from a macroeconomic DSGE-VAR model. Constituent forecasts of the combinations are formed from four linear autoregressive specifications, one of them a more sophisticated factor-augmented vector autoregression (FAVAR). The forecaster is assumed not to know the true data-generating model. Results depend on the prediction horizon. While one-step prediction fails to support test-based combinations at all sample sizes, the test-based procedure clearly dominates at prediction horizons greater than two.
    Keywords: Combining forecasts, encompassing tests, model selection, time series, DGSE-VAR model
    JEL: C15 C32 C53
    Date: 2012–10

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