nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2012‒12‒06
twenty papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Job Search, Human Capital and Wage Inequality By Carrillo-Tudela, Carlos
  2. The Empirical Implications of the Interest-Rate Lower Bound By Gust, Christopher; López-Salido, J David; Smith, Matthew E
  3. Appendix: Business Cycle Implications of Internal Consumption Habit for New Keynesian Models By Kano, Takashi; Nason, James M.
  4. Endogenous Growth and Sustainable Tourism By Fabio Cerina
  5. Optimal Policy for Macro-Financial Stability By Benigno, Gianluca; Chen, Huigang; Otrok, Christopher; Rebucci, Alessandro; Young, Eric R
  6. Loss Aversion and the Asymmetric Transmission of Monetary Policy By Edoardo Gaffeo; Ivan Petrella; Damjan Pfajfar; Emiliano Santoro
  7. Managing Financial Crises: Lean or Clean? By Mitsuru Katagiri; Ryo Kato; Takayuki Tsuruga
  8. The Making Of A Great Contraction With A Liquidity Trap and A Jobless Recovery By Stephanie Schmitt-Grohé; Martín Uribe
  9. Technological Opportunity, Long-Run Growth, and Convergence By Jakub Growiec; Ingmar Schumacher
  10. The Optimal Carbon Tax and Economic Growth: Additive versus Multiplicative Damages By Armon Rezai; Frederick van der Ploeg; Cees Withagen
  11. On deficit bias and immigration By Ben-Gad, M.
  12. Fiscal Rules and Discretion under Persistent Shocks By Marina Halac; Pierre Yared
  13. The Farm, the City, and the Emergence of Social Security By Elizabeth M. Caucutt; Thomas F. Cooley; Nezih Guner
  14. Elementary Results on Solutions to the Bellman Equation of Dynamic Programming: Existence, Uniqueness, and Convergence By Takashi Kamihigashi
  15. Learning How to Export By Paul S. Segerstrom; Ignat Stepanok
  16. Technical Appendix to "Business Cycle Accounting East and West: Asian Finance and the Investment Wedge By Dooyeon Cho; Antonio Doblas-Madrid
  17. Dynamic Programming with Hermite Approximation By Yongyang Cai; Kenneth L. Judd
  18. Use Less, Pay More: Can Climate Policy Address the Unfortunate Event for Being Poor? By Lucas Bretschger; Nujin Suphaphiphat
  19. Technology and the Changing Family: A Unified Model of Marriage, Divorce, Educational Attainment and Married Female Labor-Force Participation By Jeremy Greenwood; Nezih Guner; Georgi Kocharkov; Cezar Santos
  20. Technical Appendix to "Quantitative Analysis of Health Insurance Reform: Separating Regulation from Redistribution" By Svetlana Pashchenko; Ponpoje Porapakkarm

  1. By: Carrillo-Tudela, Carlos
    Abstract: This paper constructs and quantitatively assesses an equilibrium search model with on-the- job search and general human capital accumulation. In the model workers differ in their innate abilities and firms in their productivities. Wages are dispersed because of search frictions and workers productivity differentials. Using the (log) wage variance decomposition implied by the model I show that wage inequality among low skilled workers is mostly driven by differ- ences in their productivities. Among medium skilled workers, productivity differentials and search frictions are equally important. The model reproduces the observed cross-sectional wage distribution, the average wage-experience profile and the observed Mean-min ratio.
    Date: 2012–10–22
  2. By: Gust, Christopher; López-Salido, J David; Smith, Matthew E
    Abstract: Using Bayesian methods, we estimate a nonlinear DSGE model in which the interest-rate lower bound is occasionally binding. We quantify the size and nature of disturbances that pushed the U.S. economy to the lower bound in late 2008 as well as the contribution of the lower bound constraint to the resulting economic slump. Compared with the hypothetical situation in which monetary policy can act in an unconstrained fashion, our estimates imply that U.S. output was more than 1 percent lower, on average, over the 2009{2011 period. Moreover, around 20 percent of the drop in U.S. GDP during the recession of 2008-2009 was due to the interest-rate lower bound. We show that the estimated model is capable of generating lower bound episodes that resemble salient characteristics of the observed U.S. episode, including its expected duration.
    Keywords: Bayesian estimation; DSGE model; zero lower bound
    JEL: C11 C32 E32 E52
    Date: 2012–11
  3. By: Kano, Takashi; Nason, James M.
    Abstract: The appendix discusses computational aspects of the paper “Business Cycle Implications of Internal Consumption Habit for New Keynesian Models.” These topics range from solving the baseline new Keynesian dynamic stochastic general equilibrium (NKDSGE) model, estimating the structural infinite-order vector moving averages, checking whether these models recover the fundamental shocks, to computing the permanent and transitory output and consumption growth spectral densities. More evidence about the fit of the NKDSGE models is also reviewed. The NKDSGE models are evaluated using alternative priors, and modification of the VARs generating the posterior distributions, and a different goodness of fit statistic. These evaluations reflect the robustness of the evidence about NKDSGE model fit reported in “Business Cycle Implications of Internal Consumption Habit for New Keynesian Models.”
    Date: 2012–11
  4. By: Fabio Cerina
    Abstract: I build a dynamic general equilibrium model of a small economy specialized in tourism where visitors are attracted by the stock of existing environmental assets, and the stock of tourism and leisure facilities. Residents, at any date, choose the level of consumption, the number of visitors, and the quantity of resources to be devoted to abatement of pollution, the latter being generated by the existing stock of tourism facilities and by the flow of tourists. I analyze the balanced growth path properties of this economy, and focus on the sensitiveness of its qualitative dynamic behaviour, according to different subsets in the parameters space. The model is able to perform both endogenous growth and sustainability of the environmental resource. We analyse the condition for this result to hold and we find that when tourists preferences are greener (i.e. they care for environmental quality and they are crowding-adverse), the economy generally grows faster. Finally, we develop the transitional dynamics analysis in the case of constant environmental quality in the long-run. Given its generality and flexibility, we believe our model may serve as a workhorse model suitable to be used as an instrument to perform for many relevant policy exercises.
    Keywords: Growth; Tourism Specialization; Tourism Facilities; Environmental Assets; Pollution Abatement; Transitional Dynamics
    JEL: Q56 O41 L83
    Date: 2012
  5. By: Benigno, Gianluca; Chen, Huigang; Otrok, Christopher; Rebucci, Alessandro; Young, Eric R
    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: Bailouts; Capital Controls; Exchange Rate Policy; Financial Crises; Financial Frictions; Macro-Financial Stability; Macro-Prudential Policies
    JEL: E52 F37 F41
    Date: 2012–11
  6. By: Edoardo Gaffeo (University of Trento); Ivan Petrella (Birkbeck, University of London); Damjan Pfajfar (University of Tilburg); Emiliano Santoro (Catholic University of Milan and University of Copenhagen)
    Abstract: There is widespread evidence that monetary policy exerts asymmetric effects on output over contractions and expansions in economic activity, while price responses display no sizeable asymmetry. To rationalize these facts we develop a dynamic general equilibrium model where households' utility depends on consumption deviations from a reference level below which loss aversion is displayed. In line with the prospect theory pioneered by Kahneman and Tversky (1979), losses in consumption loom larger than gains. State-dependent degrees of real rigidity and elasticity of intertemporal substitution in consumption generate competing effects on output and infl?ation. The resulting state-dependent trade-off between output and infl?ation stabilization recommends stronger policy activism towards in?flation during expansions
    Keywords: Asymmetry, Monetary Policy, Business Cycle, Prospect Theory
    JEL: E32 E42 E52 D03 D11
    Date: 2012–07–16
  7. By: Mitsuru Katagiri (Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:; Ryo Kato (Director, Institute for Monetary and Economic Studies (currently, Research and Statistics Department), Bank of Japan (E-mail:; Takayuki Tsuruga (Associate Professor, Graduate School of Economics, Kyoto University, (E-mail:
    Abstract: This paper discusses the lean vs. clean policy debate in managing financial crises based on dynamic general equilibrium models with an occasionally binding collateral constraint. We show that a full state-contingent subsidy for debtors can restore the first-best allocations by forestalling disorderly deleveraging in a crisis. While this result appears to favor the clean policy against a lean policy that achieves the second-best allocation, further assessment points to various risks associated with the clean policy from a practical viewpoint. First, the optimal clean policy is likely to call for an unrealistically large amount of fiscal resources. Second, if the clean policy is activated with an empirically realistic intervention, the less-than-optimal clean policy incentivizes debtors to take on undue risks, exposing the economy to higher crisis probabilities. Finally, the less-than-optimal clean policy may give rise to huge welfare losses due to the policy maker's misrecognition of the state of the economy.
    Keywords: Financial Crisis, Credit Externalities, Bailout, Macroprudential Policy
    JEL: E32 G01 G18
    Date: 2012–11
  8. By: Stephanie Schmitt-Grohé; Martín Uribe
    Abstract: The great contraction of 2008 pushed the U.S. economy into a protracted liquidity trap (i.e., a long period with zero nominal interest rates and inflationary expectations below target). In addition, the recovery was jobless (i.e., output growth recovered but unemployment lingered). This paper presents a model that captures these three facts. The key elements of the model are downward nominal wage rigidity, a Taylor-type interest-rate feedback rule, the zero bound on nominal rates, and a confidence shock. Lack-of-confidence shocks play a central role in generating jobless recoveries, for fundamental shocks, such as disturbances to the natural rate, are shown to generate recessions featuring recoveries with job growth. The paper considers a monetary policy that can lift the economy out of the slump. Specifically, it shows that raising the nominal interest rate to its intended target for an extended period of time, rather than exacerbating the recession as conventional wisdom would have it, can boost inflationary expectations and thereby foster employment.
    JEL: E24 E31 E32 E52
    Date: 2012–11
  9. By: Jakub Growiec (Warsaw School of Economics - Institut of Econometrics); Ingmar Schumacher (Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X)
    Abstract: We derive a R&D-based growth model where the rate of technological progress depends, inter alia, on the amount of technological opportunity. Incremental innovations provide direct increases to the knowledge stock but they reduce technological opportunity and thus the potential for further improvements. Technological opportunity is renewed by radical innovations, which have no direct impact on factor productivity. We study both the market equilibrium and the social planner allocation in this economy. Investigating the model for its implications on economic growth we find: (i) in the long run, a balanced growth path requires that the returns to radical innovations are at least as large as those of the incremental ones; (ii) the transition need not be monotonic. We show under which conditions our model generates endogenous cycles via complex dynamics without resorting to uncertainty; (iii) the calibrated model exhibits substantial quantitative differences between the market outcome and the social planner allocation.
    Date: 2012–11–19
  10. By: Armon Rezai; Frederick van der Ploeg; Cees Withagen
    Abstract: In a calibrated integrated assessment model we investigate the differential impact of additive and multiplicative damages from climate change for both a socially optimal and a business-as-usual scenario in the market economy within the context of a Ramsey model of economic growth. The sources of energy are fossil fuel which is available at a cost which rises as reserves diminish and a carbon-free backstop supplied at a decreasing cost. If damages are not proportional to aggregate production output, and the economy is along a development path, the social cost of carbon and the optimal carbon tax are smaller as damages can more easily be compensated for by higher output. As a result, the economy switches later from fossil fuelto the carbon-free backstop and leaves less fossil fuel in situ. This is in contrast to a partial equilibrium analysis with damages in utility rather than in production which finds that the willingness to forsake current consumption to avoid future global warming is higher (lower) under additive damages in a growing economy if the elasticity of intertemporal substitution is smaller (bigger) than one.
    Keywords: climate change, multiplicative damages, additive damages, integrated assessment models, Ramsey growth model, fossil fuel, carbon-free backstop
    JEL: H21 Q51 Q54
    Date: 2012–09–10
  11. By: Ben-Gad, M.
    Abstract: How much can governments shift the cost of government expenditure from today’s voters to tomorrow’s generations of immigrants, without resorting to taxation that is explicitly discriminatory? I demonstrate that if their societies are absorbing continuous flows of new immigrants, we should expect governments that represent the interests of today’s population, even if that population is altruistically linked to future generations, to choose policies that shift some portion of the tax burden to the future. This bias in favor of deficit finance is not infinite. Today’s population or their descendents, together with future immigrants, ultimately pay the higher taxes necessary to finance the accumulated debt, and live with the additional excess burdens these higher taxes generate. For a given rate of immigration and policy horizon, governments balance the deadweight losses associated with fluctuating tax rates against the benefits that accrue to the initial resident population from shifting part of the burden of financing government expenditure to future immigrant families. To measure the deficit bias, I analyse the dynamic behavior of an optimal growth model with overlapping dynasties and factor taxation, calibrated for the US economy. Models with overlapping infinite-lived dynasties allow for a very clear distinction between natural population growth (an increase in the size of existing dynasties) and immigration (the addition of new dynasties). They also provide an alternative to the strict dichotomy between models with overlapping generations, where agents disregard the impact of their choices on future generations, and the quasi-Ricardian world of infinite-lived dynasties with representative agents that fully participate in both the economy and the political system in every period. The trajectory of the debt burden predicted by the model is a good match for the rise in US Federal government debt since the early 1980’s, as well as the increases in debt projected by the Congressional Budget Office over the next few decades.
    Keywords: immigration; fiscal policy; public debt
    Date: 2012
  12. By: Marina Halac; Pierre Yared
    Abstract: This paper studies the optimal level of discretion in policymaking. We consider a fiscal policy model where the government has time-inconsistent preferences with a present-bias towards public spending. The government chooses a fiscal rule to trade off its desire to commit to not overspend against its desire to have flexibility to react to privately observed shocks to the value of spending. We analyze the optimal fiscal rule when the shocks are persistent. Unlike under i.i.d. shocks, we show that the ex-ante optimal rule is not sequentially optimal, as it provides dynamic incentives. The ex-ante optimal rule exhibits history dependence, with high shocks leading to an erosion of future fiscal discipline compared to low shocks, which lead to the reinstatement of discipline. The implied policy distortions oscillate over time given a sequence of high shocks, and can force the government to accumulate maximal debt and become immiserated in the long run.
    JEL: D02 D82 E6 H1 P16
    Date: 2012–11
  13. By: Elizabeth M. Caucutt; Thomas F. Cooley; Nezih Guner
    Abstract: We study the social, demographic and economic origins of social security. The data for the U.S. and for a cross section of countries suggest that urbanization and industrializa- tion are associated with the rise of social insurance. We describe an OLG model in which demographics, technology, and social security are linked together in a political economy equilibrium. In the model economy, there are two locations (sectors), the farm (agricul- tural) and the city (industrial) and the decision to migrate from rural to urban locations is endogenous and linked to productivity differences between the two locations and survival probabilities. Farmers rely on land inheritance for their old age and do not support a pay- as-you-go social security system. With structural change, people migrate to the city, the land loses its importance and support for social security arises. We show that a calibrated version of this economy, where social security taxes are determined by majority voting, is consistent with the historical transformation in the United States.
    Keywords: Social Security, Political Economy, Structural Change, Migration
    JEL: H55 H3 D72
    Date: 2012–11–19
  14. By: Takashi Kamihigashi (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan)
    Abstract: We establish some elementary results on solutions to the Bellman equation without introducing any topological assumption. Under a small number of conditions, we show that the Bellman equation has a unique solution in a certain set, that this solution is the value function, and that the value function can be computed by value iteration with an appropriate initial condition. We also show that the value function can be computed by the same procedure under alternative conditions. We apply our results to two optimal growth models, one with a discontinuous production function, the other with "roughly increasing" returns.
    Keywords: Dynamic programming, Bellman equation, Value function, Fixed point
    JEL: C61
    Date: 2012–11
  15. By: Paul S. Segerstrom; Ignat Stepanok
    Abstract: In this paper, we present a standard quality ladders endogenous growth model with one significant new assumption, that it takes time for firms to learn how to export. We show that this model without Melitz-type assumptions can account for all the evidence that the Melitz (2003) model was designed to explain plus much evidence that the Melitz model can not account for. In particular, consistent with the empirical evidence we find that trade liberalization leads to a higher exit rate of firms, that exporters charge higher prices for their products as well as higher markups, and that many large firms do not export. We also find that trade iberalization promotes economic growth and that it has the opposite effect of retarding economic growth in a closely comparable growth model with Melitz-type assumptions
    Keywords: Trade liberalization, heterogeneous firms, quality ladders, endogenous growth
    JEL: F12 F13 F43 O31 O41
    Date: 2012–10
  16. By: Dooyeon Cho (Korea Institute for International Economic Policy); Antonio Doblas-Madrid (Michigan State University)
    Abstract: Technical appendix for the Review of Economic Dynamics article
    Date: 2012
  17. By: Yongyang Cai; Kenneth L. Judd
    Abstract: Numerical dynamic programming algorithms typically use Lagrange data to approximate value functions over continuous states. Hermite data is easily obtained from solving the Bellman equation and can be used to approximate value functions. We illustrate this method with one-, three-, and six-dimensional examples. We find that value function iteration with Hermite approximation improves accuracy by one to three digits using little extra computing time. Moreover, Hermite approximation is significantly faster than Lagrange for the same accuracy, and this advantage increases with dimension.
    JEL: C61 C63
    Date: 2012–11
  18. By: Lucas Bretschger; Nujin Suphaphiphat
    Abstract: The paper develops a two-region endogenous growth model with climate change affecting the countries' capital stocks negatively. We compare two different policies aimed at supporting less developed countries: climate mitigation by rich countries, which diminishes the increase in stock pollution and hence capital depreciation, and income transfers in the tradition of development aid. Under a mild set of assumptions we find that active climate policies are more efficient for rich economies and also, remarkably, better for poor countries than additonial development aid. The main reason is the difference between the two policies with respect to their effects on economic growth. The results are robust with respect to possible model extensions.
    Keywords: Climate policy, development aid, endogenous growth, stock pollution
    JEL: O10 Q52 Q54
    Date: 2012–06
  19. By: Jeremy Greenwood (Department of Economics, University of Pennsylvania, USA); Nezih Guner (Universitat Autonoma de Barcelona and Barcelona GSE, Spain); Georgi Kocharkov (Department of Economics, University of Konstanz, Germany); Cezar Santos (Department of Economics, University of Mannheim, Germany)
    Abstract: Marriage has declined since 1960, with the drop being bigger for non-college educated individuals versus college educated ones. Divorce has increased, more so for the non-college educated vis-à-vis the college educated. Additionally, assortative mating has risen; i.e., people are more likely to marry someone of the same educational level today than in the past. A unified model of marriage, divorce, educational attainment and married female labor force participation is developed and estimated to fit the postwar U.S. data. The role of technological progress in the household sector and shifts in the wage structure for explaining these facts is gauged.
    Keywords: Assortative mating, education, married female labor supply, household production, marriage and divorce, minimum distance estimation
    JEL: E24 D31 J13 J17 J62
    Date: 2012–06–30
  20. By: Svetlana Pashchenko (Uppsala University); Ponpoje Porapakkarm (University of Macau)
    Abstract: Technical appendix for the Review of Economic Dynamics article
    Date: 2012

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