nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2013‒01‒19
sixteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. News and Financial Intermediation in Aggregate and Sectoral Fluctuations By Christoph Gortz; John D Tsoukalas
  2. Unemployment and Endogenous Reallocation over the Business Cycle By Carrillo-Tudela, Carlos; Visschers, Ludo
  3. When Do Inventories Destabilize the Economy? ---A Tractable Approach to (S,s) Policies By Zhiwei Xu; Yi Wen; pengfei Wang
  4. Default Risk and Economic Activity: A Small Open Economy Model with Sovereign Debt and Default By Jessica Roldán-Peña
  5. Privately optimal contracts and suboptimal outcomes in a model of agency costs By Charles T. Carlstrom; Timothy S. Fuerst; Matthias Paustian
  6. Observed Expectations, News Shocks, and the Business Cycle By Fabio Milani; Ashish Rajrhandari
  7. Risk Shocks By Lawrence Christiano; Roberto Motto; Massimo Rostagno
  8. Leverage Restrictions in a Business Cycle Model By Lawrence Christiano; Daisuke Ikeda
  9. Policy Regimes, Policy Shifts, and U.S. Business Cycles By Woong Yong Park; Jae Won Lee; Saroj Bhattarai
  10. The cyclical behavior of equilibrium unemployment and vacancies across OECD countries By Pedro S. Amaral; Murat Tasci
  11. Sorting and the output loss due to search frictions By Coen N. Teulings; Pieter Gautier
  12. Matching models and housing markets: the role of the zero-profit condition By Gaetano Lisi
  13. Optimal Life-cycle Capital Taxation under Self-Control Problems By Nicola Pavoni; Hakki Yazici
  14. interaction between demand for labor and consumption over the business cycle By Wouter Den Haan
  15. Rational Inattention to News: The Perils of Forward Guidance. By Gaballo, G.
  16. A Fixed Point Theorem and an Application to Bellman Operators By Yuhki Hosoya; Masayuki Yao

  1. By: Christoph Gortz; John D Tsoukalas
    Abstract: We estimate a two-sector DSGE model with financial intermediaries - a-la Gertler and Karadi (2011) and Gertler and Kiyotaki (2010) - and quantify the importance of news shocks in accounting for aggregate and sectoral fluctuations. Our results indicate a significant role of financial market news as a predictive force behind fluctuations. Specifically, news about the value of assets held by financial intermediaries, reflected one to two years in advance in corporate bond markets, generate countercyclical corporate bonds spreads, affect the supply of credit, and are estimated to be a significant source of aggregate fluctuations, accounting for approximately 31% of output, 22% of investment and 31% of hours worked variation in cyclical frequencies. Importantly, asset value news shocks generate both aggregate and sectoral co-movement with a standard preference specification. Financial intermediation is key for importance and propagation of asset value news shocks.
    Keywords: News, Financial intermediation, Business Cycles, DSGE, Bayesian estimation
    JEL: E2 E3
    Date: 2012–07
  2. By: Carrillo-Tudela, Carlos; Visschers, Ludo
    Abstract: We build an analytically and computationally tractable stochastic equilibrium model of unemployment in heterogeneous labor markets. Facing search frictions within markets and reallocation frictions between markets, workers endogenously separate from employment and endogenously reallocate between markets, in response to changing aggregate and local conditions. Empirically, using the 1986-2008 SIPP panels, we document the occupational mobility patterns of the unemployed, finding notably that occupational change of unemployed workers is procyclical. The heterogeneous-market model yields highly volatile countercyclical unemployment, and is simultaneously consistent with procyclical reallocation, countercyclical separations and a negatively-sloped Beveridge curve. Moreover, the model exhibits unemployment duration dependence, which (when calibrated to long-term averages) responds realistically to the business cycle, creating substantial longer-term unemployment in downturns. Finally, the model is also consistent with different employment and reallocation outcomes as workers gain experience in the labor market, on average and over the business cycle.
    Keywords: Unemployment; Business Cycle; Search; Endogenous Separations; Reallocation; Occupational Mobility
    JEL: J62 E32 J64
    Date: 2012–12–31
  3. By: Zhiwei Xu (Hong Kong University of Science and Technology); Yi Wen; pengfei Wang (Hong Kong University of Science and Technology)
    Abstract: This paper provides a method to analytically (or tractably) solve (S,s) inventory policies in general equilibrium. This solution method can handle large state space with many state variables, such as multiple capital stocks, lagged aggregate investment and consumption, and other predetermined aggregate variables, thus greatly reducing the computation costs of DSGE models with inventories. We use the Khan-Thomas (2007) model to illustrate how standard log-linearization methods can be used to solve various versions of this inventory model and generate impulse response functions. We find that the conventional wisdom that inventory investment destabilizes the economy can still hold in general-equilibrium if firms face investment adjustment costs or can vary the capacity utilization rate.
    Date: 2012
  4. By: Jessica Roldán-Peña
    Abstract: Empirical evidence shows that sovereign defaults are associated with significant downturns in economic activity in defaulting countries. However, the existing literature on sovereign debt and default mainly analyzes endowment economies and, therefore, does not address the relationship between default risk and macroeconomic dynamics. This paper develops a general equilibrium small open economy model with financial frictions that allows to simultaneously examine the behavior of output, investment and borrowing dynamics and its interaction with sovereign default. When calibrated to match the business cycles properties of an average emerging market economy, the model is able to reproduce the countercyclicality of net exports and sovereign spreads and the negative correlation between investment and net exports observed in the data. Furthermore, when analyzing its behavior around sovereign default, the model successfully captures the declines in output, consumption and investment that are actually associated with these episodes.
    Keywords: Sovereign debt, sovereign default, business cycles, small open economy.
    JEL: E32 E44 F32 F34
    Date: 2012–12
  5. By: Charles T. Carlstrom; Timothy S. Fuerst; Matthias Paustian
    Abstract: This paper derives the privately optimal lending contract in the celebrated financial accelerator model of Bernanke, Gertler, and Gilchrist (1999). The privately optimal contract includes indexation to the aggregate return on capital and household consumption. Although privately optimal, this contract is not welfare maximizing, as it exacerbates fluctuations in real activity. The household’s desire to hedge business cycle risk, leads, via the financial contract, to greater business cycle risk. The welfare cost of the privately optimal contract (when compared to the planner’s outcome) is significant. A menu of time-varying taxes and subsidies on household income and monitoring costs can decentralize the planner’s allocations. But just one wedge, a time-varying tax on monitoring costs, can come close to achieving the planner’s allocation. This can also be decentralized with a time-varying subsidy on loan repayment rates.
    Keywords: Equilibrium (Economics) - Mathematical models ; Financial markets ; Macroeconomics
    Date: 2012
  6. By: Fabio Milani (Department of Economics, University of California-Irvine); Ashish Rajrhandari (Department of Economics, University of California-Irvine)
    Abstract: This paper exploits information from the term structure of survey expectations to identify news shocks in a a DSGE model with rational expectations. We estimate a structural business-cycle model with price and wage stickiness. We allow for both unanticipated and anticipated components (“newsâ€) in each structural disturbance: neutral and investment-specific technology shocks, government spending shocks, risk premium, price and wage markup shocks, and monetary policy shocks. We show that the estimation of a standard DSGE model with realized data obfuscates the identification of news shocks and yields weakly or non-identified parameters pertaining to such shocks. The identification of news shocks greatly improves when we re-estimate the model using data on observed expectations regarding future output, consumption, investment, government spending, inflation, and interest rates - at horizons ranging from one-period to five-periods ahead. The news series thus obtained largely differ from their counterparts that are estimated using only data on realized variables. Moreover, the results suggest that the identified news shocks explain a sizable portion of aggregate fluctuations. News about investment-specific technology and risk premium shocks play the largest role, followed by news about labor supply (wage markup) and monetary policy.
    Keywords: News Shocks; Estimation of DSGE Model with Survey Expectations; News in Business Cycles; Identification in DSGE Models; Rational Expectations
    JEL: E32 E50
    Date: 2012–12
  7. By: Lawrence Christiano; Roberto Motto; Massimo Rostagno
    Abstract: We augment a standard monetary DSGE model to include a Bernanke-Gertler-Gilchrist financial accelerator mechanism. We fit the model to US data, allowing the volatility of cross-sectional idiosyncratic uncertainty to fluctuate over time. We refer to this measure of volatility as 'risk'. We find that fluctuations in risk are the most important shock driving the business cycle.
    JEL: E2 E3 E44
    Date: 2013–01
  8. By: Lawrence Christiano; Daisuke Ikeda
    Abstract: We modify an otherwise standard medium-sized DSGE model, in order to study the macroeconomic effects of placing leverage restrictions on financial intermediaries. The financial intermediaries ('bankers') in the model must exert effort in order to earn high returns for their creditors. An agency problem arises because banker effort is not observable to creditors. The consequence of this agency problem is that leverage restrictions on banks generate a very substantial welfare gain in steady state. We discuss the economics of this gain. As a way of testing the model, we explore its implications for the dynamic effects of shocks.
    JEL: E44 E5 E52
    Date: 2013–01
  9. By: Woong Yong Park (University of Hong Kong); Jae Won Lee (Rutgers University); Saroj Bhattarai (Penn State University)
    Abstract: Using an estimated DSGE model that features monetary and fiscal policy interactions and allows for equilibrium indeterminacy, we find that a passive monetary and passive fiscal policy regime prevailed in the pre-Volcker period while an active monetary and passive fiscal policy regime prevailed post-Volcker. Since both monetary and fiscal policies were passive pre-Volcker, there was equilibrium indeterminacy that gave rise to self-fulfilling beliefs and resulted in substantially different transmission mechanisms of policy as compared to conventional models: unanticipated increases in interest rates increased inflation and output while unanticipated increases in lump-sum taxes decreased inflation and output. Unanticipated shifts in monetary and fiscal policies however, played no substantial role in explaining the variation of inflation and output at any horizon in either of the time periods. Pre-Volcker, in sharp contrast to post-Volcker, we find that a time-varying inflation target does not explain low-frequency movements in inflation. A combination of shocks account for the dynamics of output, inflation, and government debt, with the relative importance of a particular shock quite different in the two time-periods due to changes in the systematic responses of policy. Finally, in a counterfactual exercise, we show that had the monetary policy regime of the post-Volcker era been in place pre-Volcker, inflation volatility would have been lower by 34% and the rise of inflation in the 1970s would not have occurred.
    Date: 2012
  10. By: Pedro S. Amaral; Murat Tasci
    Abstract: We show that the inability of a standardly-calibrated stochastic labor search-and-matching model to account for the observed volatility of unemployment and vacancies extends beyond U.S. data to a set of OECD countries. We also argue that using cross-country data is helpful in evaluating the relative merits of the alternatives that have appeared in the literature. In illustrating this point, we take the solution proposed in Hagedorn and Manovskii (2008) and show that its ability to match the labor market volatility magnitudes seen in the data depends crucially on how persistent the estimated productivity process is.
    Keywords: Unemployment ; Wages ; Business cycles ; Human capital
    Date: 2012
  11. By: Coen N. Teulings (CPB Netherlands Bureau for Economic Policy Analysis); Pieter Gautier (VU University Amsterdam)
    Abstract: We analyze a general search model with on-the-job search and sorting of heterogeneous workers into heterogeneous jobs. This model yields a simple relationship between (i) the unemployment rate, (ii) the value of non-market time, and (iii) the max-mean wage differential. The latter measure of wage dispersion is more robust than measures based on the reservation wage, due to the long left tail of the wage distribution. We estimate this wage differential using data on match quality and allow for measurement error. The estimated wage dispersion and mismatch for the US is consistent with an unemployment rate of 5%. Finally, we find that without search frictions, output would be 6.6% higher
    Date: 2012
  12. By: Gaetano Lisi (Creativity and Motivations (CreaM) Economic Research Centre Department of Economics and Law. University of Cassino and Southern Lazio, Italy)
    Abstract: The recent and growing literature which has extended the use of search and matching models even to the housing market does not use the free entry or zero-profit assumption as a key condition for solving the equilibrium of the model. This is because a straightforward adaptation of the basic matching model to the housing market seems impossible. However, this paper shows that the zero-profit condition can be easily reformulated to take the distinctive features of the housing market into account. Indeed, it helps to provide a theoretical explanation for well-known empirical regularities in the housing markets.
    Date: 2013–01
  13. By: Nicola Pavoni; Hakki Yazici
    Abstract: We study optimal taxation of savings in an economy where agents face self-control problems and are allowed to be partially naive. We assume that the severity of self-control problems changes over the life-cycle. We focus on quasihyperbolic discounting with constant elasticity of intertemporal substitution utility functions and linear Markov equilibria. We derive explicit formulas for optimal taxes that implement the efficient allocation. We show that if agents’ ability to self-control increases concavely with age, then savings should be subsidized and the subsidy should decrease with age. We also show that allowing for age-dependent self-control problems creates large effects on the level of optimal subsidies, while optimal taxes are not very sensitive to the level of sophistication. JEL classification: E21, E62, D03. Keywords: Self-control problems, Linear Markov equilibrium, Life cycle taxation of savings.
    Date: 2012
  14. By: Wouter Den Haan (London School of Economics)
    Abstract: This paper develops a framework with a standard labor market matching friction and a friction in commodities markets which leads to firms not always selling everything being produced and thus to inventory accumulation. A savings glut can lead to a downward spiral in which reductions in consumer demand and demand for workers reinforce each other. Key is that the need for firms to finance inventories provides an outlet for the additional savings, so that there is no or not enough downward pressure on interest rates to kill the savings glut. These results do not require sticky prices and/or sticky wages.
    Date: 2012
  15. By: Gaballo, G.
    Abstract: This paper studies the social value of information about the future when agents are rationally inattentive. In a stylized OLG model of inflation the central bank (CB) can set money supply in response to the current price. The CB has perfect foresight about the future T shocks and releases this information to rationally inattentive agents. At the unique REE, individual and aggregate risks can increase with the release when the monetary conduct is not "tight enough" and agents are "not attentive enough" to the news. In particular, the shorter the T, the more attentive the agents must be to avoid perverse welfare effects, whereas the notion of "tight enough" remains invariant. In this sense, efficient communication requires effective monetary policy.
    Keywords: Information Acquisition, Central Bank Communication, Monetary Policy, Social Value of Information.
    JEL: E50 E58 E60 D83
    Date: 2013
  16. By: Yuhki Hosoya (Graduate School of Economics, Keio University); Masayuki Yao (Graduate School of Economics, Keio University)
    Abstract: This study introduces a new definition of a metric that corresponds with the topology of uniform convergence on any compact set, and shows both the existence of a unique fixed point of some operator by using this metric and that the iteration of such an operator results in convergence to this fixed point. We demonstrate that this result can be applied to Bellman operators in many situations involving economic dynamics.
    Date: 2013–01

This nep-dge issue is ©2013 by Christian Zimmermann. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.