nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2013‒01‒26
eighteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Firm Entry, Endogenous Markups and the Dynamics of the Labor Share of Income By Andrea Colciago; Lorenza Rossi
  2. Mismatch, Sorting and Wage Dynamics By Jeremy Lise; Costas Meghir; Jean-Marc Robin
  3. Offshoring and Occupational Specificity of Human Capital By Moritz Ritter
  4. A General Equilibrium Model with Banks and Default on Loans By Tamon Takamura
  5. International Reserves and Rollover Risk By Javier Bianchi; Juan Carlos Hatchondo; Leonardo Martinez
  6. Double Matching: Social Contacts in a Labour Market with On-the-Job Search By Anna Zaharieva
  7. The prospect of higher taxes and weak job growth during the recovery from the great recession: macro versus micro Frisch elasticities By Carlos E.J.M. Zarazaga
  8. Fiscal sentiment and the weak recovery from the Great Recession: a quantitative exploration By Finn E. Kydland; Carlos E. J. M. Zarazaga
  9. Financing constraints, firm dynamics, and international trade By Stephane Verani; Till Gross
  10. Explaining Educational Attainment across Countries and over Time By Diego Restuccia; Guillaume Vandenbroucke
  11. The equity premium in a small open economy, and an application to Israel By Borenstein, Eliezer; Elkayam, David
  12. Optimal Waste Control with Abatement and Productive Capital Stocks. By Enrico Saltari; Giuseppe Travaglini
  13. The Social Cost of Stochastic and Irreversible Climate Change By Yongyang Cai; Kenneth L. Judd; Thomas S. Lontzek
  14. Too big to cheat: efficiency and investment in partnerships By Emilio Espino; Julian Kozlowski; Juan M. Sánchez
  15. Interaction of Formal and Informal Financial Markets in Quasi-Emerging Market Economies By Harold P.E. Ngalawa and Nicola Viegi
  16. A 4-DICE: quantitatively addressing uncertainty effects in climate change By Traeger, Christian
  17. Solving Dynamic Programming Problems on a Computational Grid By Yongyang Cai; Kenneth L. Judd; Greg Thain; Stephen J. Wright
  18. Numerical Solution of Dynamic Portfolio Optimization with Transaction Costs By Yongyang Cai; Kenneth L. Judd; Rong Xu

  1. By: Andrea Colciago; Lorenza Rossi
    Abstract: Recent U.S. evidence suggests that the response of labor share to a productivity shock is characterized by countercyclicality and overshooting. These findings cannot be easily reconciled with existing business cycle models. We extend the Diamond-Mortensen-Pissarides model of search in the labor market by considering strategic interactions among an endogenous number of producers, which leads to countercyclical price markups. While Nash bargaining delivers a countercyclical labor share, we show that countercyclical markups are fundamental to address the overshooting. On the contrary, we find that real wage rigidity does not seem to play a crucial role for the dynamics of the labor share of income.
    Keywords: Labor Share Overshooting; Endogenous Market Structures; Search and Matching Frictions
    JEL: E24 E32 L11
    Date: 2013–01
  2. By: Jeremy Lise; Costas Meghir; Jean-Marc Robin
    Abstract: We develop an empirical search-matching model which is suitable for analyzing the wage, employment and welfare impact of regulation in a labor market with heterogeneous workers and jobs. To achieve this we develop an equilibrium model of wage determination and employment which extends the current literature on equilibrium wage determination with matching and provides a bridge between some of the most prominent macro models and microeconometric research. The model incorporates productivity shocks, long-term contracts, on-the-job search and counter-offers. Importantly, the model allows for the possibility of assortative matching between workers and jobs due to complementarities between worker and job characteristics. We use the model to estimate the potential gain from optimal regulation and we consider the potential gains and redistributive impacts from optimal unemployment insurance policy. Here optimal policy is defined as that which maximizes total output and home production, accounting for the various constraints that arise from search frictions. The model is estimated on the NLSY using the method of moments.
    JEL: C15 C63 D04 J08 J3 J63 J64 J65
    Date: 2013–01
  3. By: Moritz Ritter (Department of Economics, Temple University)
    Abstract: I document that workers in newly tradable service occupations possess more occupation-specific human capital and are more highly educated than workers in previously tradable occupations. Motivated by this observation, I develop a dynamic equilibrium model with labor market frictions and specific human capital to study the labor adjustment process after a trade shock. When calibrated to match the increase in U.S. trade between 1990 and 2010, the model suggests that (1) output increases immediately after a trade shock and converges quickly to the steady state; (2) labor market institutions play a larger role in the adjustment process than specific human capital; (3) the short run distributional effects are small if the labor market is flexible, even in the presence of specific human capital.
    Keywords: Offshoring, Sectoral Labor Reallocation, Human Capital
    JEL: E24 F16 J24 J62
    Date: 2012–12
  4. By: Tamon Takamura
    Abstract: During the recent financial crisis in the U.S., banks reduced new business lending amidst concerns about borrowers’ ability to repay. At the same time, firms facing higher borrowing costs alongside a worsening economic outlook reduced investment. To explain these aggregate business cycle patterns, I develop a model with households, banks and firms. I assume that a bank’s ability to raise deposits is constrained by a limited commitment problem and that, furthermore, loans to firms involve default risk. In this environment, changes in loan rates affect the size of the business sector. I explore how banks influence the behavior of households and firms and find that both productivity and financial shocks lead to counter-cyclical default and interest rate spreads. I examine the implications of a government capital injection designed to mitigate the effect of negative productivity and financial shocks in the spirit of the Troubled Asset Relief Program (TARP). I find that the stabilizing effect of such policy interventions hinges on the source of the shock. In particular, a capital injection is less effective against aggregate productivity shocks because easing banks’ lending stance only weakly stimulates firms’ demand for loans when aggregate productivity falls. In contrast, a capital injection can counteract the adverse effect of financial shocks on the supply of loans. Finally, I measure aggregate productivity and financial shocks to evaluate the role of each in the business cycle. I find that the contribution of aggregate productivity shocks in aggregate output and investment is large until mid-2008. Financial shocks explain 65% of the fall in investment and 55% of the fall in output in the first quarter of 2009.
    Keywords: Business fluctuations and cycles; Economic models; Financial stability
    JEL: E32 E44 E69
    Date: 2013
  5. By: Javier Bianchi; Juan Carlos Hatchondo; Leonardo Martinez
    Abstract: Two striking facts about international capital flows in emerging economies motivate this paper: (1) Governments hold large amounts of international reserves, for which they obtain a return lower than their borrowing cost. (2) Purchases of domestic assets by nonresidents and purchases of foreign assets by residents are both procyclical and collapse during crises. We propose a dynamic model of endogenous default that can account for these facts. The government faces a trade-off between the benefits of keeping reserves as a buffer against rollover risk and the cost of having larger gross debt positions. Long-duration bonds, the countercyclical default premium, and sudden stops are important for the quantitative success of the model.
    JEL: F41 F42 F44
    Date: 2012–12
  6. By: Anna Zaharieva (Bielefeld University)
    Abstract: This paper develops a labour market matching model with heterogeneous firms, on-thejob search and referrals. Social capital is endogenous, so that better connected workers bargain higher wages for a given level of productivity. This is a positive effect of referrals on reservation wages. At the same time, employees accept job offers from more productive employers and forward other offers to their unemployed social contacts. Therefore, the average productivity of a referred worker is lower than the average productivity in the market. This is a negative selection effect of referrals on wages. In the equilibrium, wage premiums (penalties) associated with referrals are more likely in labour markets with lower (higher) productivity heterogeneity and lower (higher) worker’s bargaining power. Next, the model is extended to allow workers help each other climb a wage ladder. On-the-job search is then intensified and wage inequality is reduced as workers employed in high paid jobs pool their less successful contacts towards the middle range of the productivity distribution.
    Date: 2012–12
  7. By: Carlos E.J.M. Zarazaga
    Abstract: Labor input growth during the recovery of the U.S. economy from the Great Recession of 2008–2009 has been considerably lower than expected. A number of scholars have attributed this disappointing outcome to the prospect of higher taxes, induced by the fiscal imbalances that will materialize in coming decades under current policies. The paper examines this fiscal sentiment hypothesis from the perspective of a neoclassical growth model, under the assumption that the typical household's preferences can be represented by a utility function that implies a constant intertemporal (Frisch) elasticity of substitution for aggregate hours of work, and for a hypothetical tax regime that incorporates the Congressional Budget Office' s assessment of the U.S. fiscal situation. The paper finds that the empirical relevance of the fiscal sentiment hypothesis depends on whether this Frisch elasticity of labor supply is closer to the relatively large values needed to account for the observed volatility of labor input at business cycle frequencies, than to the lower values estimated by microeconomic and quasi-experimental studies.
    Date: 2013
  8. By: Finn E. Kydland; Carlos E. J. M. Zarazaga
    Abstract: The U.S. economy isn' t recovering from the deep Great Recession of 2008–2009 with the strength predicted by models that incorporate a variety of shocks and frictions in the basic analytical framework of the neoclassical growth model. It has been argued that the counterfactual predictions shouldn 't be attributed to inherent features of that framework, but to the omission from the analysis of the prospects of an imminent switch to a higher taxes regime prompted by the unprecedented fiscal challenges faced by the U.S. economy in peacetime. The paper explores quantitatively this fiscal sentiment hypothesis. The main finding is that the hypothesis can account for a substantial fraction of the decline in investment and labor input in the aftermath of the Great Recession, relative to their pre-recession trends. These results require, however, a quali cation: The perceived higher taxes must fall almost exclusively on capital income.
    Date: 2013
  9. By: Stephane Verani; Till Gross
    Abstract: There is growing empirical support for the conjecture that access to credit is an important determinant of firms' export decisions. We study a multi-country general equilibrium economy in which entrepreneurs and lenders engage in long-term credit relationships. Financial constraints arise as a consequence of financial contracts that are optimal under private information. Consistent with empirical regularities, the model implies that older and larger firms have lower average and more stable growth rates, and are more likely to survive. Exporters are larger, their survival in international markets increases with the time spent exporting, and the sales of older exporters are larger and more stable.
    Date: 2013
  10. By: Diego Restuccia; Guillaume Vandenbroucke
    Abstract: Consider the following facts. In 1950 the richest ten-percent of countries attained an average of 8.1 years of schooling whereas the poorest ten-percent of countries attained 1.3 years, a 6-fold difference. By 2005, the difference in schooling declined to 2-fold. The fact is that schooling has increased faster in poor than in rich countries. What explains educational attainment differences across countries and their evolution over time? We develop an otherwise standard model of human capital accumulation with two novel but important features: non-homotetic preferences and an operating labor supply margin. We use the model to assess the quantitative contribution of productivity and life expectancy differences across countries in explaining educational attainment. Calibrating the parameters of the model to reproduce the historical time-series data for the United States, we find that the model accounts for 96 percent of the difference in schooling levels between rich and poor countries in 1950 and 89 percent of the increase in schooling over time in poor countries. The model generates a faster increase in schooling in poor than in rich countries consistent with the data. These results highlight the role of development in education and thus have important implications for educational policy.
    Keywords: schooling, productivity, life expectancy, education policy, labor supply
    JEL: O1 O4 E24 J22 J24
    Date: 2013–01–10
  11. By: Borenstein, Eliezer; Elkayam, David
    Abstract: In this paper we attempt to reproduce both the business cycle facts and the equity premium of the Israeli economy—an economy which is "typical" in the sense that investment is much more volatile than output (and consumption). We show that GHH preferences, which are quite common in RBC models of small open economies, are not suited for reproducing both the business cycle and the equity premium facts of a "typical" small open economy. We found that a way to progress is to "correct" the GHH preferences by adding some degree of wealth effect on labor supply. That is, by switching to the Jaimovich-Rebelo (2006) type of preferences. However, in this case we also need to add to the model some kind of limitations on labor supply (we used both real wage rigidity and habits in labor). Our main finding is that the use of Jaimovich-Rebelo preferences considerably improves the results relative to that achieved by GHH preferences. The reason for this is that the GHH preferences are characterized by a relatively high degree of substitutability between consumption and leisure and this moderates the volatility of the stochastic discount factor (SDF). By adding some degree of wealth effect we can achieve a significant increase in the volatility of the SDF, and hence an increase in the equity premium and in the volatility of investment. Following the relevant literature we used three shocks: to productivity, to government expenditure and to the world interest rate. Our analysis suggests that by adding one or more of two kinds of shocks: shocks to wealth and shocks to the real exchange rate – one can achieve a significant progress in reproducing both the business cycle facts and the equity premium.
    Keywords: Equity Premium; Asset Pricing; Business Cycle; Small Open Economy
    JEL: E32 G12 F41 E44
    Date: 2013–01–01
  12. By: Enrico Saltari (Department of Economics and Law, Università "La Sapienza" Roma); Giuseppe Travaglini (Department of Economics, Society & Politics, Università di Urbino "Carlo Bo")
    Abstract: In this paper we address the control problem of a social optimum in presence of waste and capital stocks. We address this problem in two stages. In the first, we suppose that output is fixed; next, we endogenize output allowing for growth. The analytical framework is simple. Consumption is assumed to generate an undesirable residue. Society can control waste accumulation using abatement capital, and rise output using productive capital which accumulates over time. We have three main results. (1) On the analytical ground we are able to find a closed form solution to the optimal consumption with waste, abatement and productive capital stocks. (2) For the case of fixed output, we get a solution where stocks and flows affect the dynamics of the system. Environmental policies may have permanent effects on the level of variables. Then, (3) when waste and abatement capital are embedded in a classical growth model, we obtain an Environmental Keynes-Ramsey rule which states that the growth rate of the productive capital is positive if and only if its net marginal productivity is greater than the net social cost it generates, given by the marginal disutility of waste weighted by its shadow cost.
    Keywords: Abatement capital, waste accumulation, optimal control, Pigouvian taxes and subsidies, output growth
    JEL: E22 L51 H23 Q28
    Date: 2013
  13. By: Yongyang Cai; Kenneth L. Judd; Thomas S. Lontzek
    Abstract: There is great uncertainty about the impact of anthropogenic carbon on future economic wellbeing. We use DSICE, a DSGE extension of the DICE2007 model of William Nordhaus, which incorporates beliefs about the uncertain economic impact of possible climate tipping events and uses empirically plausible parameterizations of Epstein-Zin preferences to represent attitudes towards risk. We find that the uncertainty associated with anthropogenic climate change imply carbon taxes much higher than implied by deterministic models. This analysis indicates that the absence of uncertainty in DICE2007 and similar models may result in substantial understatement of the potential benefits of policies to reduce GHG emissions.
    JEL: C63 D81 Q54
    Date: 2013–01
  14. By: Emilio Espino; Julian Kozlowski; Juan M. Sánchez
    Abstract: This paper studies the efficient arrangement among several agents that are subject to idiosyncratic, privately observed taste shocks affecting their marginal utility of current consumption. Agents accumulate capital and have access to a technology to produce goods. The framework deviates from previous literature, which assumed that (i) there is a continuum of agents and (ii) agents are exogenously endowed with output every period with no investment opportunities. A new method is proposed to solve for the optimal allocation that takes advantage of the fact that the utility possibility set is convex. Pareto weights play the role of promised utility in Abreu, Pearce, and Stac- chetti (1990). The method is applied to study efficiency in a partnership between the founder, who faces the taste shock, and the partner, who provides funds but do not face shocks. New insights are derived. Under private information the ownership structure determines to what extent private information matters. If the founder’s share of the partnership is too big his incentives to cheat vanish. Additionally, efficiency implies that, while incentive constraints bind, equity shares must fluctuate to alleviate infor- mation problems. In the long run, there are two possible extreme structures: (1) the founder’s equity share becomes sufficiently large to make the incentive problem irrele- vant and (2) the founder’s equity share converges to zero. Two alternative economies are studied to understand the role of key assumptions: (i) an endowment economy and (ii) an economy in which both partners face taste shocks. It turned out that to obtain the main results allowing for a production economy is crucial but having only one agent with shock is not.>
    Keywords: Disclosure of information ; Risk ; Capital
    Date: 2013
  15. By: Harold P.E. Ngalawa and Nicola Viegi
    Abstract: The primary objective of this paper is to investigate the interaction of formal and informal financial markets and their impact on economic activity in quasi-emerging market economies. Using a four-sector dynamic stochastic general equilibrium model with asymmetric information in the formal financial sector, we come up with three fundamental findings. First, we demonstrate that formal and informal financial sector loans are complementary in the aggregate, suggesting that an increase in the use of formal financial sector credit creates additional productive capacity that requires more informal financial sector credit to maintain equilibrium. Second, it is shown that interest rates in the formal and informal financial sectors do not always change together in the same direction. We demonstrate that in some instances, interest rates in the two sectors change in diametrically opposed directions with the implication that the informal financial sector may frustrate monetary policy, the extent of which depends on the size of the informal financial sector. Thus, the larger the size of the informal financial sector the lower the likely impact of monetary policy on economic activity. Third, the model shows that the risk factor (probability of success) for both high and low risk borrowers plays an important role in determining the magnitude by which macroeconomic indicators respond to shocks.
    Keywords: Informal financial sector, formal financial sector, monetary policy, general equilibrium
    JEL: E44 E47 E52 E58
    Date: 2013
  16. By: Traeger, Christian
    Abstract: We introduce a version of the DICE-2007 model designed for uncertaintyanalysis. DICE is a wide-spread deterministic integrated assessment model of climatechange. However, climate change, long-term economic development, and theirinteractions are highly uncertain. A thorough empirical analysis of the effects ofuncertainty requires a recursive dynamic programming implementation of integratedassessment models. Such implementations are subject to the curse of dimensionality.Every increase in the dimension of the state space is paid for by a combinationof (exponentially) increasing processor time, lower quality of the value function andcontrol rules approximations, and reductions of the uncertainty domain. The paperpromotes a four stated recursive dynamic programming implementation of the DICEmodel. Our implementation solves the infinite planning horizon problem for an arbitrarytime step. Moreover, we present a closed form continuous time approximationto the exogenous (discretely and inductively defined) processes in DICE and presenta Bellman equation for DICE that disentangles risk attitude from the propensity tosmooth consumption over time.
    Keywords: Natural Resources and Conservation, climate change, uncertainty, integrated assessment, intergrated assessment, DICE, dynamic programming, risk aversion, interemporal substitution, recursive utility
    Date: 2012–12–15
  17. By: Yongyang Cai; Kenneth L. Judd; Greg Thain; Stephen J. Wright
    Abstract: We implement a dynamic programming algorithm on a computational grid consisting of loosely coupled processors, possibly including clusters and individual workstations. The grid changes dynamically during the computation, as processors enter and leave the pool of workstations. The algorithm is implemented using the Master-Worker library running on the HTCondor grid computing platform. We implement value function iteration for several large dynamic programming problems of two kinds: optimal growth problems and dynamic portfolio problems. We present examples that solve in hours on HTCondor but would take weeks if executed on a single workstation. The use of HTCondor can increase a researcher’s computational productivity by at least two orders of magnitude.
    JEL: C61 C63 G11
    Date: 2013–01
  18. By: Yongyang Cai; Kenneth L. Judd; Rong Xu
    Abstract: We apply numerical dynamic programming to multi-asset dynamic portfolio optimization problems with proportional transaction costs. Examples include problems with one safe asset plus two to six risky stocks, and seven to 360 trading periods in a finite horizon problem. These examples show that it is now tractable to solve such problems.
    JEL: C61 C63 G11
    Date: 2013–01

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