nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2013‒02‒03
eighteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Fiscal Stimulus in an Endogenous Job Separation Model By Ryuta Ray Kato; Hiroaki Miyamoto
  2. Population Ageing and PAYG Pensions in the OLG Model By Cipriani, Giam Pietro
  3. The Dynamics of Utility in the Neoclassical OLG Model By Wolfgang Kuhle
  4. Creative Destruction and Unemployment in an Open Economy Model By Ignat Stepanok
  5. Leaving the empirical (battle)ground: Output and welfare effects of fiscal consolidation in general equilibrium By T. BUYSE; F. HEYLEN
  6. Costly intermediation and the Friedman rule By Benjamin Eden
  7. Intangible Capital and the Excess Volatility of Aggregate Profits By Kegiang Hou; Alok Johri
  8. On Ramsey´s conjecture By Gerhard Sorger; Tapan Mitra
  9. Human Capital and Competition: Strategic Complementarities in Firm-based Training By Margaret Stevens
  10. Online Appendix to "Search for Financial Returns and Social Security Privatization" By Alisdair McKay
  11. Accounting for age in marital search decisions By Serife Nuray Akin; Matthew Butler; Brennan C. Platt
  12. The Role of Consumer Leverage in Generating Financial Crises By Dilyana Dimova
  13. Uncertainty and the Politics of Employment Protection By Andrea Vindigni; Cristina Tealdi
  14. A Model of Comparative Advantage with Matching in the Urban Tanzanian Labour Market By Andrew Kerr
  15. Interaction of Formal and Informal Financial Markets in Quasi-Emerging Market Economies By Harold Ngalawa; Nicola Viegi
  16. On the stability of the Ramsey accumulation path By Bellino, Enrico
  17. Limited Commitment and the Legal Restrictions Theory of the Demand for Money By Leo Ferraris; Fabrizio Mattesini
  18. The Influence of the Taylor rule on US monetary policy By Pelin Ilbas; Øistein Røisland; Tommy Sveen

  1. By: Ryuta Ray Kato (International University of Japan); Hiroaki Miyamoto (International University of Japan)
    Abstract: This paper re-visits effects of fiscal expansion on employment and unemployment by focusing on both hiring and firing margins. We develop a dynamic stochastic general equilibrium model with labor search frictions in which job separation is endogenously determined. We study effects of fiscal stimuli in the form of government spending and hiring subsidies. The prediction of our model is in contrast with earlier studies that assume exogenous job separation. First, our model generates a larger size of the impact of a government spending shock on labor market variables than the model without endogenous separation. Second, while an increase in hiring subsidies increases employment and reduces unemployment in the model without endogenous separation, it reduces employment and increases unemployment in our model.
    Keywords: Fiscal Policy, Unemployment, Labor market, Search and matching, Endogenous separation
    JEL: E24 E62 J64
    Date: 2013–01
  2. By: Cipriani, Giam Pietro (University of Verona)
    Abstract: This paper shows the effects on a pay-as-you-go pension system of the demographic change in the standard overlapping generations model. Firstly, we consider a setting with exogenous fertility and then a model with endogenous fertility. In both cases, population ageing due to increased longevity implies a reduction in pensions payouts.
    Keywords: PAYG pensions, fertility, longevity
    JEL: J13 H55
    Date: 2013–01
  3. By: Wolfgang Kuhle (Max Planck Institute for Research on Collective Goods, Bonn)
    Abstract: This paper develops a method to study how life-cycle utility of a sequence of cohorts converges towards its steady state level in the neoclassical two-generations-overlapping model. This method allows to characterize utility changes associated with variations in exogenous policy parameters along the entire transition path between two steady states. At the same time it is not more complicated than a pure steady state analysis. Moreover, it can be applied to economies for which an explicit solution of the transition path is not available.
    Date: 2012–11
  4. By: Ignat Stepanok
    Abstract: I develop a model of endogenous economic growth and search and matching frictions in the labor market. I study the effect of trade liberalization between two identical economies on unemployment. I solve for two versions of the growth model, the first one where trade liberalization has only a temporary effect on growth, a semi-endogenous growth model. In the second version trade liberalization has a permanent effect on growth, a fully endogenous growth model. I show that in both versions trade liberalization has a steady state effect on unemployment that can be either negative or positive depending on parameters
    Keywords: Creative destruction, unemployment, trade liberalization
    JEL: O41 J63 F16
    Date: 2013–01
  5. By: T. BUYSE; F. HEYLEN
    Abstract: We study the effects of fiscal consolidation within a dynamic general equilibrium model with overlapping generations. Our contribution to the theoretical consolidation literature is threefold. (i) Individual decisions of time allocation between work, leisure and education are fully endogenous in our model. (ii) We pay particular attention to also modeling public employment and production. We distinguish public employees in the construction of infrastructure, in education, and in the production of useful public consumption goods. (iii) We go beyond the analysis of the usual economic aggregates (such as GDP) and also look at the welfare impact of different fiscal consolidation strategies on current and future generations of both high and low-ability individuals. Our main findings are as follows. As to output effects, we confirm that expenditure based consolidation is better than labor or capital tax based consolidation. Truly expansionary output effects after spending cuts, however, can only be observed for private output. We do generally not observe them when we consider GDP and include the value added produced by public employees. Our results for welfare bring even more nuance on the possibility of expansionary fiscal consolidation. When aggregated over all generations that are alive at the time consolidation is started, almost all consolidation strategies bring about net negative welfare effects. Only the youngest and future generations experience positive welfare effects. Interestingly, the positive effects for these generations are smaller under spending based adjustments in the area of education, investment, and overall public employment, than under tax based adjustments. Robustness tests by changing key assumptions of our model never imply changes of these conclusions, quite on the contrary.
    Keywords: Employment by age, Endogeous growth, Fiscal consolidation, Overlapping generations
    JEL: E62 H63 J22 O41
    Date: 2012–12
  6. By: Benjamin Eden (Department of Economics, Vanderbilt University)
    Abstract: I examine the implementation of the Friedman rule under the assumption that age dependent lump sum transfers are possible and private intermediation is costly. This is done both in an infinitely lived agents model and in an overlapping generations model. I argue that in addition to a zero nominal-interest-rate policy (the so called Friedman rule) a transfer to young agents, or a government loan program is required for satiating agents with real balances. The paper also contributes to the understanding of Friedman's original article and discusses related questions about the size of the financial sector. It is shown that the adoption of the (modified) Friedman rule will crowd out private lending and borrowing. I also look at the social value of a market for contingent claims and argue that resources spent on operating a market for accidental nominal bequests are a waste from the social point of view in spite of the fact that individuals have an incentive to trade in such markets.
    Keywords: The Friedman Rule, Accidental bequests, The optimal size of the financial sector, Government loans
    JEL: E0 E4
    Date: 2012–12–04
  7. By: Kegiang Hou; Alok Johri
    Abstract: Aggregate profits measured from NIPA data are over six times more volatile than output. We use recent estimates of the return on physical capital to decompose NIPA profits into the part that can be explained by capital income and a residual called net profits. We find that capital income explains only a small fraction of the overall volatility of NIPA profits, the net-profit series is over seven times more volatile than output with a contemporaneous correlation of .55. Most dynamic general equilibrium models of the business cycle cannot deliver this excess volatility of net-profits as they rely mainly on capital income to explain NIPA profits. We develop a model of the U.S. economy in which firms expend resources to create intangible capital (IC), which is an additional input in their production technology. The model is estimated using aggregate data on output growth and labor productivity. Simulations using two versions of the estimated model deliver pro-cyclical net profits that are over three times more volatile than output. IC investments are large and pro-cyclical and act to propagate shocks over time. Overall, the model explains aggregate US business cycles well on traditional metrics. In particular it does a good job of explaining observed movements in hours, productivity, output and the labor wedge without relying on preference shocks. As an external validation exercise, we show that the model is capable of delivering movements in IC investment that resemble recent estimates of R&D investment in the US. Moreover it delivers counter-cyclical markups along with a pro-cyclical profit share, another feature of the data. We emphasize that we do not use profit data to estimate the model so that any movements in profit over and above those of output are solely generated within the model as firms optimally reallocate resources between goods production and intangible capital creation.
    Keywords: business cycles, aggregate profits, Bayesian estimation, intangible capital, labor wedge, markups.
    JEL: E3
    Date: 2013–01
  8. By: Gerhard Sorger; Tapan Mitra
    Abstract: Studying a one-sector economy populated by finitely many heterogeneous households that are subject to no-borrowing constraints, we confirm a conjecture by Frank P. Ramsey according to which, in the long run, society would be divided into the set of patient households who own the entire capital stock and impatient ones without any physical wealth. More specifically, we prove (i) that there exists a unique steady state equilibrium that is globally asymptotically stable and (ii) that along every equilibrium the most patient household owns the entire capital of the economy after some finite time. Furthermore, we prove that despite the presence of the no-borrowing constraints all equilibria are efficient. Our results are derived for the continuous-time formulation of the model that was originally used by Ramsey, and they stand in stark contrast to results that – over the last three decades – have been found in the discrete-time version of the model.
    JEL: D61 D91 E21 O41
    Date: 2013–01
  9. By: Margaret Stevens
    Abstract: Vocational training systems differ markedly between countries. A model of firm-based human capital investment predicts equilibria characterised by particular patterns of training and job-to-job mobility, consistent with observed cross-country differences. Incentives to invest in human capital are determined jointly with labour turnover and the intensity of competition between employers for skilled workers, and the dependence of labour market conditions on human capital leads to strategic complementarity between training decisions. Depending on the extent of market frictions and match heterogeneity, we may expect to see either equilibria characterised by general training, steep wage profiles and high mobility; or equilibria in which both general and specific investment may occur, but turnover is low and wage profiles are relatively flat. Multiple equilibria are possible, in which case high turnover equilibria generate higher welfare.  
    Keywords: Human capital, labor turnover, specific training, general training, search, matching
    JEL: J24 J63
    Date: 2012–11–05
  10. By: Alisdair McKay (Boston University)
    Abstract: Online appendix for the Review of Economic Dynamics article
    Date: 2013
  11. By: Serife Nuray Akin (Department of Economics, University of Miami); Matthew Butler (Department of Economics, Brigham Young University); Brennan C. Platt (Department of Economics, Brigham Young University)
    Abstract: The average quality of spouse an individual marries varies significantly with age at marriage, peaking in the mid-twenties, then declining through the mid-forties, as does the hazard rate of marriage. Using a non-stationary sequential search model, we identify the search frictions that generate these age-dependent marriage outcomes. We find that the arrival rate of suitors is the dominant friction, responsible for 80% of hazard rate variation and 49% of spouse quality variation. Surprisingly, the distribution of suitor quality is a lower-order concern. Also, individual choice, rather than worsening frictions, is responsible for most of the decline in spouse quality.
    Keywords: Marriage market frictions, spouse quality, reservation quality over the life-cycle, non-stationary search
    JEL: C81 D83 J12
    Date: 2013–01–11
  12. By: Dilyana Dimova
    Abstract: Consumer leverage can generate financial crises characterized by increased bankruptcy, tightened credit access and reduced demand for goods.  This paper embeds financial frictions in the mortgage contracts of homeowners within a two-sector economy to show that even at moderate initial levels, household indebtedness can create a lasting financial downturn such as the subprime mortgage crisis.  Using two seemingly positive disturbances that triggered the subprime mortgage crisis - an increased housing supply and a relaxation of borrowing conditions - the model demonstrated that the subprime downturn was not a precedent but the natural consequence of financial frictions.  The oversupply of houses lowers asset prices and reduces the value of the real estate collateral used in the mortgage.  This worsens the leverage of indebted consumers and raised their bankruptcy prospects generating a pro-cyclical risk premium.  A relaxation of borrowing conditions turns credit-constrained households into a potential source of disturbances themselves when market optimism allows them to overleverage with little downpayment.  In both cases, the resulting excessive consumer leverage impairs household credit access for a lengthy after-shock period and diverts resources from their consumption.  Their reduced demand for goods may propagate the downturn to the rest of the economy depressing output in other sectors.  Adding credit constraints in the financial sector that provides housing mortgages deepens the negative impact of the shocks and makes recovery even more protracted.
    Keywords: Financial frictions, consumer leverage, credit-constrained consumers, subprime mortgage crisis, pro-cyclical risk-premium
    JEL: E21 E27 E44 G21 G33
    Date: 2012–11–28
  13. By: Andrea Vindigni (IMT Lucca Institute for Advanced Studies); Cristina Tealdi (IMT Lucca Institute for Advanced Studies)
    Abstract: This paper investigates the social preferences over labor market flexibility, in a general equilibrium model of dynamic labor demand where the productivity of active firms evolves as a Geometric Brownian motion. A key result demonstrated is that how the economy responds to shocks, i.e. unexpected changes in the drift and standard deviation of the stochastic process describing the dynamics of productivity, depends on the power of labor to extract rents and on the status quo level of firing costs. In particular, we show that when firing costs are initially relatively low, a transition to a rigid labor market is favored by all and only the employed workers with idiosyncratic productivity below some threshold value. A more volatile environment, and a lower rate of productivity growth, i.e. "bad times," increase the political support for more labor market rigidity only where labor appropriates of relatively large rents. Moreover, we demonstrate that when the status quo level of firing costs is relatively high, the preservation of a rigid labor market is favored by the employed with intermediate productivity, whereas all other workers favor more flexibility. The coming of better economic conditions need not favor the demise of high firing costs in rigid high-rents economies, because "good times" cut down the support for flexibility among the least productive employed workers. The model described provides some new insights on the comparative dynamics of labor market institutions in the U.S. and in Europe over the last few decades, shedding some new light both on the reasons for the original build-up of "Eurosclerosis," and for its relative persistence until the present day.
    Keywords: employment protection, job creation and destruction, ?ring costs, idiosyncratic productivity, volatility, growth, political economy, voting, rents, status quo, path depen- dency, institutional divergence.
    JEL: D71 D72 E24 J41 J63 J65
    Date: 2012–11
  14. By: Andrew Kerr
    Abstract: In this paper I build an equilibrium search model of the urban Tanzanian labour market that explains the choice between wage and self-employment and the variation in earnings across and within these sectors.  Self-employment is very common in urban Tanzania and survey data show both that there are large overlaps in the distribution of earnings in private wage employment and self-employment and that there is little movement between wage and self-employment.  This suggests that self-employment represents a worthwhile alternative to wage employment in small, low-productivity firms for the majority of urban Tanzanians, in contrast to the traditional view of African labour markets in which wage employment in small firms and self-employment are lumped together as the informal sector.
    Date: 2012–12–03
  15. By: Harold Ngalawa (School of Economics and Finance, University of KwaZulu-Natal); Nicola Viegi (Department of Economics, University of Pretoria)
    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: 2013–01
  16. By: Bellino, Enrico
    Abstract: The Ramsey (1928) accumulation path is characterized as a saddle-path in the standard presentations of the model based on the works of Cass (1965) and Koopmans (1965). From a mathematical stance a saddle-path is unstable: if the system is exactly on that path, it converges to the steady state of the system; if it diverges slightly from that path, it shifts indefinitely from the steady state. The 'transversality' condition is then invoked in the Ramsey model to prevent the system from following such divergent paths; from the economical point of view this condition can be interpreted as a perfect foresight assumption. This kind of instability, which is typical of infinite horizon optimal growth models, has been sometime considered to account for actual economic crises. The claim would seem to be grounded on the idea that if the consumer optimizes myopically, i.e., by only considering the current and the subsequent period, the ensuing dynamics diverges almost surely from the steady state equilibrium. Convergence requires perfect foresight. The present work aims to challenge this conclusion, which seems not inherent to the choice problem between consumption and savings, but it is due to the presumption that the consumer must face this problem in an infinite horizon setting. The Ramsey problem of selection of the accumulation path will be re-proposed here within a framework where consumer's ability to optimize over the future is assumed to be imperfect. However, the ensuing path will converge to the steady state, without assuming perfect foresight. Myopia is thus not ultimately responsible for the instabilities of the 'optimal' accumulation path. Explanations of instability phenomena of actual economic systems (crises, bubbles, etc.) must be sought in other directions, probably outside the strait-jacket of the optimization under constraint.
    Keywords: Ramsey model; transversality condition; bounded rationality; convergence; saddle path
    JEL: E22 B22 E21
    Date: 2013–01–28
  17. By: Leo Ferraris (University of Rome "Tor Vergata"); Fabrizio Mattesini (University of Rome "Tor Vergata")
    Abstract: This paper addresses the "rate of return" puzzle of monetary theory. Similarly to the legal restrictions theory of the demand for money, we assume that Government bonds are subject to a minimum purchase requirement. Differently from this theory, however, we assume that intermediaries, when issuing private notes, cannot commit to always redeem them. First, we study an environment with legal restrictions to intermediation and show that cash and interest bearing bonds both circulate in the economy. Then, we drop the legal restrictions and show that also with active intermediation, under limited commitment, there is an equilibrium with rate of return dominance. A positive interest rate provides the intermediaries with the incentive to issue and redeem their notes.
    Keywords: Money, Government Bonds, Rate of Return Dominance, Legal Restrictions
    JEL: E40
    Date: 2013–01–21
  18. By: Pelin Ilbas (National Bank of Belgium, Research Department); Øistein Røisland (Norges Bank); Tommy Sveen (BI Norwegian Business School)
    Abstract: We analyze the influence of the Taylor rule on US monetary policy by estimating the policy preferences of the Fed within a DSGE framework. The policy preferences are represented by a standard loss function, extended with a term that represents the degree of reluctance to letting the interest rate deviate from the Taylor rule. The empirical support for the presence of a Taylor rule term in the policy preferences is strong and robust to alternative specifications of the loss function. Analyzing the Fed's monetary policy in the period 2001-2006, we find no support for a decreased weight on the Taylor rule, contrary to what has been argued in the literature. The large deviations from the Taylor rule in this period are due to large, negative demand-side shocks, and represent optimal deviations for a given weight on the Taylor rule.
    Keywords: optimal monetary policy, simple rules, central bank preferences
    JEL: E42 E52 E58 E61 E65
    Date: 2013–01

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