nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2013‒02‒16
eighteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Financial shocks in Japan : A case for a small open economy By Yue Zhao
  2. Education Policy and Intergenerational Transfers in Equilibrium By Brant Abbott; Giovanni Gallipoli; Costas Meghir; Giovanni L. Violante
  3. Rare shocks, Great Recessions By Vasco Cúrdia; Marco Del Negro; Daniel L. Greenwald
  4. Exhaustible Resources in an Overlapping Generations Economy By David R. F. Love
  5. A note on the identification of dynamic economic models with generalized shock processes By Christopher Reicher
  6. It’s About Time: Implications of the Period Length in an Equilibrium Search Model By Ronald Wolthoff
  7. Financial development and long-run volatility trends By Pengfei Wang; Yi Wen
  8. Shopping Externalities and Self-Fulfilling Unemployment Fluctuations By Greg Kaplan; Guido Menzio
  9. Frequentist evaluation of small DSGE models By Gunnar Bårdsen; Luca Fanelli
  10. Place Based Policies with Unemployment By Kline, Patrick; Moretti, Enrico
  11. The structural shift to green services By Emanuele Campiglio
  12. An OLG model of global imbalances By Sara Eugeni
  13. Real wage cyclicality of newly hired workers By Stüber, Heiko
  14. Are Turbulences of Sargent and Ljungqvist consistent with lower Aggregate Volatility? By Batyra, Anna
  15. Environmental Macroeconomics: Environmental Policy, Business Cycles, and Directed Technical Change By Garth Heutel; Carolyn Fischer
  16. Macroprudential policy and imbalances in the euro area By Michał Brzoza-Brzezina; Marcin Kolasa; Krzysztof Makarski
  17. Monetary regime change and business cycles By Vasco Cúrdia; Daria Finocchiaro
  18. House prices, expectations, and time-varying fundamentals By Paolo Gelain; Kevin J. Lansing

  1. By: Yue Zhao (Graduate School of Economics, Kyoto University)
    Abstract: Following Jermann and Quadrini (2012), we apply the dynamic stochastic general equilib- rium modeling method (DSGE) to assess whether nancial shocks matter for the Japanese economy. We construct time series of nancial shocks and productivity shocks using Japan's quarterly data since 2001 and conduct simultaneous replication on major indi- cators of aggregate financial flows and real variables. Preliminary results tell us that in a closed economy, nancial shocks seem less important than they were in the U.S. economy. However, after extending the original model to a small open economy in which rms can borrow from overseas lenders but may have to pay a default risk premium on interest payments, simulated results show that nancial shocks have contributed heavily to the dynamics of aggregate debt and dividend flows. This is consistent with Jermann and Quadrini's (2012) nding on the U.S. economy. By contrast, however, productivity shocks seem to have been dominant in accounting for fluctuations of real variables, such as output, consumption ratio, and investment ratio in Japan.
    Keywords: DSGE model, financial friction, small open economy, simulation
    JEL: E44 E32 F41
    Date: 2013–02
  2. By: Brant Abbott; Giovanni Gallipoli; Costas Meghir; Giovanni L. Violante
    Abstract: This paper compares partial and general equilibrium effects of alternative financial aid policies intended to promote college participation. We build an overlapping generations life-cycle, heterogeneous-agent, incomplete-markets model with education, labor supply, and consumption/saving decisions. Altruistic parents make inter vivos transfers to their children. Labor supply during college, government grants and loans, as well as private loans, complement parental transfers as sources of funding for college education. We find that the current financial aid system in the U.S. improves welfare, and removing it would reduce GDP by two percentage points in the long-run. Any further relaxation of government-sponsored loan limits would have no salient effects. The short-run partial equilibrium effects of expanding tuition grants (especially their need-based component) are sizeable. However, long-run general equilibrium effects are 3-4 times smaller. Every additional dollar of government grants crowds out 20-30 cents of parental transfers.
    JEL: E24 I22 J23 J24
    Date: 2013–02
  3. By: Vasco Cúrdia; Marco Del Negro; Daniel L. Greenwald
    Abstract: We estimate a DSGE model where rare large shocks can occur, by replacing the commonly used Gaussian assumption with a Student-t distribution. Results from the Smets and Wouters (2007) model estimated on the usual set of macroeconomic time series over the 1964-2011 period indicate that the Student-t specification is strongly favored by the data even when we allow for low-frequency variation in the volatility of the shocks, and that the estimated degrees of freedom are quite low for several shocks that drive U.S. business cycles, implying an important role for rare large shocks. This result holds even if we exclude the Great Recession period from the sample. We also show that inference about low-frequency changes in volatility and in particular, inference about the magnitude of the Great Moderation is different once we allow for fat tails.
    Date: 2013
  4. By: David R. F. Love
    Abstract: This paper explores the natural resource consumption behavior of a competitively determined economy relative to a socially planned benchmark when agents are characterized as having finite lifespans which overlap. A general equilibrium model of a production economy which uses inputs from a finite stock of an aggregate natural resource is formulated and solved for the rates of resource extraction associated with the competitive outcome and the socially planned one. It is shown that resource extraction in the competitive economy can exceed that of the socially planned optimum and that intergenerational inequities result.
    Keywords: overlapping generation, essential non-renewable resources, social planning problem, competitive agents, extraction rates, dynamic programming, stability and convergence.
    Date: 2013–01
  5. By: Christopher Reicher
    Abstract: DSGE models with generalized shock processes have been a major area of research in recent years. In this paper, I show that the structural parameters governing DSGE models are not identified when the driving process behind the model follows an unrestricted VAR. This finding implies that parameter estimates derived from recent attempts to estimate DSGE models with generalized driving processes should be treated with caution, and that there exists a tradeoff between identification and the risk of model misspecification
    Keywords: Identification, DSGE models, observational equivalence, maximum likelihood
    JEL: C13 C32 E00
    Date: 2013–01
  6. By: Ronald Wolthoff
    Abstract: Empirical evidence suggests that transitions between employment states are highly clustered around the ï¬rst day of each workweek or each month. Motivated by this observation, I present an equilibrium search model in which the period length is a parameter that determines the degree of clustering. If the period length goes to zero, convergence to a continuous-time model without clustering is obtained. Longer time periods, however, introduce the possibility of recall (or simultaneity) of job offers. In this environment, I show that the period length has a profound effect on the equilibrium outcomes, including the unemployment rate, average unemployment duration, the labor share, the amount of wage dispersion, as well as the shape of the wage density.
    Keywords: labor market flows, search frictions, simultaneous search, on-the-job search, wage dispersion, wage mobility, unemployment
    JEL: E24 J31 J64
    Date: 2013–02–04
  7. By: Pengfei Wang; Yi Wen
    Abstract: Countries with more developed financial markets (as measured by the private debt- to-GDP ratio) tend to have significantly lower aggregate volatility. This relationship is also highly non-linear starting from a low level of financial development the reduction in aggregate volatility by financial deepening is far more significant than it is when the financial market is more developed. We build a fully-edged neoclassical growth model with an endogenous financial market of credit arrangements and private debt to rationalize these stylized facts. We show how financial development that promotes better credit allocations under more relaxed borrowing constraints can reduce the impact of non-financial shocks (such as TFP shocks, government spending shocks, preference shocks) on aggregate out- put and investment, and why this volatility-reducing effect diminishes with continuing financial development. Our simple model also sheds light on a number of other important issues, such as the "Great Moderation" and the simultaneously rising trends of dispersions in sales growth and stock returns for publicly traded firms.
    Keywords: Financial markets
    Date: 2013
  8. By: Greg Kaplan; Guido Menzio
    Abstract: We propose a novel theory of self-fulfilling fluctuations in the labor market. A firm employing an additional worker generates positive externalities on other firms, because employed workers have more income to spend and have less time to shop for low prices than unemployed workers. We quantify these shopping externalities and show that they are sufficiently strong to create strategic complementarities in the employment decisions of different firms and to generate multiple rational expectations equilibria. Equilibria differ with respect to the agents' (rational) expectations about future unemployment. We show that negative shocks to the agents' expectations lead to fluctuations in vacancies, unemployment, labor productivity and the stock market that closely resemble those observed in the US during the Great Recession.
    JEL: D11 D21 D43 E32
    Date: 2013–02
  9. By: Gunnar Bårdsen (Department of Economics, Norwegian University of Science and Technology); Luca Fanelli
    Abstract: This paper proposes a new evaluation approach of the class of small-scale `hybrid' New Keynesian Dynamic Stochastic General Equilibrium (NK-DSGE) models typically used in monetary policy and business cycle analysis. The novelty of our method is that the empirical assessment of the NK-DSGE model is based on a conditional sequence of likelihood-based tests conducted in a Vector Autoregressive (VAR) system in which both the low and high frequency implications of the model are addressed in a coherent framework. The idea is that if the low frequency behaviour of the original time series of the model can be approximated by unit roots, stationarity must be imposed by removing the stochastic trends. This means that with respect to the original variables, the solution of the NK-DSGE model is a VAR that embodies a set of recoverable unit roots/cointegration restrictions, in addition to the cross-equation restrictions implied by the rational expectations hypothesis. The procedure is based on the sequence `LR1->LR2->LR3', where LR1 is the cointegration rank test, LR2 the cointegration matrix test and LR3 the cross-equation restrictions test: LR2 is computed conditional on LR1 and LR3 is computed conditional on LR2. The type-I errors of the three tests are set consistently with a pre-fixed overall nominal significance level and the NK-DSGE model is not rejected if no rejection occurs. We investigate the empirical size properties of the proposed testing strategy by a Monte Carlo experiment and illustrate the usefulness of our approach by estimating a monetary business cycle NK-DSGE model using U.S. quarterly data.
    Keywords: DSGE models, LR test, Maximum Likelihood, New-Keynesian model, VAR
    JEL: C5 E4 E5
    Date: 2013–01–30
  10. By: Kline, Patrick (University of California, Berkeley); Moretti, Enrico (University of California, Berkeley)
    Abstract: Many countries have policies aimed at creating jobs in depressed areas with high unemployment rates. In standard spatial equilibrium models with perfectly competitive labor and land markets, local job creation efforts are distortionary. We develop a stylized model of frictional local labor markets with the goal of studying the efficiency of unemployment differences across areas and the potential for place based policies to correct local market failures. Our model builds on the heavily studied Diamond-Mortensen-Pissarides framework, adapted to a local labor market setting with a competitive housing market. The result is a simple search analogue of the classic Roback (1982) model that provides a tractable environment for studying the effects of local job creation efforts. In the model, workers are perfectly mobile and the productivity of worker-firm matches may vary across metropolitan areas. In equilibrium, higher local productivity results in higher nominal wages, higher housing costs, and lower unemployment rates. Although workers can move freely to arbitrage away differences in expected utility across metropolitan areas, equilibrium unemployment rates are not equalized across space. We find that if hiring costs are excessive, firms may post too few vacancies. This problem may be offset via local hiring subsidies of the sort found in many place based policies. The optimal hiring subsidy is city specific in the sense that it depends upon the local productivity level.
    Keywords: spatial equilibrium, cities
    JEL: J6
    Date: 2013–01
  11. By: Emanuele Campiglio (Grantham Research Institute, London School of Economics)
    Abstract: In this paper I investigate the role of an increasingly demanded class of green services, characterised by having strong roots in local communities, high human labour intensity, flat labour productivity growth and a low impact on the environment. In order to do so, I build an endogenous growth model with a progressive manufacturing sector and a stagnant service sector. Productivity growth in the former sector is driven by the presence of a public stock of capital, representing infrastructure. The progressive sector also generates a negative externality on an open-access renewable resource that enters the households welfare function. I thus study the long-run behaviour of the economy and present a numerical example to analyse the transition during which structural change takes place. Results show the possibility of a conflict between growth and welfare by investigating the effects of a change in some relevant policy and technological parameters.
    Date: 2013–02
  12. By: Sara Eugeni
    Abstract: In this paper, we investigate the relationship between East Asian countries’ high propensity to save and global imbalances in a two-country OLG model with production. The absence of pay-as-you-go pension systems can rationalize the saving behavior of emerging economies and capital outflows to the United States. The model predicts that the country with no pay-as-you-go system can run a trade surplus only as long as the long-run growth rate of the economy is higher than the real interest rate (capital overaccumulation case). The low real interest rates in the US is evidence in favor of the hypothesis that there is a “global saving glut†in the world economy. The model can also explain why the US current account deteriorated gradually and only in the late 1990s, although the net foreign asset position had already turned negative in the early 1980s. Finally, this analysis implies that the introduction of a pay-as-you-go system in China would have the effect of reducing the imbalances.
    Keywords: global imbalances, capital flows, current account dynamics, OLG model, pay-as-you-go-system
    JEL: F21 F33 F34 F41
    Date: 2013–02
  13. By: Stüber, Heiko
    Abstract: Several recent marcoeconomic models rely on rigid wages. Especially wage rigidity of newly hired workers seems to play a crucial role, since the decision of opening a vacancy or not is mainly influenced by their real wages. However, so far little empirical evidence exists on how real wages of newly hired workers react to business cycle conditions. This paper aims at filling this gap for a large economy, namely Germany, by analyzing the cyclical behavior or real wages of newly hired workers while controlling for cyclical up- and downgrading in employer/employee matches. For the analysis two endogenous variables are used: either the typical (e.g. modal) real wages paid to entrants into particular jobs of particular firms or entrants' individual real wages. The results show that entry-wages are not rigid, but considerably respond to business cycle conditions. This finding strengthens Pissarides' (2009) dismissal of theories based on cyclically rigid hiring wages. Furthermore, I show that the procyclicality of the employment / population ratio is (nearly) identical to the procyclicality of real entry-wages. --
    Keywords: real wage cyclicality,entry-wages,search and matching model
    JEL: E24 E32 J31
    Date: 2013
  14. By: Batyra, Anna (Galatasaray University Economic Research Center)
    Abstract: Ljungqvist and Sargent (1998, 2008, 2007a, 2007b) impute the persistence of long term unemployment in Europe since 80s to the welfare state’s inability to cope with more turbulent times. They claim that global economic conditions have been more turbulent in the 80s and 90s, comparing to the earlier decades, and construct a model based on search with a turbulence at the micro level to reproduce the evolution of unemployment in laissez-faire and welfare economies. Plethora of research, among others Stock and Watson (2002, 2005), document on the other hand a fall in the aggregate volatility of macro series in the USA and G7 countries since 80s. We attempt to reconcile these two findings. Can the model of Ljungqvist and Sargent (1998) based on the micro turbulence be consistent with the macro data? We look at the macro series of productivity and real wages (plus real GDP and employment) for a number of countries and find a decline in the aggregate volatility since the 80s. We then generate the macro series based on Ljungqvist and Sargent (1998) search model and establish what sort of aggregate volatility it predicts for welfare and laissez-faire economies under different degrees of turbulence. We find that, although the model fails to match the data exactly, it has a potential to be consistent with labor market outcomes but is unable to match broader aggregate measures.
    Keywords: Search unemployment; turbulences; volatility
    JEL: C52 E32 J64
    Date: 2013–02–04
  15. By: Garth Heutel; Carolyn Fischer
    Abstract: Environmental economics has traditionally fallen in the domain of microeconomics, but recently approaches from macroeconomics have been applied to studying environmental policy. We focus on two macroeconomic tools and their application to environmental economics. First, real business cycle models can incorporate pollution and pollution policy and be used to answer several questions. How can environmental policy adjust to business cycles? How do different types of policies fare in a context with business cycles? Second, endogenous technological growth is an important component of environmental policy. Several studies ask how policy can be designed to both tackle emissions directly and influence the adoption of clean technologies. We focus on these two aspects of environmental macroeconomics but emphasize that there are many other potential applications.
    JEL: E32 O44 Q50 Q55
    Date: 2013–02
  16. By: Michał Brzoza-Brzezina (National Bank of Poland, Warsaw School of Economics); Marcin Kolasa (National Bank of Poland, Warsaw School of Economics); Krzysztof Makarski (National Bank of Poland, Warsaw School of Economics)
    Abstract: Since its creation the euro area suffered from imbalances between its core and peripheral members. This paper checks whether macroprudential policy applied to the peripheral countries could contribute to providing more macroeconomic stability in this region. To this end we build a twoeconomy macrofinancial DSGE model and simulate the effects of macroprudential policies under the assumption of asymmetric shocks hitting the core and the periphery. We find that macroprudential policy is able to partly make up for the loss of independent monetary policy in the periphery. Moreover, LTV policy seems more efficient than regulating capital adequacy ratios. However, for the policies to be effective, they must be set individually for each region. Area-wide policy is almost ineffective in this respect.
    Keywords: euro-area imbalances, macroprudential policy, DSGE with banking sector
    JEL: E32 E44 E58
    Date: 2013
  17. By: Vasco Cúrdia; Daria Finocchiaro
    Abstract: This paper proposes a simple method to structurally estimate a model over a period of time containing a regime shift. It then evaluates to which degree it is relevant to explicitly acknowledge the break in the estimation procedure. We apply our method on Swedish data, and estimate a DSGE model explicitly taking into account the monetary regime change in 1993, from exchange rate targeting to inflation targeting. We show that ignoring the break in the estimation leads to spurious estimates of model parameters including parameters in both policy and non-policy economic relations. Accounting for the regime change suggests that monetary policy reacted strongly to exchange rate movements in the first regime, and mostly to inflation in the second. The sources of business cycle fluctuations and their transmission mechanism are significantly affected by the exchange rate regime.
    Date: 2013
  18. By: Paolo Gelain (Norges Bank (Central Bank of Norway)); Kevin J. Lansing (Federal Reserve Bank of San Francisco)
    Abstract: We investigate the behavior of the equilibrium price-rent ratio for housing in a simple Lucas-type asset pricing model. We allow for time-varying risk aversion (via external habit formation) and time-varying persistence and volatility in the stochastic process for rent growth, consistent with U.S. data for the period 1960 to 2011. Under fully-rational expectations, the model signi ficantly underpredicts the volatility of the U.S. price-rent ratiofor reasonable levels of risk aversion. We demonstrate that the model can approximately match the volatility of the price-rent ratio in the data if near-rational agents continually update their estimates for the mean, persistence and volatility of fundamental rent growth using only recent data (i.e., the past 4 years), or if agents employ a simple moving-average forecast rule that places a large weight on the most recent observation. These two versions of the model can be distinguished by their predictions for the correlation between expected future returns on housing and the price-rent ratio. Only the moving-average model predicts a positive correlation such that agents tend to expect higher future returns when house prices are high relative to fundamentals–a feature that is consistent with survey evidence on the expectations of real-world housing investors.
    Keywords: Asset pricing, Excess volatility, Housing bubbles, Predictability, Time-varying risk premiums, Expected returns
    JEL: D84 E32 E44 G12 O40 R31
    Date: 2013–02–04

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