nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2013‒03‒23
sixteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Equilibrium Unemployment during Financial Crises By Andres Fernandez; Juan Herreno
  2. Taxing capital is a good idea: the role of idiosyncratic risk in an OLG model By Ryoji Hiraguchi; Akihisa Shibata
  3. International reserves and rollover risk By Javier Bianchi; Juan Carlos Hatchondo; Leonardo Martinez
  4. Distribution capital and the short- and long-run import demand elasticity By Mario J. Crucini; J. Scott Davis
  5. An Equilibrium Search Model of the Labor Market Entry of Second-Generation Immigrants and Ethnic Danes By Datta Gupta, Nabanita; Kromann, Lene
  6. A disaggregated approach to the government spending shocks: an theoretical analysis By Cortuk, Orcan; Güler, Mustafa Haluk
  7. Optimal capital taxation for time-nonseparable preferences By Koehne, Sebastian; Kuhn, Moritz
  8. Modeling monetary economies: an equivalence result By Gabriele Camera; YiLi Chien
  9. Environmental Externality on Production in an OLG Economy By Hiroshi Danbara
  10. The Labor Market Effects of Introducing Unemployment Benefits in an Economy with High Informality By Mariano Bosch; Julen Esteban-Pretel
  11. A Tractable Monetary Model Under General Preferences By Tsz-Nga Wong
  12. Using a DSGE Model to Assess the Macroeconomic Effects of Reserve Requirements in Brazil By Waldyr Dutra Areosa; Christiano Arrigoni Coelho
  13. Household leveraging and deleveraging By Alejandro Justiniano; Giorgio Primiceri; Andrea Tambalotti
  14. Global dynamics at the zero lower bound By William T. Gavin; Benjamin D. Keen; Alexander Richter; Nathaniel Throckmorton
  15. Reconstructing the great recession By Michele Boldrin; Carlos Garriga; Adrian Peralta-Alva; Juan M. Sánchez
  16. Lucas's Early Research and the Natural Rate of Unemployment By Danilo Freitas Ramalho da Silva

  1. By: Andres Fernandez; Juan Herreno
    Abstract: Financial crises in both emerging and developed economies have been characterized by large output drops and spikes in unemployment and interest rates. To account for these stylized facts this paper builds a business cycle model where financial and labor market frictions interact as occasionally binding borrowing constraints and search frictions. The model is calibrated to a Sudden Stop-prone emerging economy and also to some peripheral European economies in the recent crisis. The model accounts for unemployment dynamics both during crises and at regular business cycle frequencies. The paper also assesses the welfare implications of policies that reduce real minimum wages during crises.
    JEL: E32 E44 F41
    Date: 2013–02
  2. By: Ryoji Hiraguchi (Faculty of Economics, Ritsumeikan University); Akihisa Shibata (Institute of Economic Research, Kyoto University)
    Abstract: We investigate an overlapping generations model (OLG) model in which agents who live for two periods receive idiosyncratic productivity shocks when they are old. We show that a combination of lump-sum and linear capital taxes can always Pareto-improve the allocation, that is, it can raise the equilibrium welfare of one generation without affecting that of the others. As D?vila et al. (Econometrica (2012)) show, a capital reduction in one period raises the welfare levels of agents who are old in that period, but lowers that of the young agents, because it reduces their wages. We show that the government can compensate for these wage losses by additionally taxing the old agents, such that their welfare gains remain positive.
    Keywords: idiosyncratic risk; capital tax, incomplete markets, overlapping generations
    JEL: E5
    Date: 2013–03
  3. 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.
    Keywords: Economic growth ; Business cycles ; Financial markets ; Financial institutions
    Date: 2013
  4. By: Mario J. Crucini; J. Scott Davis
    Abstract: International business-cycle models assume that home and foreign goods are poor substitutes. International trade models assume they are close substitutes. This paper constructs a model where this discrepancy is due to frictions in distribution. Imports need to be combined with a local non-traded input, distribution capital, which is slow to adjust. As a result, imported and domestic goods appear as poor substitutes in the short run. In the long run this non-traded input can be reallocated, and quantities can shift following a change in relative prices. Thus the observed substitutability between home and foreign goods gets larger as time passes.
    Keywords: International trade
    Date: 2013
  5. By: Datta Gupta, Nabanita (Aarhus University); Kromann, Lene (CEBR, Copenhagen)
    Abstract: Using a search model for Danish labor market entrants, we are one of the first studies to test whether second‐generation immigrants have the same job‐offer arrival and layoff rates as ethnic Danes have. We contribute to the search literature by incorporating matching as a way to ensure sub‐sample homogeneity. Thus, we match second‐generation immigrants to their ethnic Danish twins on the basis of parental characteristics and informal network quality. There are big differences before matching, but after matching, second‐generation immigrants perform as well or better than their ethnic Dane counterparts do on the labor market, though not with respect to layoffs. This result is mainly driven by the group of high school graduates and those with a primary school education only. Second generation immigrants with vocational education, males in particular, face both significantly lower arrival rates when unemployed and significantly higher layoff rates than those of their ethnic Danish twins.
    Keywords: firm behavior, equilibrium search model, matching, second‐generation immigrants
    JEL: J15 J61 J71
    Date: 2013–02
  6. By: Cortuk, Orcan; Güler, Mustafa Haluk
    Abstract: We examine different types of government spending while literature usually treats government spending as a homogenous compound. We disaggregate the government spending into three parts; namely, government investment, government wage component consumption (i.e. wage expenditure) expenditure, and non-wage component consumption (i.e. purchases of goods and services). Next, we estimate a dynamic stochastic general equilibrium model that features a transmission mechanism with different types of government spending. In this regard, we manage to distinguish between different types of government spending where each type of spending has varied role in the economy. Such set up enables them produce different effects on macroeconomic variables.
    Keywords: Disaggregated government spending, Government investment, Government wage consumption, Government non-wage component consumption, DSGE model.
    JEL: E62 H50
    Date: 2013–03–13
  7. By: Koehne, Sebastian; Kuhn, Moritz
    Abstract: This paper studies the effect of habit formation on optimal capital taxes in a dynamic Mirrleesian model. We make three distinct contributions. First, we decompose intertemporal wedges (implicit capital taxes) for general time-nonseparable preferences into a wealth effect, a complementarity effect, and a future incentive effect. Second, we provide conditions under which intertemporal wedges are positive. Third, we derive a recursive formulation of constrained efficient allocations and evaluate the quantitative impact of habit formation. In a model parameterized to the U.S. economy, habit formation reduces average intertemporal wedges by about 40 percent compared to the time-separable case. Moreover, intertemporal wedges are close to zero for the largest part of the working life.
    Keywords: optimal taxation; intertemporal wedge; habit formation; recursive contracts; new dynamic public finance
    JEL: D82 E21 H21
    Date: 2013–03–18
  8. By: Gabriele Camera; YiLi Chien
    Abstract: This paper offers a methodological contribution to monetary theory. First, it presents a model economy with cash-in-advance constraints, following the work of Lucas in the early 80’s; then, it specializes the model to preferences and shocks assumed in the Lagos and Wright (2005) framework. Second, it derives the main equations describing allocations under competitive pricing and demonstrates that the two models—which on the surface appear different—are mathematically equivalent. Such equivalence result is extended to stationary equilibrium under non-competitive pricing; in both models, allocations depend on a free parameter controlling price markups.
    Keywords: Monetary theory ; Money ; Inflation (Finance)
    Date: 2013
  9. By: Hiroshi Danbara (Graduate School of Economics, Keio University)
    Abstract: In this paper, we introduce the environmental externality into the Diamond (1965) model. The environmental externality affects on the production negatively. We define a socially optimal allocation and a competitive equilibrium, and obtain the first-order necessary conditions. In competitive equilibrium, both consumers and firms have no incentives to maintain the environment, hence competitive equilibrium allocation can not be socially optimal. Therefore we propose a tax scheme. Our model requires two types of taxes in order to achieve a social optimum.
    Date: 2013–03
  10. By: Mariano Bosch (Inter-American Development Bank); Julen Esteban-Pretel (National Graduate Institute for Policy Studies)
    Abstract: Unemployment benefit systems are non-existent in many developing economies. Introducing such programs in these economies poses many challenges, which is partly due to the high level of informality in their labor markets. In this paper we study the consequences on the labor market of implementing an unemployment benefit system in economies with large informal sectors and high flows of workers between formality and informality. We build a search and matching model with endogenous destruction, on-the-job search and inter-sectoral flows, where agents in the economy decide optimally whether or not to formalize jobs. We calibrate the model for Mexico and show that the introduction of an unemployment subsidy system, where workers contribute during formal employment and collect benefits when they lose the job, can deliver an increase in formality in the economy while also producing small increases in unemployment. The exact impact of incorporating such benefits depends on the relative strength of two opposing effects: the generosity of the benefits and the level of the contributions that finance those benefits. We also show important policy complementarities with other interventions in the labor market. In particular, combining the unemployment benefit program with policies that reduce the cost of formality, such as lower firing costs or taxes, can produce decreases in informality and lower impacts on unemployment than when the subsidy program is applied in isolation.
    Date: 2013–02
  11. By: Tsz-Nga Wong
    Abstract: Consider the monetary model of Lagos and Wright (JPE 2005) but with general preferences and general production. I show that preferences satisfying UXXUHH – (UXH)2 = 0 is a sufficient condition for the existence and uniqueness of monetary equilibrium with degenerate money distribution. I solve for the entire class of exact solutions to the above non-linear second order partial differential equation. This class of preferences includes ones with constant return to scale, for example, constant elasticity of substitution (CES), and ones used in many other macroeconomics literatures. I also analyze the welfare implication of monetary policy in this economy.
    Keywords: Economic models
    JEL: E40 D83
    Date: 2013
  12. By: Waldyr Dutra Areosa; Christiano Arrigoni Coelho
    Abstract: The goal of this paper is to present how a Dynamic General Equilibrium Model (DSGE) can be used by policy makers in the qualitative and quantitative evaluation of the macroeconomics impacts of two monetary policy instruments: (i) short term interest rate and (ii) reserve requirements ratio. In our model, this last instrument affects the leverage of banks that have to deal with agency problems in order to raise funds from depositors. We estimated a modified version of Gertler and Karadi (2011), incorporating a reserve requirement ratio, in order to answer two questions: (i) what is the impact of a transitory increase of 1% p.y. of the short term interest rate on macroeconomic variables like GDP, inflation and investment? (ii) what is the macroeconomic impact of a transitory increase of 10% in the reserve requirement ratio? We found that these two shocks have the same qualitative effects on the most of the macroeconomic variables, but that the impact of interest rate is much stronger.
    Date: 2013–01
  13. By: Alejandro Justiniano; Giorgio Primiceri; Andrea Tambalotti
    Abstract: U.S. households' debt skyrocketed between 2000 and 2007, but has since been falling. This leveraging and deleveraging cycle cannot be accounted for by the liberalization and subsequent tightening of mortgage credit standards that occurred during the period. We base this conclusion on a quantitative dynamic general equilibrium model calibrated using macroeconomic aggregates and microeconomic data from the Survey of Consumer Finances. From the perspective of the model, the credit cycle is more likely due to factors that impacted house prices more directly, thus affecting the availability of credit through a collateral channel. In either case, the macroeconomic consequences of leveraging and deleveraging are relatively minor because the responses of borrowers and lenders roughly wash out in the aggregate.
    Keywords: Households - Economic aspects ; Debt ; Consumer credit ; Housing - Prices ; Mortgages
    Date: 2013
  14. By: William T. Gavin; Benjamin D. Keen; Alexander Richter; Nathaniel Throckmorton
    Abstract: This article presents global solutions to standard New Keynesian models to show how economic dynamics change when the nominal interest rate is constrained at its zero lower bound (ZLB). We focus on the canonical New Keynesian model without capital, but we also study the model with capital, with and without investment adjustment costs. Our solution method emphasizes accuracy to capture the expectational effects of hitting the ZLB and returning to a positive interest rate. We find that the response to a technology shock has perverse consequences when the ZLB binds, even when a discount factor shock drives the interest rate to zero. Although we do not model the large scale asset purchases used by the Fed since 2009, our results suggest that the economy may have trouble recovering if the interest rate remains at zero. Given the perverse dynamics at the ZLB, we evaluate how monetary policy affects the likelihood of encountering the ZLB. We find that the probability of hitting the ZLB depends importantly on the monetary policy rule. A policy rule based on a dual mandate, such as the one proposed by Taylor (1993), is more likely to cause ZLB events when the central bank places greater emphasis on the output gap.
    Keywords: Monetary policy ; Bonds
    Date: 2013
  15. By: Michele Boldrin; Carlos Garriga; Adrian Peralta-Alva; Juan M. Sánchez
    Abstract: This paper evaluates the role of the construction sector in accounting for the performance of the U.S. economy in the last decade. During the Great Recession (2008-09) employment in the construction sector experienced an unprecedented decline that followed the largest expansion in employment since the 1950s. A simple input-output exercise reveals that the contribution of construction to the variations of the macro variables was significant. Despite the small size of the construction sector, its inter- linkages with other sectors in the economy propagate the effect from changes in the demand of residential investment, hence amplifying the effect on the overall economy. The importance of interlinkages is illustrated in a static model and then quantified in a generalized framework that includes xed and residential investment. The model is calibrated to reproduce the boom-bust dynamics of construction employment in the period 2000-10. We nd that construction and its interlinkages account for a large share of the actual changes in aggregate employment and gross domestic product during the expansion and the recession. Through the lens of the standard business cycle accounting, the recession generated in the model, as in the data, is due to the worsening of the labor wedge.
    Keywords: Construction industry ; Business cycles ; Recessions
    Date: 2013
  16. By: Danilo Freitas Ramalho da Silva
    Abstract: This paper builds a narrative on the early work of Robert E. Lucas Jr., in the late 1960’s, which culminated in the modeling and testing of the natural rate of unemployment hypothesis. Lucas’s modeling and testing of the natural rate can be found, respectively, in two papers: “Expectations and the Neutrality of Money” (Lucas, 1972a) and “Econometric Testing of the Natural Rate Hypothesis” (Lucas, 1972b). These papers are the synthesis of the two branches of Lucas’s research at that time; one on labor market behavior and other on optimal investment by firms. This synthesis changed the way in which the natural rate of unemployment was originally elaborated by Friedman (1968a) and Phelps (1967, 1968), by modeling it in a general equilibrium framework with rational expectations and giving it a proper test. Lucas’s research agenda synthesis in the late 1960’s was the result of his close interaction with Phelps and Prescott, backed up by his pragmatic equilibrium approach to economics, concerning modeling, econometric estimation and testing. Phelps explicitly suggested a general equilibrium approach to Lucas’s labor market modeling, while Prescott helped him in dealing with the rational expectations hypothesis.
    Date: 2013

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.