nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2013‒04‒06
twenty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. The role of financial frictions in the 2007-2008 crisis: an estimated DSGE model By Rossana Merola
  2. Optimal Monetary Policy in Response to Shifts in the Beveridge Curve By Mariya Mileva
  3. What explains schooling differences across countries? By Cordoba, Juan Carlos; Ripoll, Marla
  4. Capital Investment and Equilibrium Unemployment By Jósef Sigurdsson
  5. Inequality Without Imperfection: The Role of Uncertainty By Keith Blackburn; David Chivers
  6. Wages and informailty in developing countries By Costas Meghir; Renata Narita; Jean-Marc Robin
  7. Perturbation methods for Markov-switching DSGE models By Andrew Foerster; Juan Rubio-Ramírez; Daniel F. Waggoner; Tao Zha
  8. Assortative matching and search with labour supply and home production By Nicolas Jacquemet; Jean-Marc Robin
  9. Saving Rate Dynamics in the Neoclassical Growth Model — Hyperbolic Discounting and Observational Equivalence By Y. Hossein Farzin; Ronald Wendner
  10. Entrepreneurs, Jobs, and Trade By Bulent Unel; Elias Dinopoulos
  11. Three essays on imbalances in a monetary union. By HJORTSØ, Ida Maria
  12. Does Short-Time Work Save Jobs? A Business Cycle Analysis By Almut Balleer; Britta Gehrke; Wolfgang Lechthaler; Christian Merkl
  13. Life Expectancy, Schooling, and Lifetime Labor Supply: Theory and Evidence Revisited By Cervellati, Matteo; Sunde, Uwe
  14. Beyond Expected Utility in the Economics of Health and Longevity By Cordoba, Juan Carlos; Ripoll, Marla
  15. Three essays in macroeconomics. By SÁNCHEZ-MARTÍNEZ, Miguel
  16. Is government spending a free lunch? -- evidence from China By Xin Wang; Yi Wen
  17. Central Bank Financial Strength and Credibility: A Simple Dynamic Optimization Model By Atsushi Tanaka
  18. A theory of rollover risk, sudden stops, and foreign reserves By Sewon Hur; Illenin O. Kondo
  19. Sticky information diffusion and the inertial behavior of durable consumption By Yulei Luo; Jun Nie; Eric R. Young
  20. Career progression, economic downturns and skills By Jerome Adda; Christian Dustmann; Costas Meghir; Jean-Marc Robin
  21. Health, Work Intensity, and Technological Innovations By Raouf Boucekkine; Natali Hritonenko; Yuri Yatsenko

  1. By: Rossana Merola
    Abstract: After the banking crises experienced by many countries in the 1990s and in 2008, financial market conditions have turned out to be a relevant factor for economic fluctuations. The purpose of this paper is to determine whether frictions in financial markets are important for business cycles, and whether the recent 2007-2008 crisis has enhanced (or reduced) the size of some shocks and the role played by financial factors in driving economic fluctuations. The analysis is based on both versions of the Smets and Wouters DSGE model (2003, 2007), which are estimated using Bayesian techniques. The two versions differ because the Smets and Wouters (2007) version entails a risk premium shock, which captures that interest rate faced by firms and households might be different from the policy rate because of some unmodelled frictions. Both versions are augmented to include an endogenous financial accelerator mechanism as in Bernanke, Gertler and Gilchrist (1999), which arises from information asymmetries between lenders and borrowers that create inefficiencies in financial markets. The analysis is based on the same data-set as in the Smets and Wouters model, but extended to 2010. One first set of results suggests that the recent crisis has amplified the relevance of financial factors, as well as unmodelled frictions. Overall, this paper proves that the Smets and Wouters model augmented with a financial accelerator mechanism is suitable to capture much of the historical developments in U.S. financial markets that led to the financial crisis in 2007-2008. In particular, the concomitance of a peak in leverage ratio and the deepening of the recession supports the argument that leverage and credit have an important role to play in shaping the business cycle, in particular the intensity of recessions.
    Keywords: Business cycle, financial frictions, Bayesian estimation.
    JEL: C11 E32 E44
    Date: 2013–03
  2. By: Mariya Mileva
    Abstract: I build a dynamic stochastic general equilibrium model with search and matching frictions in the labor market and analyze the optimal monetary policy response to an outward shift in the Beveridge curve. The results cover several cases depending on the reason for the shift. If the shift is due to a fall in the efficiency of matching, then the optimal response of the central bank is to stabilize inflation. On the other hand, if the shift arises from an increase in the elasticity of employment matches with respect to vacancies, then the policy maker faces a trade off between stabilizing inflation and unemployment. The optimal policy response to the efficient labor market shock changes when real wages are sticky but remains unchanged when home and market goods are imperfect substitutes, compared to the case when they are not. When contrasted to a Taylor rule that targets inflation and output growth, the optimal monetary policy is more aggressive in pursuit of its objectives
    Keywords: Beveridge curve; Optimal monetary policy; Labor market; Search and matching
    JEL: E24 E32 E52 J68
    Date: 2013–03
  3. By: Cordoba, Juan Carlos; Ripoll, Marla
    Abstract: This paper provides a theory that explains the cross-country distribution of average years of schooling, as well as the so called human capital premium puzzle. In our theory, credit frictions as well as differences in access to public education, fertility and mortality turn out to be the key reasons why schooling differs across countries. Differences in growth rates and in wages are second order.
    Keywords: human capital; life expectancy; per capita income di§erences; public education spend- ing; life cycle model
    JEL: I J O
    Date: 2013–03–01
  4. By: Jósef Sigurdsson
    Abstract: Econometric analysis of cross-country data reveals a robust long-term relationship between capital investment and unemployment. This paper studies this relationship within a search and matching model of the labor market. In the model developed, firms employ labor for two purposes: for production of a final good and for production of capital. Quantitative analysis shows that an increase in growth of capital-production technology increases capital formation and employment in capital production, reducing unemployment in equilibrium. The model is therefore successful in generating the negative long-run investment-unemployment relationship found in macroeconomic data.
    Date: 2013–02
  5. By: Keith Blackburn; David Chivers
    Abstract: We present an overlapping generations model in which aspirationalagents face uncertainty about the returns to human capital. Investment in human capital requires external funding, implying a probability of bankruptcy that is greater the lower the human capital endowment of an agent. We show that agents with sufficiently low human capital endowments may experience such a strong influence of loss aversion that they abstain from human capital investment. We further show how this behaviour may be transmitted through successive generations to cause initial inequalities to persist. These results do not rely on any capital market imperfections.
    Date: 2013
  6. By: Costas Meghir (Institute for Fiscal Studies and Yale University); Renata Narita; Jean-Marc Robin (Institute for Fiscal Studies and Sciences Po)
    Abstract: It is often argued that informal labour markets in developing countries are the engine of growth because their existence allows firms to operate in an environment where wage and regulatory costs are lower. On the other hand informality means that the amount of social protection offered to workers is lower. In this paper we extend the wage-posting framework of Burdett and Mortensen (1998) to allow for two sectors of employment. Firms are heterogeneous and decide endogenously in which sector to locate. Workers engage in both off the job and on the job search and decide which offers to accept. Direct transitions across sectors are permitted, which matches the evidence in the data about job mobility. Our empirical analysis uses Brazilian labour force surveys. We use the model to discuss the relative merits of alternative policies towards informality. In particular, we evaluate the impact of a tighter regulatory framework on employment in the formal and the informal sector on the distribution of wages.
    Date: 2013–03
  7. By: Andrew Foerster; Juan Rubio-Ramírez; Daniel F. Waggoner; Tao Zha
    Abstract: This paper develops a general perturbation methodology for constructing high-order approximations to the solutions of Markov-switching DSGE models. We introduce an important and practical idea of partitioning the Markov-switching parameter space so that a steady state is well defined. With this definition, we show that the problem of finding an approximation of any order can be reduced to solving a system of quadratic equations. We propose using the theory of Grobner bases in searching all the solutions to the quadratic system. This approach allows us to obtain all the approximations and ascertain how many of them are stable. Our methodology is applied to three models to illustrate its feasibility and practicality.
    Date: 2013
  8. By: Nicolas Jacquemet; Jean-Marc Robin (Institute for Fiscal Studies and Sciences Po)
    Abstract: We extend the search-matching model of the marriage market of Shimer and Smith (200) to allow for labour supply and home production. We characterise the steady-state equilibrium when exogenous divorce is the only source of risk. We study nonparametric identification using cross-section data on wages and hours worked, and we develop a nonparametric estimator. The estimated matching probabilities that can be derived from the steady-state flow conditions are strongly increasing in male and female wages. We estimate the expected share of marriage surplus appropriated by each spouse as a function of wages. The model allows to infer the specialisation of female spouses in home production from observations on wages and hours worked.
    Keywords: search-matching, sorting, assortative matching, collective labour supply, structural estimation
    JEL: C78 D83 J12 J22
    Date: 2013–03
  9. By: Y. Hossein Farzin (University of California at Davis); Ronald Wendner (Karl-Franzens University of Graz)
    Abstract: The standard neoclassical growth model with Cobb-Douglas production predicts a mono- tonically declining saving rate, when reasonably calibrated. Ample empirical evidence, however, shows that the transition path of a countrys saving rate exhibits a rising or non- monotonic pattern. In important cases, hyperbolic discounting, which is empirically strongly supported, implies transitional dynamics of the saving rate that accords well with empirical evidence. This holds true even in a growth model with Cobb-Douglas production technology. We also identify those cases in which hyperbolic discounting is observation- ally equivalent to exponential discounting. In those cases, hyperbolic discounting does not affect the saving rate dynamics. Numerical simulations employing a generalized class of hyperbolic discounting functions that we term regular discounting functions support the results.
    Keywords: Saving rate, non-monotonic transition path, hyperbolic discounting, regular discounting, commitment, short planning horizon, neoclassical growth model
    JEL: D91 E21 O40
    Date: 2013–03
  10. By: Bulent Unel; Elias Dinopoulos
    Abstract: We propose a simple theory of personal income distribution, equilibrium unemployment, and interindustry trade, in which product markets are perfectly competitive and labor markets exhibit search related frictions. Individuals, based on their managerial talent, choose to become self-employed entrepreneurs and acquire more managerial capital, or they become workers and face the prospect of unemployment. We analyze the effects of trade on a small-open jobless economy and a two-country global economy. In the case of a small-open economy, improvements in international competitiveness raise the possibility of immiserizing recessions with higher unemployment, lower GDP, and lower aggregate welfare. Reductions in the costs of acquiring managerial capital or appropriate job-vacancy subsidies generally lead to lower unemployment rate, higher aggregate welfare, and higher income inequality. In a two-country global economy, a country exports the good with lower labor-market frictions or lower costs of managerial capital acquisition. Unilateral job-creating policies have asymmetric effects on income inequality and unemployment across countries, and ambiguous effects on welfare in each country.
  11. By: HJORTSØ, Ida Maria
    Abstract: This thesis investigates the implications of imbalances within a monetary union. In the first chapter, I study how international financial frictions lead to international imbalances and affect optimal fiscal policy in a two-country, two-good DSGE model of a monetary union. I show that the presence of international imbalances affects the optimal conduct of cooperative fiscal policies when the traded goods are complements. Government expenditures optimally play a cross-country risk sharing role which is in conflict with the domestic stabilization role: optimal fiscal policy consists in setting government expenditures such as to reduce international imbalances at the expense of higher domestic inefficiencies. In the second chapter, I assess the implications of strategic fiscal policy interactions in a two-country DSGE model of a monetary union with nominal rigidities and international financial frictions. I show that the fiscal policy makers face an incentive to set fiscal policy such as to switch the terms of trade in their favour. This incentive results in a Nash equilibrium characterized by excessive inflation differentials as well as sub-optimally high current account imbalances within the monetary union. There are thus non-negligeable welfare losses associated with strategic fiscal policy making in a monetary union. The third chapter investigates empirically the degree of risk sharing in the European Economic and Monetary Union (EMU), using two different methods. The first measure relates to the capacity of consumption smoothing. This measure indicates that risk sharing is rather low and that the introduction of the common currency did not lead to higher intra-EMU risk sharing. The second measure is based on the welfare losses associated with deviations from full risk sharing. These welfare losses have fallen since the introduction of the common currency. However, this is mostly due to changes in macroeconomic risk - not to changes in risk sharing per se.
    Date: 2012
  12. By: Almut Balleer; Britta Gehrke; Wolfgang Lechthaler; Christian Merkl
    Abstract: This paper analyzes the effects of short-time work (i.e., government subsidized working time reductions) on unemployment and output fluctuations. The central question is whether the rule based component (i.e., the existence of the institution short-time work) and the discretionary component (i.e., rule changes) stabilize employment over the business cycle. In our baseline scenario the rule based component stabilizes unemployment fluctuations by 15% and output fluctuations by 7%. Given the small share of short-time work expenses in terms of GDP, the stabilization effects are large compared to other instruments such as the income tax system. By contrast, discretionary short-time work interventions do not have any statistically significant effect on unemployment. These effects are based on a structural VAR estimation which is identified using the output elasticity of short-time work estimated from German establishment paneldata. The model shows that non-effects of discretionary interventions may be due to their low persistence
    Keywords: Short-time work, fiscal policy, business cycles, search-and-matching, SVAR
    JEL: E24 E32 E62 J08 J63
    Date: 2013–03
  13. By: Cervellati, Matteo (University of Bologna); Sunde, Uwe (University of Munich)
    Abstract: This paper presents a theoretical and empirical analysis of the role of life expectancy for optimal schooling and lifetime labor supply. The results of a simple prototype Ben-Porath model with age-specific survival rates show that an increase in lifetime labor supply is not a necessary, nor a sufficient, condition for greater life expectancy to increase optimal schooling. The observed increase in survival rates during working ages that follows from the "rectangularization" of the survival function is crucial for schooling and labor supply. The empirical results suggest that the relative benefits of schooling have been increasing across cohorts of US men born 1840-1930. A simple quantitative analysis shows that a realistic shift in the survival function can lead to an increase in schooling and a reduction in lifetime labor hours.
    Keywords: longevity, life expectancy, schooling, lifetime labor supply, rectangularization of the survival function
    JEL: E20 J22 J24 J26 O11
    Date: 2013–03
  14. By: Cordoba, Juan Carlos; Ripoll, Marla
    Abstract: We document various limitations of the expected utility model for the study of health and longevity. The model assumes individuals are indifferent between early and late resolution of uncertainty. This assumption gives rise to predictions regarding the economic value of life that are inconsistent with relevant evidence. For example, poor individuals would price life below the present value of foregone income or even negatively. We show that a non-expected utility model disentangling intertemporal substitution from risk aversion can overcome these limitations. We illustrate the quantitative implications of our model for the economic value of life across countries and time.
    Keywords: life expectancy; value of statistical life; mortality risk aversion; Epstein-Zin-Weil pref- erences; Welfare; AIDS.
    JEL: I J
    Date: 2013–03–28
  15. By: SÁNCHEZ-MARTÍNEZ, Miguel
    Abstract: This thesis comprises three thorough investigations into different important economic issues. The common nexus between them is the long-horizon nature of the subjects covered, in which economic growth plays a central role. Specifically, the contents of the thesis address questions such as the extent to which financial integration is favorable for economic development, the implications that population growth has for the natural environment and the design of optimal policy when considering the latest insights on individuals' consumption behavior. The study of the specific topics addressed throughout each chapter of this thesis delivers a number of important results that are summarized subsequently. The first chapter provides an analysis of the relationship between aggregate economic uncertainty, growth and welfare. The model generates two main predictions. First, consumption growth is, ceteris paribus, higher on average in a country that participates in the international financial markets compared to one that is financially autarkic. Second, the sign of the net effect of financial integration on overall social welfare is ambiguous. In the second chapter, an inquiry is made into the implications of population growth for an optimal management problem with pollution externalities. The presence of a potential irreversibility in the dynamics for the stock of pollution is responsible for an outcome overlooked by the previous literature. In line with the available empirical evidence, the model implies that a growing population leads to a deteriorated state of environmental quality. Finally, the third chapter explores an optimal taxation problem in the presence of both congestion and habituation effects in consumption in an economy featuring endogenous growth. The results show that the second-best solution entails a constant consumption tax rate in the long-run and a counter-cyclical consumption tax growth rate in the short-run whose level hinges on the importance of both congestion and habit effects in preferences.
    Date: 2012
  16. By: Xin Wang; Yi Wen
    Abstract: Most empirical studies based on U.S. data suggest that the fiscal multiplier is less than 1 (e.g., Barro and Redlick, 2011). However, Keynes argued that the multiplier would be the largest when markets have failed to the greatest extent in coordinating economic activities (such as during the Great Depression with rampant unemployment and low capacity utilization). As a large developing country with high household saving rates, a large pool of rural labor force, and a wide range of market failures, China offers a unique opportunity to test the Keynesian notion that government expenditures (even as a pure waste of aggregate resources) can have a fiscal multiplier larger than 1 on aggregate income. Perhaps even more exceptional is China’s extensive use of government spending as a major policy tool to stimulate the economy over the past three decades. Based on both aggregate time-series data and panel data from 29 Chinese provinces, we find that the fiscal multiplier in China is larger than 2. We provide a theoretical model with market failures and Monte Carlo analysis to rationalize our empirical findings. Specifically, we build a model that can generate the same multiplier and business cycles observed in China and use the model as a data-generating process to gauge whether structural vector autoregressions can yield consistent estimates of the theoretical multiplier in short samples. Our analysis supports the large multiplier found in China but also suggests that government spending may not necessarily be a free lunch despite the large multiplier.
    Keywords: Government spending policy ; Multiplier (Economics) ; Economic conditions - China ; China
    Date: 2013
  17. By: Atsushi Tanaka (School of Economics, Kwansei Gakuin University)
    Abstract: In this paper, we develop a simple dynamic optimization model of a central bank, in which the bank’s profit affects its balance sheet. The model derives the transversality condition that is necessary for a central bank to be sustainable and to conduct an optimal monetary policy. In this sense, the transversality condition needs to be satisfied to maintain central bank credibility. We discuss some factors affecting the transversality condition and show that what is important to satisfy the condition and thus to maintain central bank credibility is not capital alone but the financial strength that generates no sustained loss.
    Keywords: central bank, capital, financial strength, credibility, monetary policy
    JEL: E5
    Date: 2013–03
  18. By: Sewon Hur; Illenin O. Kondo
    Abstract: Emerging economies, unlike advanced economies, have accumulated large foreign reserve holdings. We argue that this policy is an optimal response to an increase in foreign debt rollover risk. In our model, reserves play a key role in reducing debt rollover crises ("sudden stops"), akin to the role of bank reserves in preventing bank runs. We find that a small, unexpected, and permanent increase in rollover risk accounts for the outburst of sudden stops in the late 1990s, the subsequent increase in foreign reserves holdings, and the salient resilience of emerging economies to sudden stops ever since. Finally, we show that a policy of pooling reserves can substantially reduce the reserves needed by emerging economies.
    Date: 2013
  19. By: Yulei Luo; Jun Nie; Eric R. Young
    Abstract: A leading theory of consumption behavior is that consumers choose their consumption based only on their expected total lifetime income. This theory is called the permanent income hypothesis. According to this theory, consumers should adjust their consumption if they experience a change that affects their expected lifetime income, such as through an unexpected change in employment that affects their expected earnings going forward. One challenge for this theory is that the empirical evidence on consumer spending decisions for durable and nondurable goods does not match the implications of this theory. In particular, this theory overpredicts the volatility of changes in both durable and nondurable goods and the correlation between them. ; This paper studies whether the standard permanent income model can better explain the behavior of durable and nondurable consumption if a more realistic assumption is used regarding the information that consumers possess when making decisions. The standard theory assumes that consumers observe all of the information that is relevant for decision making. Given that there is realistically a limit on the amount of information that an individual can acquire and use, this paper assumes that consumers can only observe part of the information that they need at the time of their consumption decision. One rationale for this assumption is that ordinary consumers simply cannot pay attention to all of the information in the real world (this idea is called rational inattention, proposed by Christopher Sims, Nobel Laureate in economics in 2011). This paper shows that introducing this partial information assumption improves the permanent income model by generating realistic dynamics of durable and nondurable consumption.
    Date: 2012
  20. By: Jerome Adda (Institute for Fiscal Studies and European University Institute); Christian Dustmann (Institute for Fiscal Studies and University College London); Costas Meghir (Institute for Fiscal Studies and Yale University); Jean-Marc Robin (Institute for Fiscal Studies and Sciences Po)
    Abstract: This paper analyses the career progression of skilled and unskilled workers, with a focus on how careers are affected by economic downturns and whether formal skills, acquired early on, can shield workers from the effect of recessions. Using detailed administrative data for Germany for numerous birth cohorts across different regions, we follow workers from labour market entry onwards and estimate a dynamic life-cycle model of vocational training choice, labour supply and wage pogression. Most particularly, our model allows for labour market frictions that vary by skill group and over the business cycle. We find that sources of wage growth differ: learning-by-doing is an important component for unskilled workers early on in their careers, while job mobility is important for workers who acquire skills in an apprenticeship scheme before labour market entry. Likewise, economic downturns affect skill groups through very different channels: unskilled workers lose out from a decline in productivity and human capital, whereas skilled individuals suffer mainly from lack of mobility.
    Keywords: Wage determination, skills, business cycles, apprenticeship training, job mobility
    Date: 2013–03
  21. By: Raouf Boucekkine (AMSE - Aix-Marseille School of Economics - Aix-Marseille Univ. - Centre national de la recherche scientifique (CNRS) - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - Ecole Centrale Marseille (ECM), IRES-CORE - Université Catholique de Louvain); Natali Hritonenko (Prairie View - A&M University); Yuri Yatsenko (School of business, Houston Baptist University - Houston Baptist University)
    Abstract: Work significantly affects human life and health. Overworking may decrease the quality of life and cause direct economic losses. Technological innovations encourage modernization of firms' capital and improve labor productivity in the workplace. The paper investigates the optimal individual choice of work intensity under improving technology embodied in new equipment leading to shorter lifetime of capital goods (obsolescence). The balanced growth trajectories are analyzed in this context to find out, in particular, how the optimal choice of work intensity is tied to the rate of embodied technological change. The impact of embodied technological advances on the work/life balance problem is discussed and their macroeconomic consequences are highlighted.
    Keywords: work-life balance; rational individual choice; technological development; vintage capital
    Date: 2013–03

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