nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2013‒05‒05
twenty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. External Constraints and Endogenous Growth: Why Didn’t Some Countries Benefit from Capital Flows? By Karine Gente; Miguel A. León-Ledesma; Carine Nourry
  2. (Un)anticipated monetary policy in a DSGE model with a shadow banking system By Verona , Fabio; Martins, Manuel M. F.; Drumond , Inês
  3. Banking and the Macroeconomy in China: A Banking Crisis Deferred? By Le, Vo Phuong Mai; Matthews, Kent; Meenagh, David; Minford, Patrick; Xiao, Zhigui
  4. Solution-Driven Specification of DSGE Models By Francisco Blasques
  5. A Monte Carlo procedure for checking identification in DSGE models By Le, Vo Phuong Mai; Minford, Patrick; Wickens, Michael
  6. Engineering a paradox of thrift recession By Zhen Huo; José-Víctor Ríos-Rull
  7. Innovation and growth with financial, and other, frictions By Jonathan Chiu; Cesaire Meh; Randall Wright
  8. An Expectations-Driven Interpretation of the "Great Recession" By Christopher M. Gunn; Alok Johri
  9. An Equilibrium Analysis of the Rise in House Prices and Mortgage Debt By Shaofeng Xu
  10. Female Labour Supply, Human Capital and Welfare Reform By Richard Blundell; Monica Costa Dias; Costas Meghir; Jonathan Shaw
  11. Optimal Taxation in Life-Cycle Economies in the Presence of Commitment and Temptation Problems By Cagri Seda Kumru; Saran Sarntisart
  12. Social Insurance and Retirement: A Cross-Country Perspective By Laun, Tobias; Wallenius, Johanna
  13. Should Central Bank respond to the Changes in the Loan to Collateral Value Ratio and in the House Prices? By Tatiana Damjanovic; Sarunas Girdenas
  14. Intergenerational policy and the measurement of tax incidence By Juan Carlos Conesa; Carlos Garriga
  15. Monetary Shocks with Observation and menu Costs By Fernando Alvarez; Francesco Lippi; Luigi Paciello
  16. Women's emancipation through education: a macroeconomic analysis By Fatih Guvenen; Michelle Rendall
  17. A General Equilibrium Analysis of Inflation and Microfinance in Developing Countries By Daniel Mueller
  18. Why Ten $1's Are Not Treated as a $10 By Huang, Pidong; Igarashi, Yoske
  19. Optimal Unemployment Insurance With Different Types of Job By Huang, Pidong
  20. Robustness of Stability to cost of carrying money in a Matching Model of Money By Huang, Pidong
  21. Trejos-Wright with a 2-unit bound: existence and stability of monetary steady states By Huang, Pidong; Igarashi, Yoske

  1. By: Karine Gente (Aix-Marseille University (Aix-Marseille School of Economics), CNRS & EHESS); Miguel A. León-Ledesma (University of Kent); Carine Nourry (Aix-Marseille University (Aix-Marseille School of Economics), CNRS & EHESS)
    Abstract: Empirical evidence on the growth benefits of capital inflows is mixed. The growth benefits accruing from capital inflows also appear to be larger for high savings countries. We explain this phenomenon using an OLG model of endogenous growth in open economies with borrowing constraints that can generate both positive and negative growth effects of capital inflows. The amount an economy can borrow is restricted by an endogenous enforcement constraint. In our setting, with physical capital and a pay-as-you-go pensions system, the steady state is unique. However, it can either be constrained or unconstrained. In a constrained economy, opening up to equity and FDI inflows can be bad for growth because it makes the domestic interest rate too low, which endogenously tightens borrowing constraints. Agents decrease savings and investment in productivity-enhancing activities resulting in lower growth. Results are reversed in an unconstrained economy. We also provide a quantitative analysis of these constraints and some policy implications.
    Keywords: Overlapping generations, endogenous credit constraint, capital flows, endogenous growth.
    JEL: F43 F34
    Date: 2013–03
  2. By: Verona , Fabio (Bank of Finland Research); Martins, Manuel M. F. (University of Porto, Faculty of Economics and CEF:UP); Drumond , Inês (University of Porto, Faculty of Economics and CEF:UP, and DG-ECFIN, European Commission)
    Abstract: Motivated by the U.S. events of the 2000s, we address whether a too low for too long interest rate policy may generate a boom-bust cycle. We simulate anticipated and unanticipated monetary policies in state-of-the-art DSGE models and in a model with bond financing via a shadow banking system, in which the bond spread is calibrated for normal and optimistic times. Our results suggest that the U.S. boom-bust was caused by the combination of (i) interest rates that were too low for too long, (ii) excessive optimism and (iii) a failure of agents to anticipate the extent of the abnormally favourable conditions.
    Keywords: DSGE model; shadow banking system; too low for too long; boom-bust
    JEL: E32 E44 E52 G24
    Date: 2013–04–11
  3. By: Le, Vo Phuong Mai (Cardiff Business School); Matthews, Kent (Cardiff Business School); Meenagh, David (Cardiff Business School); Minford, Patrick (Cardiff Business School); Xiao, Zhigui
    Abstract: The downturn in the world economy following the global banking crisis has left the Chinese economy relatively unscathed. This paper develops a model of the Chinese economy using a DSGE framework with a banking sector to shed light on this episode. It differs from other applications in the use of indirect inference procedure to test the ?tted model. The model finds that the main shocks hitting China in the crisis were international and that domestic banking shocks were unimportant. However, directed bank lending and direct government spending was used to supplement monetary policy to aggressively offset shocks to demand. The model finds that government expenditure feedback reduces the frequency of a business cycle crisis but that any feedback effect on investment creates excess capacity and instability in output.
    Keywords: DSGE model; Financial Frictions; China; Crises; Indirect Inference
    JEL: E3 E44 E52 C1
    Date: 2013–04
  4. By: Francisco Blasques (VU University Amsterdam)
    Abstract: This paper proposes a functional specification approach for dynamic stochastic general equilibrium (DSGE) models that explores the properties of the solution method used to approximate policy functions. In particular, the solution-driven specification takes the properties of the solution method directly into account when designing the structural model in order to deliver enhanced flexibility and facilitate parameter identification within the structure imposed by the underlying economic theory. A prototypical application reveals the importance of this method in improving the specification of functional nonlinearities that are consistent with economic theory. The solution-driven specification is also shown to have the potential to greatly improve model fit and provide alternative policy recommendations when compared to standard DSGE model designs.
    Keywords: Nonlinear Model Specification; DSGE; Perturbation Solutions
    JEL: C51 E17 E37
    Date: 2013–04–19
  5. By: Le, Vo Phuong Mai (Cardiff Business School); Minford, Patrick (Cardiff Business School); Wickens, Michael (Cardiff Business School)
    Abstract: We propose a numerical method, based on indirect inference, for checking the identification of a DSGE model. Monte Carlo samples are generated from the model's true structural parameters and a VAR approximation to the reduced form estimated for each sample. We then search for a different set of structural parameters that could potentially also generate these VAR parameters. If we can find such a set, the model is not identified.
    Keywords: Identification; DSGE model; Monte Carlo; Indirect Inference
    JEL: C13 C51 C52 E32
    Date: 2013–03
  6. By: Zhen Huo; José-Víctor Ríos-Rull
    Abstract: We build a variation of the neoclassical growth model in which financial shocks to households or wealth shocks (in the sense of wealth destruction) generate recessions. Two standard ingredients that are necessary are (1) the existence of adjustment costs that make the expansion of the tradable goods sector difficult and (2) the existence of some frictions in the labor market that prevent enormous reductions in real wages (Nash bargaining in Mortensen-Pissarides labor markets is enough). We pose a new ingredient that greatly magnifies the recession: a reduction in consumption expenditures reduces measured productivity, while technology is unchanged due to reduced utilization of production capacity. Our model provides a novel, quantitative theory of the current recessions in southern Europe.
    Date: 2013
  7. By: Jonathan Chiu; Cesaire Meh; Randall Wright
    Abstract: The generation and implementation of ideas, or knowledge, is crucial for economic performance. We study this process in a model of endogenous growth with frictions. Productivity increases with knowledge, which advances via innovation, and with the exchange of ideas from those who generate them to those best able to implement them (technology transfer). But frictions in this market—including search, bargaining, and commitment problems—impede exchange and thus slow growth. We characterize optimal policies to subsidize research and trade in ideas, given both knowledge and search externalities. We discuss the roles of liquidity and financial institutions, and show two ways in which intermediation can enhance efficiency and innovation. First, intermediation allows us to finance more transactions with fewer assets. Second, it ameliorates certain bargaining problems, by allowing entrepreneurs to undo otherwise sunk investments in liquidity. We also discuss some evidence suggesting that technology transfer is a significant source of innovation and showing how it is affected by credit considerations.
    Date: 2013
  8. By: Christopher M. Gunn (Department of Economics, Carleton University); Alok Johri (Department of Economics, McMaster University)
    Abstract: The boom-years preceding the "Great Recession" were a time of rapid innovation in the financial industry. We explore the idea that both the boom and eventual bust emerged from overoptimistic ex-pectations of efficiency-gains in the financial sector. We treat the bankruptcy costs facing intermediaries in a costly state verification problem as a stochastic process, and model the boom-bust in terms of an unfulfilled news-shock where the expected fall in costs are eventually not realized. In response to a change in expectations only, the model generates a boom-bust cycle in aggregate activity, asset pricesand leverage, and a countercyclical credit spread.
    Keywords: expectations-driven business cycles, intermediation shocks, news shocks, great recession, financial accelerator
    JEL: E3 E44
    Date: 2013–04–25
  9. By: Shaofeng Xu
    Abstract: This paper examines the contributions of population aging, mortgage innovation and historically low interest rates to the sharp rise in U.S. house prices and mortgage debt between 1994 and 2005. I construct an overlapping generations general equilibrium housing model and find that these three factors together account for over half of the increase in house prices and most of the increase in mortgage debt during this period. Population aging contributes to rising house prices and mortgage debt, but it accounts for only a small portion of their observed changes. Meanwhile, mortgage innovation significantly increases the mortgage borrowing of various age cohorts, but it has a trivial effect on house prices because interest rates rise due to higher demand for mortgage loans. This increases households’ savings in financial assets and leaves their housing assets nearly unchanged. The observed run-up in house prices can, however, be justified in an open-economy setting where interest rates fall due to a global saving glut. Declining interest rates force households at prime saving ages to reallocate their wealth from financial assets to housing assets, which dramatically drives up house prices.
    Keywords: Asset Pricing; Credit and credit aggregates; Economic models
    JEL: E21 E44 G11 R21
    Date: 2013
  10. By: Richard Blundell (University College London); Monica Costa Dias (Institute for Fiscal Studies and CEF-UP at the University of Porto); Costas Meghir (Cowles Foundation, Yale University); Jonathan Shaw (Institute for Fiscal Studies and University College London)
    Abstract: We consider the impact of Tax credits and income support programs on female education choice, employment, hours and human capital accumulation over the life-cycle. We thus analyze both the short run incentive effects and the longer run implications of such programs. By allowing for risk aversion and savings we are also able to quantify the insurance value of alternative programs. We find important incentive effects on education choice, and labor supply, with single mothers having the most elastic labor supply. Returns to labour market experience are found to be substantial but only for full-time employment, and especially for women with more than basic formal education. For those with lower education the welfare programs are shown to have substantial insurance value. Based on the model marginal increases to tax credits are preferred to equally costly increases in income support and to tax cuts, except by those in the highest education group.
    Keywords: Female labor supply, Welfare reform, Tax credits, Education choice, Dynamic discrete choice models, Life cycle models
    JEL: H2 H3 J22 J24
    Date: 2013–04
  11. By: Cagri Seda Kumru; Saran Sarntisart
    Abstract: Self-control problem is an important determinant of individuals. economic decisions. The decision maker’s future utility is affected by unwanted temptation. This implies that implications of various government policies would differ if one incorporates these behavioural aspects. Public finance instruments could, however, be used to correct anomalies created by temptation. The purpose of this paper is to examine the question of optimal taxation when individuals have self-control problems. In order to capture our agents’ temptation towards current consumption, our model make use of the preference structure pioneered by Gul and Pesendorfer and further elaborated by Krusell et al. in the context of optimal taxation. We extend by adding labor choice and besides savings tax, we also analyze capital income tax, consumption tax and labor income tax. Results show that when the analysis is restricted to logarithmic preferences separable in consumption and labor supply, the government should subsidize either capital income or investment as it maximizes both an individual’s commitment utility for consumption and labor supply at the same time. Because individuals consume and supply labor more than their commitment utility, subsidizing improves welfare as it makes temptation less attractive.
    Keywords: Temptation; self-control; consumption-savings; optimal taxation
    JEL: E21 E62 H21
    Date: 2013–04
  12. By: Laun, Tobias (Department of Economics, Uppsala University); Wallenius, Johanna (Dept. of Economics, Stockholm School of Economics)
    Abstract: In this paper we study the role of social insurance, namely old-age pensions, disability insurance and healthcare, in accounting for the differing labor supply patterns of older individuals across OECD countries. To this end, we develop a life cycle model of labor supply and health with heterogeneous agents. The key features of the framework are: (1) people choose when to stop working, and when/if to apply for disability and pension benefits, (2) the awarding of disability insurance benefits is imperfectly correlated with health, and (3) people can partially insure against health shocks by investing in health, the cost of which is dependent on health insurance coverage. We find that the incentives faced by older workers differ hugely across countries. In fact, based solely on differences in social insurance programs, the model predicts even more cross-country variation in the employment rates of people aged 55-64 than we observe in the data.
    Keywords: Life cycle; Retirement; Disability insurance; Health
    JEL: E24 J22 J26
    Date: 2013–04–25
  13. By: Tatiana Damjanovic (Department of Economics, University of Exeter); Sarunas Girdenas (Department of Economics, University of Exeter)
    Abstract: We study optimal policy in a New Keynesian model at zero bound interest rate where households use cash alongside with house equity borrowing to conduct transactions. The amount of borrowing is limited by a collateral constraint. When either the loan to value ratio declines or house prices fall we observe decrease in the money multiplier. We argue that the central bank should respond to the fall in the money multiplier and therefore to the reduction in house prices or in the loan to collateral value ratio. We also find that optimal monetary policy generates large and more persistent fall in the money multiplier in response to drop in the loan to collateral value ratio.
    Keywords: optimal monetary policy, money supply, money multiplier, loan to value ratio, collateral constraint, house prices, zero bound interest rate.
    JEL: E44 E51 E52 E58
    Date: 2013
  14. By: Juan Carlos Conesa; Carlos Garriga
    Abstract: Policymakers often use measures of tax incidence (generational accounts) as criteria for policy selection. We use a quantitative model of optimal intergenerational policy to evaluate the ability of the tax incidence metric to capture the identity of recipients and contributors and the magnitudes transferred. The analysis suggests that when the reform implies a substantial change in economic efficiency, the tax metric fails to identify the magnitude of the welfare changes and those who benefit from those who pay. In contrast, when the policies evaluated imply only intergenerational redistribution, the metric correctly identifies winners and losers and provides reasonable estimates of the magnitude of welfare changes.
    Keywords: Taxation ; Fiscal policy
    Date: 2013
  15. By: Fernando Alvarez (University of Chicago and NBER); Francesco Lippi (University of Sassari and EIEF); Luigi Paciello (EIEF)
    Abstract: We compute the impulse response of output to an aggregate monetary shock in a general equilibrium when firms set prices subject to a costly observation of the state and a menu cost. We study how the aggregate effects of a monetary shock depend on the relative size of these costs. We find that empirically reasonable observations costs increase the impact and the persistence of the output response to monetary shocks compared to models with menu cost only, flattening the shape of the impulse response function. Moreover we show that if the shocks are not large the results are independent of the assumption of whether firms know the realization of the monetary shock on impact.
    Date: 2013
  16. By: Fatih Guvenen; Michelle Rendall
    Abstract: In this paper, we study the role of education as insurance against a bad marriage. Historically, due to disparities in earning power and education across genders, married women often found themselves in an economically vulnerable position, and had to suffer one of two fates in a bad marriage: either they get divorced (assuming it is available) and struggle as low-income single mothers, or they remain trapped in the marriage. In both cases, education can provide a route to emancipation for women. To investigate this idea, we build and estimate an equilibrium search model with education, marriage/divorce/remarriage, and household labor supply decisions. A key feature of the model is that women bear a larger share of the divorce burden, mainly because they are more closely tied to their children relative to men. Our focus on education is motivated by the fact that divorce laws typically allow spouses to keep the future returns from their human capital upon divorce (unlike their physical assets), making education a good insurance against divorce risk. However, as women further their education, the earnings gap between spouses shrinks, leading to more unstable marriages and, in turn, further increasing demand for education. The framework generates powerful amplification mechanisms, which lead to a large rise in divorce rates and a decline in marriage rates (similar to those observed in the US data) from relatively modest exogenous driving forces. Further, in the model, women overtake men in college attainment during the 1990s, a feature of the data that has proved challenging to explain. Our counterfactual experiments indicate that the divorce law reform of the 1970s played an important role in all of these trends, explaining more than one-quarter of college attainment rate of women post-1970s and one-half of the rise in labor supply for married women.
    Keywords: Marriage ; Women - Education
    Date: 2013
  17. By: Daniel Mueller (University of Basel)
    Abstract: <p style="margin-bottom:0cm; margin-bottom:.0001pt; text-align: justify; line-height:normal; text-autospace:none"><span style="font-size:10.0pt; font-family:"Arial","sans-serif"">This paper analyses the welfare effects of microfinance and inflation in developing countries. Therefore, we introduce a moral hazard problem into a monetary search model with money and credit. We show how access to basic financial services affects households' decisions to borrow, to save and to hold money balances. The group lending mechanism of the microfinance institution induces peer monitoring, which in turn enables entrepreneurship. Our main result is that there exists an inflation threshold beyond which entrepreneurship collapses. We show that inflation affects the impact of microfinance on social welfare in a nonlinear way. The positive effect of microfinance is largest for moderate rates of inflation and drops substantially for inflation rates above the threshold.</span></p> <p style="margin-bottom:0cm; margin-bottom:.0001pt; text-align: justify; line-height:normal; text-autospace:none"><span style="font-size:10.0pt; font-family:"Arial","sans-serif""> </spa n>
    Keywords: Microfinance, Moral Hazard, Group Lending, Peer Monitoring and Monetary Policy
    JEL: D82 E44 G21 O16
    Date: 2013
  18. By: Huang, Pidong; Igarashi, Yoske
    Abstract: We study the stability of monetary steady states in a random matching model of money where money is indivisible, the bound on individual money holding is finite, and the trading protocol is buyer take-it-or-leave-it offers. The class of steady states we study have a non-full-support money-holding distribution and are constructed from the steady states of Zhu (2003). We show that no equilibrium path converges to such steady states if the initial distribution has a different support.
    Keywords: random matching model; monetary steady state;
    JEL: E00
    Date: 2013–04–30
  19. By: Huang, Pidong
    Abstract: This paper considers the design of optimal unemployment insurance with multiple types of job. The environment is an extension of Hopenhayn and Nicolini(1997). We study the model by using the fi�rst-order approach. The optimal contract still displays benefit� decreasing over the length of the unemployment spell. The wage tax after reemployment depends on the length of unemployment spell.
    Keywords: Unemployment insurance
    JEL: J01
    Date: 2013–04–15
  20. By: Huang, Pidong
    Abstract: This paper studies stability of monetary steady states in a Trejos-Wright random matching model of money with money holding set {0,1,2} and cost of carrying money. There kinds of steady states exist generically: pure-strategy full-support steady states, mixed-strategy full-support steady state, and non-full-support steady state. Stability analysis shows that full-support steady states are stable and determinate generically and that non-full-support steady state is stable and indeterminate if there is a small positive carrying cost.
    Keywords: random matching model; monetary steady state; instability; determinacy; Zhu (2003).
    JEL: E00
    Date: 2013–04–18
  21. By: Huang, Pidong; Igarashi, Yoske
    Abstract: We investigate in details a Trejos-Wright random matching model of money with a consumer take-it-or-leave-it offer and the individual money holding set {0,1,2}. First we show generic existence of three kinds of steady states: (1) pure-strategy full-support steady states, (2) mixed-strategy full-support steady states, and (3) non-full-support steady states, and then we show relations between them. Finally we provide stability analyses. It is shown that (1) and (2) are locally stable, (1) being also determinate. (3) is shown to be unstable.
    Keywords: random matching model; monetary steady state; local stability; determinacy; instability; Zhu (2003).
    JEL: E00
    Date: 2013–04–16

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