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

  1. International Risk Sharing and Land Dynamics By Jean-François Rouillard
  2. Optimal Growth under Flow-Based Collaterals By Daria Onori
  3. A DSGE Model for a SOE with Systematic Interest and Foreign Exchange Policies in Wich Policymakers Exploit the Risk Premium for Stabilization Purposes By Guillermo Escudé
  4. Austerity versus Stimulus: A DSGE Political Economy Explanation By Richard McManus
  5. Dissecting saving dynamics: Measuring wealth, precautionary, and credit effects By Carroll, Christopher D.; Slacalek, Jiri; Sommer, Martin
  6. Energy and Capital in a New-Keynesian Framework. By Verónica Acurio Vasconez; Gaël Giraud; Florent Mc Isaac; Ngoc Sang Pham
  7. Reference-Dependence and Labor-Market Fluctuations By Kfir Eliaz; Rani Spiegler
  8. Expectations-Based Reference-Dependent Life-Cycle Consumption By Pagel, Michaela
  9. A life-cycle model of unemployment and disability insurance By Sagiri Kitao
  10. Export Dynamics in Large Devaluations By George Alessandria; Sangeeta Pratap; Vivian Yue
  11. Optimal Taxation and Life Cycle Labor Supply Profile By Michael Kuklik; Nikita Cespedes
  12. Optimal Capital Versus Labor Taxation with Innovation-Led Growth By Philippe Aghion; Ufuk Akcigit; Jesús Fernández-Villaverde
  13. "We're all in this together"? A DSGE interpretation By Richard McManus
  14. Uncertainty and the Politics of Employment Protection By Andrea Vindigni; Simone Scotti; Cristina Tealdi
  15. Does Unemployment Insurance Crowd out Home Production? By Bulent Guler; Temel Taskin
  16. Belief shocks and the macroeconomy. By Suda, J.
  17. Assessing policy reforms for Italy using ITEM and QUESTIII By Barbara Annicchiarico; Fabio Di Dio; Francesco Felici; Francesco Nucci
  18. The Determinants of Rising Inequality in Health Insurance and Wages: An Equilibrium Model of Workers' Compensation and Health Care Policies By Rong Hai
  19. Analyzing the effects of insuring health risks: On the trade-off between short run insurance benefits vs. long run incentive costs By Cole, Harold L.; Kim, Soojin; Krueger, Dirk
  20. Comment on: Ravenna, F., 2007. Vector autoregressions and reduced form representations of DSGE models. Journal of Monetary Economics 54, 2048-2064. By Massimo Franchi
  21. The Productive Government Spending Multiplier, In and Out of The Zero Lower Bound By Jordan Roulleau-Pasdeloup
  22. Financial Globalization, Financial Crises, and the External Portfolio Structure of Emerging Markets By Enrique G. Mendoza; Katherine A. Smith
  23. Inequality Constraints and Euler Equation based Solution Methods By Pontus Rendahl
  24. Capital Controls, Global Liquidity Traps and the International Policy Trilemma By Michael B. Devereux; James Yetman
  25. Inflation in Poland under state-dependent pricing By Pawel Baranowski; Mariusz Gorajski; Maciej Malaczewski; Grzegorz Szafranski
  26. Disaster Risk in a New Keynesian Model By Marlène Isoré; Urszula Szczerbowicz
  27. Stability analysis of Uzawa-Lucas endogenous growth model By Barnett, William A.; Ghosh, Taniya
  28. Spatial dynamics and convergence: The spatial AK model. By Raouf Boucekkine; Carmen Camacho; Giorgio Fabbri

  1. By: Jean-François Rouillard (Département d'économique and GREDI, Université de Sherbrooke)
    Abstract: While business cycles of industrialized countries have become more synchronized in the past decade, the gap between cross-country correlations in output and in consumption, known as the quantity anomaly, has widened on average. A two-country real business cycle model with national endogenous borrowing constraints and frictionless international financial markets can account for these stylized facts that are related to international risk sharing. When preferences are non-separable between consumption and leisure, the borrowing mechanism brings about an internal labor wedge that interacts with the efficient international allocation. This labor wedge is also fundamental to explain the Backus-Smith puzzle or consumption—real-exchange-rate anomaly. Technology shocks contribute to explain international co-movements, whereas country-specific financial shocks to borrowing capacity allow the model to replicate the lack of international risk sharing. When the model is augmented with an additional sector, real estate, international co-movements are matched more closely.
    Keywords: international risk sharing, real estate dynamics, borrowing constraints, labor wedge, financial shocks
    JEL: E44 F34 F44
    Date: 2013–05
  2. By: Daria Onori (Aix-Marseille University (Aix-Marseille School of Economics), CNRS & EHESS; Université catholique de Louvain, IRES; University of Rome “La Sapienza”, Departement of Economics and Law, Faculty of Economics.)
    Abstract: Some recent evidence on government finance statistics of European countries suggests that countries with public debt issues also show a low tax revenue-GDP ratio. In this paper we develop a small open economy model of endogenous growth in which the engine of growth is public spending. We assume that government can finance public expenditures by borrowing on imperfect international financial markets where her borrowing capacity is limited. In contrast to the existing literature, where debt is constrained by the stock of capital, the collaterals are based on GDP. The balanced growth path and the transitional dynamics are studied. First, we show that the economy may converge in a finite time to the regime with binding collateral constraint. Second, in such regime the steady state public expenditures-GDP ratio is greater than that of the models without collateral constraints and of the stock-based collaterals literature. Third, the model predictions are consistent with recent empirical literature: there exists a certain threshold of financial and institutional development and economic features that an economy needs to attain in order to benefit from financial liberalization. Finally, if the degree of financial markets imperfections is weak, technologically developed countries experience a higher long-run growth rate than that of the stock-based collaterals literature, otherwise the world interest rate need to be high enough.
    Keywords: open economy; two-stage growth; public debt; flow collaterals; imperfect financial markets; multi-stage optimal control.
    JEL: C61 F34 F43 H63 O4 O16
    Date: 2013–05–21
  3. By: Guillermo Escudé (Central Bank of Argentina)
    Abstract: This paper builds a DSGE model for a SOE in which the central bank systematically intervenes both the domestic currency bond and the FX markets using two policy rules: a Taylor-type rule and a second rule in which the operational target is the rate of nominal currency depreciation. For this, the instruments used by the central bank (bonds and international reserves) must be included in the model, as well as the institutional arrangements that determine the total amount of resources the central bank can use. The "corner" regimes in which only one of the policy rules is used are particular cases of the model. The model is calibrated and implemented in Dynare for 1) simple policy rules, 2) optimal simple policy rules, and 3) optimal policy under commitment. Numerical losses are obtained for ad-hoc loss functions for different sets of central bank preferences (styles). The results show that the losses are systematically lower when both policy rules are used simultaneously, and much lower for the usual preferences (in which only inflation and/or output stabilization matter). It is shown that this result is basically due to the central bank´s enhanced ability, when it uses the two policy rules, to influence capital flows through the effects of its actions on the endogenous risk premium in the (risk-adjusted) interest parity equation.
    Keywords: DSGE models, exchange rate policy, optimal policy, Small Open Economy
    JEL: E58 F41 O24
    Date: 2013–03
  4. By: Richard McManus
    Abstract: The 2008 financial crisis and subsequent global economic downturn has brought fiscal policy back onto the political and academic agenda. Despite the vast literature, the discussion is primarily focused upon the fiscal policy multiplier. This positive analysis omits normative consequences from policy and moreover, fails to consider political frictions to policy: something frequently observed in fiscal debates. By constructing a small scale New Keynesian DSGE model with a proportion of credit constrained (non-Ricardian) agents, this paper address these omissions. The results show that there is a normative justification of fiscal policy, in the presence of modest multipliers and the absence of progressive taxes, but on redistributive rather than aggregate grounds. Shocks impact the two agents differently and in polarising ways: countercyclical fiscal policy can be used to alleviate this divergence. However, aggregate improvements from policy are minimal as the gains of one agent are matched by the losses of another, thus giving rise to political frictions and moreover, predicting the current austerity versus stimulus debate.
    Keywords: Fiscal policy; heterogeneity; welfare; zero lower bound; liquidity rule-of-thumb; fiscal cyclicality
    JEL: E30 E62 H30
    Date: 2013–05
  5. By: Carroll, Christopher D.; Slacalek, Jiri; Sommer, Martin
    Abstract: We argue that the US personal saving rate's long stability (1960s-1980s), subsequent steady decline (1980s-2007), and recent substantial rise (2008-2011) can be interpreted using a parsimonious buffer stock model of consumption in the presence of labor income uncertainty and credit constraints. Saving in the model is affected by the gap between target and actual wealth, with the target determined by credit conditions and uncertainty. An estimated structural version of the model suggests that increased credit availability accounts for most of the long-term saving decline, while fluctuations in wealth and uncertainty capture the bulk of the business-cycle variation. --
    Keywords: Consumption,Saving,Wealth,Credit,Uncertainty
    JEL: E21 E32
    Date: 2012
  6. By: Verónica Acurio Vasconez (Centre d'Economie de la Sorbonne); Gaël Giraud (Centre d'Economie de la Sorbonne - Paris School of Economics); Florent Mc Isaac (Centre d'Economie de la Sorbonne); Ngoc Sang Pham (Centre d'Economie de la Sorbonne)
    Abstract: The economic implications of oil price shocks have been extensively studied since the oil price shocks of the 1970s'. Despite this huge literature, no dynamic stochastic general equilibrium model is available that captures two well-known stylized facts: 1) the stagflationary impact of an oil price shock, together with 2) two possible reactions of real wages: either a decrease (as in the US) or an increase (as in Japan). We construct a New-Keynesian DSGE model, which takes the case of an oil-importing economy where oil cannot be stored and where fossil fuels are used in two different ways: One part of the imported energy is used as an additional input factor next to capital and labor in the intermediate production of manufactured goods, the remaining part of imported energy is consumed by households in addition to their consumption of the final good. Oil prices, capital prices and nominal government spendings are exogenous random processes. We show that, without capital accumulation, the stagflationary effect is accounted for in general, and provide conditions under which a rise (resp. a declinr) of real wages follows the oil price shock.
    Keywords: New-Keynesian model, DSGE, oil, capital accumulation, stagflation
    JEL: C11 C53 Q31 Q32
    Date: 2012–12
  7. By: Kfir Eliaz; Rani Spiegler
    Abstract: We incorporate reference-dependent worker behavior into a search-matching model of the labor market, in which firms have all the bargaining power and productivity follows a log-linear AR(1) process. Motivated by Akerlof (1982) and Bewley (1999), we assume that existing workers' output falls stochastically from its normal level when their wage falls below a "reference point", which (following Kőszegi and Rabin (2006)) is equal to their lagged-expected wage. We formulate the model game-theoretically and show that it has a unique subgame perfect equilibrium that exhibits the following properties: existing workers experience downward wage rigidity, as well as destruction of output following negative shocks due to layoffs or loss of morale; newly hired workers earn relatively flexible wages, but not as much as in the benchmark without reference dependence; market tightness is more volatile than under this benchmark. We relate these findings to the debate over the "Shimer puzzle" (Shimer (2005)).
    JEL: D03 E24 E32 J64
    Date: 2013–05
  8. By: Pagel, Michaela
    Abstract: I incorporate expectations-based reference-dependent preferences into a dynamic stochastic model to explain three major life-cycle consumption facts; the intuitions behind these three implications constitute novel connections between recent advances in behavioral economics and prominent ideas in the macro consumption literature. First, expectations-based loss aversion rationalizes excess smoothness and sensitivity in consumption, the puzzling empirical observation of lagged consumption responses to income shocks. Intuitively, in the event of an adverse shock, the agent delays painful cuts in consumption to allow his reference point to decrease. Second, the preferences generate a hump-shaped consumption profile. Early in life, consumption is low due to a first-order precautionary-savings motive, but as uncertainty resolves, this motive is dominated by time-inconsistent overconsumption, forcing consumption to decline toward the end of life. Third, consumption drops at retirement. When uncertainty is absent, the agent does not overconsume because he dislikes the associated certain loss in future consumption. Additionally, I obtain several new predictions about consumption; compare the preferences with habit formation, hyperbolic discounting, and temptation disutility; and structurally estimate the preference parameters.
    Keywords: Expectations-based reference-dependent preferences, life-cycle consumption, excess smoothness, excess sensitivity
    JEL: D03 D91
    Date: 2013–02–15
  9. By: Sagiri Kitao (Hunter College; Hunter College)
    Abstract: The paper builds a life-cycle model of heterogeneous agents with search frictions, in which individuals choose a sequence of saving and labor supply faced with uncertainty in longevity, employment, health status and medical expenditures. Unemployed individuals decide search intensity and whether to apply for disability insurance (DI) benefits if eligible. We investigate, first, the effects of cash and Medicare benefits of the DI system on the life-cycle pattern of employment. Without in-kind benefits through Medicare, the DI coverage could fall by 30%. Second, the impact of a change in labor market conditions and roles of the DI are studied. A rise in exogenous job separation rates or a fall in job finding rates by 20% each can lead to a drop in employment rate by 1.7 and 2.1 percentage points, respectively. A model without the DI could underestimate the effect on employment by more than 30%.
    Keywords: Disability insurance, labor force participation, life-cycle, Medicare, unemployment insurance.
    JEL: E2 E6 J2 J6
    Date: 2013
  10. By: George Alessandria (Federal Reserve Bank of Philadelphia); Sangeeta Pratap (City University of New York); Vivian Yue (Federal Reserve Board of Governors and Hong Kong Institute for Monetary Research)
    Abstract: This paper studies export dynamics in emerging markets following large devaluations. We document two main features of exports that are puzzling for standard trade models. First, given the change in relative prices, exports tend to grow gradually following a devaluation. Second, high interest rates tend to suppress exports. To address these features of export dynamics, we embed a model of endogenous export participation due to sunk and per period export costs into an otherwise standard small open economy. In response to shocks to productivity, interest rates, and the discount factor, we find the model can capture the salient features of export dynamics documented. At the aggregate level, the features giving rise to sluggish export dynamics leading to more gradual net export dynamics, sharper contractions in output, and endogenous declines in labor productivity
    Keywords: Export Dynamics, Devaluation, Net Exports
    JEL: E31 F12
    Date: 2013–05
  11. By: Michael Kuklik; Nikita Cespedes
    Abstract: La tasa óptima de impuesto a los ingresos de capital en Estados Unidos es 36% según Conesa y otros (2009). Este resultado se deriva de un modelo de ciclo de vida y se debe a la existencia de mercado incompletos y a la oferta laboral endógena. Se muestra que este modelo tiene problemas en explicar algunos aspectos básicos de la oferta de trabajo a lo largo de ciclo de vida de los trabajadores. En este trabajo, introducimos no linealidad en los salarios y transferencias entre personas y logramos reproducir las características de ciclo de vida de la oferta de trabajo. El primer supuesto induce a que las horas de trabajo sean altamente persistentes y ayuda a considerar las decisiones de trabajo en el margen extensivo a lo largo del ciclo de vida. El segundo supuesto permite modelar las decisiones de trabajo a temprana edad. El modelo propuesto sugiere que la tasa de impuesto optima a los ingresos de capital es de 7,4%.
    Abstract: The optimal capital income tax rate is 36 percent as reported by Conesa, Kitao, and Krueger (2009). This result is mainly driven by the market incompleteness as well as the endogenous labor supply in a life-cycle framework. We show that this model fails to account for the basic life-cycle features of the labor supply observed in the U.S. data. In this paper, we introduce into this model nonlinear wages and inter-vivos transfers into this model in order to account for the life-cycle features of labor supply. The former makes hours of work highly persistent and helps to account for labor choices at the extensive margin over the life cycle. The latter allows us to account for labor choicesearly in life. The suggested model delivers an optimal capital income tax rate of 7.4 percent, which is significantly lower than what Conesa, Kitao, and Krueger (2009) found.
    Keywords: Labor supply, optimal taxation, capital taxation, non-linear wage, inter-vivos transfer.
    JEL: E13 H21 H24 H25
    Date: 2013
  12. By: Philippe Aghion; Ufuk Akcigit; Jesús Fernández-Villaverde
    Abstract: Chamley (1986) and Judd (1985) showed that, in a standard neoclassical growth model with capital accumulation and infinitely lived agents, either taxing or subsidizing capital cannot be optimal in the steady state. In this paper, we introduce innovation-led growth into the Chamley-Judd framework, using a Schumpeterian growth model where productivity-enhancing innovations result from profit-motivated R&D investment. Our main result is that, for a given required trend of public expenditure, a zero tax/subsidy on capital becomes suboptimal. In particular, the higher the level of public expenditure and the income elasticity of labor supply, the less should capital income be subsidized and the more it should be taxed. Not taxing capital implies that labor must be taxed at a higher rate. This in turn has a detrimental effect on labor supply and therefore on the market size for innovation. At the same time, for a given labor supply, taxing capital also reduces innovation incentives, so that for low levels of public expenditure and/or labor supply elasticity it becomes optimal to subsidize capital income.
    JEL: H2 O3 O4
    Date: 2013–05
  13. By: Richard McManus
    Abstract: The recent global economic downturn has resulted in hardship for many individuals and the unequal distribution of this hardship across agents is frequently debated. This paper constructs a small scale New Keynesian DSGE model to test whether individuals suffer to similar degrees during recessions: in effect testing the common political mantra `we're all in this together'. It does this by including heterogeneity in the actions of households through their access to capital markets distinguishing those with full access (Ricardian agents) from those with no access (rule-of-thumb agents). In aggregate welfare movements as a result of recessionary shocks are small but this hides a big divergence with the credit constrained signi cantly losing. There is a redistribution of welfare from non-Ricardian to Ricardian households from the shock, and under reasonable calibrations, the latter are seen to gain at the expense of the former.
    Keywords: Cost of business cycles; rule-of-thumb consumers; welfare; heterogeneity
    JEL: E32 I30 D63
    Date: 2013–05
  14. By: Andrea Vindigni; Simone Scotti; Cristina Tealdi
    Abstract: This paper investigates the social preferences over labor market exibility, in a general equilibrium model of dynamic labor demand. We demonstrate that how the economy responds to productivity shocks depends on the power of labor to extract rents and on the status quo level of the firing cost. In particular, we show that when the ring cost is initially relatively low, a transition to a rigid labor market is favored by all the employed workers with idiosyncratic productivity below some threshold value. Conversely, when the status quo level of the firing cost is relatively high, the preservation of a rigid labor market is favored by the employed with intermediate productivity, whereas all other workers favor more exibility. A more volatile environment, and a lower rate of productivity growth, i.e., "bad times," increase the political support for more labor market rigidity only where labor appropriates of relatively large rents. The coming of better economic conditions not necessarily favors the demise of high firing costs in rigid high-rents economies, because "good times" cut down the support for exibility among the least productive employed workers. The model described provides some new insights on the comparative dynamics of labor market institutions in the U.S. and in Europe over the last few decades, shedding some new light both on the reasons for the original build-up of "Eurosclerosis," and for its relative persistence until the present day.
    Keywords: employment protection, job creation and destruction, firing cost, idiosyncratic productivity, volatility, growth, political economy, voting, rents, status quo, path dependency, institutional divergence.
    JEL: D71 D72 E24 J41 J63 J65
    Date: 2013
  15. By: Bulent Guler; Temel Taskin
    Abstract: In this paper, we study the interaction between self insurance and public insurance. In particular, we provide evidence on a negative correlation between unemployment insurance benefits and home production using the American Time Use Survey (ATUS) and the state-level unemployment insurance data of the U.S. The empirical results suggest that moving to a two times more generous state would decrease time spent on home production about 22% for the unemployed. Then, we pursue a quantitative assessment of this empirical finding using a dynamic competitive equilibrium model in which households do home production as well as market production. The model is able to generate the empirical facts regarding the unemployment benefits and home production. The fact that unemployment insurance benefits crowd out home production is interpreted as a substitution between the two insurance mechanisms against loss of earnings during unemployment spells.
    Keywords: Unemployment insurance, home production, public insurance, self insurance, heterogeneous-agents models
    JEL: D13 E21 J65
    Date: 2013
  16. By: Suda, J.
    Abstract: I study the role of shocks to beliefs combined with Bayesian learning in a standard equilibrium business cycle framework. By adapting ideas from Cogley and Sargent (2008b) to the general equilibrium setting, I am able to study how a prior belief arising from the Great Depression may have influenced the macroeconomy during the last 75 years. In the model, households hold twisted beliefs concerning the likelihood and persistence of recession and boom states, beliefs which are only gradually unwound during subsequent years. Even though the driving stochastic process for technology is unchanged over the entire period, the nature of macroeconomic performance is altered considerably for many decades before eventually converging to the rational expectations equilibrium. This provides some evidence of the lingering effects of beliefs-twisting events on the behavior of macroeconomic variables.
    Keywords: Bayesian learning, business cycles, Great Depression.
    JEL: E32 E37 D83 D84
    Date: 2013
  17. By: Barbara Annicchiarico (University of Rome "Tor Vergata"); Fabio Di Dio (Consip SpA); Francesco Felici (Italian Ministry of Economy and Finance); Francesco Nucci (Università di Roma “La Sapienza)
    Abstract: In this paper we assess the implications of policy reforms for the Italian economy by jointly using the Italian Treasury Econometric Model (ITEM) and QUEST III, the endogenous growth dynamic general equilibrium (DGE) model of the European Commission (DG ECFIN) in the version calibrated for Italy. We point out some of the key differences between the two models, highlighting some policy insights that DGE models can provide compared to those of traditional macro-econometric models. Their structural characteristics and the results of simulations are analyzed by using an array of shocks commonly examined in the evaluation of possible reforms. We show that two elements incorporated into the QUEST model play a key role in explaining the qualitative and quantitative differences among the two models in the dynamic responses to structural shifts, namely: the role of expectations in the transmission of reforms and the endogenous growth mechanism. We conclude that the joint consideration of the two models can improve our understanding of how the assessment of policy interventions is likely to be affected by the uncertainty surrounding model-based evaluation.
    Keywords: Economic Modelling, DGE, Structural Reforms, Italy
    JEL: E10 C50 E60
    Date: 2013–05–17
  18. By: Rong Hai (Department of Economics, University of Pennsylvania)
    Abstract: I develop and structurally estimate a non-stationary overlapping generations equilibrium model of employment and workers' health insurance and wage compensation, to investigate the determinants of rising inequality in health insurance and wages in the U.S. over the last 30 years. I find that skill-biased technological change and the rising cost of medical care services are the two most important determinants, while the impact of Medicaid eligibility expansion is quantitatively small. I conduct counterfactual policy experiments to analyze key features of the 2010 Patient Protection and Affordable Care Act, including employer mandates and further Medicaid eligibility expansion. I find that (i) an employer mandate reduces both wage and health insurance coverage inequality, but also lowers the employment rate of less educated individuals; and (ii) further Medicaid eligibility expansion increases employment rate of less educated individuals, reduces health insurance coverage disparity, but also causes larger wage inequality.
    Keywords: Labor Market, Health Insurance, Health Care Policies, Inequality
    JEL: J2 J3 I1 I24
    Date: 2013–01–16
  19. By: Cole, Harold L.; Kim, Soojin; Krueger, Dirk
    Abstract: This paper constructs a dynamic model of health insurance to evaluate the short- and long run effects of policies that prevent firms from conditioning wages on health conditions of their workers, and that prevent health insurance companies from charging individuals with adverse health conditions higher insurance premia. Our study is motivated by recent US legislation that has tightened regulations on wage discrimination against workers with poorer health status (Americans with Disability Act of 2009, ADA, and ADA Amendments Act of 2008, ADAAA) and that will prohibit health insurance companies from charging different premiums for workers of different health status starting in 2014 (Patient Protection and Affordable Care Act, PPACA). In the model, a trade-off arises between the static gains from better insurance against poor health induced by these policies and their adverse dynamic incentive effects on household efforts to lead a healthy life. Using household panel data from the PSID we estimate and calibrate the model and then use it to evaluate the static and dynamic consequences of no-wage discrimination and no-prior conditions laws for the evolution of the cross-sectional health and consumption distribution of a cohort of households, as well as ex-ante lifetime utility of a typical member of this cohort. In our quantitative analysis we find that although a combination of both policies is effective in providing full consumption insurance period by period, it is suboptimal to introduce both policies jointly since such policy innovation induces a more rapid deterioration of the cohort health distribution over time. This is due to the fact that combination of both laws severely undermines the incentives to lead healthier lives. The resulting negative effects on health outcomes in society more than offset the static gains from better consumption insurance so that expected discounted lifetime utility is lower under both policies, relative to only implementing wage nondiscrimination legislation. --
    Keywords: Health,Insurance,Incentive
    JEL: E61 H31 I18
    Date: 2012
  20. By: Massimo Franchi (Universita' di Roma "La Sapienza")
    Abstract: Solutions of DSGE models are usually represented by state space forms. This note shows that if one wishes to determine whether the observables of the model admit a finite order VAR representation, minimality of the state space representation of the solution matters. More specifically, we first provide a counterexample to Proposition 2.1 and Corollary 2.2 in Ravenna (2007), which state that in the square casea finite order VAR exists if and only if a `unimodularity condition' holds. Our counterexample shows that the proposed condition is not necessary for the existence of a finite order VAR representation. That is, if the state space representation of the solution is non-minimal, the observables of the DSGE may admit a finite order VAR representation even though the unimodularity condition fails. It is further shown that if the state space representation of the solution is minimal, then the unimodularity condition is necessary. Given that a minimal state space representation always exists, before applying the unimodularity condition one simply needs to check whether the state space representation of the solution is minimal and if not transform it into an equivalent minimal form. A discussion of how to perform such reduction is presented and further it is shown that the economic interpretation of the system is not affected by this transformation. An interpretation of the results in terms of the eigenvalues of the matrix defined in Fernandez-Villaverde et al. (2007) for the poor man's invertibility condition is also provided. The analysis is then applied to the Smets and Wouters (2007) model.
    Keywords: VAR,DSGE,invertibility condition.
    Date: 2013–05
  21. By: Jordan Roulleau-Pasdeloup (CREST and Paris School of Economics)
    Abstract: Recently, a series of papers have argued that output multipliers of government spending can be potentially large during times when the Zero Lower Bound on nominal interest rates is binding (Christiano et al. (2011)). This literature generally considers "excess-savings" liquidity traps and identifies the reaction of real interest rates —that follows the effect of government purchases on marginal cost and, hence, inflation —as the main channel of propagation. Here, I show that taking explicitly into account the fact that government spending is productive can mitigate this result. The higher the share of productive government spending in total stimulus spending, the lower the gap between the government spending multipliers in and out of the Zero Lower Bound. Furthermore, a sufficient share of productive government spending in total stimulus spending will imply a higher multiplier when the Zero Lower Bound is not binding. It follows that the government spending multiplier need not be unusually large when the economy is in an "excess-savings" liquidity trap. In a "expectationsdriven" liquidity trap (Mertens & Ravn (2010)) however, the government spending multiplier will be larger than in normal times for a sufficient share of productive government spending. But for this to happen, a rise in inflation is still needed. While the predictions of the model with an "expectations-driven" liquidity trap are difficult to compare with the data, I show that the model with an "excess-savings" liquidity trap is at odds with recent empirical evidence on the behavior of key macroeconomic variables in a recession. In contrast, the simple New-keynesian model augmented with a sufficient share of productive government spending is qualitatively consistent with aforementioned evidence.
    Date: 2013–02
  22. By: Enrique G. Mendoza; Katherine A. Smith
    Abstract: We study the short- and long-run effects of financial integration in emerging economies using a two-sector model with a collateral constraint on external debt and trading costs incurred by foreign investors. The probability of a financial crisis displays overshooting: It rises sharply initially and then falls sharply but remains positive in the long run. While equity holdings fall permanently, bond holdings initially fall but rise after the crisis probability peaks. Conversely, asset returns and asset prices first rise and then fall. These results are in line with the post-globalization dynamics observed in emerging markets, and the higher frequency of crises they displayed. Without financial frictions, the model yields a negligible fall in equity and a large increase in debt. The results also depend critically on supply-side effects of financial frictions affecting the price of nontradables and dividends from nontradables producers, and on strong precautionary savings incentives induced by the risk of financial crises.
    JEL: D52 E44 F32 F41
    Date: 2013–05
  23. By: Pontus Rendahl
    Abstract: Solving dynamic models with inequality constraints poses a challenging problem for two major reasons: dynamic programming techniques are reliable but often slow, while Euler equation based methods are fast but have problematic or unknown convergence properties. This paper attempts to bridge this gap. I show that a common iterative procedure on the Euler equation { usually referred to as time iteration { delivers a sequence of approximate policy functions that converges to the true solution under a wide range of circumstances. These circumstances extend to an arbitrarily large, but nite, set of endogenous and exogenous state-variables as well as a very broad spectrum of occasionally binding constraints.
    Keywords: Inequality constraints; Envelope theorem; Time iteration
    JEL: C61 C63 C68
    Date: 2013–05–30
  24. By: Michael B. Devereux; James Yetman
    Abstract: The 'International Policy Trilemma' refers to the constraint on independent monetary policy that is forced on a country which remains open to international financial markets and simultaneously pursues an exchange rate target. This paper shows that, in a global economy with open financial markets, the problem of the zero bound introduces a new dimension to the international policy trilemma. International financial market openness may render monetary policy ineffective, even within a system of fully flexible exchange rates, because shocks that lead to a 'liquidity trap' in one country are propagated through financial markets to other countries. But monetary policy effectiveness may be restored by the imposition of capital controls, which inhibit the transmission of these shocks across countries. We derive an optimal monetary policy response to a global liquidity trap in the presence of capital controls. We further show that, even though capital controls may facilitate effective monetary policy, except in the case where monetary policy is further constrained (beyond the zero lower bound constraint), capital controls are not desirable in welfare terms.
    JEL: F3 F32 F33
    Date: 2013–05
  25. By: Pawel Baranowski; Mariusz Gorajski; Maciej Malaczewski; Grzegorz Szafranski (Department of Econometrics, Institute of Econometrics, Faculty of Economics and Sociology, University of Lodz)
    Abstract: We analyse the short-term dynamics of Polish economy with a prominent state-dependent pricing mechanism of Dotsey, King and Wolman (1999). We compare macroeconomic evidence of price rigidity in a small-scale DSGE model with a state-dependent Phillips curve (SDPC) derived by Bakhshi, Khan and Rudolf (2007) to a benchmark model including hybrid New-Keynesian Phillips Curve (NHPC) of Gali and Gertler (1999). To analyse monetary policy transmission mechanism we estimate both models with Bayesian techniques and focus on the comparison of distribution of price vintages, a degree of price stickiness, values of parameters in Phillips curve equations, and impulse responses to macroeconomic shocks. The estimated state-dependent pricing model generates a median duration of prices about 4 quarters compared to 8 quarters in a time-dependent model. In the state-dependent pricing model it takes more time to dampen inflation dynamics after a monetary policy relative to a time-dependent counterpart. The menu cost model is also able to identify higher variance of technology shocks, and higher persistence in preference shocks, while the dynamics of the impulse responses in time- and state-dependent pricing models are hard to distinguish.
    Keywords: state-dependent pricing, inflation, menu costs, monetary policy, Polish economy
    JEL: E31
    Date: 2013–04
  26. By: Marlène Isoré; Urszula Szczerbowicz
    Abstract: This paper incorporates a small and time-varying “disaster risk” à la Gourio (2012) in a New Keynesian model. A change in the probability of disaster may affect macroeconomic quantities and asset prices. In particular, a higher risk is sufficient to generate a recession without effective occurrence of the disaster. By accounting for monopolistic competition, price stickiness, and a Taylor-type rule, this paper provides a baseline framework of the dynamic interactions between the macroeconomic effects of rare events and nominal rigidity, particularly suitable for further analysis of monetary policy. We also set up our next research agenda aimed at assessing the desirability of several policy measures in case of a variation in the probability of rare events.
    Keywords: Disaster risk;rare events;DSGE models;business cycles
    JEL: E17 E20 E32 G12
    Date: 2013–04
  27. By: Barnett, William A.; Ghosh, Taniya
    Abstract: This paper analyzes, within its feasible parameter space, the dynamics of the Uzawa-Lucas endogenous growth model. The model is solved from a centralized social planner perspective as well as in the model’s decentralized market economy form. We examine the stability properties of both versions of the model and locate Hopf and transcritical bifurcation boundaries. In an extended analysis, we investigate the existence of Andronov-Hopf bifurcation, branch point bifurcation, limit point cycle bifurcation, and period doubling bifurcations. While these all are local bifurcations, the presence of global bifurcation is confirmed as well. We find evidence that the model could produce chaotic dynamics, but our analysis cannot confirm that conjecture. It is important to recognize that bifurcation boundaries do not necessarily separate stable from unstable solution domains. Bifurcation boundaries can separate one kind of unstable dynamics domain from another kind of unstable dynamics domain, or one kind of stable dynamics domain from another kind (called soft bifurcation), such as bifurcation from monotonic stability to damped periodic stability or from damped periodic to damped multiperiodic stability. There are not only an infinite number of kinds of unstable dynamics, some very close to stability in appearance, but also an infinite number of kinds of stable dynamics. Hence subjective prior views on whether the economy is or is not stable provide little guidance without mathematical analysis of model dynamics. When a bifurcation boundary crosses the parameter estimates’ confidence region, robustness of dynamical inferences from policy simulations are compromised, when conducted, in the usual manner, only at the parameters’ point estimates.
    Keywords: bifurcation, endogenous growth, Lucas-Uzawa model, Hopf, inference robustness, dynamics, stability.
    JEL: C1 C15 E0 E3 O4 O41
    Date: 2013–05–27
  28. By: Raouf Boucekkine (GREQAM - Aix-Marseille School of Economics); Carmen Camacho (Centre d'Economie de la Sorbonne); Giorgio Fabbri (EPEE - Université d'Evry-Val-d'Essonne)
    Abstract: We study the optimal dynamics of an AK economy where population is uniformly distributed along the unit circle. Locations only differ in initial capital endowments. Spatio-temporal capital dynamics are described by a parabolic partial differential equation. The application of the maximum principle leads to necessary but non-sufficient first-order conditions. Thanks to the linearity of the production technology and the special spatial setting considered, the value-fonction of the problem is found explicitly, and the (unique) optimal control is identified in feedback form. Despite constant returns to capital, we prove that the spatio-temporal dynamics, induced by the willingness of the planner to give the same (detrended) consumption over space and time, lead to convergence in the level of capital across locations in the long-run.
    Keywords: Economic growth, spatial dynamics, optimal control, partial-differential equations.
    JEL: C60 O11 R11 R12 R13
    Date: 2013–04

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