nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2013‒09‒28
twenty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Hysteresis in Unemployment and Jobless Recoveries By Dmitry Plotnikov
  2. Inventories and the Role of Goods-Market Frictions for Business Cycles By Den Haan, Wouter
  3. China's Savings Multiplier By Mehlum, Halvor; Torsvik, Ragnar; Valente, Simone
  4. Efficiency, Distortions and Factor Utilization during the Interwar Period By Alex Klein; Keisuke Otsu
  5. Distribution Capital and the Short- and Long-run Import Demand Elasticity By Mario J. Crucini; J. Scott Davis
  6. Fiscal Rules and Discretion under Persistent Shocks By Halac, Marina; Yared, Pierre
  7. Dynamic Aid Allocation By Carter, Paddy; Postel-Vinay, Fabien; Temple, Jonathan
  8. Flexible pension take-up in social security By Jan Bonenkamp; Yvonne Adema; Lex Meijdam
  9. Fiscal Policy and Lending Relationships By Giovanni Melina; Stefania Villa
  10. Assessing International Efficiency By Heathcote, Jonathan; Perri, Fabrizio
  11. Adverse Selection and Search Frictions in Corporate Loan Contracts By Beyhaghi, Mehdi; Mahmoudi, Babak; Mohammadi, Ali
  12. Current Account Norms in Natural Resource Rich and Capital Scarce Economies By Juliana Dutra Araujo; Grace Bin Li; Marcos Poplawski-Ribeiro; Luis-Felipe Zanna
  13. The Impact of Foreign Bank Deleveraging on Korea By Sonali Jain-Chandra; Min Jung Kim; Sung Ho Park; Jerome Shin
  14. Investing Volatile Oil Revenues in Capital-Scarce Economies: An Application to Angola By Christine J. Richmond; Irene Yackovlev; Shu-Chun S. Yang
  15. From Sudden Stops to Fisherian Deflation: Quantitative Theory and Policy Implications By Anton Korinek; Enrique G. Mendoza
  16. Was Stalin Necessary for Russia's Economic Development? By Anton Cheremukhin; Mikhail Golosov; Sergei Guriev; Aleh Tsyvinski
  17. Credit Crunches and Credit Allocation in a Model of Entrepreneurship By Marco Bassetto; Marco Cagetti; Mariacristina De Nardi
  18. Macroeconomic Analysis without the Rational Expectations Hypothesis By Michael Woodford
  19. Culture, Entrepreneurship, and Growth By Doepke, Matthias; Zilibotti, Fabrizio
  20. Fiscal Reform and Government Debt in Japan: A Neoclassical Perspective By Gary Hansen; Selo Imrohoroglu
  21. News Driven Business Cycles: Insights and Challenges By Paul Beaudry; Franck Portier

  1. By: Dmitry Plotnikov (University Of California, Los Angeles)
    Abstract: This paper develops and estimates a general equilibrium rational expectations model with search and multiple equilibria where aggregate shocks have a permanent effect on the unemployment rate. If agents' wealth decreases, the unemployment rate increases for a potentially indefinite period. This makes unemployment rate dynamics path dependent as in Blanchard and Summers (1987). I argue that this feature explains the persistence of the unemployment rate in the U.S. after the Great Recession and over the entire postwar period.
    Date: 2013
  2. By: Den Haan, Wouter
    Abstract: Investment in inventories is known to be important for observed changes in GDP. However, inventory investment and the possibility that firms may fail to sell all goods are typically ignored in business cycle models. Using US data, the ability to sell is shown to be strongly procyclical. By including both a goods-market friction and a standard labor-market search friction, the model developed here can---in principal---substantially magnify and propagate shocks, even when prices and wages are not sticky. Despite its simplicity, the model can also replicate key inventory facts. However, when these inventory facts are used to discipline the choice of parameter values, then the analysis indicates that the quantitative importance of goods-market frictions is not that large, at least not in this type of model without sticky prices and wages.
    Keywords: magnification; matching models; propagation; search frictions
    JEL: E12 E24 E32
    Date: 2013–09
  3. By: Mehlum, Halvor (Dept. of Economics, University of Oslo); Torsvik, Ragnar (Norwegian University of Science and Technology); Valente, Simone (Norwegian University of Science and Technology)
    Abstract: China's growth is characterized by massive capital accumulation, made possible by high and increasing domestic savings. In this paper we develop a model with the aim of explaining why savings rates have been high and increasing, and we investigate the general equilibrium effects on capital accumulation and growth. We show that increased savings and capital accumulation stimulates further savings and capital accumulation, through an intergenerational distribution effect and an old-age requirement effect. We introduce what we term the savings multiplier, and we discuss why and how the one-child policy, and the dismantling of the cradle-to-grave social benefits provided through the state owned enterprises, have stimulated savings and capital accumulation.
    Keywords: China; One-child policy; Overlapping generations; Growth; Savings
    JEL: D91 E21 O11
    Date: 2013–07–04
  4. By: Alex Klein; Keisuke Otsu
    Abstract: In this paper, we analyze the International Great Depression in the US and Western Europe using the business cycle accounting method a la Chari, Kehoe and McGrattan (CKM 2007). We extend the business cycle accounting model by incorporating endogenous factor utilization which turns out to be an important transmission mechanism of the disturbances in the economy. Our main findings are that in the US labor wedges account for roughly half of the drop in output while efficiency and investment wedges each account for a quarter of it during the 1929-1933 period while in Western Europe labor wedges account for more than one-third of the output drop and efficiency, government and investment wedges are responsible for the remaining during the 1929-1932 period. Our findings are consistent with several strands of existing descriptive and empirical literature on the International Great Depression.
    Keywords: International Great Depression; Business Cycle Accounting; Efficiency; Market Distortions
    JEL: E13 E32 N10
    Date: 2013–09
  5. By: Mario J. Crucini; J. Scott Davis
    Abstract: International business-cycle models assume that home and foreign goods are poor substitutes. International trade models assume they are close substitutes. This paper constructs a model where this discrepancy is due to frictions in distribution. Imports need to be combined with a local non-traded input, distribution capital, which is slow to adjust. As a result, imported and domestic goods appear as poor substitutes in the short run. In the long run this non-traded input can be reallocated, and quantities can shift following a change in relative prices. Thus the observed substitutability between home and foreign goods gets larger as time passes.
    JEL: F1 F14 F44
    Date: 2013–09
  6. By: Halac, Marina (Department of Economics, University of Warwick); Yared, Pierre (Columbia University and NBER)
    Abstract: This paper studies the optimal level of discretion in policymaking. We consider a fiscal policy model where the government has time-inconsistent preferences with a present-bias towards public spending. The government chooses a fiscal rule to trade off its desire to commit to not overspend against its desire to have exibility to react to privately observed shocks to the value of spending. We analyze the optimal fiscal rule when the shocks are persistent. Unlike under i.i.d: shocks, we show that the ex-ante optimal rule is not sequentially optimal, as it provides dynamic incentives. The ex-ante optimal rule exhibits history dependence, with high shocks leading to an erosion of future scal discipline compared to low shocks, which lead to the reinstatement of discipline. The implied policy distortions oscillate over time given a sequence of high shocks, and can force the government to accumulate maximal debt and become immiserated in the long run. JEL classification: Institutions ; Asymmetric and Private Information ; Macroeconomic Polic ; Structure of Government ; Political Economy JEL codes: D02 ; D82 ; E6 ; H1 ; P16
    Date: 2013
  7. By: Carter, Paddy; Postel-Vinay, Fabien; Temple, Jonathan
    Abstract: This paper introduces a framework for studying the optimal dynamic allocation of foreign aid among multiple recipients. We pose the problem as one of weighted global welfare maximization. A donor in the North chooses an optimal path for international transfers, anticipating that consumption and investment decisions will be made by optimizing households in the South, and accounting for limits in the extent to which recipients can effectively absorb aid. We present quantitative results on optimal aid policy by applying our approach to a neoclassical growth model, where the scope for aid-funded growth is determined by the recipients' distance from steady-state.
    Keywords: Aid Allocation; Economic Growth; Foreign Aid
    JEL: F35 O41
    Date: 2013–08
  8. By: Jan Bonenkamp; Yvonne Adema; Lex Meijdam
    Abstract: This paper studies the redistribution and welfare effects of increasing the flexibility of individual pension take-up. We use an overlapping-generations model with Beveridgean pay-as-you-go pensions, where individuals differ in ability and life span. We find that introducing flexible pension take-up can induce a Pareto improvement when the initial pension scheme contains within-cohort redistribution and induces early retirement. Such a Pareto-improving reform entails the application of uniform actuarial adjustment of pension entitlements based on average life expectancy. Introducing actuarial non-neutrality that stimulates later retirement further improves such a flexibility reform.
    JEL: H55 H23 J26
    Date: 2013–09
  9. By: Giovanni Melina; Stefania Villa
    Abstract: This paper studies how fiscal policy affects loan market conditions in the US. First, it conducts a Structural Vector-Autoregression analysis showing that the bank spread responds negatively to an expansionary government spending shock, while lending increases. Second, it illustrates that these results are mimicked by a Dynamic Stochastic General Equilibrium model where the bank spread is endogenized via the inclusion of a banking sector exploiting lending relationships. Third, it shows that lending relationships represent a friction that generates a financial accelerator effect in the transmission of the fiscal shock.
    Keywords: Fiscal policy;United States;Banking sector;Loans;Economic models;Fiscal policy; deep habits; lending relationships
    Date: 2013–06–05
  10. By: Heathcote, Jonathan; Perri, Fabrizio
    Abstract: This paper is structured in three parts. The first part outlines the methodological steps, involving both theoretical and empirical work, for assessing whether an observed allocation of resources across countries is efficient. The second part applies the methodology to the long-run allocation of capital and consumption in a large cross section of countries. We find that countries that grow faster in the long run also tend to save more both domestically and internationally. These facts suggest that either the long-run allocation of resources across countries is inefficient, or that there is a systematic relation between fast growth and preference for delayed consumption. The third part applies the methodology to the allocation of resources across developed countries at the business cycle frequency. Here we discuss how evidence on international quantity comovement, exchange rates, asset prices, and international portfolio holdings can be used to assess efficiency. Overall, quantities and portfolios appear consistent with efficiency, while evidence from prices is difficult to interpret using standard models. The welfare costs associated with an inefficient allocation of resources over the business cycle can be significant if shocks to relative country permanent income are large. In those cases partial financial liberalization can lower welfare.
    Keywords: International business cycles; International risk sharing; Long-run growth; Long-run risk; Real exchange rate
    JEL: F21 F32 F36 F41 F43 F44
    Date: 2013–04
  11. By: Beyhaghi, Mehdi; Mahmoudi, Babak; Mohammadi, Ali
    Abstract: We provide empirical evidence of both (1) price dispersion and (2) credit rationing in the corporate loan market. We argue that these properties are caused by two factors: an adverse selection resulting from the information asymmetry between lenders and borrowers, and search frictions in matching borrowers with lenders. We develop a model of loan markets in which lenders post an array of heterogeneous contracts, then borrowers tradeoff terms of loan contracts and matching probability between themselves. We show that a unique separating equilibrium exists where each type of borrower applies to a certain type of contract.
    Keywords: loan contract, capital structure, debt heterogeneity, adverse selection, competitive search
    JEL: D86 G20 G21 G32
    Date: 2013–09–12
  12. By: Juliana Dutra Araujo; Grace Bin Li; Marcos Poplawski-Ribeiro; Luis-Felipe Zanna
    Abstract: The permanent income hypothesis implies that frictionless open economies with exhaustible natural resources should save abroad most of their resource windfalls and, therefore, feature current account surpluses. Resource-rich developing countries (RRDCs), on the other hand, face substantial development needs and tight external borrowing constraints. By relaxing these constraints and providing a key financing source for public investment in RRDCs, temporary resource revenues might then be associated with current account deficits, or at least low surpluses. This paper develops a neoclassical model with private and public investment and several frictions that capture pervasive features in RRDCs, including absorptive capacity constraints, inefficiencies in investment, and borrowing constraints that can be relaxed when natural resources lower the country risk premium. The model is used to study the role of investment and these frictions in shaping the current account dynamics under windfalls. Since consumption and investment decisions are optimal, the model also serves to provide current account benchmarks (norms). We apply the model to the Economic and Monetary Community of Central Africa and discuss how our results can be used to inform the current account norm analysis pursued at the International Monetary Fund.
    Keywords: Current account balances;Central Africa;Natural resources;Developing countries;Private investment;Public investment;Central African Economic and Monetary Community;Economic models;Current Account, External Sustainability, Developing Economies
    Date: 2013–03–27
  13. By: Sonali Jain-Chandra; Min Jung Kim; Sung Ho Park; Jerome Shin
    Abstract: Korea was hit hard by the 2008 global financial crisis, with the foreign bank deleveraging channel coming prominently into play. The global financial crisis demonstrated that a sharp deleveraging can be transmitted to emerging markets through the bank lending channel to a slowdown in credit growth. The analysis finds that a sharp decline in external funding led to relatively modest decline in domestic credit by Korean banks, due to concerted policy efforts by the government in 2008. Impulse responses from a Dynamic Stochastic General Equilibrium (DSGE) model calibrated to Korea shows that it appears better prepared to handle such shocks relative to 2008. Indeed, Korea is much more resilient to such shocks due to the efforts by the authorities, which has led to the strengthening of external buffers, such as higher foreign exchange reserves and bilateral and multilateral currency swap arrangements.
    Keywords: International banks;Korea, Republic of;Global Financial Crisis 2008-2009;External shocks;Banking sector;Liquidity;Financial crisis;Economic models;Global banks, liquidity shock, cross-border lending
    Date: 2013–05–08
  14. By: Christine J. Richmond; Irene Yackovlev; Shu-Chun S. Yang
    Abstract: Natural resource revenues are an increasingly important financing source for public investment in many developing economies. Investing volatile resource revenues, however, may subject an economy to macroeconomic instability. This paper applies to Angola the fiscal framework developed in Berg et al. (forthcoming) that incorporates investment inefficiency and absorptive capacity constraints, often encountered in developing countries. The sustainable investing approach, which combines a stable fiscal regime with external savings, can convert resource wealth to development gains while maintaining economic stability. Stochastic simulations demonstrate how the framework can be used to inform allocations between capital spending and external savings when facing uncertain oil revenues. An overly aggressive investment scaling-up path could result in insufficient fiscal buffers when faced with negative oil price shocks. Consequently, investment progress can be interrupted, driving up the capital depreciation rate, undermining economic stability, and lowering the growth benefits of public investment.
    Keywords: Oil revenues;Angola;Public investment;Fiscal policy;Natural resources;Developing countries;Economic models;Angola, natural resource, public investment, resource-rich developing countries, DSGE models
    Date: 2013–06–12
  15. By: Anton Korinek; Enrique G. Mendoza
    Abstract: The 1990s Sudden Stops in emerging markets were a harbinger for the 2008 global financial crisis. During Sudden Stops, countries lost access to credit, causing abrupt current account reversals, and suffered Great Recessions. This paper reviews a class of models that yields quantitative predictions consistent with these observations, based on an occasionally binding credit constraint that limits debt to a fraction of the market value of incomes or assets used as collateral. Sudden Stops are infrequent events nested within regular business cycles, and occur in response to standard shocks after periods of expansion increase leverage ratios sufficiently. When this happens, the Fisherian debt-deflation mechanism is set in motion, as lower asset or goods prices tighten further the constraint causing further deflation. This framework also embodies a pecuniary externality with important implications for macro-prudential policy, because agents do not internalize how current borrowing decisions affect collateral values during future financial crises.
    JEL: E44 F34 F41
    Date: 2013–08
  16. By: Anton Cheremukhin; Mikhail Golosov; Sergei Guriev; Aleh Tsyvinski
    Abstract: This paper studies structural transformation of Soviet Russia in 1928-1940 from an agrarian to an industrial economy through the lens of a two-sector neoclassical growth model. We construct a large dataset that covers Soviet Russia during 1928-1940 and Tsarist Russia during 1885-1913. We use a two-sector growth model to compute sectoral TFPs as well as distortions and wedges in the capital, labor and product markets. We find that most wedges substantially increased in 1928-1935 and then fell in 1936-1940 relative to their 1885-1913 levels, while TFP remained generally below pre-WWI trends. Under the neoclassical growth model, projections of these estimated wedges imply that Stalin's economic policies led to welfare loss of -24 percent of consumption in 1928-1940, but a +16 percent welfare gain after 1941. A representative consumer born at the start of Stalin's policies in 1928 experiences a reduction in welfare of -1 percent of consumption, a number that does not take into account additional costs of political repression during this time period. We provide three additional counterfactuals: comparison with Japan, comparison with the New Economic Policy (NEP), and assuming alternative post-1940 growth scenarios.
    JEL: E6 N23 N24 O4 O41
    Date: 2013–09
  17. By: Marco Bassetto; Marco Cagetti; Mariacristina De Nardi
    Abstract: We study the effects of credit shocks in a model with heterogeneous entrepreneurs, financing constraints, and a realistic firm size distribution. As entrepreneurial firms can grow only slowly and rely heavily on retained earnings to expand the size of their business in this set-up, we show that, by reducing entrepreneurial firm size and earnings, negative shocks have a very persistent effect on real activity. In determining the speed of recovery from an adverse economic shock, the most important factor is the extent to which the shock erodes entrepreneurial wealth.
    JEL: E2 E21 E23 E6
    Date: 2013–08
  18. By: Michael Woodford
    Abstract: This paper reviews a variety of alternative approaches to the specification of the expectations of economic decisionmakers in dynamic models, and reconsiders familiar results in the theory of monetary and fiscal policy when one allows for departures from the hypothesis of rational expectations. The various approaches are all illustrated in the context of a common model, a log-linearized New Keynesian model in which both households and firms solve infinite-horizon decision problems; under the hypothesis of rational expectations, the model reduces to the standard “3-equation model” used in studies such as Clarida et al. (1999). The alternative approaches considered include rationalizable equilibrium dynamics (Guesnerie, 2008); restricted perceptions equilibria (Branch, 2004); decreasing-gain and constant-gain variants of least-squares learning dynamics (Evans and Honkapohja, 2001); rational belief equilibria (Kurz, 2012); and near-rational expectations equilibria (Woodford, 2010). Issues treated include Ricardian equivalence; the determinacy of equilibrium under alternative interest-rate rules; non-fundamental sources of aggregate instability; the trade-off between inflation stabilization and output-gap stabilization; and the possibility of a “deflation trap.”
    JEL: E52 E63
    Date: 2013–08
  19. By: Doepke, Matthias; Zilibotti, Fabrizio
    Abstract: We discuss the two-way link between culture and economic growth. We present a model of endogenous technical change where growth is driven by the innovative activity of entrepreneurs. Entrepreneurship is risky and requires investments that affect the steepness of the lifetime consumption profile. As a consequence, the occupational choice of entrepreneurship hinges on risk tolerance and patience. Parents expecting their children to become entrepreneurs have an incentive to instill these two values in their children. Cultural transmission is Beckerian, i.e., parents are driven by the desire to maximize their children's happiness. We also consider, in an extension, a paternalistic motive for preference transmission. The growth rate of the economy depends on the fraction of the population choosing an entrepreneurial career. How many entrepreneurs there are in a society hinges, in turn, on parental investments in children's patience and risk tolerance. There can be multiple balanced-growth paths, where in faster-growing countries more people exhibit an "entrepreneurial spirit". We discuss applications of models of endogenous preferences to the analysis of socio-economic transformations, such as the British Industrial Revolution. We also discuss empirical studies documenting the importance of culture and preference heterogeneity for economic growth.
    Keywords: culture; economic growth; endogenous preferences; entrepreneurship; innovation; preference transmission
    JEL: J20 O10 O40
    Date: 2013–06
  20. By: Gary Hansen; Selo Imrohoroglu
    Abstract: Past government spending in Japan is currently imposing a significant fiscal burden that is reflected in a net debt to output ratio near 150 percent. In addition, the aging of Japanese society implies that public expenditures and transfers payments relative to output are projected to continue to rise until at least 2050. In this paper we use a standard growth model to measure the size of this burden in the form of additional taxes required to finance these projected expenditures and to stabilize government debt. The fiscal adjustment needed is very large, in the range of 30-40% of total consumption expenditures. Using a distorting tax such as the consumption tax or the labor income tax requires either tax to rise to unprecedented highs, although the former is much less distorting than the latter. The extremely high tax rates we find highlight the importance of considering alternatives that attenuate the projected increases in public spending and/or enlarge the tax base.
    JEL: E2 E62 H6
    Date: 2013–09
  21. By: Paul Beaudry; Franck Portier
    Abstract: There is a widespread belief that changes in expectations may be an important independent driver of economic fluctuations. The news view of business cycles offers a formalization of this perspective. In this paper we discuss mechanisms by which changes in agents' information, due to the arrival of news, can cause business cycle fluctuations driven by expectational change, and we review the empirical evidence aimed at evaluating its relevance. In particular, we highlight how the literature on news and business cycles offers a coherent way of thinking about aggregate fluctuations, while at the same time we emphasize the many challenges that must be addressed before a proper assessment of its role in business cycles can be established.
    JEL: E00 E3
    Date: 2013–09

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