nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2013‒10‒18
27 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. The Cyclicality of Search Intensity in a Competitive Search Model By Paul Gomme; Damba Lkhagvasuren
  2. Implications of labor market frictions for risk aversion and risk premia By Eric T. Swanson
  3. External Habit in a Production Economy By Chen, Andrew Y.
  4. Financial Frictions, Investment Delay and Asset Market Interventions By Shouyong Shi; Christine Tewfik
  5. Learning and the Size of the Government Spending Multiplier. By E. QUAGHEBEUR
  6. Startups, Credit, and the Jobless Recovery By Immo Schott
  7. Risk Sharing and Real Exchange Rate : The Roles of Non-tradable Sector and Trend Shocks By Huseyin Cagri Akkoyun; Yavuz Arslan; Mustafa Kilinc
  8. Cash-In-Advance Constraint on R&D in a Schumpeterian Growth Model with an Endogenous Market Structure By Chien-Yu Huang; Juin-Jen Chang; Lei Ji
  9. Asset Prices, Business Cycles, and Markov-Perfect Fiscal Policy when Agents are Risk-Sensitive By Richard Dennis
  10. Inflation, Unemployment and Economic Growth in a Schumpeterian Economy By Chu, Angus C.; Cozzi, Guido; Furukawa, Yuichi
  11. Financing Growth without Banks: Korean Housing Repo Contract By Hyun Shin; Se-Jik Kim
  12. Endogenous Growth with a Ceiling on the Stock of Pollution By Kollenbach, Gilbert
  13. The optimal distribution of the tax burden over the business cycle By Konstantinos Angelopoulos; Stylianos Asimakopoulos; James Malley
  14. On the distribution of information in the moment structure of DSGE models By Nikolay Iskrev
  15. Unemployment Risk and the Distribution of Assets By Jan Eeckhout
  16. Two Monetary Models with Alternating Markets By Gabriele Camera; YiLi Chien
  17. Health Cycles and Health Transitions By Chakraborty, Shankha; Papageorgiou, Chris; Perez Sebastian, Fidel
  18. On optimal emission control – Taxes, substitution and business cycles By Lintunen , Jussi; Vilmi, Lauri
  19. Optimal Exchange Rate Policy in a Growing Semi-Open Economy. By Bacchetta, P.; Benhima, K.; Kalantzis, Y.
  20. Factor specificity and real rigidities By Carlos Carvalho; Fernanda Nechio
  21. Matching and Sorting in a Global Economy By Philipp Kircher (University of Edinburgh)
  22. Bifurcation Analysis of an Endogenous Growth Model By William Barnett; Taniya Ghosh
  23. The impact of immigration on the employment and wages of native workers By Andri Chassamboulli; Theodore Palivos
  24. Crisis and Commitment: Inflation Credibility and the Vulnerability to Sovereign Debt Crises By Mark Aguiar; Manuel Amador; Emmanuel Farhi; Gita Gopinath
  25. Unemployment Risk and Wage Differentials By Ludo Visschers (The University of Edinburgh, Universidad Carlos III de Madrid, and CESifo)
  26. Imperfect Credibility and Robust Monetary Policy By Richard Dennis
  27. On business cycles of variety and quality By Masashige Hamano

  1. By: Paul Gomme (Concordia University and CIREQ); Damba Lkhagvasuren (Concordia University and CIREQ)
    Abstract: Shimer's puzzle is that the textbook Diamond-Mortensen-Pissarides model exhibits fluctuations in labor market variables that are an order of magnitude too small. Introducing search effort of the unemployed brings the model's predictions for these fluctuations very close to those seen in the data. The search cost function and the matching technology are intimately related and thus should be estimated simultaneously. Ignoring worker search effort leads to a large upward bias in the elasticity of matches with respect to vacancies. Evidence in support of the model's prediction of procyclical search effort is presented.
    Keywords: Variable Search Effort, Educational Differences in Unemployment Volatility, Endogenous Matching Technology, Time Use, Wage Posting, Competitive Search
    JEL: E24 E32 J63 J64
    Date: 2013–09
  2. By: Eric T. Swanson
    Abstract: A flexible labor margin allows households to absorb shocks to asset values with changes in hours worked as well as changes in consumption. This ability to absorb shocks along both margins can greatly alter the household’s attitudes toward risk, as shown in Swanson (2012). The present paper analyzes how frictional labor markets affect that analysis. Risk aversion is higher: 1) in recessions, 2) in countries with more frictional labor markets, and 3) for households that have more difficulty finding a job. These predictions are consistent with empirical evidence from a variety of sources. Traditional, fixed-labor measures of risk aversion show no stable relationship to the equity premium in a standard real business cycle model with search frictions, while the closed-form expressions derived in the present paper match the equity premium closely.
    Date: 2013
  3. By: Chen, Andrew Y. (OH State University)
    Abstract: A unified framework for understanding asset prices and aggregate fluctuations is critical for understanding both issues. I show that a real business cycle model with external habit preferences and capital adjustment costs provides one such framework. The estimated model matches the first two moments of the equity premium and risk-free rate, return and dividend predictability regressions, and the second moments of output, consumption, and investment. The model also endogenizes a key mechanism of consumption-based asset pricing models. In order to address the Shiller volatility puzzle, external habit, long-run risk, and disaster models require the assumption that the volatility of marginal utility is countercyclical. In the model, this countercyclical volatility arises endogenously. Production makes precautionary savings effects show up in consumption. These effects lead to countercyclical consumption volatility and countercyclical volatility of marginal utility. External habit amplifies this channel and makes it quantitatively significant.
    JEL: E21 E30 G12
    Date: 2013–10
  4. By: Shouyong Shi; Christine Tewfik
    Abstract: We construct a dynamic macro model to incorporate financial frictions and investment delay. Investment is undertaken by entrepreneurs who face liquidity frictions in the equity market and a collateral constraint in the debt market. After calibrating the model to the US data, we quantitatively examine how aggregate activity is affected by a shock to equity liquidity and a shock to entrepreneurs' borrowing capacity. We then analyze the effectiveness of government interventions in the asset market after such financial shocks. In particular, we compare the effects of government purchases of private equity and of private debt in the open market. In addition, we examine how these effects of government interventions depend on the option to delay investment.
    Keywords: Financial frictions; Liquidity; Asset market interventions; Investment delay; Equity; Collateral.
    JEL: E3 G1
    Date: 2013–10–04
    Abstract: This paper examines the government spending multiplier when economic agents form their expectations based on an adaptive learning scheme. The learning mechanism is such that the agents forecast future values of forward-looking variables using a linear function of an information set that does not contain the fiscal shock. Our impulse response analysis shows that the effects of a government spending shock change substantially when the rational expectations hypothesis is replaced by this learning mechanism. In contrast to the dynamics under rational expectations, a government spending shock in a small-scale new Keynesian DSGE model with this adaptive learning mechanism crowds in private consumption and is associated with a positive comovement between real wages and hours worked. The learning model also relies less on consumption-leisure non-separability in utility and price stickiness to deliver high output multipliers, as opposed to the rational expectations benchmark. In the baseline calibration, the multiplier under learning is nearly twice as large as under rational expectations. These results are robust to a richer specification, irrespective of the financing strategy. An alternative adaptive learning model, where agents know the future path of taxes implied by the government spending shock, leads to results that differ to a large extent from those of the benchmark learning model and are largely incompatible with most of the empirical evidence
    Keywords: adaptive learning, DSGE, fiscal policy, fiscal multipliers, government spending
    JEL: E62 D83 D84 E32 E37
    Date: 2013–10
  6. By: Immo Schott (EUI)
    Abstract: Abstract Job creation depends on a firm's age. Startups (firms of age zero) and young firms play a crucial role for job creation: they grow faster and create more net jobs than older incumbent firms. During the 2008-2009 recession the jobs created by those firms declined considerably, aversely affecting aggregate employment figures. While net job creation by existing firms is beginnig to recover, job creation by startups in 2010 was at its lowest point since 1983 and continues to be at historically low levels. This paper argues that the conditions on the credit market are linked to the 'jobless recovery' phenomenon. Especially young and small firms are still finding it difficult to obtain credit, limiting their growth prospects and job creation. The paper links regional conditions in the US housing market to state-level data on job creation by startups. I then estimate a search model augmented with heterogeneous firms, entry and exit, and financial frictions. This model is able to match key moments of the firm distribution and employment at the micro- and macrolevel. In the context of this model I analyze the effects of a 'credit crunch' and consider possible policies to boost job creation by startups.
    Date: 2013
  7. By: Huseyin Cagri Akkoyun; Yavuz Arslan; Mustafa Kilinc
    Abstract: In this paper, we show that tradable and non-tradable TFP processes of the US and Europe have unit roots and can be modeled by a vector error correction model (VECM). Then, we develop a standard two country and two good (tradable and non-tradable) DSGE model. Our model implies that using cointegrated TFP processes improves the real exchange rate (RER) volatility and risk sharing puzzles compared to the model with transitory TFP processes. Cointegrated TFP shocks, or trend shocks, generate signi?cant income e¤ects, and amplify the mechanisms that produce high RER volatility. Moreover, trend shocks break the tight link between relative consumption and RER for low and high values of trade elasticity parameters.
    Keywords: Trends Shocks, Risk Sharing, Real Exchange Rates
    JEL: E32 F41 F44
    Date: 2013
  8. By: Chien-Yu Huang (School of Economics, Southwest University of Finance and Economics, China); Juin-Jen Chang (Institute of Economics, Academia Sinica, Taipei, Taiwan); Lei Ji (School of Economics, Shanghai School of Economics and Finance, China)
    Abstract: In this paper we explore the effects of monetary policy on the number of firms, firm market size, ination and growth in a Schumpeterian growth model with endogenous market structure and cash-in-advance (CIA) constraints on two distinct types of R&D investment - in-house R&D and entry investment. This allows us to match empirical evidence and provides novel implications to the literature. We show that if in-house R&D (quality improvement-type R&D) is subject to the CIA constraint, raising the nominal interest rate increases the the number of rms and ination, but decreases the rm size and economic growth. By contrast, if entry investment (variety expansion-type R&D) is subject to the CIA constraint, these variables adversely respond to such a monetary policy. Besides, our model generates rich transitional dynamics in response to a change in monetary policy, when R&D/entry is restricted by a cash constraint.
    Keywords: CIA constraints on R&D, endogenous market structure, monetary policy, economic growth
    JEL: O30 O40 E41
    Date: 2013–09
  9. By: Richard Dennis
    Abstract: We study a business cycle model in which a benevolent fiscal authority must determine the optimal provision of government services, while lacking credibility, lump-sum taxes, and the ability to bond finance deficits. Households and the fiscal authority have risk sensitive preferences. We find that outcomes are affected importantly by the household’s risk sensitivity, but not by the fiscal authority’s. Further, while household risk-sensitivity induces a strong precautionary saving motive, which raises capital and lowers the return on assets, its effects on fluctuations and the business cycle are generally small, although more pronounced for negative shocks. Holding the stochastic steady state constant, increases in household risk-sensitivity lower the risk-free rate and raise the return on equity, increasing the equity premium. Finally, although risk-sensitivity has little effect on the provision of government services, it does cause the fiscal authority to lower the income tax rate. An additional contribution of this paper is to present a method for computing Markov-perfect equilibria in models where private agents and the government are risk-sensitive decision makers.
    Keywords: Asset prices, business cycles, risk-sensitivity, Markov-Perfect fiscal policy
    JEL: E63 C61
    Date: 2013–10
  10. By: Chu, Angus C.; Cozzi, Guido; Furukawa, Yuichi
    Abstract: This study analyzes the effects of inflation on the long-run nexus between unemployment and economic growth. We introduce money demand via a cash-in-advance (CIA) constraint on R&D investment into a scale-invariant Schumpeterian growth model with matching frictions in the labor market. Given the CIA constraint on R&D, a higher inflation that raises the opportunity cost of cash holdings leads to a decrease in innovation and economic growth, which in turn decreases labor-market tightness and increases unemployment. In summary, the model predicts a positive relationship between inflation and unemployment, a negative relationship between inflation and R&D, and a negative relationship between inflation and economic growth. These theoretical predictions are consistent with recent empirical evidence. Therefore, when inflation is a fundamental variable that affects the economy, unemployment and economic growth exhibit a negative relationship.
    Keywords: inflation; unemployment; innovation; economic growth.
    JEL: E24 E41 O3 O4
    Date: 2013–10
  11. By: Hyun Shin (Princeton University); Se-Jik Kim (Seoul National University)
    Abstract: Imperfect financial intermediation is a key bottleneck in economic development. Korea's unique Jeonse or housing repo contract channels funds directly from tenant/lenders to landlord/entrepreneurs, by-passing the banking system. In a housing repo, the landlord/entrepreneur puts up the house as collateral when borrowing from the tenant/lender. The lender's loan is secured by living in the collateral asset, lowering the cost of capital and increasing credit. Jeonse has been the dominant form of rental contract in Korea, and has served as a mode of direct debt financing that by-passes the banking sector.
    Date: 2013
  12. By: Kollenbach, Gilbert
    Abstract: The effects of an agreement such as the Kyoto Protocol, which implicitly imposes a ceiling on the stock of pollution, have recently been studied in Hotelling models. We add pollution and a ceiling to the endogenous growth model of \cite{tsur2005scarcity} to study the effects of the ceiling on capital accumulation and research investments. The ceiling increases the scarcity of the exhaustible resource in the short run, which boosts backstop utilization. This implies that R\&D becomes more beneficial compared with capital accumulation. How the short run development path of an economy is affected depends on its capital endowment or richness, respectively. Only economies which are neither too rich nor too poor may invest more into research. In the long run an economy with a ceiling follows basically the same long run development path as an economy without the ceiling.
    Keywords: Endogenous growth, Environmental agreements, Fossil fuels, Nonrenewable resources, Research and Development
    JEL: O44 Q32 Q54 Q55 Q56
    Date: 2013–10–14
  13. By: Konstantinos Angelopoulos; Stylianos Asimakopoulos; James Malley
    Abstract: This paper analyses optimal income taxes over the business cycle under a balanced-budget restriction, for low, middle and high income agents. A model incorporating capital-skill complementarity in pro- duction and differential access to capital and labour markets is de- veloped to capture the cyclical characteristics of the US economy, as well as the empirical observations on wage (skill premium) and wealth inequality. We fi…nd that the tax rate for high income agents is opti- mally the least volatile and the tax rate for low income agents the least countercyclical. In contrast, the path of optimal taxes for the middle income group is found to be the most volatile and counter-cyclical. We further fi…nd that the optimal response to output-enhancing capi- tal equipment technology and spending cuts is to increase the progres- sivity of income taxes. Finally, in response to positive TFP shocks, taxation becomes more progressive after about two years.
    Keywords: optimal taxation, business cycle, skill premium, income distribution
    JEL: E24 E32 E62
    Date: 2013–10
  14. By: Nikolay Iskrev (Bank of Portugal)
    Abstract: There is a long tradition in macroeconomics of using selected moments of the data to determine empirically relevant values of structural parameters. This paper presents a formal approach for evaluating the implications of DSGE models for the distribution of information in the moment structure of their variables. Specifically, it shows how to address the following questions: (1) what are the efficiency gains from using more instead of fewer moments; (2) what is the efficiency loss from assigning suboptimal weights on the used moments; and (3) which particular dimensions of the data - first and second order moments in the time domain, and sets of frequencies in the fre quency domain - are most informative about individual structural parameters. The analysis is based on the asymptotic properties of maximum likelihood and moment matching estimators and is simple to perform for general linearized models. A standard real business cycle model is used as an illustration.
    Date: 2013
  15. By: Jan Eeckhout (University College London and GSE-UPF)
    Abstract: How does the distribution of assets affect job search decisions? We analyze unemployed workers and how their asset holdings affect the allocation to jobs of different productivity. In the absence of insurance, workers with low asset holdings direct their search to low productivity jobs because they offer a low wage and low risk. We show that this occurs under a condition closely related to Decreasing Relative Risk Aversion. There is perfect segregation of asset holders into job productivities even when assets holdings are private. We also find that for a given worker, the productivity of jobs she applies for is decreasing in the duration of unemployment. As assets gradually deplete, she takes more secure, low wage jobs. When workers are heterogeneous in skills, there is a trade off between wages and insurance. The skilled but poor worker will necessarily go for the less ambitious, low wage job in order to hedge risk.
    Date: 2013
  16. By: Gabriele Camera (Economic Science Institute, Chapman University); YiLi Chien (Research Division, Federal Reserve Bank of St. Louis)
    Abstract: We examine two monetary models with periodic interactions in centralized and decentralized markets: the cash-in-advance model and the model in Lagos and Wright (2005). Given conformity of preferences, technologies and shocks, both models reduce to a single di?erence equation. In stationary equilibrium, such equations coincide when the price distortion present in one model, due to Nash bargaining, is replicated in the other using a tax on cash revenues. In that case, the quantitative implications for the welfare cost of in?ation in each model are also comparable. Di?erences in the model’s performance reduce to di?erences in the pricing mechanism assumed to govern those transactions that must be settled with the exchange of cash.
    Keywords: cash-in-advance, matching, microfoundations, money, in?ation
    JEL: E1 E4 E5
    Date: 2013
  17. By: Chakraborty, Shankha; Papageorgiou, Chris; Perez Sebastian, Fidel
    Abstract: We study the dynamics of poverty and health in a model of endogenous growth and rational health behavior. Population health depends on the prevalence of infectious diseases that can be avoided through costly prevention. The incentive to do so comes from the negative effects of ill health on the quality and quantity of life. The model can generate a poverty trap where infectious diseases cycle between high and low prevalence. These cycles originate from the rationality of preventive behavior in contrast to the predator-prey dynamics of epidemiological models. We calibrate the model to reflect sub-Saharan Africa's recent economic recovery and analyze policy alternatives. Unconditional transfers are found to improve welfare relative to conditional health-based transfers: at low income levels, income growth (quality of life) is valued more than improvements to health (quantity of life).
    Keywords: Infectious Disease, Cycles, Economic Epidemiology, Morbidity, Mortality, Conditional Transfers, Unconditional Transfers
    JEL: I15 O11 O40 O47
    Date: 2013–10–10
  18. By: Lintunen , Jussi (Finnish Forest Research Institute); Vilmi, Lauri (Bank of Finland, Monetary Policy and Research Department)
    Abstract: This paper studies the cyclical properties of optimal emission taxes and emissions using a real business cycle model with a stock pollutant. We derive conditions for the procyclicality of optimal emission tax and show that the tax is in typical conditions procyclical. The possibility of a countercyclical behavior of the emission tax increases if 1) the pollution is short-lived and the emission transfer into environmental damages rapidly 2) emissions are countercyclical, 3) marginal damages are strongly increasing and 4), in disutility case, the marginal utility of consumption increases with the increase in the intensity of the harmful environmental process. In the climate change context we show that the optimal carbon tax is procyclical irrespectively on the production technology. Instead, the technology is a key determinant of the cyclicality of the emissions. The optimal carbon tax correlates almost fully with the consumption and as a rule-of thumb, it could be indexed to the consumption level of the economy. The relative scale of tax deviations relative to the consumption deviations is determined by the inverse of the intertemporal elasticity of substitution. Comparison between the optimal emission tax and an optimally set constant emission tax shows that the constant tax leads to very slightly higher emissions but the general economic effects are next to negligible.
    Keywords: optimal emission tax; cyclical properties
    JEL: E32 Q54 Q58
    Date: 2013–10–09
  19. By: Bacchetta, P.; Benhima, K.; Kalantzis, Y.
    Abstract: In this paper, we consider an alternative perspective to China's exchange rate policy. We study a semi-open economy where the private sector has no access to international capital markets but the central bank has full access. Moreover, we assume limited financial development generating a large demand for saving instruments by the private sector. We analyze the optimal exchange rate policy by modeling the central bank as a Ramsey planner. Our main result is that in a growth acceleration episode it is optimal to have an initial real depreciation of the currency combined with an accumulation of reserves, which is consistent with the Chinese experience. This depreciation is followed by an appreciation in the long run. We also show that the optimal exchange rate path is close to the one that would result in an economy with full capital mobility and no central bank intervention.
    Keywords: China, exchange rate policy and international reserves.
    JEL: E58 F31 F41
    Date: 2013
  20. By: Carlos Carvalho; Fernanda Nechio
    Abstract: We develop a multisector model in which capital and labor are free to move across firms within each sector, but cannot move across sectors. To isolate the role of sectoral specificity, we compare our model with otherwise identical multisector economies with either economy-wide factor markets (as in Chari et al. 2000) or firm-specific factor markets (as in Woodford 2005). Sectoral specificity induces within-sector strategic substitutability and across-sector strategic complementarity in price setting. Our model can produce either more or less monetary non-neutrality than those other two models, depending on the distribution of price rigidity across sectors. Under the empirical distribution for the U.S., our model behaves similarly to an economy with firm-specific factors in the short-run, and later on approaches the dynamics of the model with economy-wide factor markets. This is consistent with the idea that factor price equalization might take place gradually over time, so that firm-specificity might be a reasonable short-run approximation, whereas economy-wide markets might be a better description of how factors of production are allocated in the longer run.
    Date: 2013
  21. By: Philipp Kircher (University of Edinburgh)
    Abstract: We develop a neoclassical trade model with heterogeneous factors of production. We consider a world with two factors, labor and ?managers?, each with a distribution of ability levels. Production combines a manager of some type with a group of workers. The output of a unit depends on the types of the two factors, with complementarity between them, while exhibiting diminishing returns to the number of workers. We examine the sorting of factors to sectors and the matching of factors within sectors, and we use the model to study the determinants of the trade pattern and the e¤ects of trade on the wage and salary distributions. Finally, we extend the model to include search frictions and consider the distribution of employment rates.
    Keywords: heterogeneous labor, matching, sorting, productivity, wage distribution, international trade.
    JEL: F11 F16
    Date: 2013–10–11
  22. By: William Barnett (Department of Economics, The University of Kansas); Taniya Ghosh (Indira Gandhi Institute of Development Research, Reserve Bank of India, Mumbai)
    Abstract: This paper analyzes the dynamics of a variant of Jones (2002) semi-endogenous growth model within the feasible parameter space. We derive the long run growth rate of the economy and do a detailed bifurcation analysis of the equilibrium. We show the existence of codimension-1 bifurcations (Hopf, Branch Point, Limit Point of Cycles, and Period Doubling) and codimension-2 (Bogdanov-Takens and Generalized Hopf) bifurcations within the feasible parameter range of the model. 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, Jones growth model, Hopf, inference robustness, dynamics, stability.
    Date: 2013–10
  23. By: Andri Chassamboulli (University of Cyprus); Theodore Palivos (Athens University of Economics and Business)
    Abstract: We analyze the impact of the immigration influx that took place during the years 2000-2007 in Greece on labor market outcomes. We employ a search and matching framework that allows for skill heterogeneity and differential unemployment income (search cost) between immigrants and natives. Within such a framework, we .find that skilled native workers, who complement immigrants in production, gain in terms of both wages and employment. The effects on unskilled native workers, who compete with immigrants, on the other hand, are ambiguous and depend first on the presence of a statutory minimum wage and second on the way that this minimum wage is determined.
    Keywords: Immigration; Search and Matching; Unemployment; Skill-heterogeneity;Minimum Wage; Greek Economy.
    JEL: F22 J61 J64
    Date: 2013–05
  24. By: Mark Aguiar; Manuel Amador; Emmanuel Farhi; Gita Gopinath
    Abstract: We propose a continuous time model of nominal debt and investigate the role of inflation credibility in the potential for self-fulfilling debt crises. Inflation is costly, but reduces the real value of outstanding debt without the full punishment of default. With high inflation credibility, which can be interpreted as joining a monetary union or issuing foreign currency debt, debt is effectively real. By contrast, with low inflation credibility, sovereign debt is nominal and in a debt crisis a government may opt to inflate away a fraction of the debt burden rather than explicitly default. This flexibility potentially reduces the country's exposure to self-fulfilling crises. On the other hand, the government lacks credibility not to inflate in the absence of crisis. This latter channel raises the cost of debt in tranquil periods and makes default more attractive in the event of a crisis, increasing the country's vulnerability. We characterize the interaction of these two forces. We show that there is an intermediate inflation credibility that minimizes the country's exposure to rollover risk. Low inflation credibility brings the worst of both worlds—high inflation in tranquil periods and increased vulnerability to a crisis.
    JEL: E31 E4 E62 F34 G15
    Date: 2013–10
  25. By: Ludo Visschers (The University of Edinburgh, Universidad Carlos III de Madrid, and CESifo)
    Abstract: We develop a neoclassical trade model with heterogeneous factors of production. We consider a world with two factors, labor and ?managers?, each with a distribution of ability levels. Production combines a manager of some type with a group of workers. The output of a unit depends on the types of the two factors, with complementarity between them, while exhibiting diminishing returns to the number of workers. We examine the sorting of factors to sectors and the matching of factors within sectors, and we use the model to study the determinants of the trade pattern and the effects of trade on the wage and salary distributions. Finally, we extend the model to include search frictions and consider the distribution of employment rates.
    Keywords: Layoff Rates, Unemployment risk, Wage Differentials, Unemployment Scarring.
    JEL: J31 J63
    Date: 2013–10–11
  26. By: Richard Dennis
    Abstract: This paper studies the behavior of a central bank that seeks to conduct policy optimally while having imperfect credibility and harboring doubts about its model. Taking the Smets-Wouters model as the central bank’s approximating model, the paper’s main findings are as follows. First, a central bank’s credibility can have large consequences for how policy responds to shocks. Second, central banks that have low credibility can benefit from a desire for robustness because this desire motivates the central bank to follow through on policy announcements that would otherwise not be time-consistent. Third, even relatively small departures from perfect credibility can produce important declines in policy performance. Finally, as a technical contribution, the paper develops a numerical procedure to solve the decision-problem facing an imperfectly credible policymaker that seeks robustness.
    Keywords: Imperfect Credibility, Robust Policymaking, Time-consistency
    JEL: E58 E61 C63
    Date: 2013–10
  27. By: Masashige Hamano (CREA, Université de Luxembourg)
    Abstract: This paper explores the role played by product variety and quality in a real business cycle model. Firms are heterogeneous in terms of their specific quality as well as pro- ductivity levels. Firms which have costly technology enter in a period of high aggregated demand and produce high quality goods. Thus, the average quality level and number of available varieties are procyclical, as in the data. The model can replicate the observed inflationary bias in the conventional Consumer Price Index due to a rise in the number of new product varieties and quality.
    Keywords: Entry and exit, firm heterogeneity, the Schumpeterian destruction, product quality, business cycles
    JEL: D21 E23 E32 L11 L60
    Date: 2013

This nep-dge issue is ©2013 by Christian Zimmermann. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.