nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒02‒21
eleven papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Bayesian evaluation of DSGE models with financial frictions By Michal Brzoza-Brzezina; Marcin Kolasa
  2. A multi-country DSGE model with incomplete Exchange Rate Passthrough:application for the Euro area. By Tovonony Razafindrabe
  3. The Cyclical Behavior of Equilibrium Unemployment and Vacancies Across OECD Countries By Pedro S. Amaral; Murat Tasci
  4. Efects of Carbon Taxes in an Economy with Large Informal Sector and Rural-Urban Migration By Karlygash Kuralbayeva
  5. Optimal Tax Progressivity: An Analytical Framework By Jonathan Heathcote; Kjetil Storesletten; Giovanni L. Violante
  6. Can Intangible Capital Explain Cyclical Movements in the Labor Wedge? By Francois Gourio; Leena Rudanko
  7. On the Importance of Fertility Behavior in School Finance Policy Design By Kuzey Yilmaz
  8. Access to finance, product innovation and middle-income traps By Agenor, Pierre-Richard; Canuto, Otaviano
  9. Does social security reform reduce gains from increasing the retirement age? By Karolina Goraus; Krzysztof Makarski; Joanna Tyrowicz
  10. Search Frictions and Market Power in Negotiated Price Markets By Jason Allen; Robert Clark; Jean-François Houde
  11. Euler equation with habits and measurement errors: estimates on Russian micro data By Irina Khvostova; Alexander Larin; Anna Novak

  1. By: Michal Brzoza-Brzezina (National Bank of Poland, Warsaw School of Economics); Marcin Kolasa (National Bank of Poland, Warsaw School of Economics)
    Abstract: We evaluate two most popular approaches to implementing financial frictions into DSGE models: the Bernanke et al. (1999) setup, where frictions affect the price of loans, and the Kiyotaki and Moore (1997) model, where they concern the quantity of loans. We take both models to the data and check how well they fit it on several margins. Overall, comparing the models favors the Bernanke et al. framework. However, even this model does not make a clear improvement over the New Keynesian benchmark in terms of marginal likelihood and similarity of impulse responses to those obtained from a VAR. These findings point at the need for further research to develop macrofinancial models that would better describe the business cycle dynamics.
    Keywords: financial frictions, DSGE models, Bayesian analysis
    JEL: E30 E44
    Date: 2014–02–13
  2. By: Tovonony Razafindrabe
    Abstract: This paper develops an estimated multi-country open economy dynamic stochastic gen- eral equilibrium (DSGE) model with incomplete Exchange Rate Pass-Through (ERPT) for the Euro-area. It is designed to model global international linkages and to assess inter- national transmission of shocks under an endogenous framework and incomplete ERPT assumption. On the one hand, we relax the small open economy framework (SOEF) but derive a canonical representation of the equilibrium conditions to maintain analytical tractability of the complex international transmission mechanism underlying the model. Namely, the model considers economies of di¤erent size that are open and endogenously related. On the other hand, in order to take into account international linkages, possible cointegration relationships within domestic variables and between domestic and foreign variables, and the role of common unobserved and observed global factors such as the oil price, we use the Global VAR model to estimate the steady state of observed endoge- nous variables of the multi-country DSGE model. Namely, steady states are computed as long-horizon forecasts from a reduced-form cointegrating GVAR model. ERPT analysis conducted from the estimated multi-country DSGE model for the Euro-area in relation with its …ve main trade partners which are the United Kingdom, the United States, China, Japan and Switzerland yields the following results. First, exchange rate volatility contributes to a large part of import price in‡ation variation of the Euro-area in contrast to foreign mark-up shocks. Second, deviation from in‡ation objective of the foreign trade partners contributes to another source of the Euro-area import price variability. Third, nominal rigidity induces a persistent but a lower impact of the exchange rate changes on import in‡ation.
    Date: 2014–02–07
  3. By: Pedro S. Amaral (Federal Reserve Bank of Cleveland); Murat Tasci (Federal Reserve Bank of Cleveland)
    Abstract: We show that the inability of a standardly-calibrated labor search-and-matching model to account for labor market volatility extends beyond the U.S. to a set of OECD countries. That is, the volatility puzzle is ubiquitous. We argue cross-country data is helpful in scrutinizing between potential solutions to this puzzle. To illustrate this, we show that the solution proposed in Hagedorn and Manovskii (2008) continues to deliver counterfactually low volatility in countries where labor productivity persistence and/or steady-state job-finding rates are sufficiently low. Moreover, the model's ability to generate high enough volatility depends on vacancy-filling rate levels that seem counterfactual outside the U.S.
    Keywords: Labor Market, Vacancies, Unemployment, OECD countries.
    JEL: E24 E32 J63 J64
    Date: 2014–02
  4. By: Karlygash Kuralbayeva
    Abstract: I build an equilibrium search and matching model of an economy with an informal sector and rural-urban migration to analyze the effects of budget-neutral green tax policy (raising pollution taxes, while cutting payroll taxes) on the labor market. The key results of the paper suggest that when general public spending varies endogenously in response to tax reform and higher energy taxes can reduce the income from self-employed work in the informal sector, green tax policy can produce a triple dividend: a cleaner environment, lower unemployment rate and higher after-tax income of the private sector. This is due to the ability of the government, by employing public spending as an additional policy instrument, to reduce the overall tax burden when an increase in energy tax rates does not exceed some threshold level. Thus governments should employ several instruments if they are concerned with labor market implicatoins of green tax policies.
    Keywords: informal sector, matching frictions, pollution taxes, double dividend subsidy, learning by doing, directed technical change, multiplicative damages, additive damages
    JEL: H20 H23 H30
    Date: 2014
  5. By: Jonathan Heathcote; Kjetil Storesletten; Giovanni L. Violante
    Abstract: What shapes the optimal degree of progressivity of the tax and transfer system? On the one hand, a progressive tax system can counteract inequality in initial conditions and substitute for imperfect private insurance against idiosyncratic earnings risk. At the same time, progressivity reduces incentives to work and to invest in skills, and aggravates the externality associated with valued public expenditures. We develop a tractable equilibrium model that features all of these trade-offs. The analytical expressions we derive for social welfare deliver a transparent understanding of how preferences, technology, and market structure parameters influence the optimal degree of progressivity. A calibration for the U.S. economy indicates that endogenous skill investment, flexible labor supply, and the externality linked to valued government purchases play quantitatively similar roles in limiting desired progressivity.
    JEL: E20 H20 H40 J22 J24
    Date: 2014–02
  6. By: Francois Gourio; Leena Rudanko
    Abstract: Intangible capital is an important factor of production in modern economies that is generally neglected in business cycle analyses. We demonstrate that intangible capital can have a substantial impact on business cycle dynamics, especially if the intangible is complementary with production capacity. We focus on customer capital: the capital embodied in the relationships a firm has with its customers. Introducing customer capital into a standard real business cycle model generates a volatile and countercyclical labor wedge, due to a mismeasured marginal product of labor. We also provide new evidence on cyclical variation in selling effort to discipline the exercise.
    JEL: E13 E32
    Date: 2014–02
  7. By: Kuzey Yilmaz (Department of Economics, University of Rochester)
    Abstract: To design an optimal education policy, it is essential to account for the fertility differential between the poor and the rich because it affects the human capital investment through the child quantity-quality tradeoff of children. We develop a dynamic general equilibrium in which parents choose the quantity of children, transfer a preschool ability to their children, determine the quality of children by choosing private expenditures on basic education in addition to public expenditures on basic education, leave a bequest that could be used to finance college education. Moreover, there is an uncertainty in college completion depending on ability and endogenous wage determination based on the amount of schooling in the economy. It is very important to consider general equilibrium effects because the change in either fertility behavior or college outcomes as a result of policy changes leads to a large change in aggregate skill distribution. We find that ignoring fertility behavior, especially differential fertility substantially underestimates the role of credit constraints in the economy. We also analyze the impact of basic education subsidies and college subsidies on welfare, inequality, and intergenerational mobility. Strikingly, the choice between these two policies is found to be dependent on the magnitude of differential fertility rate.
    Keywords: differential fertility; human capital investment; education subsidies; general equilibrium; inequality; intergenerational mobility.
    JEL: H2 I2 D5 J1 J3
    Date: 2014–02
  8. By: Agenor, Pierre-Richard; Canuto, Otaviano
    Abstract: This paper studies interactions between access to finance, product innovation, and labor supply in a two-period overlapping generations model with an endogenous skill distribution and credit market frictions. In the model lack of access to finance (induced by high monitoring costs) has an adverse effect on innovation activity not only directly but also indirectly, because too few individuals may choose to invest in skills. If monitoring costs fall with the number of successful projects, multiple equilibria may emerge, one of which, a middle-income trap, characterized by low wages in the design sector, a low share of the labor force engaged in innovation activity, and low growth. A sufficiently ambitious policy aimed at alleviating constraints on access to finance by innovators may allow a country to move away from such a trap by promoting the production of ideas and improving incentives to invest in skills.
    Keywords: Labor Policies,Access to Finance,Debt Markets,Economic Theory&Research,Banks&Banking Reform
    Date: 2014–02–01
  9. By: Karolina Goraus (Faculty of Economic Sciences, University of Warsaw); Krzysztof Makarski (National Bank of Poland, Warsaw School of Economics); Joanna Tyrowicz (Faculty of Economic Sciences, University of Warsaw; National Bank of Poland)
    Abstract: The objective of this paper is to analyze the welfare effects of raising the retirement age. With aging populations, in many countries de iure retirement age has been raised. With a standard assumption that individuals prefer leisure to work, such policy necessitates some welfare deterioration. This could be outweighed by lower taxation (defined benefit schemes becoming more balanced) or higher pension benefits (defined contribution schemes yield higher effective replacement rate). Moreover, it is often argued that actuarially fair pension systems provide sufficient incentives for individuals to extend the number of working years, which undermines the need to change de iure retirement age. In this paper we construct an OLG model in which we analyze welfare effects of extending the retirement age under PAYG defined benefit, PAYG defined contribution and partially funded defined contribution pension schemes. We find that such policy is universally welfare improving. However, postponed retirement translates to lower savings, which implies decrease in per capita capital and output.
    Keywords: PAYG, retirement age, pension system reform, time inconsistency, welfare
    JEL: C68 E17 E25 J11 J24 H55 D72
    Date: 2014
  10. By: Jason Allen; Robert Clark; Jean-François Houde
    Abstract: This paper develops and estimates a search and bargaining model designed to measure the welfare loss associated with frictions in oligopoly markets with negotiated prices. We use the model to quantify the consumer surplus loss induced by the presence of search frictions in the Canadian mortgage market, and evaluate the relative importance of market power, inefficient allocation, and direct search costs in explaining the loss. Our results suggest that search frictions reduce consumer surplus by almost $20 per month on a $100, 000 loan, and that 17% of this reduction can be associated with discrimination, 30% with inefficient matching, and the remainder with the search cost. In addition, we find that product differentiation attenuates the effect of search frictions by reducing the cost of gathering quotes and improving efficiency, while posted prices do so through the ability of the first-mover to price discriminate. In contrast, competition amplifies the welfare effect of search frictions. Despite this, the overall effect of competition is to increase aggregate consumer surplus and drive prices down, but these effects are not spread equally across consumers: those with low search costs benefit more from competition.
    JEL: L13 L41 L81
    Date: 2014–02
  11. By: Irina Khvostova (National Research University Higher School of Economics); Alexander Larin (National Research University Higher School of Economics); Anna Novak (National Research University Higher School of Economics)
    Abstract: This paper presents estimates for the consumption Euler equation for Russia. The estimation is based on micro-level panel data and accounts for the preference heterogeneity, measurement errors, and the impact of macroeconomic shocks. The presence of multiplicative habits is checked with the LM-test in a GMM framework. We obtain estimates of the elasticity of intertemporal substitution and of the subjective discount factor, which are consistent with the theoretical model and can be used for calibration, as well as for a Bayesian estimation of DSGE models for the Russian economy. We also show that the effects of habit formation are not significant. The hypotheses on habits (external, internal, and both external and internal) are not supported by the data
    Keywords: household consumption, Euler equation, habit formation, elasticity of intertemporal substitution, RLMS-HSE
    JEL: E21 C23
    Date: 2014

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