nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒03‒30
twenty papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Monetary policy and growth with trend inflation and financial frictions By Olmos, Lorena; Sanso Frago, Marcos
  2. Endogenous Firms Dynamics and Banking By Carla La Croce; Lorenza Rossi
  3. Tenure, experience, human capital and wages: a tractable equilibrium search model of wage dynamics By Jesper Bagger; Francois Fontaine; Jean-Marc Robin
  4. A Theory of Aggregate Supply and Aggregate Demand as Functions of Market Tightness with Prices as Parameters By Emmanuel Saez; Pascal Michaillat
  5. Monetary and macroprudential policy in an estimated DSGE model of the Euro Area By Quint, Dominic; Rabanal, Pau
  6. Tractable Latent State Filtering for Non-Linear DSGE Models Using a Second-Order Approximation By Robert Kollmann
  7. Anatomy of a Credit Crunch: From Capital to Labor Markets By Francisco J. Buera; Roberto Fattal-Jaef; Yongseok Shin
  8. Growth, unemployment and wage inertia By Xavier Raurich; Valeri Sorolla
  9. Labor market reforms and unemployment dynamics By Fabrice Murtin; Jean-Marc Robin
  10. Optimal Development Policies with Financial Frictions By Oleg Itskhoki; Benjamin Moll
  11. Forecasting the US Economy with a Factor-Augmented Vector Autoregressive DSGE model By Stelios Bekiros; Alessia Paccagnini
  12. The Time Path of the Saving Rate: Hyperbolic Discounting and Short-Term Planning By Farzin, Y. Hossein; Wendner, Ronald
  13. Dynamic Corporate Liquidiy By Roberto Steri; Lukas Schmid
  14. Social Security and the Interactions Between Aggregate and Idiosyncratic Risk By Daniel Harenberg; Alexander Ludwig
  15. A model of mortgage default By Campbell, John Y.; Cocco, João F.
  16. Multiple Interior Steady States in the Ramsey Model with Elastic Labor Supply By Takashi Kamihigashi
  17. A recursive method for solving a climate-economy model: value function iterations with logarithmic approximations By Hwang, In Chang
  18. Online Appendix to "Explaining Educational Attainment across Countries and over Time" By Diego Restuccia; Guillaume Vandenbroucke
  19. A Model of Monetary Exchange in Over-the-Counter Markets By Shengxing Zhang; Ricardo Lagos
  20. Optimal Employment Contracts with Hidden Search By Rasmus Lentz

  1. By: Olmos, Lorena; Sanso Frago, Marcos
    Abstract: This paper studies the effects that conventional and unconventional monetary policies generate when endogenous growth, trend inflation and financial frictions are considered in a New Keynesian macroeconomic model. Financial variables play a key role in the determination of the steady state growth rate, given the value of the trend inflation. Calibrating the model following Gertler and Karadi (2011), long-run growth rate, welfare, normalized investment and financial wealth are maximized when trend inflation is 1.7% while leverage, external finance premium and marginal gain of the financial intermediaries are minimized. Finally, unconventional policies could extend their impact to the long run.
    Keywords: New Keynesian DSGE models, endogenous growth, financial frictions, trend inflation, unconventional monetary policy
    JEL: E31 E44 E58 O42
    Date: 2014
  2. By: Carla La Croce (Department of Economics and Management, University of Pavia); Lorenza Rossi (Department of Economics and Management, University of Pavia)
    Abstract: We consider a DSGE model with flexible prices, monopolistic competitive banks and sticky interest rates, together with endogenous ?firms exit and entry decisions. We find that economies characterized by endogenous ?firms dynamics imply higher volatilities of both real and financial variables than those implied by a DSGE with monopolistic banking and a fixed number of firms, in response to both real and financial shocks. The model with endogenous exit, in line with the empirical evidence, implies: i) countercyclical exit; ii) an endogenous countercyclical bank markup and an endogenous countercyclical interest rate spread; iii) a quicker recovery in the aftermath of a financial crisis, when the macroprudential authority implements countercyclical capital requirements (Basel III). This policy is more stabilizing than Basel II as well as than an alternative Taylor rule explicitly targeting capital-to-asset ratio.
    Keywords: firms endogenous exit, bank markup, interest rate spread, macro- prudencial policies, Taylor rule.
    JEL: E32 E44 E52 E58
    Date: 2014–03
  3. By: Jesper Bagger; Francois Fontaine; Jean-Marc Robin (Institute for Fiscal Studies and Sciences Po)
    Abstract: We develop and estimate an equilibrium job search model of worker careers, allowing for human capital accumulation, employer heterogeneity and individual-level shocks. Career wage growth is decomposed into the contributions of human capital and job search, within and between jobs. Human capital accumulation is largest for highly educated workers, and both human capital accumulation and job search contribute to the observed concavity of wage-experience profiles. The contribution from job search to wage growth, both within- and between-job, declines over the first ten years of a career- the `job-shopping' phase of a working life - after which workers settle into high-quality jobs and use outside offers to generate gradual wage increases, thus reaping the benefits from competition between employers.
    Date: 2014–03
  4. By: Emmanuel Saez (UC Berkeley); Pascal Michaillat (London School of Economics)
    Abstract: This paper presents a parsimonious equilibrium business cycle model with trade frictions in the product and labor markets. The model features unemployment and unsold production and its general equilibrium can be represented very simply: as the intersection of an aggregate supply and an aggregate demand, with product market tightness acting as a price. The aggregate supply represents the expected amount of sales by firms given product market tightness and optimal hiring on the labor market. The aggregate demand represents optimal product consumption given product market tightness--consumers can also spend their income on an unproduced good. We use a search-andmatching structure to realistically represent trade frictions in the product and labor markets. In such a structure, it is not price or wage but market tightness that equalizes supply to demand. In fact, the frictions create situations of bilateral monopoly in price and wage setting that make price and wage indeterminate. To resolve this indeterminacy, we take price and wage as parameters, thus disconnecting price and wage determination from our analysis. Since the equilibrium representation is very transparent and tractable, we are able to obtain a broad range of comparative statics with respect to demand and supply shocks. The model is also suited to think about inventories, labor hoarding, income and wealth inequality. It can be extended to a dynamic environment.
    Date: 2013
  5. By: Quint, Dominic; Rabanal, Pau
    Abstract: In this paper, we study the optimal mix of monetary and macroprudential policies in an estimated two-country model of the euro area. The model includes real, nominal and ?nancial frictions, and hence both monetary and macroprudential policy can play a role. We ?nd that the introduction of a macroprudential rule would help in reducing macroeconomic volatility, improve welfare, and partially substitute for the lack of national monetary policies. Macroprudential policy would always increase the welfare of savers, but their e¤ects on borrowers depend on the shock that hits the economy. In particular, macroprudential policy may entail welfare costs for borrowers under technology shocks, by increasing the countercyclical behavior of lending spreads. --
    Keywords: Monetary Policy,EMU,Basel III,Financial Frictions
    JEL: C51 E44 E52
    Date: 2014
  6. By: Robert Kollmann
    Abstract: This paper develops a novel approach for estimating latent state variables of Dynamic Stochastic General Equilibrium (DSGE) models that are solved using a second-order accurate approximation. I apply the Kalman filter to a state-space representation of the second-order solution based on the ‘pruning’ scheme of Kim, Kim, Schaumburg and Sims (2008). By contrast to particle filters, no stochastic simulations are needed for the filter here--the present method is thus much faster. In Monte Carlo experiments, the filter here generates more accurate estimates of latent state variables than the standard particle filter. The present filter is also more accurate than a conventional Kalman filter that treats the linearized model as the true data generating process. Due to its high speed, the filter presented here is suited for the estimation of model parameters; a quasi-maximum likelihood procedure can be used for that purpose.
    Keywords: latent state filtering; estimation of DSGE models; second-order approximation; pruning; Kalman filter; particle filter; quasi-maximum likelihood
    JEL: C63 C68 E37
    Date: 2013–05
  7. By: Francisco J. Buera; Roberto Fattal-Jaef; Yongseok Shin
    Abstract: Why are financial crises associated with a sustained rise in unemployment? We develop a tractable model with frictions in both credit and labor markets to study the aggregate and micro-level implications of a credit crunch--i.e., a tightening of collateral constraints. When we simulate a credit crunch calibrated to match the observed decline in the ratio of debt to non-financial assets of the United States business sector following the 2007-8 crisis, our model generates a sharp decline in output--explained by a drop in aggregate total factor productivity and investment--and a protracted increase in unemployment. We then explore the micro-level impact by tracking the employment dynamics for firms of different sizes and ages. The credit crunch causes a much larger reduction in the net employment growth rate of small, young establishments relative to that of large, old producers, consistent with the recent empirical findings in the literature.
    JEL: E24 E44 L25
    Date: 2014–03
  8. By: Xavier Raurich (Facultat d'Economia i Empresa; Universitat de Barcelona (UB)); Valeri Sorolla (Univrsitat Autònoma de Barcelona)
    Abstract: We introduce wage setting via efficiency wages in the neoclassical one-sector growth model to study the growth effects of wage inertia. We compare the dynamic equilibrium of an economy with wage inertia with the equilibrium of an economy without it. We show that wage inertia affects the long run employment rate and that the transitional dynamics of the main economic variables will be different because wages are a state variable when wage inertia is introduced. In particular, we show that the model with wage inertia can explain some growth patterns that cannot be explained when wages are flexible. We also study the growth effects of permanent technological and fiscal policy shocks in these two economies. During the transition, the growth effects of technological shocks obtained when wages exhibit inertia may be the opposite of those obtained when wages are flexible. These technological shocks may have long run effects if there is wage inertia.
    Keywords: Wage inertia, Growth, Efficiency wages, Transitional dynamics, Unemployment.
    JEL: O41
    Date: 2014
  9. By: Fabrice Murtin; Jean-Marc Robin (Institute for Fiscal Studies and Sciences Po)
    Abstract: In this paper, we quantify the contribution of labor market reforms to unemployment dynamics in nine OECD countries (Australia, France, Germany, Japan, Portugal, Spain, Sweden, the United Kingdom and the United States). We build and estimate a dynamic stochastic search-matching model with heterogeneous workers, where aggregate shocks to productivity fuel up the cycle, and unanticipated policy interventions shift structural parameters and displace the long-term equilibrium. We show that the heterogeneous-worker mechanism proposed by Robin (2011) to explain unemployment volatility by productivity shocks works well in all countries. The amount of resources injected into placement and employment services, the reduction of UI benefits and product market deregulation stand out as the most prominent policy levers for unemployment reduction. All other LMPs have a significant but lesser impact. We also find that business cycle shocks and LMPs explain about the same share of unemployment volatility (except for Japan, Portugal and the US).
    Date: 2014–03
  10. By: Oleg Itskhoki; Benjamin Moll
    Abstract: We study optimal dynamic Ramsey policies in a standard growth model with financial frictions. For developing countries with low financial wealth, the optimal policy intervention increases labor supply and lowers wages, resulting in higher entrepreneurial profits and faster wealth accumulation. This in turn relaxes borrowing constraints in the future, leading to higher labor productivity and wages. The use of additional policy instruments, such as subsidized credit, may be optimal as well. In the long run, the optimal policy reverses sign. Taking advantage of the tractability of our framework, we extend the model to study its implications for optimal exchange rate and sectoral industrial policies.
    JEL: E60 F40 O0
    Date: 2014–03
  11. By: Stelios Bekiros; Alessia Paccagnini
    Abstract: Although policymakers and practitioners are particularly interested in DSGE models, these are typically too stylized to be applied directly to the data and often yield weak prediction re- sults. Very recently, hybrid DSGE models have become popular for dealing with some of the model misspecifications. Ma jor advances in estimation methodology could allow these models to outperform well-known time series models and effectively deal with more complex real-world prob- lems as richer sources of data become available. ln this study we introduce a Bayesian approach to estimate a novel Factor Augmented DSGE model that extends the model of Consolo et al. [Consolo, A., Favero, C.A., and Paccagnini, A., 2009. On the Statistical ldentification of DSGE Models. Journal of Econometrics 150, 99-115]. We perform a comparative predictive evaluation of many different specifications of estimated DSGE models and various classes of VAR models, using datasets from the US economy. Simple and hybrid DSGE models are implemented, such as DSGE-VAR and tested against standard, Bayesian and Factor Augmented VARs. The results can be useful for macro-forecasting and monetary policy analysis.
    Keywords: Forecasting, Marginal data density, DSGE-FAVAR
    JEL: C32 C11 C15
    Date: 2014–02–25
  12. By: Farzin, Y. Hossein; Wendner, Ronald
    Abstract: The standard neoclassical growth model with Cobb-Douglas production predicts a monotonically declining saving rate, when reasonably calibrated. Ample empirical evidence, however, shows that the transition paths of most countries’ saving rates exhibit a statistically significant hump-shaped pattern. Prior literature shows that CES production may imply a hump-shaped pattern of the saving rate (Goméz, 2008). However, the implied magnitude of the hump falls short of what is seen in empirical data. We introduce two non-standard features of preferences into a neoclassical growth model with CES production: hyperbolic discounting and short planning horizons. We show that, in contrast to the commonly accepted argument, in general (except for the special case of logarithmic utility) a model with hyperbolic discounting is not observationally equivalent to one with exponential discounting. We also show that our framework implies a hump-shaped saving rate dynamics that is consistent with empirical evidence. Hyperbolic discounting turns out to be a major factor explaining the magnitude of the hump of the saving rate path. Numerical simulations employing a generalized class of hyperbolic discount functions, which we term regular discount functions, support the results.
    Keywords: Saving rate dynamics, non-monotonic transition path, hyperbolic discounting, regular discounting, short-term planning, neoclassical growth model
    JEL: D91 E21 O40
    Date: 2014–03–19
  13. By: Roberto Steri (Duke University); Lukas Schmid (Duke University)
    Abstract: When external finance is costly, liquid funds provide corporations with instruments to absorb and react to shocks. Making optimal use of liquid funds means transferring them to times and states where they are most valuable. We examine the determinants of corporate liquidity management in a dynamic model where stochastic investment opportunities and cash shortfalls provide liquidity needs. Firms can transfer liquidity across time using cash and across states drawing on credit lines subject to debt capacity constraints. We generate empirical and quantitative predictions by means of calibration. Small and constrained firms use cash to provide liquidity to fund investment opportunities, while large and unconstrained firms manage their liquidity needs by means of credit lines. In the time series, equity issuances are used to replenish cash balances, and credit lines to fund unanticipated investment opportunities. We find strong support for our predictions in the data. Overall, the model thus provides a quantitatively and empirically successful framework explaining corporate investment, financing and liquidity policies and the joint occurrence of cash, debt and credit lines in the presence of capital market imperfections.
    Date: 2013
  14. By: Daniel Harenberg; Alexander Ludwig
    Abstract: We ask whether a PAYG-financed social security system is welfare improving in an economy with idiosyncratic and aggregate risk. We argue that interactions between the two risks are important for this question. One is a direct interaction in the form of a countercyclical variance of idiosyncratic income risk. The other indirectly emerges over a household's life-cycle because retirement savings contain the history of idiosyncratic and aggregate shocks. We show that this leads to risk interactions, even when risks are statistically independent. In our quantitative analysis, we find that introducing social security with a contribution rate of two percent leads to welfare gains of $2.2 \%$ of lifetime consumption in expectation, despite substantial crowding out of capital. This welfare gain stands in contrast to the welfare losses documented in the previous literature, which studies one risk in isolation. We show that jointly modeling both risks is crucial: 60% of the welfare benefits from insurance result from the interactions of risks.
    Keywords: social security, idiosyncratic risk, aggregate risk, welfare
  15. By: Campbell, John Y.; Cocco, João F.
    Abstract: This paper solves a dynamic model of households' mortgage decisions incorporating labor income, house price, inflation, and interest rate risk. It uses a zero-profit condition for mortgage lenders to solve for equilibrium mortgage rates given borrower characteristics and optimal decisions. The model quantifies the effects of adjustable vs. fixed mortgage rates, loan-to-value ratios, and mortgage affordability measures on mortgage premia and default. Heterogeneity in borrowers' labor income risk is important for explaining the higher default rates on adjustable-rate mortgages during the recent US housing downturn, and the variation in mortgage premia with the level of interest rates. --
    Keywords: household finance,loan to value ratio,loan to income ratio,mortgage affordability,negative home equity,mortgage premia
    JEL: G21 E21
    Date: 2014
  16. By: Takashi Kamihigashi
    Abstract: In this paper we show that multiple interior steady states are pos- sible in the Ramsey model with elastic labor supply. In particular we establish the following three results: (i) for any discount factor and production function, there is a utility function such that a continuum of interior steady states exist; (ii) the number of interior steady states can also be any nite number; and (iii) for any discount factor and production function, there is a utility function such that there is no interior steady state. Some numerical examples are provided
    Date: 2014–02–25
  17. By: Hwang, In Chang
    Abstract: A recursive method for solving an integrated assessment model of climate and the economy is developed in this paper. The method approximates value function with a logarithmic basis function and searches for solutions on a set satisfying optimality conditions. These features make the method suitable for a highly nonlinear model with many state variables and various constraints, as usual in a climate-economy model.
    Keywords: Dynamic programming; recursive method; value function iteration; integrated assessment
    JEL: C61 C63 Q54
    Date: 2014–03–25
  18. By: Diego Restuccia (University of Toronto); Guillaume Vandenbroucke (University of Southern California)
    Abstract: Online appendix for the Review of Economic Dynamics article
    Date: 2014
  19. By: Shengxing Zhang (New York University); Ricardo Lagos (New York University)
    Abstract: We develop a model of monetary exchange in over-the-counter (OTC) markets and use it to study the effects of inflation on asset prices, as well as on standard measures of financial liquidity, such as the size of bid-ask spreads, trade volume, and the incentives of dealers to supply immediacy, both by choosing to participate in the market-making activity, and by holding asset inventories on their own account.
    Date: 2013
  20. By: Rasmus Lentz
    Abstract: In this paper I explore optimal employment contract design in a random search framework, where workers search on and off the job for employment opportunities similar to that of Lentz (2010) and Bagger and Lentz (2013). The worker determines the frequency by which employment opportunities arrive through a costly choice of search intensity, which is unobserved by the firm and cannot be directly contracted upon. Firms differ in productivity by which they employ workers. Firms compete over workers in terms of utility promises in a fashion otherwise similar to that of Postel-Vinay and Robin (2002). As in Burdett and Coles (2003) and Burdett and Coles (2010), optimal tenure conditional contracts are shown to be back loaded to discourage the worker from generating outside competitive pressure. The analysis establishes existence, uniqueness and provides characterization of the core mechanism. The paper applies the framework to the analysis of firm provided general human capital training. It is shown that more productive firms provide more training and pay higher wages.
    JEL: E24 J01 J24 J31 J33 J41 J6 J63 J64
    Date: 2014–03

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