nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒04‒18
eighteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Why is Old Workers' Labor Market more Volatile? Unemployment Fluctuations over the Life-Cycle By Jean-Olivier Hairault; François Langot; Thepthida Sopraseuth
  2. Efficiency, Distortions and Factor Utilization during the Interwar Period By Klein, Alexander; Otsuy, Keisuke
  3. Tax smoothing in a business cycle model with capital-skill complementarity By Konstantinos Angelopoulos; Stylianos Asimakopoulos; James Malley
  4. An Empirical Model of Wage Dispersion with Sorting By Jesper Bagger; Rasmus Lentz
  5. The Uncertainty Multiplier and Business Cycles By Hikaru Saijo
  6. Uncertainty, Financial Frictions, and Investment Dynamics By Simon Gilchrist; Jae W. Sim; Egon Zakrajšek
  7. The possible trinity: Optimal interest rate, exchange rate, and taxes on capital flows in a DSGE model for a small open economy By Escudé, Guillermo J.
  8. Shadow banks and macroeconomic instability By Meeks, Roland; Nelson, Benjamin; Alessandri, Piergiorgio
  9. The "Second Dividend" and the Demographic Structure By Frédéric Gonand; Pierre-André Jouvet
  10. DSGE Priors for BVAR Models By Thomai Filippeli; Konstantinos Theodoridis
  11. Sovereign defaults, external debt and real exchange rate dynamics By Asonuma, Tamon
  12. Economic Growth and the Politics of Intergenerational Redistribution By Tetsuo Ono
  13. Understanding the Great Recession By Lawrence J. Christiano; Martin S. Eichenbaum; Mathias Trabandt
  14. Inheritance, Search Friction and International Trade: A General Equilibrium Model By Mazumder, Debojyoti
  15. Fiscal Devaluation Scenarios: A Quantitative Assessment for the Italian Economy By Barbara Annicchiarico; Fabio Di Dio; Francesco Felici
  16. Capital Taxation under Political Constraints By Florian Scheuer; Alexander Wolitzky
  17. Liquidity, Trends and the Great Recession By Pablo A. Guerron-Quintana; Ryo Jinnai
  18. Growth Experience in Ukraine during Twenty Years of Independence: Business Cycle Accounting Perspective By Dubovyk Tetyana

  1. By: Jean-Olivier Hairault (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris 1 - Panthéon-Sorbonne); François Langot (IZA - Institute for the Study of Labor, GAINS-TEPP - Université du Maine, CEPREMAP - Centre pour la recherche économique et ses applications); Thepthida Sopraseuth (CEPREMAP - Centre pour la recherche économique et ses applications, THEMA - Théorie économique, modélisation et applications - CNRS : UMR8184 - Université de Cergy Pontoise)
    Abstract: Since the last recession, it is usually argued that older workers are less affected by the economic downturn because their unemployment rate rose less than the one of prime-age workers. This view is a myth: older workers are more sensitive to the business cycle. We document volatilities of worker flows and hourly wage across age groups on CPS data. We find that old worker's job flows are characterized by a higher responsiveness to business cycles than their younger counterparts. In contrast, their wage cyclicality is lower than prime-age workers'. Beyond this empirical contribution, we show that a life-cycle Mortensen & Pissarides (1994) model is well suited to explain these facts: older workers' shorter work-life expectancy endogenously reduces their outside options and leads their wages to be less sensitive to the business cycle. Thus, in a market where wage adjustments are small, quantities vary a lot: this is the case for older workers, whereas the youngest behave like infinitively-lived agents. Our theoretical results point out that Shimer (2005)'s view on the MP model is consistent with prime-age workers' labor market while aging endogenously introduces real wage rigidities, allowing to match what we observe for old workers, without specific assumptions as in Hagendorn & Manovskii (2008).
    Keywords: search ; matching ; business cycle ; life-cycle
    Date: 2014–03
  2. By: Klein, Alexander (University of Kent); Otsuy, Keisuke (University of Kent)
    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 …ndings are that in the U.S. 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 …ndings 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
    Date: 2013
  3. By: Konstantinos Angelopoulos; Stylianos Asimakopoulos; James Malley
    Abstract: This paper undertakes a normative investigation of the quantita- tive properties of optimal tax smoothing in a business cycle model with state contingent debt, capital-skill complementarity, endogenous skill formation and stochastic shocks to public consumption as well as total factor and capital equipment productivity. Our main …nding is that an empirically relevant restriction which does not allow the relative supply of skilled labour to adjust in response to aggregate shocks, signi…cantly changes the cyclical properties of optimal labour taxes. Under a restricted relative skill supply, the government …nds it optimal to adjust labour income tax rates so that the average net returns to skilled and unskilled labour hours exhibit the same dynamic behaviour as under exible skill supply.
    Keywords: skill premium, tax smoothing, optimal …scal policy
    JEL: E13 E32 E62
    Date: 2014–03
  4. By: Jesper Bagger; Rasmus Lentz
    Abstract: This paper studies wage dispersion in an equilibrium on-the-job-search model with endogenous search intensity. Workers differ in their permanent skill level and firms differ with respect to productivity. Positive (negative) sorting results if the match production function is supermodular (submodular). The model is estimated on Danish matched employer-employee data. We find evidence of positive assortative matching. In the estimated equilibrium match distribution, the correlation between worker skill and firm productivity is 0.12. The assortative matching has a substantial impact on wage dispersion. We decompose wage variation into four sources: Worker heterogeneity, firm heterogeneity, frictions, and sorting. Worker heterogeneity contributes 51% of the variation, firm heterogeneity contributes 11%, frictions 23%, and finally sorting contributes 15%. We measure the output loss due to mismatch by asking how much greater output would be if the estimated population of matches were perfectly positively assorted. In this case, output would increase by 7.7%.
    JEL: J24 J33 J62 J63 J64
    Date: 2014–04
  5. By: Hikaru Saijo
    Abstract: I study a business cycle model where agents learn about the state of the economy by accumulating captal. During recessions, agents invest less, abd this generates noisier estimates of macroeconomic conditions and an increase in uncertainty. The endogenous increase in aggregate uncertainty further reduces economic activity, which in turn leads to more uncertainty, and so on. Thus, through changes in uncertainty, learning gives rise to a multiplier effect that amplifies business cycles. I use the calibrated model to measure the size of this uncertainty multiplier.
    Date: 2013–11
  6. By: Simon Gilchrist; Jae W. Sim; Egon Zakrajšek
    Abstract: Micro- and macro-level evidence indicates that fluctuations in idiosyncratic uncertainty have a large effect on investment; the impact of uncertainty on investment occurs primarily through changes in credit spreads; and innovations in credit spreads have a strong effect on investment, irrespective of the level of uncertainty. These findings raise a question regarding the economic significance of the traditional “wait-and-see” effect of uncertainty shocks and point to financial distortions as the main mechanism through which fluctuations in uncertainty affect macroeconomic outcomes. The relative importance of these two mechanisms is analyzed within a quantitative general equilibrium model, featuring heterogeneous firms that face time-varying idiosyncratic uncertainty, irreversibility, nonconvex capital adjustment costs, and financial frictions. The model successfully replicates the stylized facts concerning the macroeconomic implications of uncertainty and financial shocks. By influencing the effective supply of credit, both types of shocks exert a powerful effect on investment and generate countercyclical credit spreads and procyclical leverage, dynamics consistent with the data and counter to those implied by the technology-driven real business cycle models.
    JEL: E22 E32 G31
    Date: 2014–04
  7. By: Escudé, Guillermo J.
    Abstract: A traditional way of thinking about the exchange rate regime and capital account openness has been framed in terms of the 'impossible trinity' or 'trilemma', according to which policymakers can only have two of three possible outcomes: open capital markets, monetary independence and pegged exchange rates. The present paper is a natural extension of Escude (A DSGE Model for a SOE with Systematic Interest and Foreign Exchange Policies in Which Policymakers Exploit the Risk Premium for Stabilization Purposes, 2013), which focuses on interest rate and exchange rate policies, since it introduces the third vertex of the 'trinity' in the form of taxes on private foreign debt. These affect the risk-adjusted uncovered interest parity equation and hence influence the SOE's international financial flows. A useful way to illustrate the range of policy alternatives is to associate them with the faces of an isosceles triangle. Each of three possible government intervention policies taken individually (in the domestic currency bond market, in the foreign currency market, and in the foreign currency bonds market) corresponds to one of the vertices of the triangle, each of the three possible pairs of intervention policies corresponds to one of the three edges of the triangle, and the three simultaneous intervention policies taken jointly correspond to the triangle's interior. This paper shows that this interior, or 'possible trinity' is quite generally not only possible but optimal, since the central bank obtains a lower loss when it implements a policy with all three interventions. --
    Keywords: DSGE models,small open economy,monetary and exchange rate policy,capital controls,optimal policy
    JEL: E58 O24
    Date: 2014
  8. By: Meeks, Roland (Bank of England); Nelson, Benjamin (Bank of England); Alessandri, Piergiorgio (Bank of England)
    Abstract: We develop a macroeconomic model in which commercial banks can offload risky loans to a ‘shadow’ banking sector, and financial intermediaries trade in securitised assets. We analyse the responses of aggregate activity, credit supply and credit spreads to business cycle and financial shocks. We find that: interactions and spillover effects between financial institutions affect credit dynamics; high leverage in the shadow banking system makes the economy excessively vulnerable to aggregate disturbances; and following a financial shock, stabilisation policy aimed solely at the securitisation markets is relatively ineffective.
    Keywords: Business fluctuations; shadow banks; credit; securitisation
    JEL: E32 E50 G20
    Date: 2014–03–28
  9. By: Frédéric Gonand; Pierre-André Jouvet
    Abstract: The demographic structure of a country influences economic activity. The "second dividend" modifies growth. Accordingly, in general equilibrium, the second dividend and the demographic structure are interrelated. This paper aims at assessing empirically the "second dividend" in a dynamic, empirical and intertemporal setting that allows for measuring its impact on growth, its intergenerational redistributive effects, and its interaction with the demographic structure. The article uses a general equilibrium model with overlapping generations, an energy module and a public finance module. Policy scenarios compare the consequences of recycling a carbon tax through lower proportional income tax rather than higher public lumpsum expenditures. They are computed for two countries with different demographics (France and Germany). Results suggest that the magnitude of the "second dividend" is significantly related with the demographic structure. The more concentrated the demographic structure on cohorts with higher income and saving rate, the stronger the effect on capital supply of the second dividend. The second dividend weighs on the welfare of relatively aged working cohorts. It fosters the wellbeing of young working cohorts and of future generations. The more concentrated the demographic structure on aged working cohorts, the higher the intergenerational redistributive effects of the second dividend.
    Keywords: Energy transition, intergenerational redistribution, overlapping generations, double dividend, general equilibrium
    JEL: D58 D63 E62 L7 Q28 Q43
    Date: 2014
  10. By: Thomai Filippeli (Queen Mary University of London); Konstantinos Theodoridis (Bank of England)
    Abstract: Similar to Ingram and Whiteman (1994), De Jong et al. (1993) and Del Negro and Schorfheide (2004) this study proposes a methodology of constructing Dynamic Stochastic General Equilibrium (DSGE) consistent prior distributions for Bayesian Vector Autoregressive (BVAR) models. The moments of the assumed Normal-Inverse Wishart (no conjugate) prior distribution of the VAR parameter vector are derived using the results developed by Fernandez-Villaverde et al. (2007), Christiano et al. (2006) and Ravenna (2007) regarding structural VAR (SVAR) models and the normal prior density of the DSGE parameter vector. In line with the results from previous studies, BVAR models with theoretical priors seem to achieve forecasting performance that is comparable - if not better - to the one obtained using theory free "Minnesota" priors (Doan et al., 1984). Additionally, the marginal-likelihood of the time-series model with theory founded priors - derived from the output of the Gibbs sampler - can be used to rank competing DSGE theories that aim to explain the same observed data (Geweke, 2005). Finally, motivated by the work of Christiano et al. (2010b,a) and Del Negro and Schorfheide (2004) we use the theoretical results developed by Chernozhukov and Hong (2003) and Theodoridis (2011) to derive the quasi Bayesian posterior distribution of the DSGE parameter vector.
    Keywords: BVAR, SVAR, DSGE, Gibbs sampling, Marginal-likelihood evaluation, Predictive density evaluation, Quasi-Bayesian DSGE estimation
    JEL: C11 C13 C32 C52
    Date: 2014–03
  11. By: Asonuma, Tamon
    Abstract: Emerging countries experience real exchange rate depreciations around defaults. In this paper, we examine this observed pattern empirically and through the lens of a dynamic stochastic general equilibrium model. The theoretical model explicitly incorporates bond issuances in local and foreign currencies, and endogenous determination of real exchange rate and default risk. Our quantitative analysis, using the case of Argentina�s default in 2001, replicates the link between real exchange rate depreciation and default probability around defaults and moments of the real exchange rate that match the data. Prior to default, interactions of real exchange rate depreciation, originated from a sequence of low tradable goods shocks with the sovereign�s large share of foreign currency debt, trigger defaults. In post-default periods, the resulting output costs and loss of market access due to default lead to further real exchange rate depreciation.
    Keywords: Sovereign defaults; External debt; Real exchange rate; Currency composition of debt;
    JEL: E43 F32 F34 G12
    Date: 2014–03–23
  12. By: Tetsuo Ono (Graduate School of Economics, Osaka University)
    Abstract: This paper presents an overlapping-generation model featuring probabilistic vot- ing over two policy issues, namely, pension and public goods. To capture the forward-looking behavior of voters, we characterize a Markov-perfect political equi- librium in which the two policy variables are conditioned on a payoff-relevant state variable, that is, capital. It is shown that (i) as the population ages, the pension- to-GDP ratio and the growth rate of capital increase, but the public goods-to-GDP ratio decreases and (ii) the pension-to-GDP and public goods-to-GDP ratios are too high and the growth rate too low from the standpoint of social welfare.
    Keywords: Economic Growth; Population Aging; Probabilistic Voting; Public Pension; Public Goods Provision
    JEL: D70 E24 H55
    Date: 2014–04
  13. By: Lawrence J. Christiano; Martin S. Eichenbaum; Mathias Trabandt
    Abstract: We argue that the vast bulk of movements in aggregate real economic activity during the Great Recession were due to financial frictions interacting with the zero lower bound. We reach this conclusion looking through the lens of a New Keynesian model in which firms face moderate degrees of price rigidities and no nominal rigidities in the wage setting process. Our model does a good job of accounting for the joint behavior of labor and goods markets, as well as inflation, during the Great Recession. According to the model the observed fall in total factor productivity and the rise in the cost of working capital played critical roles in accounting for the small size of the drop in inflation that occurred during the Great Recession.
    JEL: E1 E2 E3
    Date: 2014–04
  14. By: Mazumder, Debojyoti
    Abstract: In a general equilibrium framework, an economy, with one non-traded final good and two traded intermediate goods, is modeled in this paper. It is shown that even if the economy consists of one frictionless labor market and a labor market with the search-friction, a status-conscious preference can yield unemployment in equilibrium. If such an economy opens up to trade then comparative advantage can be generated through the difference in the degree of the labor market imperfection even between two otherwise very similar countries. This setup rejects the possibility of complete specialization. Wage inequality persists within the country, for both home and foreign, in spite of free trade and, free trade does not guarantee the reduction of unemployment.
    Keywords: Trade; Search Unemployment; Inheritance Distribution
    JEL: E24 F10 F11 F16 J64
    Date: 2013–12–28
  15. By: Barbara Annicchiarico (CEIS, University of Rome "Tor Vergata"); Fabio Di Dio (Sogei S.p.A., IT Economia); Francesco Felici (Ministero dell’Economia e delle Finanze, Dipartimento del Tesoro)
    Abstract: We study the potential impact of fiscal devaluation policies on the Italian economy using IGEM, a dynamic general equilibrium model for the Italian economy developed at the Department of Treasury of the Italian Ministry of the Economy and Finance. The simulations show that fiscal devaluation policies are likely to produce short-run slight improvements on the external position of the economy, while the output gains seem to persist in the long run. Non-negligible distributional effects across households are also observed, since taxation on consumption tends to be regressive.
    Keywords: Fiscal Devaluation, DGE, Structural Reforms, Italy
    JEL: E10 C50 E60
    Date: 2014–04–09
  16. By: Florian Scheuer; Alexander Wolitzky
    Abstract: This paper studies optimal dynamic tax policy under the threat of political reform. A policy will be reformed ex post if a large enough political coalition supports reform; thus, credible policies are those that will continue to attract enough political support in the future. If the only credible reform threat is to fully equalize consumption, we find that optimal marginal capital taxes are U-shaped, so that savings are subsidized for the middle class but are taxed for the poor and rich. If ex post the government may strategically propose a reform other than full equalization in order to secure additional political support, then optimal capital taxes are instead progressive throughout the income distribution.
    JEL: D31 D82 E62 H21
    Date: 2014–04
  17. By: Pablo A. Guerron-Quintana; Ryo Jinnai (Texas A&M University)
    Abstract: We study the impact that the liquidity crunch in 2008-2009 had on the U.S. economy’s growth trend. To this end, we propose a model featuring endogenous growth á la Romer and a liquidity friction á la Kiyotaki-Moore. A key finding in our study is that liquidity declined around the demise of Lehman Brothers, which lead to the severe contraction in the economy. This liquidity shock was a tail event. Improving conditions in financial markets were crucial in the subsequent recovery. Had conditions remained at their worst level in 2008, output would have been 20 percent below its actual level in 2011.
    Date: 2013–11
  18. By: Dubovyk Tetyana
    Abstract: This paper studies the macroeconomic performance of Ukraine since 1991. During last twenty years, Ukraine experienced three episodes of prolonged recessions. The project uses business cycle accounting methodology developed by Chari et al. (2007) to identify driving forces behind economic downturns and growth episodes experienced in recent years. Ukrainian government needs to develop policies for sustainable growth. The research project studies this issue in two dimensions. First, the analysis within a general equilibrium framework identifies distortions which are the most harmful to the economic growth and will help to design future policies. Secondly, the wedges estimated from the data take into account not only legislatively declared taxes, for example, labor income taxes, but also incorporate institutional distortions in the labor market such as hiring and firing costs, expenditures associated with regulations’ compliance. We also estimate the contribution of each wedge to each crisis episode and to subsequent recovery.
    JEL: E3 O4 O5 P2
    Date: 2014–04–09

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