nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒06‒28
thirteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Business cycles in emerging markets: the role of liability dollarization and valuation effects By Stefan Notz; Peter Rosenkranz
  2. The Equity Premium in a DSGE Model with Limited Asset Market Participation By Lorenzo Menna; Patrizio Tirelli
  3. Existence of bubbly equilibria in overlapping generations models with stochastic production By Hillebrand, Marten
  4. Endogenous Wage Indexation and Aggregate Shocks By Julio A. Carrillo; Gert Peersman; Joris Wauters
  5. Tax Collection, The Informal Sector, and Productivity By Julio C. Leal-Ordoñez
  6. Analyzing the Effects of Insuring Health Risks: On the Trade-off between Short Run Insurance Benefits vs. Long Run Incentive Costs By Harold L. Cole; Soojin Kim; Dirk Krueger
  7. Explaining the U-Shape of the Referral Hiring Pattern in a Search Model with Heterogeneous Workers By Yuliia Stupnytska
  8. Investigating the Zero Lower Bound on the Nominal Interest Rate Under Financial Instability By Julio A. Carrillo; Céline Poilly    
  9. Accounting for Spanish business cycles. By Jesús Rodríguez-López; Mario Solís-García
  10. Free to Leave? A Welfare Analysis of Divorce Regimes By Raquel Fernández; Joyce Cheng Wong
  11. Consumption and wage humps in a life-cycle model with education By Kraft, Holger; Munk, Claus; Seifried, Frank Thomas; Steffensen, Mogens
  12. Stimulus vs. Austerity vs. Default By Gabriel Cuadra; Manuel Ramos Francia
  13. Investor Sophistication and Capital Income Inequality By Marcin Kacperczyk; Jaromir B. Nosal; Luminita Stevens

  1. By: Stefan Notz; Peter Rosenkranz
    Abstract: Understanding differences in business cycle phenomena between Emerging Market Economies (EMEs) and industrialized countries has been at the center of recent research on macroeconomic fluctuations. The purpose of this paper is to investigate the importance of certain credit market imperfections in different EMEs. To this end, we develop a small open economy Dynamic Stochastic General Equilibrium (DSGE) framework featuring both permanent and transitory productivity shocks, differentiated home and foreign goods, and endogenous exchange rate movements. Furthermore, our model incorporates liability dollarization as a particular form of financial frictions in EMEs. In this vein, we account for the fact that emerging markets traditionally have had difficulties in borrowing in domestic currency on international capital markets and thus allow for valuation effects in our analysis. We estimate our model using Bayesian techniques for a number of EMEs and thereby control for potential heterogeneity across countries. Contrary to previous studies in this strand of the literature, we include a (vector-)autoregressive measurement error component to capture off-model dynamics. Regarding business cycles in emerging markets, our main findings are that (i) even though we incorporate financial frictions in the framework, trend shocks are the main determinant of macroeconomic fluctuations, (ii) accounting for liability dollarization ameliorates the model fit, and (iii) valuation effects on average stabilize changes in the net foreign asset position.
    Keywords: Emerging markets, liability dollarization, valuation effects, financial frictions, real business cycles, DSGE Model, Bayesian estimation
    JEL: E13 E44 F32 F34 F41 F44 F47 O11
    Date: 2014–06
  2. By: Lorenzo Menna; Patrizio Tirelli
    Abstract: Models based on the representative agent assumption cannot rationalize observed equity premia. In response to this, exchange economy models have introduced agents heterogeneity, typically in the form of bond and equity holders. We reconsider the issue introducing Limited Asset Market Participation in an otherwise standard medium scale DSGE model. Our model fits financial and macroeconomic data well. We obtain that the correlation between asset holders consumption and financial returns strongly increases in the share of agents excluded from financial markets participation, The predicted unconditional equity premium is therefore large. Further, the strong correlation between dividends and Ricardian households' consumption unambiguously increases precautionary savings and reduces the riskless rate.
    Keywords: asset pricing, equity premium, limited asset market participation, business cycle, DSGE, sticky prices.
    JEL: E32 G12
    Date: 2014–06
  3. By: Hillebrand, Marten
    Abstract: The paper develops a dynamical systems approach to study asset bubbles in OLG economies with stochastic production. We derive necessary and sufficient conditions for bubbly equilibria to exist and chracterize the maximum sustainable bubble. Even if they exist, bubbles are temporary and the economy converges to a bubbleless equilibrium with probability one. We also demonstrate that the existence conditions can be relaxed if frictions such as borrowing constraints are introduced. --
    Keywords: asset bubbles,OLG,stochastic production,capital accumulation,dynamical systems,borrowing constraints
    JEL: C61 C62 E23
    Date: 2014
  4. By: Julio A. Carrillo; Gert Peersman; Joris Wauters
    Abstract: Wage indexation practices have changed. Evidence on the U.S. for instance suggests that wages were heavily indexed to past inflation during the Great Inflation but not during the Great Moderation. However, most DSGE models assume fixed indexation parameters in wage setting, which might not be structural in the sense of Lucas (1976). This paper presents a New-Keynesian model in which workers, by maximizing their welfare, set their wage indexation rule in response to aggregate shocks and monetary policy. We find that workers index their wages to past inflation when technology and permanent inflation-target shocks drive output fluctuations; when aggregate demand shocks do, workers index to trend-inflation. In addition, workers' choices do not coincide with the social planner's choice, which may explain the observed changes in wage indexation in the post-WWII U.S. data.
    Keywords: Wage indexation, Welfare costs, Nominal rigidities
    JEL: E24 E32 E58
    Date: 2013–11
  5. By: Julio C. Leal-Ordoñez
    Abstract: Some authors argue that informality is associated with distorted firm decisions and inefficiency. In this paper, I assess the quantitative effect of incomplete tax enforcement on aggregate output and productivity using a dynamic general equilibrium framework. I calibrate the model using data for Mexico and investigate the effects of introducing enforcement improvements. Under complete enforcement, labor productivity and output would be 19% higher under perfect competition and 34% higher under monopolistic competition. The source of this gain is the removal of distortions induced by incomplete enforcement of taxes which affect the economy in three ways: by reducing the capital-labor ratios of informal establishments; by allowing low-productive entrepreneurs to enter; and by misallocating resources towards low-productive establishments. I isolate the effects of pure factor misallocation, distorted occupational choices, capital accumulation, and complementarities.
    Keywords: Tax enforcement, TFP, the informal sector
    JEL: E23 E26 O17 O40
    Date: 2013–12
  6. By: Harold L. Cole (Department of Economics, University of Pennsylvania and NBER); Soojin Kim (Krannert School of Management, Department of Economics, Purdue University); Dirk Krueger (Department of Economics, University of Pennsylvania, CEPR, CFS, NBER and Netspar)
    Abstract: This paper constructs a dynamic model of health insurance to evaluate the short- and long-run effects of policies that prevent firms from conditioning wages on health conditions of their workers, and that prevent health insurance companies from charging individuals with adverse health conditions higher insurance premia. Our study is motivated by recent US legislation that has tightened regulations on wage discrimination against workers with poorer health status (such as Americans with Disability Act of 1990, ADA, and its amendment in 2008, the ADAAA) and that prohibits health insurance companies from charging different premiums for workers of different health status starting in 2014 (Patient Protection and Affordable Care Act, PPACA). In the model, a trade-off arises between the static gains from better insurance against poor health induced by these policies and their adverse dynamic incentive effects on household efforts to lead a healthy life. Using household panel data from the PSID we estimate and calibrate the model and then use it to evaluate the static and dynamic consequences of no-wage discrimination and no-prior conditions laws for the evolution of the cross-sectional health and consumption distribution of a cohort of households, as well as ex-ante lifetime utility of a typical member of this cohort. In our quantitative analysis we find that although the competitive equilibrium features too little consumption insurance and a combination of both policies is effective in providing such insurance period by period, it is suboptimal to introduce both policies jointly since such a policy innovation severely undermines the incentives to lead healthier lives and thus induces a more rapid deterioration of the cohort health distribution over time. This effect more than offsets the static gains from better consumption insurance so that expected discounted lifetime utility is lower under both policies, relative to implementing wage nondiscrimination legislation alone. This is true despite the fact that both policy options are strongly welfare improving relative to the competitive equilibrium.
    Keywords: Health Risks, Social Insurance, Health Effort Choices
    JEL: E61 H31 I18
    Date: 2014–04–24
  7. By: Yuliia Stupnytska (Center for Mathematical Economics, Bielefeld University; Center for Mathematical Economics, Bielefeld University)
    Abstract: This paper presents a search model with heterogeneous workers, social networks and endogenous search intensity. There are three job search channels available to the unemployed: costly formal applications and two costless informal channels - through family and professional networks. The gain from being employed is increasing in the productivity, so the lowest motivation for preparing formal applications is proved to be among the least productive worker types. We assume that professional contacts exhibit a strong degree of homophily, thus it is profitable for firms to direct their network search towards the more productive incumbent employees. So the probability of a professional referral is increasing in the productivity of the worker, which mitigates the incentives to use the formal channel of search. Therefore, the model predicts that workers in the right (left) tail of the productivity distribution have the highest propensity of finding a job with a help of professional (family) contacts, whereas the formal channel of search is mostly utilized by workers in the middle range of the distribution. This explains the U-shaped referral hiring pattern in the model. The endogenous sorting of workers across channels also implies that professional (family) referrals are associated with wage premiums (penalties) compared to the formal channel of search. The average effect of referrals on wages is, however, ambiguous and depends on the relative proportions of high and low productivity types in the population. These findings help to explain the contradicting empirical evidence concerning the effect of referrals on wages.
    Keywords: endogenous search intensity, family contacts, professional networks, U-shape, referral puzzle, wage premiums and penalties
    JEL: J23 J31 J38 J64
    Date: 2014–06
  8. By: Julio A. Carrillo; Céline Poilly    
    Abstract: This paper studies the effects of three financial shocks in the economy: a net-worth shock, an uncertainty or risk shock, and a credit-spread shock. We argue that only the latter can push the nominal interest rate against its zero lower bound. Further, a recessionary shock to the net worth or the credit spread generates a positive response for loans, which is counter-intuitive during an economic downturn. Finally, we find that there is an optimal commitment period for the central bank to keep the nominal interest rate equal to zero (forward guidance) after a financial turmoil. Beyond that optimal period, the volatility of inflation and output rise quick and sharply. Thus, an excessive forward guidance policy may destabilize the economy.
    Keywords: Zero Lower Bound, Financial Accelerator, Financial Shocks
    JEL: E31 E44 E52 E58
    Date: 2014–01
  9. By: Jesús Rodríguez-López (Department of Economics, Universidad Pablo de Olavide de Sevilla); Mario Solís-García (Department of Economics, Macalester College, Saint Paul (USA))
    Abstract: We apply the business cycle methodology proposed by Chari, Kehoe, and McGrattan (2007) to identify the sources of Spanish business fluctuations during two outstanding cyclical episodes: the recession alongside the transition to democracy in 1977 and the great recession of 2008. We find that the labor wedge plays a key role during both recessions and that taxes and labor market institutions are likely behind the wedge movements. We conclude that any model that tries to understand the causes of recessions that occurred in the last three decades should focus on the labor wedge.
    Keywords: Business cycle accounting, efficiency wedge, labor wedge, investment wedge
    JEL: E32 O11 O41 O47 O53
    Date: 2014–06
  10. By: Raquel Fernández; Joyce Cheng Wong
    Abstract: During the 1970s the US underwent an important change in its divorce laws, switching from mutual consent to a unilateral divorce regime. Who benefitted and who lost from this change? To answer this question we develop a dynamic life-cycle model in which agents make consumption, saving, labor force participation (LFP), and marriage and divorce decisions subject to several shocks and given a particular divorce regime. We calibrate the model using statistics relevant to the life-cycle of the 1940 cohort. Conditioning solely on gender, our ex ante welfare analysis finds that women would fare better under mutual consent whereas men would prefer a unilateral system. Once we condition not only on gender but also on initial productivity, we find that men in the top three quintiles of the initial productivity distribution are made better off by a unilateral system as are the top two quintiles of women; the rest prefer mutual consent. We also find that although the change in divorce regime had only a small effect on the LFP of married women in the 1940 cohort, these effects would be considerably larger for a cohort who lived its entire life under a unilateral divorce system.
    JEL: J12 J16 K36
    Date: 2014–06
  11. By: Kraft, Holger; Munk, Claus; Seifried, Frank Thomas; Steffensen, Mogens
    Abstract: The observed hump-shaped life-cycle pattern in individuals' consumption cannot be explained by the classical consumption-savings model. We explicitly solve a model with utility of both consumption and leisure and with educational decisions affecting future wages. We show optimal consumption is hump shaped and determine the peak age. The hump results from consumption and leisure being substitutes and from the implicit price of leisure being decreasing over time; more leisure means less education, which lowers future wages, and the present value of foregone wages decreases with age. Consumption is hump shaped whether the wage is hump shaped or increasing over life. --
    Keywords: education,leisure,consumption hump,wage hump
    JEL: D11 D14 D91 I21 J24
    Date: 2014
  12. By: Gabriel Cuadra; Manuel Ramos Francia
    Abstract: There is an ongoing debate about austerity and stimulus in the Euro zone. Moreover, given the fiscal and financial problems in the region, a default has appeared likely at times. In this context, this paper develops a dynamic stochastic quantitative model of sovereign default with fiscal policy, which captures the most salient features of the recent fiscal and debt situation in the Euro zone. In this setting, this highlights the economic nature of the decision to default, the key role of official aid in avoiding such event and, thus, improving the overall economic outlook.
    Keywords: Sovereign Default, Fiscal Policy.
    JEL: E62 F34
    Date: 2014–06
  13. By: Marcin Kacperczyk; Jaromir B. Nosal; Luminita Stevens
    Abstract: What contributes to the growing income inequality across U.S. households? We develop an information- based general equilibrium model that links capital income derived from financial assets to a level of investor sophistication. Our model implies income inequality between sophisticated and unsophisticated investors that is growing in investors' aggregate and relative sophistication in the market. We show that our model is quantitatively consistent with the data from the U.S. market. In addition, we provide supporting evidence for our mechanism using a unique set of cross-sectional and time-series predictions on asset ownership and stock turnover.
    JEL: E24 E25 E44 G11 G12 G23
    Date: 2014–06

This nep-dge issue is ©2014 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.
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