nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒07‒21
sixteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Welfare Cost of Fluctuations: when Labor Market Search Interacts with Financial Frictions By Eleni Iliopulos; François Langot; Thepthida Sopraseuth
  2. Financial Shocks and the Cyclical Behavior of Skilled and Unskilled Unemployment. By J.I.Lopez; V. Olivella Moppett
  3. Intergenerational Redistribution in the Great Recession By Glover, Andrew; Heathcote, Jonathan; Krueger, Dirk; Rios-Rull, Jose-Victor
  4. On existence and bubbles of Ramsey equilibrium with borrowing constraints By Robert Becker; Stefano Bosi; Cuong Le Van; Thomas Seegmuller
  5. Existence of equilibrium in OLG economies with durable goods By Lalaina Rakotonindrainy
  6. Optimal taxation and debt with uninsurable risks to human capital accumulation By Gottardi, Piero; Kajii, Atsushi; Nakajima, Tomoyuki
  7. Export and the Labor Market: a Dynamic Model with on-the-job Search By Davide Suverato
  8. Leaning Against Windy Bank Lending By Giovanni Melina; Stefania Villa
  9. Labor-Market Uncertainty and Portfolio Choice Puzzles By Chang, Yongsung; Hong, Jay H.; Karabarbounis , Marios
  10. Financial stability in open economies By Yuki Teranishi; Ippei Fujiwara
  11. Delaying the Normal and Early Retirement Ages in Spain: Behavioural and Welfare Consequences for Employed and Unemployed Workers By Alfonso R. Sánchez; J. Ignacio García-Pérez; Sergi Jiménez
  12. Intertemporal equilibrium with production: bubbles and efficiency By Stefano Bosi; Cuong Le Van; Ngoc-Sang Pham
  13. Public Finances, Business Cycles and Structural Fiscal Balances By Kai Liu
  15. Golden Rules for Wages By Andrew T. Young; Hernando Zuleta
  16. Health and Mortality Delta: Assessing the Welfare Cost of Household Insurance Choice By Yogo, Motohiro; Koijen, Ralph S.J.; Van Nieuwerburgh, Stijn

  1. By: Eleni Iliopulos (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, CEPREMAP - Centre pour la recherche économique et ses applications - Centre pour la recherche économique et ses applications); François Langot (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, GAINS-TEPP - Université du Maine, Banque de france - Banque de France, IZA - Institute for the Study of Labor); Thepthida Sopraseuth (CEPREMAP - Centre pour la recherche économique et ses applications - Centre pour la recherche économique et ses applications, THEMA - Théorie économique, modélisation et applications - CNRS : UMR8184 - Université de Cergy Pontoise)
    Abstract: We provide a quantitative assessment of welfare costs of fluctuations in a search model with financial frictions. The matching process in the labor market leads positive shocks to reduce unemployment less than negative shocks increase it. We show that the magnitude of this non-linearity is magnified frictions. This asymmetric effect of the business cycle leads to sizable welfare costs. The model also accounts for the responsiveness of the job finding rate to the business cycle as financial frictions endogenously generate counter-cyclical opportunity costs of opening a vacancy and wage sluggishness.
    Keywords: Welfare; business cycle; financial friction; labor market search
    Date: 2014–06
  2. By: J.I.Lopez; V. Olivella Moppett
    Abstract: We study the effect of financial shocks in labor market dynamics. We build a model with two types of labor, two types of capital and both search and financial frictions. We find that financial shocks, modeled as exogenous disturbances to the borrowing constraint of firms, can generate realistic movements in aggregate employment and reproduce the volatile and countercyclical ratio of skilled to unskilled employment observed in the data. Tighter financial conditions impact employment through three channels: i) a fall in the marginal product of labor as a result of a reduction in aggregate capital, ii) an increase in the shadow cost of labor in terms of external financing and iii) an endogenous wage rigidity caused by a short-lived increase in households' consumption and in their marginal value of time. This endogenous wage rigidity together with the model’s calibration implying a higher re-hiring probability and lower recruitment costs for unskilled workers, explains the volatility of relative employment.
    Keywords: Financial Shocks, Business Cycles, Employment Volatility, Search.
    JEL: E24 E32 E44
    Date: 2014
  3. By: Glover, Andrew (University of Texas, Austin); Heathcote, Jonathan (Federal Reserve Bank of Minneapolis); Krueger, Dirk (University of Pennsylvania); Rios-Rull, Jose-Victor (Federal Reserve Bank of Minneapolis)
    Abstract: We construct a stochastic overlapping-generations general equilibrium model in which households are subject to aggregate shocks that affect both wages and asset prices. We use a calibrated version of the model to quantify how the welfare costs of big recessions are distributed across different household age groups. The model predicts that younger cohorts fare better than older cohorts when the equilibrium decline in asset prices is large relative to the decline in wages. Asset price declines hurt the old, who rely on asset sales to finance consumption, but benefit the young, who purchase assets at depressed prices. In our preferred calibration, asset prices decline 2.4 times as much as wages, consistent with the experience of the US economy in the Great Recession. A model recession is close to welfare neutral for households in the 20–29 age group, but translates into a large welfare loss of more than 8% of lifetime consumption for households aged 70 and over.
    Keywords: Great Recession; Overlapping generations; Asset prices; Aggregate risk
    JEL: D31 D58 D91 E21
    Date: 2014–05–20
  4. By: Robert Becker (Department of Economics, Indiana University - Indiana University); Stefano Bosi (EPEE - Université d'Evry-Val d'Essonne); Cuong Le Van (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, VCREME - VanXuan Center of Research in Economics, Management and Environment - VanXuan Center of Research in Economics, Management and Environment, IPAG Business School - Ipag Business School); Thomas Seegmuller (AMSE - Aix-Marseille School of Economics - Centre national de la recherche scientifique (CNRS) - École des Hautes Études en Sciences Sociales (EHESS) - Ecole Centrale Marseille (ECM))
    Abstract: We study the existence of equilibrium and rational bubbles in a Ramsey model with heterogeneous agents, borrowing constraints and endogenous labor. Applying a Kakutani's fixed-point theorem, we prove the existence of equilibrium in a time-truncated bounded economy. A common argument shows this solution to be an equilibrium for any unbounded economy with the same fundamentals. Taking the limit of a sequence of truncated economies, we eventually obtain the existence of equilibrium in the Ramsey model. In the second part of the paper, we address the issue of rational bubbles and we prove that they never occur in a productive economy à la Ramsey.
    Keywords: Existence of equilibrium; bubbles; Ramsey model; heterogeneous agents; borrowing constraint; endogenous labor
    Date: 2014–03
  5. By: Lalaina Rakotonindrainy (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: We consider a standard pure exchange overlapping generations economy. The demographic structure consists of a new cohort of agents at each period with an economic activity extended over two successive periods. Our model incorporates durable goods that may be stored from one period to a successive period through a linear technology. In this model, we intend to study the mechanism of transfer between generations, and we show that the existence of an equilibrium can be established by considering an equivalent economy "without" durable goods, where the agents economic activity is extended over three successive periods.
    Keywords: Overlapping generations model; durable goods; irreducibility; equilibrium; existence
    Date: 2014–05
  6. By: Gottardi, Piero; Kajii, Atsushi; Nakajima, Tomoyuki
    Abstract: We consider an economy where individuals face uninsurable risks to their human capital accumulation, and study the problem of determining the optimal level of linear taxes on capital and labor income together with the optimal path of the debt level. We show both analytically and numerically that in the presence of such risks it is beneficial to tax both labor and capital income and to have positive government debt..
    Keywords: Ramsey equilibrium; Optimal taxation; Incomplete markets; Optimal public debt
    JEL: D52 D60 D90 E20 E62 H21 O40
    Date: 2014
  7. By: Davide Suverato (LMU University of Munich)
    Abstract: This paper develops a two-sector, two-factor trade model with labor market frictions in which workers search for a job also when they are employed. On the job search (OJS) is a key ingredient to explain the response to trade liberalization of sectoral employment, unemployment and wage i equality. OJS generates wage dispersion and it leads to a reallocation of workers from less productive firms that pay lower wages to more productive ones. Following a trade liberalization the traditional selection effects are more severe than without OJS and the tradable sector experiences a loss of employment, while the opposite is true for the non tradable sector. Starting from autarky, the opening to trade has a positive effect on employment but it increases wage inequality. For an already open economy, a further increase of trade openness can, however, lead to an increase of unemployment. The dynamics of labor market variables is obtained in closed form. The model predicts overshooting at the time of implementation of a trade liberalization, then the paths of adjustment follow a stable transitional dynamics.
    Keywords: International Trade, Unemployment, Wage Inequality, Firm Dynamics
    JEL: F12 F16 E24
    Date: 2014–06–26
  8. By: Giovanni Melina (City University London); Stefania Villa (University of Foggia)
    Abstract: Using a dynamic stochastic general equilibrium model with banking, this paper first provides evidence that, during the Great Moderation, monetary policy leaned against the wind blowing from the loan market in the US. It then shows that the extent to which this occurred delivers a small welfare loss relative to the optimised simple interest-rate rule that features only a response to inflation. The source of business cycle fluctuations is crucial for the optimality of a leaning-against-the-wind policy. In fact, the pro-cyclical nature of lending creates a trade-off between inflation and financial stabilisation when supply shocks are prevalent.
    Keywords: lending relationships, augmented Taylor rule, Bayesian estimation, optimal policy.
    JEL: E32 E44 E52
    Date: 2014–07
  9. By: Chang, Yongsung (University of Rochester and Yonsei University); Hong, Jay H. (Seoul National University); Karabarbounis , Marios (Federal Reserve Bank of Richmond)
    Abstract: The standard theory of household-portfolio choice is hard to reconcile with the following facts: (i) Households hold a small amount of equity despite the higher average rate of return. (ii) The share of risky assets increases with the age of the household. (iii) The share of risky assets is disproportionately larger for richer households. We develop a life-cycle model with age-dependent unemployment risk and gradual learning about the income profile that can address all three puzzles. Young workers, on average asset poor, face larger labor-market uncertainty because of high unemployment risk and imperfect knowledge about their earnings ability. This labor-market uncertainty prevents them from taking too much risk in the financial market. As the labor-market uncertainty is gradually resolved over time, workers can take more financial risks.
    Keywords: Portfolio Choice; Labor-Market Uncertainty; Learning
    JEL: J6
    Date: 2014–06–14
  10. By: Yuki Teranishi; Ippei Fujiwara
    Abstract: Do financial frictions call for policy cooperation? This paper investigates the implications of financial frictions for monetary policy in the open economy. Welfare analysis shows that there are long-run gains which result from cooperation, but, dynamically, financial frictions per se do not require policy cooperation to improve global welfare over business cycles. In addition, inward-looking financial stability, namely eliminating inefficient fluctuations of loan premiums in the home country, is the optimal monetary policy in the open economy, irrespective of the existence of policy coordination.
    JEL: E50 F41
    Date: 2013
  11. By: Alfonso R. Sánchez; J. Ignacio García-Pérez; Sergi Jiménez
    Abstract: In this paper, we explore the links between pension reform, early retirement, and the use of unemployment as an alternative pathway to retirement. We use a dynamic rational expectations model to analyze the search and retirement behaviour of employed and unemployed workers aged 50 or over. The model is calibrated to reproduce the main reemployment and retirement patterns observed between 2002 and 2008 in Spain. It is subsequently used to analyze the effects of the 2011 pension reform in Spain, characterized by two-year delays in both the early and the normal retirement ages. We find that this reform generates large increases in labour supply and sizable cuts in pension costs, but these are achieved at the expense of very large welfare losses, especially among unemployed workers. As an alternative, we propose leaving the early retirement age unchanged, but penalizing the minimum pension (reducing its generosity in parallel to the cuts imposed on individual pension benefits, and making it more actuarially fair with age). This alternative reform strikes a better balance between individual welfare and labour supply stimulus.
    Date: 2014–05
  12. By: Stefano Bosi (EPEE - Université d'Evry-Val d'Essonne); Cuong Le Van (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, VCREME - VanXuan Center of Research in Economics, Management and Environment - VanXuan Center of Research in Economics, Management and Environment, IPAG Business School - Business School); Ngoc-Sang Pham (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne)
    Abstract: We consider a general equilibrium model with heterogeneous agents, borrowing constraints, and exogenous labor supply. First, the existence of intertemporal equilibrium is proved even if the aggregate capitals are not uniformly bounded above and the production functions are not time invariant. Second, (i) we call by physical capital bubble a situation in which the fundamental value of physical capital is lower than its price, (ii) we say that the interest rates are low if the sum of interest rates is finite. We show that physical capital bubble is equivalent to a situation with low interest rates. Last, we prove that with linear technologies, every intertemporal equilibrium is efficient. Moreover, there is a room for both efficiency and bubble.
    Keywords: Intertemporal equilibrium; physical capital bubble; efficiency; infinite horizon
    Date: 2014–05
  13. By: Kai Liu
    Abstract: This paper proposes a new framework to analyze and estimate structural fiscal balances. Stochastic trends are properly incorporated, and the numerical solution of the DSGE model serves as part of the Kalman smoother to extract structural fiscal balances. For the UK, a setting of an integrated random walk for the underlying stochastic trends fits the date best. The response of nominal fiscal revenue to the technology shock is small. The shocks to foreign demand and to foreign goods price both have positive effects on fiscal revenue. An expansionary monetary policy shock has a great positive short-run impact on fiscal revenue, but the influence is not persistent because of the open-economy characteristic of the UK. An expansion in government spending can also increase fiscal revenue, but the effect is not persistent as well due to the domestic and external crowd-out effects. A contractionary fiscal policy (cutting government expenditure or increasing the lump-sum tax temporarily), rather than an expasionary one, will benefit economic recovery and also improve fiscal stance. Compared to a temporary increase of the lump-sum tax, cutting government spending is relatively more effective and it alleviates the two kinds of crowd-out effects.
    Keywords: business cycles, structural fiscal balances, DSGE model, Kalman filter and smoother
    JEL: C54 E32 E62 H62
    Date: 2014–06–04
  14. By: Mertens, Jean-Francois (CORE, Universite Catholique de Louvain); Rubinchik, Anna (Department of Economics, University of Haifa)
    Abstract: In an exogenous-growth economy with overlapping generations we analyse local stability of a balanced growth equilibrium with respect to changes in consumption endowments, which could be interpreted as a transfer policy. We show that generically, in the space of parameters, equilibria around BGE are locally unique and are locally differentiable functions of endowments, with derivatives given by kernels. Further, those equilibria are stable in the sense that the effects of temporary changes decay exponentially towards plus and minus infinity.
    Keywords: Regularity of Infinite Economies, Policy Evaluation, Overlapping Generations,
    JEL: D50 H43
    Date: 2014–01–21
  15. By: Andrew T. Young; Hernando Zuleta
    Abstract: We consider a decentralized version of the neoclassical growth model where labor share is chosen by workers to maximize their long run (permanent) wages. In this framework, if the labor share increases relative to the competitive share, workers capture a larger share of a smaller total income in the steady-state. This is because the incentives to invest are lower and the steady-state capital to labor ratio is lower. We find that the “Golden Rule” labor share is equal to the elasticity of output with respect to labor. This is precisely what would obtain under the assumption of competitive factor markets. We also consider the model with two classes of workers: organized and unorganized. In this case, organized labor may choose a higher than competitive share and the difference is economically significant for plausible parameter values. Furthermore, relative to the Cobb-Douglas case, organized labor chooses a higher share for the empirically relevant case of an elasticity of substitution less than unity. We also analyze versions of the model with endogenous skill acquisition and capitalists with bargaining power.
    Keywords: labor share, capital share, factor shares, trade unions, bargaining power, organized labor, political economy
    JEL: O43 J30
    Date: 2013–08–01
  16. By: Yogo, Motohiro (Federal Reserve Bank of Minneapolis); Koijen, Ralph S.J. (London Business School); Van Nieuwerburgh, Stijn (New York University)
    Abstract: We develop a pair of risk measures, health and mortality delta, for the universe of life and health insurance products. A life-cycle model of insurance choice simplifies to replicating the optimal health and mortality delta through a portfolio of insurance products. We estimate the model to explain the observed variation in health and mortality delta implied by the ownership of life insurance, annuities including private pensions, and long-term care insurance in the Health and Retirement Study. For the median household aged 51 to 57, the lifetime welfare cost of market incompleteness and suboptimal choice is 3.2% of total wealth.
    Keywords: Annuities; Health insurance; Life-cycle model; Life insurance; Portfolio choice
    JEL: D14 D91 G11 I13
    Date: 2014–06–11

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