nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒08‒09
sixteen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. An Estimated DSGE Model with a Deflation Steady State By Yasuo Hirose
  2. Optimal Policy with Informal Sector and Endogenous Savings By Luz Adriana Flórez
  3. Social security and the interactions between aggregate and idiosyncratic risk By Harenberg, Daniel; Ludwig, Alexander
  4. Aggregate Demand, Idle Time, and Unemployment By Pascal Michaillat; Emmanuel Saez
  5. Banks, Sovereign Risk and Unconventional Monetary Policies By Stéphane Auray; Aurélien Eyquem; Xiaofei Ma
  6. The Efficiency of the Informal Sector on the Search and Matching Framework By Luz Adriana Flórez
  7. Optimal taxation and debt with uninsurable risks to human capital accumulation By Piero Gottardi; Atsushi Kajii; Tomoyuki Nakajima
  8. Why is the Government Spending Multiplier Larger at the Zero Lower Bound ? Not (Only) Because of the Zero Lower Bound By Jordan Roulleau-Pasdeloup
  9. Towards a Micro-Founded Theory of Aggregate Labor Supply By Andres Erosa; Luisa Fuster; Gueorgui Kambourov
  10. Envelope Condition Method with an Application to Default Risk Models By Cristina Arellano; Lilia Maliar; Serguei Maliar; Viktor Tsyrennikov
  11. Public Debt Overhang in the Heterogeneous Agent Model By KOBAYASHI Keiichiro
  12. Public Investment, Time to Buid, and the Zero Lower Bound By Hafedh Bouakez; Michel Guillard; Jordan Roulleau-Pasdeloup
  13. The Time Path of the Saving Rate: Hyperbolic Discounting and Short-Term Planning By Y. Hossein Farzin; Ronald Wendner
  14. A Dynamic Analysis of Sectoral Mobility, Worker Mismatc and the Wage-Tenure Profiles By Stéphane Auray; David Fuller; Damba lkhagvasuren; Antoine Terracol
  15. How good are out of sample forecasting Tests on DSGE models? By Minford, Patrick; Xu, Yongden; Zhou, Peng
  16. Financial frictions, occupational choice and economic inequality By Lian Allub; Andres Erosa Etchebehere

  1. By: Yasuo Hirose
    Abstract: Benhabib, Schmitt-Grohé, and Uribe (2001) argue for the existence of a deflation steady state when the zero lower bound on the nominal interest rate is considered in a Taylor-type monetary policy rule. This paper estimates a medium-scale DSGE model with a deflation steady state for the Japanese economy during the period from 1999 to 2013, when the Bank of Japan conducted a zero interest rate policy and the inflation rate was almost always negative. Although the model exhibits equilibrium indeterminacy around the deflation steady state, a set of specific equilibria is selected by Bayesian methods. According to the estimated model, shocks to households’ preferences, investment adjustment costs, and external demand do not necessarily have an inflationary effect, in contrast to a standard model with a targeted-inflation steady state. An economy in the deflation equilibrium could experience unexpected volatility because of sunspot fluctuations, but it turns out that the effect of sunspot shocks on Japan’s business cycles is marginal and that macroeconomic stability during the period was a result of good luck.
    Keywords: Deflation, Zero interest rate, Japanese economy, Indeterminacy, Bayesian Estimation
    JEL: E31 E32 E52
    Date: 2014–07
  2. By: Luz Adriana Flórez
    Abstract: This paper analyzes the effect of social security and lump sum layoff payment in an economy with an informal sector and savings, where the search effort is unobserved. I characterize the optimal consumption/search/non-participant strategy assuming that workers are risk averse and that formal jobs last forever. After including job destruction shocks I solve the model numerically, and focus on the effects of lump sum layoff and social security payments on workers’ decision to be formal, informal or non-participant. I find that severance payments protect formal workers against the unemployment risk. With severance payments workers do not over-accumulate to protect themselves against unemployment, instead they increase the search effort through the re-entitlement effects. In this respect my work resembles that of Coles (2006). I find that in the steady state a high severance payment increases the proportion of formal workers while reduces the proportion of informal workers and those who decide not to participate in the labor market. Even though the optimal policy with severance payment is generous, I find that in the steady state the unemployment rate is low and welfare improves.
    Keywords: Social security payment, Severance payment, Informal sector, Hidden search effort, Savings.
    JEL: D91 J32 J64 J65
    Date: 2014–07–23
  3. By: Harenberg, Daniel; Ludwig, Alexander
    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
    JEL: C68 E27 E62 G12 H55
    Date: 2014
  4. By: Pascal Michaillat (London School of Economics); Emmanuel Saez (University of California, Berkeley)
    Abstract: This paper develops a model of unemployment fluctuations. The model keeps the architecture of the Barro and Grossman (1971) general disequilibrium model but replaces the disequilibrium framework on the labor and product markets by a matching framework. On the product and labor markets, both price and tightness adjust to equalize supply and demand. There is one more variable than equilibrium condition on each market, so we consider various price mechanisms to close the model, from completely flexible to completely rigid. With some price rigidity, aggregate demand influences unemployment through a simple mechanism: higher aggregate demand raises the probability that firms find customers, which reduces idle time for firms’ employees and thus increases labor demand, which in turn reduces unemployment. We use the comparative-statistics predictions of the model together with empirical measures of quantities and tightnesses to re-examine the origins of labor market fluctuations. We conclude that (1) price and real wage are not fully flexible because product and labor market tightness fluctuate significantly; (2) fluctuations are mostly caused by labor demand and not labor supply shocks because employment is positively correlated with labor market tightness; and (3) labor demand shocks mostly reflect aggregate demand and not technology shocks because output is positively correlated with product market tightness.
    Keywords: aggregate demand, unemployment, matching frictions, business cycles
    JEL: E10 E24 E30 J2 J64
    Date: 2014–07
  5. By: Stéphane Auray (CREST-ENSAI, ULCO and CIRPEE); Aurélien Eyquem (Université Lumière Lyon 2); Xiaofei Ma (CREST-ENSAI et Université Lumière Lyon 2)
    Abstract: We develop a two-country model with an explicitly microfounded interbank market and sovereign default risk. Calibrated to the Euro Area, the model performs satisfactorily in matching key business cycle facts on real, financial and fiscal time series. We then use the model to assess the effects of a large crisis and quantify the potential effects of alternative unconventional policies on the dynamics of GDP, sovereign default risk and public indebtedness. We show that quantitative monetary easing is more efficient in stimulating GDP, while qualitative monetary easing relieves financial tensions and sovereign risk more efficiently. In terms of welfare, in the short run, unconventional monetary policies bring sizable welfare gains for households, while the long term effects are much smaller
    Keywords: Recession, Interbank Market, Sovereign Default, Monetary Policy
    JEL: E44 F34 G15
    Date: 2014–03
  6. By: Luz Adriana Flórez
    Abstract: This paper analyzes efficiency in an economy with an informal sector that consists of unregulated self-employment, and where there are no costs of being informal, (Albrecht et al. (2009)). First, assuming workers in the formal sector are ex-ante heterogeneous, I show that this type of economy is inefficient. Second, I identify the optimal policies the government can implement, where the informal sector is unobserved (or search effort is unobserved). Allowing the government to use different policies such as social security payment, severance payment, formal tax, and job creation subsidy, I show that the government cannot affect worker’s behavior by using severance and social security payments because of the risk neutrality assumption (Lazear (1990)). However, it can achieve an efficient allocation through a tax-credit policy. This result is interesting since it can guide the way in which social security programs can be implemented in developing countries, where in general social protection programs are assumed to subsidize informal activities.
    Keywords: Efficiency, Informal Sector, Hidden Search Effort.
    JEL: H21 J64 J65
    Date: 2014–07–21
  7. By: Piero Gottardi; Atsushi Kajii; Tomoyuki Nakajima
    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 bene cial to tax both labor and capital income and to have positive government debt.
    Date: 2014–06
  8. By: Jordan Roulleau-Pasdeloup (CREST and PSE)
    Abstract: I develop a New Keynesian model with search and matching frictions, in which the government buys goods produced by the firms. I solve the non-linear model globally and examine the magnitude of government spending multipliers in and out of the ZLB. I distinguish the cases of Nash-bargained and rigid real wages. The model with Nash-bargained wages gives results that do not differ qualitatively from the existing literature. It generates a high multiplier at the ZLB due to a higher elasticity of real marginal cost to aggregate demand in those conditions—which is at odds with empirical evidence. The model with rigid real wages exhibits job rationing (Michaillat (2012a)) and also delivers a higher multiplier at ZLB than in normal times. In this setup however, the multiplier is not larger because real marginal cost is more responsive to aggregate demand, but just the opposite. With a slack labor market, it is easy to recruit and real marginal cost is less responsive to aggregate demand. This is in line with available empirical evidence
    Date: 2013–11
  9. By: Andres Erosa; Luisa Fuster; Gueorgui Kambourov
    Abstract: We build a heterogeneous life-cycle model which captures a large number of salient features of individual labor supply over the life cycle, by education, both along the intensive and extensive margins. The model provides an aggregation theory of individual labor supply, firmly grounded on individual-level micro evidence, and is used to study the aggregate labor supply responses to changes in the economic environment. We find that the aggregate labor supply elasticity to a transitory wage shock is 1.75, with the extensive margin accounting for 62% of the response. Furthermore, we find that the aggregate labor supply elasticity to a permanent-compensated wage change is 0.44.
    Keywords: Aggregate labor supply, intensive margin, extensive margin, life cycle, fixed cost of work, non-linear earnings, precautionary savings, preference heterogeneity
    JEL: D9 E2 E13 E62 J22
    Date: 2014–07–14
  10. By: Cristina Arellano (Federal Reserve Bank of Minneapolis); Lilia Maliar (Department of Economics, Stanford University); Serguei Maliar (Leavey School of Business, Santa Clara University); Viktor Tsyrennikov (Department of Economics, Cornell University)
    Abstract: We develop an envelope condition method (ECM) for dynamic programming problems –a tractable alternative to expensive conventional value function iteration. ECM has two novel features: First, to reduce the cost, ECM replaces expensive backward iteration on Bellman equation with relatively cheap forward iteration on an envelope condition. Second, to increase the accuracy of solutions, ECM solves for derivatives of a value function jointly with a value function itself. We complement ECM with other computational techniques that are suitable for high-dimensional problems, such as simulation-based grids, monomial integration rules and derivative-free solvers. The resulting value-iterative ECM method can accurately solve models with at least upto 20 state variables and can successfully compete in accuracy and speed with state-of-the-art Euler equation methods. We also use ECM to solve a challenging default risk model with a kink in value and policy functions, and we …nd it to be fast, accurate and reliable.
    Keywords: Dynamic programming, Value function iteration, Bellman equation, Endogenous grid, Envelope condition, Curse of dimensionality, Large scale, Sovereign debt, Default risk
    JEL: C6 C61 C63 C68
    Date: 2014–07
  11. By: KOBAYASHI Keiichiro
    Abstract: In this paper, I demonstrate that expansionary fiscal policy associated with an increase in public debt can cause a persistent recession. I assume that entrepreneurs have borrowing constraints and that the government issues debt and collects tax from productive entrepreneurs. The government can also transfer resources to workers. Under this setting, an increase in public debt per se can enhance economic growth as it can compensate for the shortage of liquidity. However, output decreases as the transfer increases due to the income effect of the transfer on workers increasing the wage rate. Noticeably, both output and interest rates decline as the transfer and debt become larger. This result challenges the widely accepted view that the negative effect of expansionary fiscal policy on output should be the crowding-out effect that works through a hike in interest rates. It also implies that redistribution from workers to productive agents may enhance economic growth.
    Date: 2014–07
  12. By: Hafedh Bouakez (Institute of Applied Economics, CIRPEE, HEC Montréal); Michel Guillard (Université d'Evry Val d'essonne); Jordan Roulleau-Pasdeloup (CREST, PSE)
    Abstract: Public investment represents a non-negligible fraction of total public expenditures. Yet, theoretical studies of the effects of public spending when the economy is stuck in a liquidity trap invariably assume that government expenditures are entirely wasteful. In this paper, we consider a new-Keynesian economy in which a fraction of government spending increases the stock of public capital–which is an external input in the production technology–subject to a time-to-build constraint. In this environment, an increase in public spending has two conflicting effects on current and expected inflation: a positive effect due to higher aggregate demand and a negative effect reflecting future declines in real marginal cost. We solve the model analytically both in normal times and when the zero lower bound (ZLB) on nominal interest rates binds. We show that under relatively short time-to-build delays, the spending multiplier at the ZLB decreases with the fraction of public investment in a stimulus plan. Conversely, when several quarters are required to build new public capital, this relationship is reversed. In the limiting case where a fiscal stimulus is entirely allocated to investment in public infrastructure, the spending multiplier at the ZLB is 4 to 5 times larger than in normal times when the time to build is 12 quarters
    Keywords: Public spending, Public investment, Time to build, Multiplier, Zero lower bound
    JEL: E4 E52 E62 H54
    Date: 2014–01
  13. By: Y. Hossein Farzin (Department of Agricultural and Resource Economics, UC Davis, U.S.A. and Oxford Centre for the Analysis of Resource Rich Economies (OxCarre), Department of Economics, University of Oxford, UK); Ronald Wendner (Department of Economics, University of Graz, Austria)
    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: 2014–07
  14. By: Stéphane Auray (CREST-ENSAI, ULCO and CIRPEE); David Fuller (Concordia University, CIREQ); Damba lkhagvasuren (Concordia University, CIREQ); Antoine Terracol (CES-Université Paris 1)
    Abstract: A dynamic multi-sector model with net and excess mobility is developed to quantify the determinants of the canonical increasing wage-tenure profile. The model distinguishes between three factors: sector specific skill accumulation, sectoral-level shocks, and dynamic worker sector mismatch shocks. The sector-specific skill premium drives the observed negative correlation between lifetime earnings and mobility. Excess mobility driven by worker-sector mismatch shocks explains nearly 20 percent of the observed wage growth for recent movers. A model featuring only dynamic worker-sector mismatch shocks still captures the salient features of the wage-tenure profile. Sectoral-level shocks have a negligible impact on the wage-tenure profile and excess mobility
    Keywords: Labor Mobility, Wage Structure, Excess and Net Mobility, Industry-Specific Experience, Dynamic Sectoral Mismatch, Labor Income Shocks, Returns to Tenure
    JEL: E24 J31 J24 J62
    Date: 2014–03
  15. By: Minford, Patrick (Cardiff Business School); Xu, Yongden; Zhou, Peng (Cardiff Business School)
    Abstract: Out-of-sample forecasting tests of DSGE models against time-series benchmarks such as an unrestricted VAR are increasingly used to check a) the specification b) the forecasting capacity of these models. We carry out a Monte Carlo experiment on a widely-used DSGE model to investigate the power of these tests. We find that in specification testing they have weak power relative to an in-sample indirect inference test; this implies that a DSGE model may be badly mis-specified and still improve forecasts from an unrestricted VAR. In testing forecasting capacity they also have quite weak power, particularly on the lefthand tail. By contrast a model that passes an indirect inference test of specification will almost definitely also improve on VAR forecasts.
    Keywords: Out of sample forecasts; DSGE; VAR; specification tests; indirect inference; forecast performance
    JEL: E10 E17
    Date: 2014–07
  16. By: Lian Allub; Andres Erosa Etchebehere
    Abstract: We develop a quantitative theory of entrepreneurship, income inequality, and financial frictions disciplined with household data from Brazil. The theory extends Lucas (1978) by modeling heterogeneity in two skills: -working and managerial skills. Consistently with the evidence, the theory implies three occupational categories: workers, employers, and self-employed entrepreneurs. We find that the removal of financial frictions decreases self-employment rates from 24% to 11% (with small effects on the number of employers), increases aggregate output by 48%, and has non- trivial effects on the distribution of income. We also find that while most households benefit from a reform that eliminates enforcement problems, the majority of employers (about two thirds) lose from the reform. By depressing the demand for labor, limited enforcement depresses the equilibrium wage rate, increasing the profits of employers. Our theory thus suggests that employers in Brazil may have a vested interested in maintaining a status quo with low enforcement.
    Date: 2014–07

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