nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒08‒20
23 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. On the Provision of Insurance Against Search-Induced Wage Fluctuations By Jean-Baptiste Michau
  2. Indebtedness and macroeconomic imbalances in a monetary-union DSGE model By Florina-Cristina Badarau; Florence Huart; Ibrahima Sangaré
  3. News about Aggregate Demand and the Business Cycle By Jang-Ting Guo; Anca-Ioana Sirbu; Mark Weder
  4. Aggregate Fertility and Household Savings: A General Equilibrium Analysis using Micro Data By Abhijit Banerjee; Xin Meng; Tommaso Porzio; Nancy Qian
  5. Can Intangible Capital Explain Cyclical Movements in the Labor Wedge? By Leena Rudanko
  6. Financial Shocks and Optimal Monetary Policy Rules By Fabio Verona; Manuel M. F. Martins; Inês Drumond
  7. 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-Martín
  8. CES Technology and Business Cycle Fluctuations By Cristiano Cantore; Paul Levine; Joseph Pearlman; Bo Yang
  9. The Welfare Cost of Sovereign Default and Liquidity Injections By Guangling Liu
  10. Rented vs. Owner-Occupied Housing and Monetary Policy By Margarta Rubio
  11. Existence and efficiency of stationary states in a renewable resource based OLG model with different harvest costs By Birgit Bednar–Friedl; Karl Farmer
  12. Fair Accumulation under Risky Lifetime By Grégory Ponthière
  13. Racial Discrimination in the U.S. Labor Market: Employment and Wage Differentials by Skill By Borowczyk-Martins, Daniel; Bradley, Jake; Tarasonis, Linas
  14. The Political Intergenerational Welfare State By Bishnu, Monisankar; Wang, Min
  15. Forecast Shocks in Production Networks By Can Tian
  16. Optimal Financial Transaction Taxes By Eduardo Davila
  17. Estimating the Expected Duration of the Zero Lower Bound in DSGE Models with Forward Guidance By Mariano Kulish; James Morley; Tim Robinson
  18. Labor Force Composition and Aggregate Fluctuations By Mennuni, Alessandro
  19. Equity market misvaluation, financing, and investment By Toni Whited; Missaka Warusawitharana
  20. The Elasticity of Intergenerational Substitution, Parental Altruism, and Fertility Choice By Cordoba, Juan Carlos; Ripoll, Marla
  21. Corporate income tax, legal form of organization, and employment By Chen, Daphne; Qi, Shi; Schlagenhauf, Don E.
  22. Transfers within a three generations family: when the rotten kids turn into altruistic parents By Cremer, Helmuth; Roeder, Kerstin
  23. Employment Protection and Capital-Labor Ratios By Janiak, Alexandre; Wasmer, Etienne

  1. By: Jean-Baptiste Michau (Ecole Polytechnique, France)
    Abstract: This paper investigates the provision of insurance to workers against search-induced wage fluctuations. I rely on numerical simulations of a model of on-the-job search and precautionary savings. The model is calibrated to low skilled workers in the U.S.. The extent of insurance is determined by the degree of progressivity of a non-linear transfer schedule. The fundamental trade-off is that a more generous provision of insurance reduces incentives to search for better paying jobs, which is detrimental to the production efficiency of the economy. I show that progressivity raises the search intensity of unemployed worker, which reduces the equilibrium rate of unemployment, but lowers the search intensity of employed job seekers, which results in a lower output level. I also solve numerically for the optimal non-linear transfer schedule. The optimal policy is to provide almost no insurance up to a monthly income level of $1450, such as to preserve incentives to move up the wage ladder, and full insurance above $1650. This policy halves the standard deviation of labor incomes, increases output by 2.4% and generates a consumption-equivalent welfare gain of 1.3%. Forbidding private savings does not fundamentally change the shape of the optimal transfer function, but tilts the optimal policy towards more insurance at the expense of production efficiency.
    Date: 2014
  2. By: Florina-Cristina Badarau (Larefi - Laboratoire d'analyse et de recherche en économie et finance internationales - Université Montesquieu - Bordeaux IV : EA2954); Florence Huart (EQUIPPE - ECONOMIE QUANTITATIVE, INTEGRATION, POLITIQUES PUBLIQUES ET ECONOMETRIE - Université Lille I - Sciences et technologies - Université Lille II - Droit et santé - Université Lille III - Sciences humaines et sociales - PRES Université Lille Nord de France); Ibrahima Sangaré (Larefi - Laboratoire d'analyse et de recherche en économie et finance internationales - Université Montesquieu - Bordeaux IV : EA2954)
    Abstract: We build a two-country open-economy monetary union DSGE model in order to explain some macroeconomic imbalances in the euro area. We fo cus on the role of cyclic al behaviour of public spending and sovereign risk premium. Pro-cyclical primary public expenditures in one country do not lead to higher interest rates on domestic public bonds in the short term as long as output growth helps financing public debt. Spillover effects on th e other country can be positive on output as long as a real effective depreciation of the common currency leads to higher exports to the rest of the world.
    Keywords: macroeconomic divergences ; euro area ; DSGE ; risk premium ; pro-cyclical fiscal policy ; spillover effects
    Date: 2013
  3. By: Jang-Ting Guo (University of California, Riverside); Anca-Ioana Sirbu (Department of Economics, West Virginia University); Mark Weder (University of Adelaide)
    Abstract: We show that an otherwise standard one-sector real business cycle model with variable capital utilization and mild increasing returns-to-scale is able to generate qualitatively as well as quantitatively realistic aggregate fluctuations driven by news shocks to future consumption demand. In sharp contrast to many studies in the existing expectations-driven business cycle literature, our results do not rely on non-separable preferences or investment adjustment costs.
    Keywords: News Shocks, Aggregate Demand, Business Cycles
    JEL: E32
    Date: 2012–09
  4. By: Abhijit Banerjee; Xin Meng; Tommaso Porzio; Nancy Qian
    Abstract: This study uses micro data and an overlapping generations (OLG) model to show that general equilibrium (GE) forces are critical for understanding the relationship between aggregate fertility and household savings. First, we document that parents perceive children as an important source of old-age support and that, in partial equilibrium (PE), increased fertility lowers household savings. Then, we construct an OLG model that parametrically matches the PE empirical evidence. Finally, we extend the model to conduct a GE analysis and show that under standard assumptions and with the parameters implied by the data, GE forces can substantially offset the PE effects. Thus, focusing only on the PE can substantially overstate the effect of aggregate fertility on household savings.
    JEL: J11 J13 O11 O12 O4 O53
    Date: 2014–04
  5. By: Leena Rudanko (Boston University)
    Abstract: Intangible capital is an important factor of production in modern economies that is generally neglected in business cycle analyses. We demonstrate that intangible capital can have a substantial impact on business cycle dynamics, especially if the intangible is complementary with production capacity. We focus on customer capital: the capital embodied in the relationships a firm has with its customers. Introducing customer capital into a standard real business cycle model generates a volatile and countercyclical labor wedge, due to a mismeasured marginal product of labor. We also provide new evidence on cyclical variation in selling effort to discipline the exercise.
    Date: 2014
  6. By: Fabio Verona (Bank of Finland, Monetary Policy and Research Department, and University of Porto, cef.up); Manuel M. F. Martins (University of Porto, Faculty of Economics and cef.up); Inês Drumond (Banco de Portugal, Financial Stability Department, and University of Porto, cef.up)
    Abstract: We assess the performance of optimal Taylor-type interest rate rules, with and without reaction to financial variables, in stabilizing the macroeconomy following financial shocks. We use a DSGE model that comprises both a loan and a bond market, which best suits the contemporary structure of the U.S. financial system and allows for a wide set of financial shocks and transmission mechanisms. Overall, we find that targeting financial stability – in particular credit growth, but in some cases also financial spreads and asset prices – improves macroeconomic stabilization. The specific policy implications depend on the policy regime, and on the origin and the persistence of the financial shock.
    Keywords: financial shocks, optimal monetary policy, Taylor rules, DSGE models, bond market, loan market
    JEL: E32 E44 E52
    Date: 2014–07
  7. By: Alfonso R. Sánchez; J. Ignacio García Pérez; Sergi Jiménez-Martín
    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: 2014–06
  8. By: Cristiano Cantore (University of Surrey); Paul Levine (University of Surrey); Joseph Pearlman (City University London); Bo Yang (University of Surrey and Xi’an Jiaotong-Liverpool University)
    Abstract: This paper contributes to an emerging literature that brings the constant elasticity of substitution (CES) specification of the production function into the analysis of business cycle fluctuations. Using US data, we estimate by Bayesian methods a medium-sized DSGE model with a CES rather than Cobb-Douglas (CD) technology. The main empirical result is to confirm decisively the superiority of CES rather than CD production functions in terms of model fit. We estimate a elasticity of substitution of elasticity well below unity at 0.15-0.18 and in a marginal likelihood race assuming equal prior model probabilities, CES beats the CD production decisively. The marginal likelihood improvement is matched by the ability of the CES model to fit the data in terms of second moments and a comparison with a DSGE-VAR further confirms the ability of the CES model to reduce model misspecification. We find that the CES model performance is further improved when the estimation is carried out under the imperfect information assumption. The principle reason for our result is that the CES specification captures movements of factor shares at the business cycle frequency. Hence the main message for DSGE models is that we should dismiss once and for all the use of CD for business cycle analysis.
    JEL: C11 C52 D24 E32
    Date: 2014–08
  9. By: Guangling Liu
    Abstract: This paper develops a dynamic general equilibrium model with endogenous default on entrepreneur loans and funds borrowed from the central bank (liquidity injections) and investigates the welfare cost of sovereign default. The results show that sovereign default affects production through households' investment decisions and the bank's asset portfolio adjustment. The effect of sovereign default on entrepreneurs tends to be in favor of production. Sovereign default reduces the variability of the output gap and hence the welfare loss. Liquidity injections reduce the variability of the output gap and improve price stability during the period of sovereign debt crisis, resulting in an increase in households' welfare.
    Keywords: sovereign default, welfare cost, debt crisis, rollover risk, liquidity
    JEL: E50 E58 E63 G18
    Date: 2014
  10. By: Margarta Rubio
    Abstract: The aim of this paper is to show how housing tenure (rented vs. owner-occupied) affects monetary policy. In order to do that, I propose a dynamic stochastic general equilibrium model with housing, both owned and rented. First, I analyze how, in the model, preference parameters, fiscal incentives and institutional factors determine the rental market share and the residential debt-to-GDP ratio. Then, within this framework, I study how the transmission and optimality of monetary policy differ depending on these factors. From a positive perspective, impulse responses illustrate differences in the monetary transmission mechanism. In normative terms, results show that when the relative size of the rental market is larger, monetary policy is more stabilizing. An optimal monetary policy analysis also suggests that in this case, monetary policy should respond more aggressively to inflation and disregard output, since the financial accelerator effects are weaker.
    Keywords: Housing market, rental, owner-occupied housing, monetary policy
    Date: 2014
  11. By: Birgit Bednar–Friedl (University of Graz); Karl Farmer (University of Graz)
    Abstract: Harvest costs can reduce the incentive to overexploit a renewable resource stock, particularly when costs are stock dependent. This paper compares different types of harvest costs in a renewable resource based overlapping generations (OLG) model in which resource harvest competes with commodity production for labor. We analyze under which conditions a stationary state market equilibrium exists and whether this equilibrium is intergenerationally efficient. We find that stock dependent harvest costs favor the existence of an equilibrium and that a positive own rate of return on the resource stock is no longer necessary for intergenerational efficiency. Whether constant or inversely stock dependent, harvest cost in general equilibrium necessitate the inquiry of a positive resource stock price to ensure the existence of a stationary state market equilibrium.
    Keywords: natural resources; harvest costs; overlapping generations; existence; efficiency
    JEL: Q20 D90 C62
    Date: 2014–07
  12. By: Grégory Ponthière (PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - École des Hautes Études en Sciences Sociales (EHESS) - École des Ponts ParisTech (ENPC) - École normale supérieure [ENS] - Paris - Institut national de la recherche agronomique (INRA), EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: Individuals save for their old days, but not all of them enjoy the old age. This paper characterizes the optimal capital accumulation in a two-period OLG model where lifetime is risky and varies across individuals. We compare two long-run social optima: (1) the average utilitarian optimum, where steady-state average welfare is maximized; (2) the egalitarian optimum, where the welfare of the worst-o¤ at the steady-state is maximized. It is shown that, under plausible conditions, the egalitarian optimum involves a higher capital and a lower fertility than the utilitarian optimum. Those inequalities hold also in a second-best framework where survival conditions are exogenously linked to the capital level.
    Keywords: Egalitarianism ; Differentiated Mortality ; Optimal Capital Accumulation ; Golden Rule ; Fertility
    Date: 2012–10
  13. By: Borowczyk-Martins, Daniel (University of Bristol); Bradley, Jake (University of Bristol); Tarasonis, Linas (Aix-Marseille University)
    Abstract: In the US labor market the average black worker is exposed to a lower employment rate and earns a lower wage compared to his white counterpart. Lang and Lehmann (2012) argue that these mean differences mask substantial heterogeneity along the distribution of workers' skill. In particular, they argue that black-white wage and employment gaps are smaller for high-skill workers. In this paper we show that a model of employer taste-based discrimination in a labor market characterized by search frictions and skill complementarities in production can replicate these regularities. We estimate the model with US data using methods of indirect inference. Our quantitative results portray the degree of employer prejudice in the US labor market as being strong and widespread, and provide evidence of an important skill gap between black and white workers. We use the model to undertake a structural decomposition and conclude that discrimination resulting from employer prejudice is quantitatively more important than skill differences to explain wage and employment gaps. In the final section of the paper we conduct a number of counterfactual experiments to assess the effectiveness of different policy approaches aimed at reducing racial differences in labor market outcomes.
    Keywords: employment and wage differentials, discrimination, job search
    JEL: J31 J64 J71
    Date: 2014–05
  14. By: Bishnu, Monisankar; Wang, Min
    Abstract: This paper characterizes an intergenerational welfare state with endogenous education and pension choice under general equilibrium-probabilistic voting. We show that politically implementing public education program always increases the future human capital, but this higher future human capital would not help support a more generous social security in the future. The effect of implementing PAYG social security on education however crucially depends on the sources of funding for education investment. Establishing PAYG pension program depresses investment in public education. However if the source of funding for education investment is private, in both the cases when pension is the only instrument or when public pension and public education are implemented together as a package, there can be an improvement in education investment if and only if the political influence of the old is limited and so the size of the PAYG social security is small. A substantially thick pension scheme which results from a heavy influence of the old in the political process spoils the mutual benefits.
    Keywords: education; Markov perfect equilibrium; Pension; Probabilistic voting; Endogenous growth
    JEL: D90 E6 H3 H52 H55
    Date: 2014–08–01
  15. By: Can Tian (University of Pennsylvania)
    Abstract: This paper proposes a dynamic multi-sector production network model in which firms receive news on the future product-specific demand of a representative household. Since production takes time and firms in the production sectors are connected via input-output links, news on the future final demand of an individual product changes firms' forecasts of their future sales, creating economy-wide effects named as forecast shocks. Forecast shocks are transferred upwards through the supplier-customer connections in the network, from the buyer of an input good to the producer. The model explains the asymmetry in the transmission of individual shocks in the network and how shocks to the expectations generate real, persistent effects. The equilibrium is analytically solved and calibrated to the U.S. economy. A preliminary estimation under the assumptions for the shock processes shows the importance of the forecast shocks.
    Date: 2014
  16. By: Eduardo Davila (Harvard University)
    Abstract: This paper characterizes the optimal linear financial transaction tax in an equilibrium model of competitive financial markets. When belief disagreement induces excess trading on assets in fixed supply, two main results arise. First, the optimal tax is positive: although a (small) transaction tax discourages all trades equally, the reduction in fundamental trading creates a second-order welfare loss, while the reduction in non-fundamental trading creates a first-order gain. Second, the cross-sectional covariance between investors’ beliefs and investors’ equilibrium portfolio tax sensitivities becomes the relevant sufficient statistic for the optimal tax, which does not depend on the actual payoff distribution. I find additional results. First, in dynamic environments, controlling for the level of static disagreement, the optimal tax is lower when investors alternate between being buyers and sellers over time. Second, when financial markets determine production in a Walrasian sense, as in a q-theory environment, a marginal tax increase creates an additional first-order distortion (positive or negative). Third, when financial markets determine production by diffusing information, a marginal tax increase creates an additional first-order loss, due to a learning externality.
    Date: 2014
  17. By: Mariano Kulish (School of Economics, Australian School of Business, The University of New South Wales); James Morley (School of Economics, Australian School of Business, The University of New South Wales); Tim Robinson (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne)
    Abstract: Motivated by the increasing use of forward guidance, we consider DSGE models in which the central bank holds the policy rate fixed for an extended period of time. Private agents’ beliefs about how long the fixed-rate regime will last influences current output and inflation. We estimate the structural for US data and infer the expected duration of the zero lower bound regime. Our results suggest that the average expected duration is around 3 quarters and has varied significantly since the onset of the zero lower bound regime, with changes that can be related to the Federal Reserve’s forward guidance.
    Keywords: Zero lower bound, forward guidance
    JEL: E52 E58
    Date: 2014–07
  18. By: Mennuni, Alessandro
    Date: 2013–12–01
  19. By: Toni Whited (University of Rochester); Missaka Warusawitharana (Board of Governors of the Federal Reserv)
    Abstract: We quantify how much nonfundamental movements in stock prices affect firm decisions. We estimate a dynamic investment model in which firms can finance with equity, cash, or debt. Misvaluation affects equity values, and firms optimally issue and repurchase overvalued and undervalued shares. The funds owing to and from these activities come from either investment, dividends, or net cash. The model ts a broad set of data moments in large heterogeneous samples and across industries. Our estimation results imply that firms respond to misvaluation by adjusting financing more than investment. Managers' rational responses to misvaluation increase shareholder value by up to 3%.
    Date: 2014
  20. By: Cordoba, Juan Carlos; Ripoll, Marla
    Abstract: Dynastic models common in macroeconomics use a single parameter to control the willingness of individuals to substitute consumption both intertemporally, or across periods, and intergenerationally, or across parents and their children. This paper defines the concept of Elasticity of Intergenerational Substitution (EGS), and extends a standard dynastic model in order to disentangle the EGS from the EIS, or Elasticity of Intertemporal Substitution. A calibrated version of the model lends strong support to the notion that the EGS is significantly large than 1, and probably around 2.5. In contrast, estimates of the EIS suggests that it is lower than 1. What disciplines the identification is the need to match empirically plausible fertility rates for the U.S.
    Keywords: Altruism; non-separable utility; intertemporal substitution; intergenerational substitution; value of a child
    JEL: D10 D64 D91 J13
    Date: 2014–08–01
  21. By: Chen, Daphne (Florida State University); Qi, Shi (Florida State University); Schlagenhauf, Don E. (Florida State University)
    Abstract: We adopt a dynamic stochastic occupational choice model with heterogeneous agents and evaluate the impact of a potential reduction in the corporate income tax on employment. We show that a reduction in corporate income tax leads to moderate job creation. In the extreme case, the elimination of the corporate income tax would reduce the non-employed population by 5.4 percent. In the model, a reduction in the corporate income tax creates jobs through two channels, one from new entry firms and one from existing firms changing their form of legal organization. In particular, the latter accounts for 85.7 percent of the new jobs created.
    Keywords: Corporate Income Taxes; Employment; Firm heterogeneity; Entrepreneurs
    JEL: C54 E10 E69 H25 H32
    Date: 2014–04–03
  22. By: Cremer, Helmuth; Roeder, Kerstin
    Abstract: We study exchanges between three overlapping generations with non-dynastic altruism. The middleaged choose informal care provided to their parents and education expenditures for their children. The young enjoy their education, while the old may leave a bequest to their children. Within each period the three generations play a “game” inspired by Becker’s (1974, 1991) rotten kids framework, with the added features that the rotten kids turn into the altruistic parent in the next period and that parents invest in the education of their children. We show that Becker’s rotten kids theorem holds for the single period game in that informal aid is set according to an efficient rule. However, education is distorted upwards. In the stationary equilibrium the levels of both transfers are inefficient: education is too large and informal aid is too low.
    Keywords: rotten kids, altruism, education, long-term care, subgame perfect equilibrium, overlapping generations
    JEL: D1 D7 D9
    Date: 2014–05
  23. By: Janiak, Alexandre (University of Chile); Wasmer, Etienne (Sciences Po, Paris)
    Abstract: Employment protection (EPL) has a well known negative impact on labor flows as well as an ambiguous but often negative effect on employment. In contrast, its impact on capital accumulation and capital-labor ratio is less well understood. The available empirical evidence suggests a non-monotonic relation between capital-labor ratios and EPL: positive at very low levels of EPL, and then negative. We explore the theoretical effects of EPL on physical capital in a model of a firm facing labor frictions. Under standard assumptions, theory always implies a motononic negative link between capital-labor ratios and EPL. For a positive link to arise, a very specific pattern of complementarity between capital and workers protected by EPL (senior workers, as opposed to unprotected new entrants, or junior workers) has to be assumed. Further, no standard production technology is able to reproduce the inverted U-shape pattern of the data. Instead, endogenous specific skills investment leads to an inverted U-shape pattern: EPL protects and therefore induces investments in specific skills. We develop such a model and calibrate the returns to seniority by using estimates from the empirical literature. Under complementarity between capital and specific human capital, physical capital and senior workers having accumulated specific human capital are de facto complement production factors and EPL may increase capital demand at the firm level. The paper concludes that labor market institutions may sometimes favor physical and human capital investments in second-best environments.
    Keywords: employment protection, specific skills, unemployment, capital-labor ratios
    JEL: J60
    Date: 2014–07

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