nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒08‒25
twenty papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Unemployment and Endogenous Reallocation over the Business Cycle. By Carlos Carrillo-Tudela (University of Essex, CESifo and IZA) and Ludo Visschers (The University of Edinburgh & Universidad Carlos III, Madrid)
  2. Macroeconomic Dynamics in a Model of Goods, Labor and Credit Market Frictions By Nicolas Petrosky-Nadeau; Etienne Wasmer
  3. Search Frictions, Financial Frictions and Labour Market Fluctuations in Emerging Markets By Sumru Altug; Serdar Kabaca
  4. Marriage Market and Labor Market Search with Endogenous Schooling Decisions By Nezih Guner; Christopher Flinn; Luca Flabbi
  5. The Effect of Corporate Tax Rate Reduction: A simulation analysis with a small open economy DSGE model for Japan (Japanese) By HASUMI Ryo
  6. Sectoral Shift, Job Mobility and Wage Inequality By Shouyong Shi; Florian Hoffmann
  7. Debt Dilution and Sovereign Default Risk By Juan Carlos Hatchondo; Leonardo Martinez; Cesar Sosa-Padilla
  8. The Redistributive Benefits of Progressive Labor and Capital Income Taxation By Fabian Kindermann; Dirk Krueger
  9. Asset Price Bubbles and Monetary Policy in a Small Open Economy By Martha López
  10. Competitive Search with Moving Costs By KAWATA Keisuke; NAKAJIMA Kentaro; SATO Yasuhiro
  11. The Effects of Globalization on Macroeconomic Dynamics in a Trade-Dependent Economy: the Case of Korea By Fabio Milani; Sung Ho Park
  12. The Rise of the Machines: Automation, Horizontal Innovation and Income Inequality By Morten Olsen; David Hemous
  13. Financial crises, debt volatility and optimal taxes By Julian A. Parra-Polania; Carmiña O. Vargas
  14. Labor Supply, Wealth Dynamics and Marriage Decisions By Shintaro Yamaguchi; Claudia Ruiz; Maurizio Mazzocco
  15. Occupational Mobility and Wage Dynamics Within and Between Firms By Jean-Marc Robin; Fabien Postel-Vinay; Francis Kramarz
  16. Financial Frictions and New Exporter Dynamics By Fernando Leibovici; David Kohn; Michal Szkup
  17. Who Bears Firm-Level Risk? Implications for Cash Flow Volatility By Xiaolan Zhang
  18. Budget rules and resource booms : a dynamic stochastic general equilibrium analysis By Devarajan, Shantayanan; Dissou, Yazid; Go, Delfin S.; Robinson, Sherman
  19. Investment-Specific Technology Shocks: The Source of Anticipated TFP Fluctuations By Kaiji Chen; Edouard Wemy
  20. Markovian Elections By Jean Guillaume Forand; John Duggan

  1. By: Carlos Carrillo-Tudela (University of Essex, CESifo and IZA) and Ludo Visschers (The University of Edinburgh & Universidad Carlos III, Madrid)
    Abstract: This paper studies unemployed workers’ decisions to change occupations, and their impact on fluctuations in aggregate unemployment and its underlying duration distribution. We develop an analytically and computationally tractable stochastic equilibrium model with heterogenous labor markets. In this model three different types of unemployment arise: search, rest and reallocation unemployment. We document new evidence on unemployed workers’ gross occupational mobility and use it to calibrate the model. We show that rest unemployment is the main driver of unemployment fluctuations over the business cycle and causes cyclical unemployment to be highly volatile. The resulting unemployment duration distribution generated by the model responds realistically to the business cycle, creating substantial longer-term unemployment in downturns. Finally, rest unemployment also makes our model simultaneously consistent with procyclical occupational mobility of the unemployed, countercyclical job separations into unemployment and a negatively-sloped Beveridge curve.
    Keywords: Unemployment, Business Cycle, Rest, Search, Occupational Mobility.
    JEL: E24 E30 J62 J63 J64
    Date: 2014–05–01
  2. By: Nicolas Petrosky-Nadeau; Etienne Wasmer (Département d'économie)
    Abstract: This paper shows that goods-market frictions drastically change the dynamics of the labor market, bridging the gap with the data both in terms of persistence and volatility. In a DSGE model with three imperfect markets - goods, labor and credit - we find that credit- and goods-market imperfections are substitutable in raising volatility. Goods-market frictions are however unique in generating persistence. The two key mechanisms generating autocorrelation in growth rates and the hump-shaped pattern in the response to productivity shocks are related to the goods market: i) countercyclical dynamics of goods market tightness and prices, which alter future profit flows and raise persistence and ii) procyclical search effort in the goods market, by either consumers, firms or both, raises both amplification and persistence. Expanding our knowledge of goods market frictions is thus needed for a full account of labor market dynamics.
    Date: 2014–02
  3. By: Sumru Altug; Serdar Kabaca
    Abstract: This paper examines the role of the extensive and intensive margins of labour input in the context of a business cycle model with a financial friction. We document significant variation in the hours worked per worker for many emerging-market economies. Both employment and hours worked per worker are positively correlated with each other and with output. We show that a search-theoretic context in a small open-economy model requires a small income effect to explain these regularities at the expense of a smaller wage response. On the other hand, introducing a financial friction in the form of a working capital requirement can explain the observed movements of labour market variables such as employment and hours worked per worker, as well as other distinguishable business cycle characteristics of emerging economies. These include highly volatile and cyclical real wages, labour share, and consumption.
    Keywords: Business fluctuations and cycles; Labour markets; Development economics; International topics; Interest rates
    JEL: F41 E44 J40
    Date: 2014
  4. By: Nezih Guner (ICREA-MOVE); Christopher Flinn (New York University); Luca Flabbi (IDB and Georgetown University)
    Abstract: individual taxation with a system based on joint taxation.
    Date: 2014
  5. By: HASUMI Ryo
    Abstract: This paper studies the short-term and long-term effects of tax policy changes on the Japanese economy by using a small open economy dynamic stochastic general equilibrium (DSGE) model with endogenous stochastic trends. The parameters of the model are estimated by a usual Bayesian method based on Japanese quarterly macroeconomic data from 1980 to 2010. A simulation analysis of a 1% to gross domestic product (GDP) scale corporate tax reduction has been implemented, in which fiscal neutrality is kept by raising the consumption tax rate. The real GDP increases by about 1.1% and the consumer price index (CPI) (excluding the effect of the consumption tax change) rises by about 0.2% within two years. This result suggests that such tax policy change induces short-term increases in the growth and inflation rate.
    Date: 2014–08
  6. By: Shouyong Shi (University of Toronto); Florian Hoffmann (University of British Columbia)
    Abstract: In the last few decades there is a clear shift of the U.S. economy from the non-service sector to the service sector. We document the patterns of changes in the employment share in services, the transition rates of workers between the two sectors and between different employment status, the relative wage income between the sectors, and wage inequality. To understand these changes jointly, we construct a dynamic equilibrium model of a two-sector economy where workers search both on the job and in unemployment. Assuming that the value-added per labor has been increasing in services relative to non-services, we estimate the model and make inferences on how the sectoral shift interacts with skill accumulation and labor market frictions.
    Date: 2014
  7. By: Juan Carlos Hatchondo; Leonardo Martinez; Cesar Sosa-Padilla
    Abstract: In this study, we measure the effects of debt dilution on sovereign default risk and consider debt covenants that could mitigate these effects. First, we calibrate a baseline model of defaultable debt (in which debt can be diluted) with endogenous debt duration, using data from Spain. Secondly, we present a model in which sovereign bonds contain a covenant that eliminates debt dilution. We quantify the effects of dilution by comparing the simulations of the model with and without this covenant. We find that dilution accounts for 79 percent of the default risk in the baseline economy. Without dilution, the optimal duration of sovereign debt increases by almost two years. Consumption volatility also increases, but eliminating dilution still produces substantial welfare gains. Introducing debt covenants that could be easier to implement in practice has similar effects. A covenant that penalizes the government for bond prices below a threshold is more effective in reducing the default frequency. A covenant that penalizes the government for debt levels above a threshold is more effective in reducing consumption volatility. These covenants could be useful for enforcing fiscal rules.
    Keywords: sovereign default, debt dilution, debt covenant, long-term debt, endogenous borrowing constraints
    JEL: F34 F41
    Date: 2014–07
  8. By: Fabian Kindermann; Dirk Krueger (University of Pennsylvania)
    Abstract: In this paper we argue that a capital income tax is an effective tool for redistribution and insurance even when progressive labor income taxes are available to the policy maker. To make this point we construct a large scale Overlapping Generations Model with uninsurable income risk, show that it has a wealth distribution that matches the data well, and then use it characterize fiscal policies that achieve a desired degree of redistibution in society. We find that it is suboptimal to rely exclusively on progressive labor income taxes to achieve any given level of redistribution in society, and thus that a positive capital income tax should be part of a government policy aimed at redistributing welfare across ex ante homogenenous, but ex post heterogeneous households. We finally characterize the optimal Rawlsian poliy and find that it includes a significantly positive capital in addition to a redistributive labor income tax.
    Date: 2014
  9. By: Martha López
    Abstract: In this paper we expanded the closed economy model by Bernanke and Gertler (1999) in order to account for the macroeconomic effects of an asset price bubble in the context of a small open economy model. During the nineties emerging market economies opened their financial accounts to foreign investment but it generated growing macroeconomic imbalances in these economies. Our goal in this paper is twofold: first we want to analyze if the conclusions of Bernanke and Gertler (1999) remain in the case of a small open economy. And second, we want to compare the results in terms of macroeconomic volatility of the model for a closed economy versus the model for a small open economy. Our results show that the conclusion about the fact that the Central Bank should not react to asset prices remains as in the case of a closed economy model, and that small open economies are more vulnerable to asset prices bubbles due to capital inflows and the exchange rate mechanism of the monetary policy. Therefore in small open economies the business cycle is deeper. Finally, in the face of a boom followed by a bust in an asset price bubble, macroeconomic volatility would be dampened if the monetary authority focus only on inflation.
    Keywords: Exogenous bubble, monetary policy, macroeconomic volatility, DSGE model.
    JEL: E32 R40 E47 E52
    Date: 2014–08–08
  10. By: KAWATA Keisuke; NAKAJIMA Kentaro; SATO Yasuhiro
    Abstract: We developed a competitive search model involving multiple regions, geographically mobile workers, and moving costs. Equilibrium mobility patterns were analyzed and characterized, and the results indicate that shocks to a particular region, such as a productivity shock, can propagate to other regions through workers' mobility. Moreover, equilibrium mobility patterns are not efficient because of the existence of moving costs, implying that they affect social welfare because not only are they costs but also they distort equilibrium allocation. By calibrating our framework to Japanese regional data, we demonstrate the extent to which changes in moving costs affect unemployment and social welfare.
    Date: 2014–08
  11. By: Fabio Milani (Department of Economics, University of California-Irvine); Sung Ho Park (Economic Research Institute, Bank of Korea)
    Abstract: This paper studies the implications of globalization for the dynamics of macroeconomic variables over the business cycle for a small open trade-dependent economy, such as South Korea. We study the impact of globalization through the lens of a structural model. Globalization is modeled as a time-varying degree of openness in the economy. We estimate the model allowing for non-fully rational expectations, learning by economic agents, and incomplete international financial markets. The empirical results show that globalization led to important changes in the macroeconomic environment. Domestic variables have become much more sensitive toward global measures over the 1991-2012 sample. In particular, domestic output and inflation are significantly affected by global output. Fluctuations in Korean output, inflation, and interest rates, which were driven for the most part by domestic shocks in the early 1990s are, by the end of the sample, due in large part (roughly 70%) to global shocks (and shocks that are open-economy in nature).
    Keywords: Globalization; Inflation dynamics; Global slack hypothesis; Inflation expectations; Openness; Small open eonomy DSGE model; Korea
    JEL: E31 E32 E50 E52 E58 F41
    Date: 2013–12
  12. By: Morten Olsen (IESE); David Hemous (INSEAD)
    Abstract: We construct an endogenous growth model of directed technical change with automation (the introduction of machines which replace low-skill labor and complement high-skill labor) and horizontal innovation (the introduction of new products, which increases demand for both types of labor). For general processes of technical change, we demonstrate that although low-skill wages can drop during periods of increasing automation intensity, the asymptotic growth rate is weakly positive --- though lower than that of the economy. We then endogenize the evolution of technology and show that the transitional path follows three distinct phases. First, wages are low, such that few machines are used and low-skill wages keep pace with the growth rate of the economy. Then, as wages grow, the share of automated products increases and the economy substitutes towards the use of machines -- depressing the growth rate of low-skill wages (potentially to negative). Finally, as the economy reaches steady state, the share of automated products is constant and the relative growth rate of low-skill wages recovers somewhat, yet remains lower than that of the economy overall. Allowing workers to endogenously transition from low-skill to high-skill alleviates the growth in income inequality, but does not alter the structure of the model. We extend the model to include middle-skill workers and demonstrate that the model endogenously captures the defining characteristics of the U.S. income distribution over the past 50 years: initially a monotone dispersion of the income distribution, and thereafter a wage growth polarization in which middle-skill workers experience the lowest wage growth. Finally, in an extension we allow machines to be produced with a different technology than the consumption good. This allows for faster productivity growth for machines potentially leading to permanently negative growth of low-skill wages.
    Date: 2014
  13. By: Julian A. Parra-Polania; Carmiña O. Vargas
    Abstract: We study financial crises in a model of a small open production economy subject to a credit constraint and to uncertainty on the real value of debt repayments. We find that, unlike most of the previous literature, the decentralized equilibrium exhibits underborrowing. The future possibility of reducing the severity of crises gives the incentives to the central planner (CP) to increase both current debt and the crisis probability. We also find that the CP equilibrium can be implemented by means of a tax on debt (a macro-prudential policy) and, only during crises, subsidies on consumption and a tax on non-tradable labor. The welfare gain of moving to the CP equilibrium is small for the baseline scenario but very sensitive to changes in debt volatility and the degree of openness of the economy. Classification JEL: F34, F41, H21.
    Date: 2014–08
  14. By: Shintaro Yamaguchi (McMaster University); Claudia Ruiz (World Bank); Maurizio Mazzocco (UCLA)
    Abstract: Using the Panel Study of Income Dynamics (PSID), we provide evidence that labor supply, household production, savings, and marital decisions are linked. We then develop and estimatea model that has the ability to generate the patterns observed in the data. Using the estimated model we first show that it is important to consider the link between labor supply, household production, wealth, and marriage choices to understand household behavior and its response to policy changes. We then use the model to evaluate the effect of the Earned Income Tax Credit (EITC) and other subsidy programs on individual decisions and welfare.
    Date: 2014
  15. By: Jean-Marc Robin (Sciences-Po); Fabien Postel-Vinay (University College London); Francis Kramarz (CREST)
    Abstract: Recent research has emphasized the key importance of the equilibrium allocation of heterogeneous workers into heterogeneous jobs or occupations as a determinant of economic efficiency. Most of the literature on this subject envisions worker (re-)allocation as occurring between employers. Yet, the data suggest that a very large amount of reallocation occurs within firms, in the form of internal promotions or de-motions. We construct a structural job search model with internal and external labor markets. Internal labor markets mediate occupational mobility and wage dynamics within firms, whereas the external labor market organizes any mobility involving an employer change, and related wage dynamics. The aim of this construction is to understand and quantify the role of within-firm reallocation in the assignment process of workers into jobs. The model is estimated on a large-scale matched employer-employee data set covering the entire French business sector.
    Date: 2014
  16. By: Fernando Leibovici (Department of Economics, York University, Toronto, Canada); David Kohn (New York University); Michal Szkup (New York University)
    Abstract: This paper studies the role of financial frictions as a barrier to international trade. We investigate new exporter dynamics in order to identify the extent to which these frictions affect export decisions. We study an economy with heterogeneous firms subject to financing constraints and working capital requirements, and calibrate it to match key moments from Chilean plant-level data. In contrast to standard models of international trade with sunk export entry costs, our model can account for new exporter dynamics. We find that financial frictions reduce the impact of a trade liberalization, suggesting that they constitute an important trade barrier.
    Date: 2014–08–11
  17. By: Xiaolan Zhang (UCLA, Anderson School of Management)
    Abstract: Public firms in the United States that provide better insurance against productivity shocks to their workers experience higher cash flow volatility. Difference in intra-firm risk sharing between workers and capital owners accounts for more than 50\% of the variation in firm-level cash flow volatility. I develop a theory in which wages can act either as a hedge or as leverage, depending on the history of the productivity shocks the firm has faced. Heterogeneous roles of workers in the firm are derived by analyzing the dynamic equilibrium wage contracts between risk-neutral owners and risk-averse workers who can leave with a fraction of the accumulated human capital. Owners of the firm will optimally bear more risk when the current value of the firm's human capital is lower than the peak value it has reached. The model successfully explains the joint distribution of cash flow volatility and the wage-output sensitivity. Also, the model produces predictions for the dynamics of cash flow volatility that are consistent with the time series properties of the firm-level data.
    Date: 2014
  18. By: Devarajan, Shantayanan; Dissou, Yazid; Go, Delfin S.; Robinson, Sherman
    Abstract: This paper develops a dynamic stochastic general equilibrium model to analyze and derive simple budget rules in the face of volatile public revenue from natural resources in a low-income country like Niger. The simulation results suggest three policy lessons or rules of thumb. When a resource price change is positive and temporary, the best strategy is to save the revenue windfall in a sovereign fund, and use the interest income from the fund to raise citizens'consumption over time. This strategy is preferred to investing in public capital domestically, even when private investment benefits from an enhanced public capital stock. Domestic investment raises the prices of domestic goods, leaving less money for government to transfer to households; public investment is not 100 percent effective in raising output. In the presence of a negative temporary resource price change, however, the best strategy is to cut public investment. This strategy dominates other methods, such as trimming government transfers to households, which reduces consumption directly, or borrowing, which incurs an interest premium as debt rises. In the presence of persistent (positive and negative) shocks, the best strategy is a mix of public investment and saving abroad in a balanced regime that provides a natural insurance against both types of price shocks. The combination of interest income from the sovereign fund, transfers to households, and output growth brought about by public investment provides the best protective mechanism to smooth consumption over time in response to changing resource prices.
    Keywords: Economic Theory&Research,Debt Markets,Currencies and Exchange Rates,Emerging Markets,Investment and Investment Climate
    Date: 2014–07–01
  19. By: Kaiji Chen; Edouard Wemy
    Abstract: This paper explores the importance of investment-specific technology changes in anticipated TFP fluctuations. To this end, we identify two types of news shocks with the maximum forecast error variance approach: news shocks to TFP and news shocks to the relative price of investment. We show in a model with IST diffusion and spillover that the correlation of these two empirically identified shocks can be used to quantify the importance of the IST shocks in aggregate TFP fluctuations. Using postwar U.S. data, we find that these two news shocks are almost perfectly colinear, if both are identified to capture the long-run movement of the corresponding variable. Moreover, these two news shocks can explain a significant, and surprisingly similar fraction of the fluctuations in other important macro variables over business cycles. Our findings suggest that embodied technological changes are the main driver of the anticipated TFP fluctuations via spillover to the productivity of the rest of the economy.
    Date: 2014–02
  20. By: Jean Guillaume Forand (University of Waterloo); John Duggan (University of Rochester)
    Abstract: We establish existence and continuity properties of equilibria in a model of dynamic elections with a discrete (countable) state space and general policies and preferences. We provide conditions under which there is a representative voter in each state, and we give characterization results in terms of the equilibria of an associated “representative voting game.†When the conditions for these results are not met, we provide examples that uncover new classes of dynamic political failures.
    Date: 2014

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.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.